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Mergers & Acquisitions Global Oil & Gas Sector Consolidation & New Avenues over the landscape

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Contents

Introduction The regional landscape: (2008-09 and 2009-10)

5 6

Landscape across the value chain: (2008-09 and 2009-10) 8 Some key trends Some challenges going forward Contacts 12 13 16

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Introduction

The M&A landscape in 2009-10 has not changed much in 2008-09 with number of announced deals increasing from 311 to 339 while the number of concluded deals fell by around 38%

The global landscape of oil & gas M&A activities has over the past four years seen many emerging contours which even before stabilizing have been changing their shape at accelerated pace. Year 2007 saw the peak of M&A activities and not surprisingly so given the high pitch global economic activities around the period. Ever rising oil prices since mid 2000, easy availability of funds supporting leveraged buy outs and most importantly, the bullish business sentiments for the future were some of the factors underlying the peak on oil & gas M&A landscape. These M&A activities were primarily growth oriented which increased the risk profile of companies supported by higher risk appetite of the investors. Subsequent downturn in late 2008 and early 2009 along with volatile oil prices had its sobering impact on the M&A activities wherein the sellers started exploring divestment options to rationalize the risk of their portfolio and buyers could afford bargain hunting. This created a gap in the valuation expectation of the buyer and the seller leading to lesser proportion of M&A offers reaching the stage of closure. This was well reflected in the reduced M&A deals concluded over past two years. Few key features of M&A landscape during pre-Q4 2008 period were: Increased activities in Oil Field Services (OFS) space given the rise in contract prices Enhanced competition between International Oil Companies (IOCs) and National Oil Companies (NOCs) for gradually decreasing numbers of new large prospects New entrants to the hydrocarbon sector Increased focus on exploitation of unconventional hydrocarbon resources such as oil sands and coal bed methane thanks to the prevailing high oil prices and bullish outlook for the same. With global meltdown in last quarter of 2008, the focus turned on managing risks of the portfolio and getting access to fast drying credit lines. Taking a cue from these interesting developments as we entered 2009, our previous paper on this subject, published in January 2009, had expected the year 2009 to be a year of mergers of necessity resulting in relatively consolidated oil & gas landscape.

This paper maps the M&A activities within the oil & gas space for the period between Q4 2008 and Q3 2010 (study period) and intends to identify key M&A trends in the sector. The study considers only those deals which are greater than USD 5 million in value and pertain to the period during October 2008 to August 2010 as per data reported by the Merger Market. The key change in the business environment for the period of this study as compared to the period of earlier study has been a relative stability in oil prices, hovering between USD 60 85 per barrel over past twelve months, and the global economy lately moving from stabilization towards recovery to a certain extent. The analysis and the outcome of this study need to be viewed in the above context.

The period between Q4 2008 and Q3 2010 has seen some 650 oil & gas deals being announced, of which, around 69% are reported to have achieved closure. The Upstream space continued to lead the M&A activity within the sector constituting around 70% of the deals by number and 58% of the deals by value concluded during this period. The M&A landscape in 2009-10 has not changed much in 2008-09 with number of announced deals increasing from 311 to 339 while the number of concluded deals fell by around 38%. Interestingly, around 35% of the deals closed on the date of announcement itself indicating these to be predetermined bilateral deals while around 52% of transactions closed within 3 months of the announcement indicating quick convergence of expectations in the context of stabilized economic outlook. While the billion dollar deals continue to happen with 15 such deals with cumulative value of ~ USD 61.15 billion closing in 2008-09 and 14 such deals with cumulative value of ~ USD 64.62 billion in 2009-10, the average deal value followed the past trend with bulk of the deals in less than USD 50 million and USD 100 500 million ranges. Failures in satisfying specific conditions for completion of deal as well as lack of regulatory approvals had been the predominant reason for unconsummated deals during past two years while difference in expectations has played relatively minor role towards the same.

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The regional landscape: (2008-09 and 2009-10)


Over the 2 year period, USA and Canada dominated the regional M&A landscape accounting for 32.50% and 17.92% of the total value of deals respectively
Despite the slowdown and fairly cautious outlook in 2008-09, North America continued to be a land of M&A with 134 deals, valued at ~USD 56.30 billion, accounting for approximately 53% of the total deal by value. The concluded deal flow in 2009-10 decreased by approximately 38% while the corresponding deal values dropped by around 20% to 173 and ~USD 85.13 billion respectively. This cautious outlook for the future was well reflected in substantially reduced deal flow even in the prolific M&A regions of North America, Europe and Asia. In 2008-09, the deals originated from a total of 41 countries while this number dropped to 32 countries in 2009-10. The Middle East continued to witness limited deal flow with only 2 deals concluded in 2008-09 which has an average value of USD 30 million. The most affected region has been South America where the M&A deals almost dried up reducing the number from 19 deals valued at ~USD 3.73 billion in 2008-09 to 4 deals valued at ~USD 300 k in 2009-10. The following 2 charts (Chart 1 and Chart 2) plot the number of deals and the value of deals in USD billion.

