Strategic Management For Global Oil Market: Challenges And Benefits Of Merger And Acquisition Strategy

Critical analyzing the strategy of merger and acquisition

Discuss about the Strategic Management for Global Oil Market.

The dramatic price reduction in both crude oil and natural gas since the second half of 2014, combined with a high level of uncertainty about their future trajectory challenged gas and oil merger and acquisition activity in 2015. During the period of 2014-2016, the prices of crude oil have sharply declined to US$37 per barrel from the value of US$55 per barrel (Husain et al. 2015). The after effects of lower and more volatile oil prices have fluctuated across the energy industry. Evidence suggests that there are many explorations and production companies have been affected the more unfavorable since prices started plummeting in 2014 and the upstream sector’s underlying reserve value basis dropped by nearly 50 percent (Brown, S.P. and Yücel, M.K., 2015).

On the other hand, downstream companies have benefited from reduced declined costs for refining operations and chemical feed stocks. Due to widespread financial distress, the oil price has been falling. This has been identified by many market researchers that those companies with inadequate or no hedging arrangements, have seen cash flow from production noticeably diminish, impacting on their ability to fund operations, service their ability to fund operations, contractual obligations or pursue new or existing tasks. In these consequences, companies who are associated with oilfield services are encountering delays in payments or defaults, cancellations and postponements of project.

This is the base for various oil and gas companies who are ready to make strategies in terms of mergers and acquisition which has already used in the energy sector during the oil price drop of 2014-2016. This report will critically evaluate the challenges and benefits of acquisition and merger ad a strategy within the energy sector. This report will further examine the appropriate energy strategy which will help to stabilize or improve their position through either gaining access to the extended markets, technology or resources.

Merger and acquisition is relatively new strategic theory as a concept. According to
Mitchell and Mitchell (2014), several waves of the M&A led to a gradual substantial industrial restructuring in all parts of the world which has attracted many parts of the world in the view of the growth of its effects or the structures of corporate. The concepts have come into the picture as the oil price slides and nervous oil executives are wondering how low it can go. With the production of crude oil continuing to outpace demand by 2 million barrel per day, in the international market and with the no clear sign when the market will rebalance, price have continued to decline in 2016. Though there is no instant recovery in prices of oil and gas, the market participants are being expected that eventually the market will balance to full cycle marginal cost which would definitely support to price recovery in this sector.

Benefits of M&A strategy in the energy sector

Diagram 1: Global Oil and Gas transaction activity

(Source: Baumeister and Kilian 2016)

However, a range of factors led to greater volatility in the price structure of companies associated with the oil and gas in the international circuit. This has integrated uncertainty about the sustainability of US and other production at the lower costs, instability related to the impact of subordinate prices on counties contingent on revenues from oil, the impacts of the lifting of Iranian sanctions, the outlook of china economically and the related concerns about global energy demand and many others (Mohant et al. 2014). This price dropping trend in the oil and gas sector of 2014 has continued into 2015. The decline in national oil company M&A activity continued in 2015, and net deal valued declined to US$6.1 billion from about US$21 billion in 2014, down drastically from the 2012 record of almost US$122 billion. Based on 2014 report, it was previously expected Asian and Chinese NOCs to take advantage of attractively priced assets, but the integrated volatility in oil prices and lower oil price challenged such activity with many NOCs focusing more on their portfolio that on growth. Baumeister and Kilian (2016) identified two aspects as critical for the nature of oil price decline. First of all, there are underlying drivers such as global economic activity or a response to other shocks driving global growth which are hugely responsible for declined oil prices n the global economic field. Anandan and Ramaswamy (2016) argued that changes in oil supply due to technology are another reason for the nature of oil price decline. Indentifying the reasons for the reasons of oil price decline is thus critically significant for those organizations that are associated with the exploration and production in the energy sectors. According to McAuley (2015) despite the fall in oil prices, projects spending by the associated companies will increase significantly because of the long term strategic significance to governments and their national oil companies in this sector.

