Farm-in Deals reflect lack of industry confidence

Exploration deal making activity has always been at the heart of oil and gas exploration worldwide. The most successfully explored basins are those with large numbers of smaller parcels of land as the asset base, open data access and data trading, many players and an active deal flow facilitated by accommodating government regulation. The UK and the US are classic areas with the right ingredients for successful upstream activity where new ideas for creating value can be tested rapidly by buyers and sellers and where portfolios and be matched to strategies. Other important fundamental basin characteristics, for example, are the physical operating environment, cost base, fiscal terms and the potential for strategic upside.

But Oil and Gas prices are vital components in the mix.

According to JSI Service, in the three months to June 30th 2015, outside the US, a total of 17 new farm outs were announced. Of these 13 deals are considered to be ‘true’ conventional exploration farm outs defined as having no existing discoveries on the acreage being farmed out. This is a slight decrease from the first quarter of 2015 (14 exploration farm outs) (see Figure 1. However the message in the chart below is the decrease in activity from a year ago (26 exploration farm outs). In fact overall level of activity has dropped sharply in the last 12 months to reach an all-time low.

Announced Deals vs Oil Price

The chart shows that Exploration New Ventures activity followed the oil price revival through 2009 and 2010 but became detached from the oil price trend in 2011 followed by an erratic pattern of deal making – but basically showing deal making in decline until today.

The past 7 months have had historically low levels of deals. Both the onshore and offshore patterns are affected and the market remains very subdued. The correlation between total farm in costs and oil price has also de-coupled since 2014. On the other hand in the last two years there has been a reasonably high level of deals coming onto the market, which usually makes it a buyers’ market. However the industry still seems nervous with few companies having clear strategies for the next 5 years because of price uncertainty. The capital is just not there to back dealing. There are three key factors driving this lack of confidence:

The oil price: this had consistently ranged between $100 and $120 per barrel (Green line in Figure 1) from 2011 until September 2014. After the strong fall in the 4th quarter oil prices have stabilised in 2015 but remain low. Demand remains stable but the volume of oil in storage is at an all-time high. Strong supply keeps the price low, with OPEC pumping high volumes (and Iran yet to release its oil on to the market); there is no sense that new investments will benefit from a rising oil price.

E&P Costs: although costs are falling with the cost of rigs and seismic showing rapid adjustments, some large developments have seen significant cost over-runs. Companies are less willing to assign discretionary budgets for exploration in face of such uncertainty.

Geopolitics: Unrest in the Middle East, increased demand in the USA – which might restrict supply or boost demand – will be offset by slowing Chinese economic growth and reduced demand from Europe, still struggling with the future of the Greek economy and political issues in Russia and Ukraine. The US presidential elections in 2016 is likely to bring further uncertainty.

All in all, it’s hard to see deal-making activity bouncing back to 2012 levels – even if there are some great bargains on the table. What do you think – as always, we’d love to hear your views.

About JSI Services (www.jsiservices.co.uk)

JSI Services have been reviewing and analysing exploration deal making in all parts of the World excluding North America for the past 15 years. Based on the data collected JSI has a view of the deal making market and its trends. Joe Staffurth, Managing Director of the company, has over 25 years industry experience including work in Europe, Middle East, South America and Canada. Trained as a geologist he gained a strong technical and commercial background while working for Esso and Petrofina.

Comments

  1. We tend to forget the fact that oil supply has been in significant surplus for quite some extended time prior to the price fall. Other commodities also in surplus had already begun falling in price in general deflationary environment worldwide. The Saudi refusal to defend price in November was just ‘icing on the cake’.

    • Paul, thank you for the comment. There are some signs that prices are stabilising so perhaps some light at the end of the tunnel. A good indicator that the market thinks we are at the bottom of the cycle is deal flow. So let’s hope we see a significant up-tick in the JSI graph soon!

