In light of a marked increase in the number of gas divestments taking place in the Canadian oil and gas sector, Ernst & Young recently looked at a number of forces that are driving companies to shed assets thereby identifying four dimensions – deal strategy, cost management, speed and risk mitigation – as crucial for any successful divestment transaction.
The EY report notes that “companies have historically viewed divestitures as a sign of distress (…). They are now seen as strategic transactions to raise or release capital and realign business objectives. (…) By reviewing any transaction from the perspective of both buyer and seller, [surprises can be avoided and] a clearer understanding of where value can be created or destroyed [is gained] (…). At the end of the day, it is about maximizing value for both parties.”
Further, the report explains that “divestment deals are a balancing act between competing buyer and seller demands. Buyers and sellers must agree on common goals and align and understand each other’s motivations to ensure success.” To follow is an interesting graphic giving an overview of factors to consider and review from the perspective of both buyer and seller while both sides are trying to finalize a deal.
Guidance to Transaction Evaluation in the Oil & Gas Industry
Source: Ernst & Young
In general, the main driver for any investment as well as divestment decision in the oil and gas industry is a correct analysis of the current environment with proper scenario-based consideration of various potential future trajectories over respective timelines in order to ‘deal’ with uncertainty. Uncertainty is ubiquitous and interconnected – i.e. over prices and their medium- and/or long-term sustainability, demand, market access challenges and/or constraints, and production.
Bringing, for example, more production online is typically based on scenarios of future demand growth. However, we are at a point in time – Climate Week NYC is gearing up in support of the UN Climate Summit taking place next week – where alternative future scenarios could point in the opposite direction. It is possible we will see divestment on a case-by-case basis, nourished by a strengthening desire to mitigate the effects of climate change on the planet and its inhabitants.
The Carbon Tracker Initiative puts it nicely by writing that “regulation and technology continue to advance to deliver a future that will not replicate the past.” Consequently, oil and gas companies’ capital expenditure (capex) needs to be put in context. A recent Carbon Tracker oil report makes the following very important point linking capex and divestments: “Reducing exposure to high cost, high risk projects (…) to the upper end of the cost curve could be a positive process rather than a painful one.”
As for putting capex into the right context the report suggests addressing the following questions:
- What is the timing of the planned expenditure and when would production be expected to come online?
- What proportion of the next ten years of capex does this represent?
- Is the capex concentrated in a particular region or oil/resource type?
- What are other cash flow commitments?
Overall, these questions together with the above-mentioned factors to consider in divestment transactions appear to be useful for strategically aligning business operations with an increasingly climate-change-driven environment in order to remain profitable. This also applies to the coal industry, which will continue to represent a significant share of the US and global power generation mix for decades to come.