Many market participants find that Mergers and Acquisitions is the best option for restricting the sharp decline in oil prices in the past years which has put a damper on many big energy producers’ providence. However, Anandan and Ramaswamy (2016) argued that a M&A deal deluge typically an oil-price collapse-but has not always created value. Evidence suggests that deals enabling players to lower costs will probably be most essential in today’s volatile oil-price world. M&A activity has been limited since prices started to fall in 2014 during previous oil-price collapses. According to McAuley (2015), there are many M&A strategies that worked in the surging-price environment which may not work in the downwards energy market at the global platform. Hence, the producers of oil and gas companies needs to be evaluated the best alternative strategies that could help organizations to create value through the price trough, measured by total returns to shareholders. “For the Middle East, the strategic questions for the national oil companies are both about strategies related to the international diversification-taking positions, for instance, in Mexico’s opening energy sector or purchasing into North America’s unconventional oil and gas boom along with the decision such as long-term regional investment”  (Husain et al. 2015). This has been noticed that mergers and acquisitions activity and related transactions such as mergers, acquisitions, takeovers, joint ventures, tender offers, minority equity investments, spin-offs, split-ups and curve-outs, restructuring, reorganizations, leveraged buyouts and other adjustments are the best strategy to overcome issues related to the oil-price reduction in the international energy market.  The option of Merger and Acquisition in 2016 expects that many companies could reduce the liquidity pressure that may be forced to transact, whether driven by shareholders, activists, lenders and/or management (Edwards 2014). According to Brown and Yücel (2015), M&A strategy will definitely accelerate the process of price discovery in the market of assets. Furthermore, many researchers expects the same situation will stay throughout 2016 in the energy sector however, things may get better by the end of 2016 as non-OPEC production declines in reaction to continued low prices (Wild et al. 2016). In the year of 2015, oil-weighted deals continued to dominate over gas-weighted negotiations (Shuen, Feiler and Teece 2015). On the contrary, the pending acquisition of Royal Dutch Shell with BG Group is a prominent example of an acquisition more equally weighted between gas and oil. Such deal indicates that consolidation is a well accepted affair during the downside of the cycle, when supply surpluses accumulate, prices fall and competition heats up (Scharf 2015). The same strategy has been followed by the oil and gas industry and thus finds Merger and Acquisition as the most suitable option by many manufacturers and identifies several advantages for the same.

Merger and acquisition is favorable option for the helping companies to achieve certain objectives and financial strategies such as hedging the price of the small manufacturing companies to maintain the sustainability compare to the bigger one during the phase of price volatility in the global energy market (Trivedi Desai and Joshi 2013). According to Paul Navratil, the leader of the energy at consultancy PwC from Middle East, “the recent decline in the oil prices brings several issues that need to be addressed as a matter of urgency” (McAuley 2015). According to him, “if oil prices remain as they are or drop further, then there is a huge need for efficiency of capital will be even more important”. In these circumstances, this can be said that activities of M&A provide capital efficiency to both the companies who are associated in such negotiations (Baumeister and Kilian 2016). Secondly, mergers or acquisitions enhances quality staff or additional skills and deliver business intelligence. Engaging in the M&A activities, thus, definitely help companies to operate seamlessly against the least operational expenses (Mohanty et al. 2014). However, the biggest advantages of merger and acquisition in the oil and gas sector are the hedging price of products in the global market. This has often happen that sellers don’t want to sell if they think prices are bottoming out and on the other hand, buyers are not ready to overpay. In that circumstances, the M&A activities insists oil and gas companies to available at the distress prices either because they are continuing to function while restructuring their debt or because their market valuation sink to such low levels. Therefore, dealing in the market at the negotiated price with the other participants companies would be beneficial for both the parties to operate in the unfavorable market conditions such as the current down price market phase in the international energy business sector. Furthermore, accessing funds or valuable assets during the adverse phase of production or exploration of crude oil or natural gas is encouraging to all companies who are ready to involve in M&A activities. Asset optionality is another emerging synergetic benefit of M&A activity being examined by some companies. An entity with having diverse asset’s flexibility will help to maximize value of assets (Mitchell and Mitchell 2014). Thus it will increase the market dynamism and consequently it make possible to better manage potential downside risks associated during the phase of reduced price structure in the oil and gas sectors.