Chart 1: Region-wise number of concluded deals:


23 19 4 244 North America 110 110 Middle East 36 65 Europe 46 19 2 2 0 8 4 4 74 134

Chart 2: Region-wise value of deals in USD billion


4.043 0.31 3.73 111.967 North America 55.67 56.30 42.125 31.72 17.49 Europe 17.49 12.60

South America

South America

Middle East

10.41

Asia (incl Australia)

0.028 Asia (incl Australia) 0 0.03 2.515 0.66 1.86

Africa

Africa

Cumulative Mid 2009-10 Mid 2008-09 Source: Merger Market Database, website: www.mergermarket.com 6

Cumulative Mid 2009-10 Mid 2008-09 Source: Merger Market Database, website: www.mergermarket.com

Over the 2 year period, USA and Canada dominated the regional M&A landscape accounting for 32.50% and 17.92% of the total deals by value respectively. The other countries having a significant play in the M&A space are Russia, Japan and China followed by deals with multi-country origination. The following table indicates the type of transactions that have occurred in some of these countries. Table 1: More prevalent type of transactions by country (top 7): SNo 1 Country USA No of deals 137 Value in USD billion 61.99 Remark Type of transaction Marked by deals aimed at consolidation and/or to facilitate completion of investment plans in view of the reduced access to credit lines. These deals included merger of group companies, acquisition of balance shares, financial institutions and holding companies swapping shares to improve returns and diversify risks. Most of the transactions have been in the upstream segment with a signification number of transactions aimed at consolidating unconventional hydrocarbon resources such as shale assets. A majority of the transactions have been to de-risk through rationalization of portfolio and to diversify returns. The major deal (~USD 12.18 billion) in Japan has been the Nippon Oil merger with Nippon Mining Holding Inc. This appears to be a consolidation of group entities as part of a restructuring exercise. Most of the China originated transactions are outside Asia in Europe and North America (mainly Canada). A number of transactions have been made through the sovereign wealth fund in the upstream space. These transactions have occurred across all sectors with investments made in diverse geographies through subsidiary companies in order to consolidate at local level.

Canada

101

34.19

3 4

Russia Japan

23 8

19.32 13.48

China

11

12.34

MultiCountry

26

10.27

India features at 11th position on this global M&A list with a total of 7 deals valued at ~USD 3.3 billion accounting for 1.52% share of the total value of deals for the period. Reliance Industries leads the deals table from India with acquisition of 5% equity stake held by Chevron in Reliance Petroleum Limited, merger of the petrochemicals and refining businesses and acquisition of 45% equity stake in Eagle Ford Shale asset. The other India based M&A deals include government companies acquiring 10% stake in OIL India, Essars acquisition of Kenya Petroleum Refinery Co. (KPRL) from Shell, Chevron and BP and smaller tranches of investments, USD 22.3 million and USD 10 million, by the PE firms Sage NPE Fund and Concord Enviro Systems respectively. Canada reported the largest deal in 2008-09 wherein Suncor acquired Petro-Canada through a plan of arrangement for ~USD 18.39 billion. The combined entity has created a globally-competitive integrated energy company with a balanced portfolio of high

quality assets and high growth prospects backed by a strong balance sheet. The merger is expected to achieve CAD 300 million in annual savings in operating expenditures as well as CAD 1 billion of annual capital efficiencies through elimination of redundancies and targeting the capital budgets towards high-return, near term projects. The above region centric analysis of M&A transactions is based on the domicile of the target company without any consideration for the location of assets held by these companies. Many of these target companies hold assets across various regions. Any analysis considering the location of acquired assets would accordingly make the actual global M&A landscape appear a little more complex as many of these acquisitions are truly crossborder and not confined to a single country and region thanks to the wide geographical spread of assets held by these target companies.