  2. James D Strachan says:

    Angus,
    I would certainly not characterise the current lack of farm-in deals as a lack of confidence by oil explorers, but rather by industry economists and oil financiers. Our industry is caught in a bind in which the providers of capital see no near-term returns from exploration and their perceived value of discovered oil in the ground has been materially diminished, so they invest where they can achieve higher returns. Also, they have been sold lots of farm-in opportunities in the past that often proved unsuccessful, and are loathe to expose themselves to exploration risk at a time of low profitability.

    As you have commented, oversupply with current total daily production of more than 95MMb/d has flooded the market. Also, investors are aware that the purge being caused by low oil price has yet to work through to eliminate the high-cost international offshore production (including much of NW European mature production) and the bulge from onshore US light/tight gas-condensates. When this eventually happens, will we begin to see progressive modest reductions in supply accompanied by increased oil price.
    However, a near term likelihood is that 35-50MMb of Iranian stored crude oil will be released on to the market immediately after the US embargo is eased and that will further depress the oil price. The Iranians will steadily increase their oil production over subsequent years that might potentially exacerbate this glut.
    Thus, it seems that we will have low oil price probably into 2017 at which time we’ll potentially begin to see significant firming of oil prices and a return to exploration as oil stocks are run down and economists and financiers regain their confidence to invest in the best of the opportunities available at that time. A possible alternative to this scenario would be a fundamental geopolitical shock that disrupts oil supply from the middle East and instantly increases oil prices.
    It is probably only when supply and demand come into balance that oil companies will aggressively revert to seeking new opportunities, including ‘buying oil on Wall St’, signing contracts for new developments and production deals, signing up new exploration acreage and farm-ins. Sadly, by that time, several seasons of exploration opportunity will have been lost, existing infrastructure and acreage abandoned, many experienced oil company professionals will have permanently exited our business, and new graduates enticed away into other careers.

    We have seen oil price downturns like this before, but for the past forty years or so, OPEC has worked to stabilise oil prices purely in its own members’ interest, but this has generally boosted oil company economics and profits. Now we are seeing raw supply/demand economic realities in action that are profoundly impacting the economies of OPEC cartel members, the other producing countries and all producing oil companies whilst providing cheap energy for our oil consumers. Inevitably this situation will turn as a new oil price rationale is adopted from about 2017 when the supply/demand balance is achieved. After past oil price downturns, we have seen the frantic scramble by oil companies to re-build depleted exploration portfolios and to re-man for the challenges presented by renewed E+P expenditures. – We can be sure that this time will be no different.

    • James
      Thank you for the note. To pick up on your point about E&P company performance, this is very true. Even before the oil price dip investors were extremely frustrated. I lost count of the number of conferences where investors would lambast the industry, large and small companies alike. I even heard one descibe seismic as “a lot of mumbo-jumbo”.
      Angus

  3. Peter Smith says:

    While traditional farm-in and farm-out activity has languished in the current industry climate linked to increased risk averseness, a recent OGFJ article suggests that deal flow is rising as E&P firms release valuable but non-core assets to focus their portfolios. These released assets may be viewed as a less risky investment than those of a typical farm-in which often occur earlier in the life of an asset before it is well understood. These prized, but non-core assets appear to be the targets of a variety of investors including private equity firms, NOC’s, new operators and major IOC’s trying to lock into ongoing projects which have low risk and uncertainty. This may not immediately result in heightened upstream operational activity as the investment will not necessarily involve any new, compelling commitments to develop, explore or operate. But the net impact is capital flowing into the upstream market which should have some positive impact. Part of the investment could go to faster development, brownfield optimization projects or even accelerated spend on decommissioning liabilities while service and product prices are lower. Hopefully, this could provide a stimulus to activity to offset the hiatus in exploration, unconventional activity and new megaprojects.
    The OGFJ article can be found by pasting the following link into your web browser:
    http://www.ogfj.com/articles/print/volume-12/issue-10/departments/deal-monitor/deal-flow-rises-as-public-e-p-firms-let-go-of-prized-non-core-assets-to-focus-portfolios.html?cmpid=EnlOGFJOctober202015.html&eid=288189190&bid=1209476

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