Additionally, deals of mergers and acquisitions may diversify products, services and long term prospects of the business. Oil and gas businesses may be able to offer crude oil and natural gas which can sell through their own distribution channels. According to Anandan and Ramaswamy (2016), any attempts to devise a regulatory regime for takeovers suggests a balancing act and sensible handling of core issues such as fair possibilities of entrenchment motivations of directors in applying defensive strategies, principles of the freedom of shareholders and the interests of companies to decide upon the merits of the offer and many others. Dev (2016) benefits of M&A depend on varieties of reason for which companies are ready to take over such collaborative actions. For example, companies may cut their job vacancies during the price reduction phase in the oil and gas industry. However, such act may benefit the companies involved financially by eliminating redundancies between the two organizations. In a nut shell, mergers and acquisitions have become major strategic levers for gas and oil companies to strengthen the financial and technical resource base and reduce costs structure. This strategic approach will definitely be beneficial to increase sales and revenue, share of market and economies of scale. On the other hand, M&A activities are one of the capital discipline and targeted transaction activity which helps to reduction of overcapacity in the energy industry.

It is a matter of controversy if such deals certainly create value in the energy industry because it is not easy to ensure a competitive position though M&A all the time. Successful gas and oil M&A obeys many of the rules that must be prevail in any other industry, starting with not overpaying. However, the volatility of oil price adds a typical element to the mix. Several researchers have observed that post-merger performance of companies largely depends on the industry or sector which cannot be generalized (Whitfield 2015). There are many deals occurred in the past in the oil and gas industry which failed to be proved fruitful in the long run.  For instance, “UAE-based Dragon Oil takeover of Petroceltic, with the deal of $492 million was failed to make value in the global energy production market” (Tsegha 2013).

Furthermore, there are many challenges reported in the new oil and gas development. These challenges lie in the areas of employment, retention and training (Yoshino and Taghizadeh-Hesary 2016). All these workforces’ challenges are responsible for making the oil and gas industry as the place of shrinking talent pool for those with specialized expertise. It must require some time for individuals or companies who are absorbed by another companies to understand the technical know-how and risks which are definitely organization-specific (Wang and Miao 2016). Apart from technical differences, companies may face challenges due to having diverse undertaking strategic initiatives (Marin-Cadavid and Garcia 2016). Differences lie in different areas such as an individual company may take initiatives to attract a new generation of workers, offering attractive perks and aggressive employing and training processes and many others (Tsegha 2013). Indentifying different operational practices may create differences among the negotiators of the mergers and acquisitions activities.

The last decade has been shown a robust growth in the area of practices technologies related to procuring, estimating and producing oil and gas. These technologies continue is in trends in the energy sector. However, the range of the use of emerging technologies may differ with company to company. To practice same technologies in the oil and gas sector is one of the biggest challenging factors for those companies who are looking for to engage with such deal of mergers and acquisitions. Furthermore, reduced competition may hamper the reputation of the companies who are associated in this strategic alliance.

Conclusion:

The key themes of the merger and acquisition in the oil and gas sector observed during the year of 2015 are as follows:

• Comprehensive portfolio management during the phase of dropping oil price
• Aggressive cost reduction across the board
• Extended cooperation amongst all stakeholders to protect common interest, sustaining market position by recognizing the interdependencies of many parties and projects

Indentifying all these themes many oil and gas companies who are willing to work under strategic alliance. Though many market researchers are already observed and anticipated that the price of the crude oil and natural gas will be low till the end of the year of 2016, this has been anticipated that the trends of M&A will be going strong in the coming years as well. These strategic alliance ensures growth in terms of better capital efficiency, an effective hedging prices and associated investment in this sector. Based on the above discussion, thus, this can be said that Mergers and Acquisitions are the best suitable option in the energy sector during the reduction of oil price of 2014 to 2016. In this way, companies will overcome their structural crisis.