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Landscape across the value chain: (2008-09 and 2009-10)


The upstream sector continued to be the main driver for M&A in the Oil & Gas sector which for the period under review accounted for ~USD 110.17 billion from 316 deals. This is about 70% of the total number of deals and 58% of the deals in value terms for the period. Although number of deals has decreased across all sub-sectors, the midstream and other transactions (i.e. oil companies de-risking and diversifying their portfolios into utilities, mining, etc.) have shown a marginal increase of 2.63% and 9.16% respectively. In 2009-10, there were a couple of deals at the top-end of the scale which were group consolidations in the Midstream Gas business and the Mining space. A midstream deal valued at USD 11.75 billion saw Williams Partners LP agreeing to acquire certain gas pipeline and domestic midstream businesses from the Williams Companies Inc. while another mining deal consisted of Nippon Oil Corporation agreeing to merge with Nippon Mining Holding Inc., both being listed companies. Chart 3: Sub-sector wise number of concluded deals:
Others 3 2 17 14 9

The upstream sector continues to be the main driver for M&A in the Oil & Gas sector which for the period under review accounted for 70% in nymber terms and 58% in terms of total deal value.

Utilities

Upstream Services 4

Upstream Gas

2 2 0

Upstream E&P

Upstream Asset 2 1

18

24

O&G Holding/Finance Co

Midstream Services

14

17

Midstream

16 12 33 5 93

Integrated Cos

Downstream Services 54 36 Mid

67

Downstream Mid 2008-09 2009-10 8

Source: Merger Market Database, website: www.mergermarket.com

Chart 3: Sub-sector wise value of deals in USD billion


Others 36.55 45.71 Utilities 4.14 21.43 28.99 5.31 Upstream Gas 1.52 1.12 35.11 24.60 7.09 0.72 25.18 95.62 3.02 11.56 56.02 35.76 Downstream Services 38.25 Downstream Mid 2009-10 Mid 2008-09 51.53 30.02 Source: Merger Market Database, website: www.mergermarket.com 75.49 3.99 26.45

Upstream Services

Upstream E&P

Upstream Asset

O&G Holding/Finance Co

Midstream Services

Midstream

Integrated Cos

The two major transactions in the upstream asset space pertain to the assets in Gulf of Mexico and in Egypt. While Devon Energy sold its Gulf of Mexico Shelf assets to Apache Corporation for ~USD 1.05 billion in order to improve its liquidity and focus on the development of onshore properties in North America. In the case of the Abu Qir concession located in Egypt, the Egyptian General Petroleum Corporation divested it 40% stake to Edison International Spa for a consideration of ~USD 1.4 billion. Edisons acquisition is aimed at achieving consolidation of their position in Egypt and increasing their reserves base. In the upstream space, there were 14 transactions ranging between USD 1 and USD 4 billion primarily based out of North America and Europe. Russia and Canada also had its share of mega deals, one each in

the upstream space in year 2009-10. The Russian deal of ~USD 6.6 billion was acquisition of NK Russneft OAO, an E&P company owned by En+ Group Ltd, by Mikhail Gutseriyev, a private investor. En+ Group sold the asset to reduce its debt burden. The Canadian deal of ~USD 8.8 billion was acquisition by a Sinopec group company of Addax Petroleum Corporation, an international E&P company. This acquisition amidst competition is apparently in line with the Chinese strategy to expand their footprint globally. In Europe, Premier Oil Plc., a listed UK based oil and exploration company, has agreed to acquire Oilexco North Sea Limited, a UK based company engaged in oil and exploration services in the North Sea region. Premier Oil Plc. is buying this company from Oilexco Inc, a listed Canada based company engaged in oil and exploration
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services. The acquisition will help the company to carry on with its growth projects with increased cash flow, operational capability and efficiency leveraging the professional expertise of the management team of Oilexco. The upstream natural gas space also saw 3 deals each with value upwards of one billion dollars during this period. One of such deals is Apache Corporations acquisition of BP assets in the Permian Basin in Texas and south-east New Mexico and agreement to acquire Western Canadian upstream gas assets, Western Desert business concessions and East Badr El-din exploration concession in Egypt for ~USD 3.1 billion under the same arrangement. The merger deal of Atlas Energy Resources and Atlas America Inc, ~USD 1.4 billion in value, is another billion dollars plus deal in gas space which is expected to accelerate the expansion and development of its Marcellus Shale position by the combined entity through reinvestment of larger portion of its combined cash flow in Americas greatest natural gas play. The third mega gas deal is acquisition of 91.3% shares in Queensland Gas Company Limited, an Australian energy company, by BG Group Plc, a UK-listed energy company. Some of the salient features of upstream deals during this period may be identified as follows: 1. Large number of transactions has originated due to financial distress affecting the developer. 2. Such distress is reflected in the attractive valuations of the some of the deals tabulated below. Table 2: Observations on valuation of different sub-sectors within Upstream Oil & Gas Upstream development & producing assets Upstream exploration assets Upstream Services Upstream Natural Gas assets 72 transactions were valued below USD 500 million and 50% of these were valued below USD 100 million 68 transactions were valued below USD 100 million and 41 transactions were clocked in the USD 100-500 million ranges. 18 out of 38 deals valued below USD 100 million and 11 deals in the USD 100 - 500 million ranges. 6 out of 28 deals valued below USD 100 million, another 10 deals in the USD 100-500 million ranges while 8 of these deals were above USD 500 million in value.

