A significant amount of consolidation has marked every oil & gas recovery cycle for the past two decades. As it relates specifically to the oilfield service market (OFS), this recovery cycle isn’t any different in that regard. However, while M&A activity historically has mainly been large companies buying smaller companies, this recovery is different.
Factors in Mergers
Generally, mergers occur for a few specific reasons—fill a product gap, generate in-creased scale, or create cost synergies. For example, when Schlumberger acquired Smith Industries in 2010, it was clearly to fill a product gap, as was the case when Schlumberger previously acquired Reed Tool in 1998 and, later, Cameron in 2016. When General Electric acquired Baker Hughes in 2017 after the Baker Hughes/Halliburton proposed merger collapsed, it was to achieve increased scale while also filling product gaps. The TechnipFMC merger of 2017 was a combination of complementary product lines, dramatically changing that company’s scale. TechnipFMC divided itself into two companies—Technip FMC and Technip Energies—with the former focused on upstream activities.
While scale is important—maybe more now than ever—this recovery is finding mergers occurring between smaller companies to achieve adequate scale, versus merely large companies merging to achieve very large scale or making “tuck-in” acquisitions to fill product or geographic gaps. Private equity funding is focused on these smaller mergers between regional companies for a wide range of reasons, not the least of which appears to be a lack of appetite in the public markets for large-scale consolidation. Tighter-focused private funding is more available, as regional service companies find backing to expand a given service line or more focused vertical integration to provide more services to their customers.
Meanwhile, Covid-19 presented its own set of challenges, dramatically impacting the short-term demand for oil and gas products and services. While businesses across several industries faced a challenging 2020 following the spread of Covid-19 and subsequent decline in economic activity, the oil and gas industry has been one of the most negatively impacted by the pandemic, with energy industry revenues declining 54%, according to Deloitte. There were only 258 deals across the sector in 2020, the lowest number in more than a decade. Deal value fell below $30 billion the first half of the year, also the lowest in the decade, but rebounded to almost $170 billion in the second half.
According to industry experts, new sources of capital are needed, or the industry may need to rethink how it finances both organic and inorganic growth. Since 2016, equity issuance, IPOs, venture capital, and private equity investments have dropped significantly and are often replaced with debt. Oil and gas sector debt issuance has continued to rise, spiking to more than $240 billion in 2020, $98 billion of which was in the second quarter alone. Companies will need to boost performance, compared with other sectors, to attract other traditional sources of capital, as well as find other, less traditional sources to support growth, post-2020.
Due to the significant differences between the operations of the OFS industry participants, an industry downturn doesn’t impact all OFS participants to the same degree. For instance, OFS businesses that disproportionately serve the natural gas side of the industry were not as significantly impacted by the precipitous drop in oil prices during the second quarter of 2020. In the same way, OFS participants may be impacted differently, based on the E&P subsector they serve. For example, during the 2020 oil price disruption, new drilling operations were much more adversely affected than were continuing production operations. Following a sharp decline in oil prices, exploration work may be curtailed much more so than production operations.
Of course, there is a direct relationship between dramatic changes in the price of oil and the rise in mergers, acquisitions and divestitures within the oilfield services sector. During periods of downward price pressure, companies merge to gain cost synergies, while during periods of price increases, mergers occur to quickly gain scale and increased market share. The steep drop in oil prices in 2020, from $60-plus, down to $20, represented the most significant decline in the shortest time in modern history. Even when the price dropped from $160/bbl to $60 in 2008, the price slide took place over a more extended period and found its floor at a level at which profits were still possible. But, in 2020, when prices dropped to $20 (and below), profits were more difficult to achieve.
The other leading indicator for the need for mergers, acquisitions and divestitures in the oil field is the rig count. With the rig count at all-time lows in the last year, there were too many service companies pursuing the possible business. From a high of nearly 1,600 operating rigs in mid-2015 to a low of approximately 200 in mid-2020, it is obvious why there has been accelerating consolidation within the oilfield service sector.
One of the indications of this repositioning of OFS companies was in the fall of 2020, when Liberty Oilfield Services bought Schlumberger’s North American hydraulic fracturing operations for $430 million. At the same time, Schlumberger invested in Liberty, demonstrating its increased confidence in the North American OFS business. This transaction was an early indication of deals to come, as the recovery in the OFS sector was emerging.
Meanwhile, the emergence of “blank check” OFS companies has also created a market for OFS mergers. National Energy Services Reunited’s (NESR) acquisition of Gulf Energy SAOC and National Petroleum Services (NPS) in the fall of 2017 has also created a category of next-generation, well-financed OFS companies. Former Schlumberger CEO Andrew Gould’s Sentinel Energy Services, formed in late 2017, is poised to make a major impact, as well. The first installment of this effort resulted in Sentinel’s late 2018 definitive agreement to acquire a majority interest in Strike Capital LLC, which owns Strike LLC, in a deal valued at $854 million.
Private Equity Firms
Private equity firms are also entering the fray, as Argonaut Private Energy acquired BJ Services’ cementing business in late 2020 and rebranded it American Cementing. The firm also acquired Pioneer’s Well Service business, combining it with Nichols Oil Tools and rebranding it American Well Services in March 2021. Meanwhile, Edge OFS recently acquired Gladiator, Ideal, PCS and Reliance to form a set of complementary services for their customers.
In the public markets, Ranger Energy Services acquired Patriot Well Services in May 2021 to fortify its wireline service business in North America. In addition, Archer acquired Deepwell in May 2021 to strengthen its wireline and downhole services in Norway.
The current environment is ripe for more mergers, acquisitions and divestitures, as rising rig count, and increasing oil and natural gas prices, are creating a situation where demand for OFS services could challenge the supply of those services. OFS companies downsized dramatically in 2020 to reflect the dramatic decline in demand for oil and gas, due to the pandemic. However, with increased demand, mergers and acquisitions are expected to accelerate during the second half of 2021. Essentially, the OFS sector is reformulating itself to reflect the current demand/supply equation, and M&A is often the quickest and most cost-effective way to do so.
Which segments will see the most significant consolidation? Will there be more M&A activity at the high end of the market or within the mid-market? Will E&P companies determine that it is more cost-effective to own a full-service OFS company? Will international companies merge with North American firms to gain global scale?
Who will supply the funding for M&A activity, i.e., debt, stock, PE firms? Will M&A activity be basin-specific within the mid-market? Will “blank check” companies continue to enter the market? Which segments/service lines are riper than others for M&A activity? How high will oil and gas prices rise in 2021, and how long before demand reaches and/or exceeds pre-pandemic levels? How high will rig count rise in 2021? The answers to these questions will likely drive the pace of M&A activity within the OFS sector in 2021 and beyond, but every recovery has seen significant M&A activity.