References:

Anandan, M. and Ramaswamy, S., 2016. Global Oil Market: Macro Economic Scenario. Global Journal For Research Analysis, 4(9).

Baumeister, C. and Kilian, L., 2016. Forty years of oil price fluctuations: Why the price of oil may still surprise us. The Journal of Economic Perspectives,30(1), pp.139-160.

Brown, S.P. and Yücel, M.K., 2015. The shale gas and tight oil boom: US states’ economic gains and vulnerabilities. Council on Foreign Relations.

Dev, R., 2016. World’s Oil Scenario–Falling Oil Prices Winners and Losers a Study on top Oil Producing and Consuming Countries. Imperial Journal of Interdisciplinary Research, 2(6).

Edwards, J., 2014. Knowledge management in energy sector organizations.Handbook of Research on Knowledge Management: Adaptation and Context, p.157.

Husain, M.A.M., Arezki, M.R., Breuer, M.P., Haksar, M.V., Helbling, M.T., Medas, P.A. and Sommer, M., 2015. Global implications of lower oil prices(No. 15). International Monetary Fund.

Marin-Cadavid, C. and Garcia, J.J., 2016. Internationalization Strategies to Replicate in Design and Consulting Engineering Services Firms Related to the Energy Industry. Latin American Business Review, 17(1), pp.27-47.

McAuley, A. (2015). Energy sector mergers and acquisitions in focus | The National. [online] Thenational.ae. Available at: https://www.thenational.ae/business/energy/energy-sector-mergers-and-acquisitions-in-focus [Accessed 3 Jul. 2016].

Mitchell, J.V. and Mitchell, B., 2014. Structural crisis in the oil and gas industry. Energy Policy, 64, pp.36-42.

Mohanty, S.K., Akhigbe, A., Al-Khyal, T.A. and Bugshan, T., 2014. Oil and stock market activity when prices go up and down: the case of the oil and gas industry. Review of Quantitative Finance and Accounting, 41(2), pp.253-272.

Scharf, A., 2015. Mergers and acquisitions: an Oil & Gas Equipment Sector case study Siemens’ acquisition of Dresser-Rand (Doctoral dissertation).

Shuen, A., Feiler, P.F. and Teece, D.J., 2014. Dynamic capabilities in the upstream oil and gas sector: Managing next generation competition. Energy Strategy Reviews, 3, pp.5-13.

Trivedi, A., Desai, D. and Joshi, N.A., 2013. A Study on Mergers & Acquisitions in Oil & Gas Sector in India and Their Impact on the Operating Performance and Shareholders’ Wealth. Shri Chimanbhai Patel Institutes Working Paper Series No. CPI/MBA/2013/0002.

Tsegha, E. 2013. Assessing the Challenges and Opportunities in the Oil and Gas Industry. AJIS.

Wang, H. and Miao, L., 2016. Challenges and Strategies of “Going Global”. In China Goes Global (pp. 153-171). Palgrave Macmillan UK.

Whitfield, S. 2015. Solving Deepwater Challenges in a Low Price Environment. Oil and Gas Facilities, 4(05), pp.10-15.

Wild, E., Wansbury, N., Crudgington, J. and Andrews, M., 2016, May. The Consequences of New Sources of Capital for the Oil and Gas Sector. InSPE/IAEE Hydrocarbon Economics and Evaluation Symposium. Society of Petroleum Engineers.

Yoshino, N. and Taghizadeh-Hesary, F., 2016. Introductory Remarks: What’s Behind the Recent Oil Price Drop?. In Monetary Policy and the Oil Market(pp. 1-5). Springer Japan.