It may however be noted that even in a subdued valuation scenario, valuations for upstream gas businesses appear to be more optimistic.

3. The upstream sector saw involvement of financial entities as acquirer of interest in upstream assets from cash strapped sellers through investment in oil & gas holding companies. While financial investors and pension funds have participated in buy outs through investment in Oil & Gas holding / finance companies, the activity here has not been restricted to any specific geography although North America and Europe lead the trend largely on account of larger number of deals originating in these geographies. 4. The period saw increasing integration between various sub-sectors especially between the E&P and Services companies. 5. A large number of the transactions during the period also pertain to gas reserves. In the gas space, the focus had been on unconventional resources like Shale Assets, Coal Bed Methane, etc. especially in the North American region. 6. Willingness of oil and gas companies to look at other investments avenues outside their core operations, like utilities (power, water, etc), mining, transportation services, etc in order to stabilize their cash flows.

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7. A number of deals also originated out of financial difficulties of BP as a result of oil spill from its asset in the Gulf of Mexico. The M&A activities in other sub-sectors, like downstream, integrated companies and utilities have been pretty much in line with the past trend though the midstream and O&G holding / finance companies have seen relatively larger number of deal flow in the last two years. Midstream space has been dominated by the following two types of transactions: 1. E&P companies acquiring midstream companies as a forward integration strategy and 2. Midstream companies acquiring other midstream companies as horizontal expansion strategy covering larger and new markets for growth A snapshot of the M&A activities during past two years does reflect the survival and stability as two key themes underlying large proportion of deals, the necessity being the prime mover than the quest for growth which was the hall mark of M&A activities in 2007 and early 2008.

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Some key trends

The recent apparent stabilization of oil prices and financial markets after the volatility witnessed in 2008-09 has laid the ground for growth oriented M&A activities though the general sentiment continues to be cautious with wait and watch being the corner stone of M&A strategy for the investor community. Some of the key trends of the past period such as rationalization of portfolio, bargain hunting, etc. continue to hold true, while few of them have reversed on account of better conditions currently prevailing in the market. The fortune of OFS companies have seen reversal due to downsizing of E&P activities which has somewhat subdued the M&A activities involving oilfield services companies and the few deals being completed are primarily value deals as compared to the growth oriented deals during pre 2008 period. Another reversal in trend in the E&P space has been the consolidation of smaller E&P companies finding prudence in jointly pursuing their E&P activities. The E&P space also saw a large number of companies merging to unlock value for their stakeholders.

We continue to see the limited presence of International Oil Companies (IOCs) on the M&A landscape as acquirers and instead, they have been offering some of their assets for sale as part of their strategy to rationalize their portfolio, optimize the cost of operations and to focus on their core areas / businesses. The M&A activity in unconventional hydro-carbon resources space continued with increasing interest in oil sands, shale assets and coal bed methane activities. New entrants with higher levels of liquidity such as Pension funds and PE firms continued with their focus on the Oil & Gas sector and viewed the sector as potential source of growth as well as stable revenues. NOCs, especially from China, continue their purchasing spree across the globe, albeit at a lesser pace.

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Some challenges going forward

The improving outlook for the global economy and stability in the oil prices is expected to trigger growth in E&P activities thereby providing the impetus for the other sub-sectors to grow. In terms of geographies of interest, much has been reported about India and China emerging as major players on the future global M&A landscape; the rationale being the need to expand their global footprint for achieving energy security. It may be noted that India and China are likely to continue and may be accelerate, acquisition of the assets located overseas as there are limited avenues for domestic M&A at present. In terms of new sub-sectors within larger family of oil & gas, the unconventional hydrocarbon space is likely to attract larger and new players increasingly in the geographies other than North America and Europe. Few key challenges which are likely to shape the future oil & gas M&A landscape may be mentioned as follows. Where to invest? The top five IOCs have built a war chest of over USD 75 billion in the last couple of years also by slowing down their M&A activities and preferring organic growth options instead. Also, the capital projects in the sector have slowed by ~18% in 2009 with companies reluctant to invest in mature basins, frontier basins and in the countries perceived to have unstable fiscal regimes. With this backdrop, IOCs are facing a reserve replacement challenge. The upstream space has recently seen some new discoveries and the unconventional oil & gas assets is the area to watch for many seasons to come. In view of the limited options of new prolific basins available for exploration, we hope to see higher investment in existing basins going forward as any delay in implementing long lead projects will lead to further lowering of reserve replacement ratio. This would also

