How to make the best M&A deals in the energy sector
ValVestris
A world class energy consultancy firm, helping senior executives to get the big decisions right.
In this article we share our insights on deal making in the energy sector. Historically, many deals have failed to deliver value[i]. We discuss the key decision making and valuation approaches and the pitfalls that should be avoided. These are based on our experience as executives in energy companies and as consultants. Insights are primarily obtained by working on oil and gas fields but are equally applicable to renewable energy projects.
While this article is written from the perspective of acquisitions, similar principles apply to divestments.
Introduction
M&A activity in the energy sector is on an increasing trend over the last few years, following a slow-down during the COVID-19 pandemic. In 2023, there were over 1100 deals with a total value of $ 381 bln, an increase of about 8% compared to 2022 [ii]. With the energy transition continuing at pace, and many energy companies determining how to navigate this era, many experts expect M&A levels to remain high for the foreseeable future[iii].
First principle I – strategic fit
In the evaluation of a potential deal, the organisation should first decide whether the asset under consideration is a strategic fit, in terms of for example geographical footprint, desired portfolio mix and preferred technologies and capabilities. A clearly stated strategy serves as an excellent first testing principle for an acquisition target.
However, to acquire purely for strategic fit without proper valuation and due diligence is a recipe for value destruction as we have experienced on many occasions.
First principle II – the best owner
When considering the acquisition of an energy asset, it is critically important to assess whether as a potential buyer (or as a group of joint buyers) you believe?you are a better, or the best, owner of that asset. This means that given your particular strengths, you are able to extract more value out of the asset than the current owner and other potential buyers in the market.
In order to avoid overpaying, you as a buyer need to see value that the seller does not have or see. This can come from various sources such as the identification of resource and production upsides, cost advantages, supply chain opportunities, application of technology or operational strengths, synergies, fiscal positions etc. A realistic, comprehensive inventory of these upsides is important.
Valuation – the pitfalls
A key step is generating an economic valuation which informs the price you are willing to pay for the asset. Unfortunately, in doing so there are several pitfalls.
A proper economic valuation incorporates an assessment of uncertainties, risks, and option value[iv].?It considers items such as
There are a number of pitfalls that can undermine the validity of a valuation. Firstly, there is often a desire, also for immature assets, to narrow the valuation range (often to a single number) in order to help decision makers. However, in every valuation, there are many variables, unknowns and uncertainties making it impossible to do so. The result of narrow ranges is therefore a false sense of comfort, an unrealistic perception of remaining uncertainties and ultimately a value destroying deal.
A second important pitfall is neglecting the presence of biases and cognitive traps. No organization or individual, however mature and well-led, is immune to them. Well known examples are Confirmation Bias?[v]and the Sunk Cost Trap[vi], but there are many others. We have found articles by Kahneman et al [vii]and Hammond et al [viii], particularly insightful when it comes to recognizing these issues and recommending pragmatic means to cope with them.
Summary
Decision making for asset acquisition in the energy sector, and subsequently delivering value from the deal, can be very challenging for a number of reasons. Being aware of the opportunities as well as the pitfalls will help companies and investors in making the best possible deals.
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What ValVestris can offer
We have analysed many energy deals across the industry, all around the world, some very big and some much smaller ones. A significant number of them have fallen way short of their initial valuations, but some have delivered significant value to the acquirer.
We have a deep understanding of the technical and operational components that are important, the field development scenarios that may unfold, and the key drivers that ultimately determine value from the deal. We have extensive experience in creating and implementing commercial constructs that cater for possible technical outcomes. These mitigate against downside risks yet make sure that upside value can also be captured.
Finally, we offer a fully independent perspective on the potential value of the deal, the ability to add value to the asset, the assessment of competitive strengths and weaknesses, and the adequacy of the valuation approach. We provide an honest and objective assessment and are not affected by biases that may exist in the client organization. If you are considering an acquisition or a divestment and want to know more, please contact us.
Authors
Johan Pieters is a former executive at a major International Oil Company. He has held roles in M&A and oil and gas field development. Currently he is a managing partner in ValVestris.
Paul van Rijssen is a former global head of Business Development at a major International Oil Company. He specializes in Mergers, Acquisitions & Divestments, Investment Appraisal and Strategy Development.
[iv] With option value, we mean the value that is created by giving the organization potential access to other opportunities as a result of making the deal. An example could be the fact that entering into a new country may make it easier to get future projects in the same country because a presence has been established, the organization gets more familiar with the business climate in that country and has built a network in its society and with its decision makers.
[vii] “Before you make that Big Decision” by Daniel Kahneman, Dan Lovallo and Olivier Sibony originally published in Harvard Business Review, June 2011
[viii] The Hidden Traps in Decision Making originally published in Harvard Business Review, January 2006