Exclusive interview with Katan Hirachand, Managing Director, Energy Project Finance at Société Générale.
Gastech News: What factors are affecting big energy deals at the moment?
Katan Hirachand: Following the sharp fall in oil prices, increasingly the industry believes that a modest oil and gas price environment is likely to continue for some time. Players in the industry have reacted quickly through capex reductions, deferrals or the re-engineering of projects to normalise returns on capital and sustain dividend payments. Oil companies have also put the services industry under great pressure to reduce costs that had widely escalated in the past 10 years.
With divergent views between sellers and buyers, and despite some still believing in a V-shaped recovery, E&P M&A volumes fell sharply in the first half of 2015. We believe the E&P M&A volumes should pick-up over the next 12 month as views between buyers are sellers are more aligned and a number of distressed sellers start to emerge. However, the universe of buyers will be greatly reduced compared to what we saw until 2014.
Gastech News: Where do you think the most interesting M&A activities will take place in the near future?
Katan Hirachand: At the moment, the opportunity lies mostly with distressed companies (shareholder activism, high leverage, forced sellers of E&P assets). We believe that distressed sellers will mostly emerge in North America where growth was mainly underpinned by debt. Non- distressed sellers remain reluctant to transact at current commodity prices but remain open to unsolicited approaches with creative structures. Integrated players continue to streamline their portfolios to improve focus and liquidity, however, sales are focused around less-oil price sensitive assets (e.g. Infrastructure, downstream and non-oil linked gas E&P). Interestingly, most utility companies are abandoning previous ambitions to build their own E&P businesses following investor pressure and a mismatch of risk profile with their core businesses (see comments below). Therefore, in order to foster more deal activity, there will be an increased usage of alternative deal structures such as contingent payments, swaps and direct equity consideration. The market is expected to continue as a buyers’ market and within such market, it appears the demand is not composed of select pockets in places like the M-E, SE Asia, India and amongst some traders and PE players.
Gastech News: What are the main challenges in the LNG market on the consumption side?
Katan Hirachand: The LNG buyer landscape is changing dramatically largely through the introduction of more non-OECD markets where demand is very price-sensitive, and hence hard to predict. Much of the demand is expected to come from these markets going forward but this will pose dynamics that are more challenging in terms of Government energy policy, subsidies, developing a framework conducive to the use of gas and therefore making it hard, if not impossible, to take a real long-term view. Economic realities coupled with environmental advances means coal will continue to be consumed in many target markets.
The very nature of contracting LNG is changing but this should be seen both as an opportunity as well as a challenge. Lower gas prices could open up many new markets, bringing cleaner burning fuel to millions, at attractive prices. We have seen a huge rise in LNG being traded on a spot or short-term basis, and as more “aggregators” take long positions, this contracting trend will continue with such players able to provide a menu of options to buyers. The inherent flexibility of the “service provider” based US LNG model confers great flexibility on the market compared to the traditional model which has fuelled this change.
On the M&A side, we observe a few key LNG buyers looking to increase their equity exposure to the upstream side of the project, beyond their traditional role of off-takers.
Gastech News: After the BG-Shell deal, who will be next? And why?
Katan Hirachand: Given the E&P asset market has been relatively stagnant, it’s likely that mid- and down-stream assets grow in popularity again, especially as input prices (feedstock) has come down. Traders will also occupy some of this space as they look to create arbitrage opportunities. I’d expect the bulk of activity to come in North America on the sell and consolidation side and several producers have hedges that are running off, and could make themselves ripe for takeover pretty quickly. The M&A activity will likely be driven by international oil companies looking to enter North America onshore, private equity and North American players with strong balance sheets.
Gastech News: At Gastech your presentation will be about “Unlocking Greater Value Through Capital Structuring” – can you briefly explain the importance of capital structuring for global financing activities?
Katan Hirachand: Simply put, it’s critical. In a market where people are searching for more value to support project development, getting this built into the structure from the outset should be imperative. Differentiating genuine commodity risk from infrastructure risk will allow developers to tap a broader pool of capital, and importantly price these risks correctly. E&P stock is seen as a “growth play” whose shareholders seek unlevered returns in the mid-teens reflecting the nature of this risk, and as such, segregation of the infrastructure which otherwise creates a balance sheet “drag” will be even more important going forward. Risk/return can be better matched with the investor base in the energy sector. I will also be addressing the fundamental changes in the LNG market and the opportunities this may bring.
Thursday, 29th October - Katan Hirachand, Managing Director, Energy Project Finance at Société Générale will be talking about “Unlocking Greater Value Through Capital Structuring” at Gastech Singapore.