result in companies offering highly competitive terms during bidding for any prospective basin offered to international companies at the expense of profitability outlook. Development of new discoveries In the recent past we have seen large discoveries in onshore Uganda, deep offshore Mozambique, deep offshore Israel and deep offshore Philippines, deep offshore Brazil and deep offshore Ghana. Despite these finds being large and commercially viable, the subdued sentiments in global financial markets and volatile oil prices have slowed the pace of development of these discoveries. The pace of development of these asset would be key to medium term demand supply situation and the current oil prices augurs well for the development of these new discoveries. Global focus on Clean Energy The ever increasing oil prices till July 2008 turned the global attention towards reviewing their energy consumption pattern with a view to achieve reduction in use of fossil fuel based energy. Frenetic pace of global economic expansion and resultant global warming threats led to initiatives of COP-15 and UNFCC for development and expansion of renewable energy and increase its availability through development of alternative sources of energy such as hydro, solar, wind, bio, geothermal, etc. The increasing awareness to consume less fossil fuel, efficient use of energy and use of energy efficient appliances combined with national action plans has resulted in reduction in demand for fossil fuels at present and may present a potentially larger challenge to growth rates in consumption of fossil fuel in future. This has led to diversion of financial investments from the conventional oil & gas sector to the renewable sector.

India and China emerging as major players in the global M&A landscape in future; the rationale being the need to expand their global footprint for achieving energy security
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Increasing investment in unconventional Oil & Gas resources Following closely on the heels of increased business activity in the Clean Energy space is the large investment being made towards development of unconventional oil & gas resources such as Shale Oil & Gas, Oil Sands, Coal Bed Methane and Underground Coal Gasification. The development of these unconventional resources have leaped into the realms of commercial viability thanks to the high oil prices and investments made to develop the sector in past few years in the wake of prevailing high oil prices. Among all these resources, Shale gas has found its place on the natural gas firmament in US with its impact on international LNG market. With higher investment commitments being made by existing companies and new entrants, Shale gas would be a key area to watch for its meaningful and long term impact on international LNG market. A higher contribution from Shale gas resources could see some shift in natural gas market with decreasing leverage of the seller in the otherwise sellers market. NOCs to drive investment NOCs have historically been impervious to global trends and have acquired assets in every market situation. Their philosophy of long term holdings for energy security is indicative of a different investment strategy and is likely to continue driving their future plans for acquisition. NOCs from China, Korea, India, Malaysia and Thailand have been actively participating in acquisition of assets overseas and successfully acquiring some of the assets being offered by IOCs as part of their portfolio rationalization. IOC-NOC Joint Ventures IOCs and NOCs have traditionally been pursuing their businesses independent of each other and following different business practices and strategies in terms

of geographies, assets and markets. With increasing ascendance of NOCs, their requirement for larger pool of capital and technical resources combined with decreasing availability of new attractive basins for IOCs, the possibility of NOCs and IOCs jointly pursuing businesses is an increasing possibility. NOCs like ONGC have already announced their intent to work with IOCs, though the success of this model will depend on management of risk perception, cultural alignment and exploration successes of such joint ventures in future. An area where this collaboration is likely to work well would be in the development of commercially viable unconventional oil & gas resources where IOCs may offer some technical advantage. Increased play by Financial Investors The oil & gas sector requires larger commitment of risk capital to enter into a growth phase and we expect to see increased play by financial investors who have deep pockets and staying potential , such play being dependent upon the attractiveness of the investment opportunities from valuation and growth perspective. Participation by financial investors is likely to be dependent on stability of the oil prices and companies offering a balance portfolio for their investment with acceptable risk return profile. With relatively consolidated oil & gas landscape emanating from the mergers of necessity over past two years, 2010-11 is likely to witness M&A activities cautiously oriented towards growth with well diversified portfolio in order to avoid falling into the traps of overt optimism of 2007-08. Upstream space is likely to continue leading the M&A activities within the sector with increasing share of unconventional resources and de-risking of portfolio through diversification as one of its central themes.

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Contacts

Kalpana Jain Financial Advisory Direct : +91 (0)124 6792266 kajain@deloitte.com Sameer Bhatia Strategy & Operations Main: +91 (0)22 6619 8610 sambhatia@deloitte.com Sanjay Kaul Energy & Resources Mob: +91 98 737 74444 sakaul@deloitte.com

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