“Okay, Houston, we’ve had a problem here.”1
Oil and gas has quickly become the out-of-favor sector of our economy. An underperforming capital market along with a halting M&A environment has meant stakeholders are facing challenging times as major sector peers continue to prosper.
Since the last presidential election, we’ve seen a startling divergence in relative returns.
49% increase in S&P 500
The poor stock performance is difficult to understand given technological advances in the sector which have boosted crude oil and natural gas production.
- 14% relative return on oil & gas S&P 500*
The S&P 500 would be 4.5 percent higher if you hypothetically removed the 28 oil and gas companies.*
Oil trends
Innovation and technology are driving an increase in production capacity and the finite supply of crude oil is now appearing to be not so finite.
In the U.S., horizontal drilling and hydraulic fracturing have been the catalysts that have ensured U.S. crude oil production reaches unprecedented heights.
The U.S. is the world’s largest producer of crude oil 15,311 barrels per day in 20186
An increase of 17% in 2017 with no clear signs of a slowdown.
U.S. consumption trends
The U.S. is still a net importer of oil; however, the delta between imports and exports has shrunk considerably.8
15,311
barrels of oil produced domestically each day in the U.S.
20,4569
barrels consumed daily in the U.S.
4 fold
Exports of U.S. crude oil has increased nearly in the last 10 years
Oil prices are declining
There has been a 10 percent decline in U.S. per capita consumption since 2007 (BP Statistical Review of World Energy 2019) as EGS initiatives drive corporations and consumers to seek energy from “cleaner” sources.
With technology advances creating a flood of new oil to the marketplace, and a downward trend in per capita consumption of developed countries, supply fears have eased off, and with that oil prices have declined over the last 10 years.
With declining oil prices, producers have experienced a squeeze on their gross margins, impacting all participants that provide auxiliary services in the sector.
What does this mean for investors
Historically, private equity investments in energy had some of the shortest holding times on investments before profit realization on exit. However, low energy capital market and crude oil prices in the $50–$60 price range (natural gas in the $2–$3 price range) have led to a decrease in price/earnings multiples in the sector. This has caused investors to hold their investments until some sort of resurgence in transaction multiples occurs. As a result, M&A activity is relatively stagnant.
Private Equity (PE) hold times across all industries
| 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | 2017 | 2018 | 2019 | |
| Materials and resources | 5.72 | 4.73 | 6.46 | 5.96 | 6.64 | 6.58 | 6.38 | 6.10 | 5.94 | 6.18 |
| Energy | 4.02 | 4.32 | 4.89 | 4.43 | 4.59 | 4.64 | 5.53 | 5.24 | 5.87 | 5.97 |
| Business products and services (B2B) | 4.79 | 5.29 | 5.60 | 5.79 | 6.13 | 5.90 | 6.00 | 5.97 | 5.86 | 5.94 |
| Healthcare | 4.49 | 5.10 | 5.32 | 4.87 | 5.17 | 5.72 | 5.41 | 5.57 | 5.21 | 5.73 |
| Consumer products and services (B2C) | 4.56 | 5.27 | 5.96 | 5.59 | 6.33 | 6.02 | 6.27 | 5.76 | 5.82 | 5.69 |
| Financial services | 5.00 | 4.58 | 4.80 | 5.52 | 5.78 | 5.42 | 5.94 | 5.90 | 6.28 | 5.39 |
| Information technology | 5.07 | 5.37 | 5.40 | 5.41 | 6.02 | 5.48 | 5.44 | 5.56 | 5.51 | 5.05 |
M&A activity across all industries
It comes as no surprise that with an increase in PE investment holding times has come a slowdown in the number of deals completed in the sector. In fact, energy is the only sector which has experienced a decrease in volume of deals completed relative to 2010 reported numbers:
What lies ahead
There is no identifiable catalyst for a break out from the current environment for stakeholders.
Renewable energy momentum and environmental, social and governance (ESG) headwinds are placing ever increasing pressure on the oil and gas sector. As we approach a presidential election, political uncertainty is another factor which is denting confidence in the marketplace. Oil and gas companies fitting the adage, “you can be a good house (solid company) in a bad neighborhood (oil and gas sector)” face unique challenges when it comes to an exit.
Two visible remedies for companies looking for an exit:
1. Excel from a performance standpoint
- Oil prices historically have been cyclical in nature.
Businesses now must endeavor to drive marginal cost down and reap the rewards when oil prices recover.
2. Execute financial engineering
- Although M&A has slowed down, there is still value to be gained in acquisitions and disposals. The bravestakeholder will seek out the valuable acquisition at this time, trusting that a recovery in oil prices will unlock the true value of their investment.
While the catalyst for change is not yet obvious, history has shown that oil and gas is a cyclical industry and will recover.
“Does anyone remember how to use a slide rule?”13
Footnotes
- Words spoken by astronaut Jack Swigert during Apollo 13 mission
- S&P Capital IQ, KPMG analysis
- Macrotrends, S&P performance by president.
- S&P Capital IQ, S&P 500 oil, gas and consumable fuels industry.
- Wall Street Journal, Investors to Big Oil: Make it Rain, Bradley Olson and Sarah McFarlane (November 1, 2019).
- S&P Capital IQ, KPMG analysis
- BP Statistical Review of World Energy 2019. Includes crude oil, oil sands, condensates (both lease condensate and gas plant condensate) and NGLs (natural gas liquids—ethane, LPG and naphtha separated from the production of natural gas). Excludes liquid fuels from other sources such as biomass and derivatives of coal and natural gas. BP.com, BP Statistical review of world energy (2019).
- BP.com, BP Statistical review of world energy (2019).
- BP.com, BP Statistical review of world energy (2019).
- BP.com, BP Statistical review of world energy (2019).
- eia.gov, Short-term energy outlook (November 13, 2019)
- Pitchbook (Global analysis of PE).
- Thomson One. Analysis by KPMG.
- Tool used by Houston Mission control to guide Apollo 13 crew back to earth safely.
