Energy and Utilities M&A Outlook 2008

In the US today, oil and gas prices have reached levels where mainstream media are even discussing the high prices.  Given high demand and reducing supply, few expect to see these prices fall from these record highs.  Fresh reserves are increasingly difficult to access and due to remote onshore and deep offshore locations, the costs of extraction are growing.

Smaller independent energy companies and energy service companies have been increasing exploration activity.  Exploration and production spending in the US is set to increase by around 5% this year to $75 billion.  There have been poor efficiencies in onshore natural gas exploration activity as capital spending has increased by almost one half last year, but only a 4% growth in production.

Liquefied Natural Gas (LNG) is about 1/600th the volume of natural gas, so is much more cost efficient to transport.  Given the efforts to keep production costs down and find fresh energy reserves, new investments in LNG, as well as ethanol and other non-traditional fuel sources are showing rapid growth.

As larger oil companies seek new reserves, M&A activity will likely increase among the smaller energy firms.   There are vast cash piles available, looking for access to supply.  In addition to larger energy companies looking to increase their inventory, there are increasing sums of private equity going into exploration.

Energy support product suppliers and energy service suppliers are benefiting from this heightened activity and are also becoming targets of acquisitions.

A number of new trends have appeared in the utility sector.  State and national boundaries have always been significant barriers of utility companies, but increasingly investment is going across borders.  There are also many utility companies who are getting involved in the risky business of energy trading in an effort to cope with the volatility in energy prices.

Traditional methods still exist of owning much of the supply chain from production to customers.  At the same time, many firms have to concentrate on particular parts of the energy chain due to regulations.

Federal regulations have been and continue to be a limiting factor in M&A activity in the utilities sector and despite the new Energy Act, it is unlikely that there are going to be high volumes of M&A transactions.

In the mining sector, there has been an unprecedented move into global acquisitions, alliances and joint ventures.  As domestic supplies are depleted, environmental regulations tighten and operating costs increase, many larger companies are looking abroad to previously untapped emerging markets.

High barriers to entry had prevented many firms from entering emerging markets, but the rewards have been proving too great to ignore.  Many emerging markets have been offering incentives to entrants and the pool of low-cost labour and high quality reserves serves to compensate high start-up costs.

Mining companies have responded to domestic problems through restructuring and cost reduction initiative, as well as adopting more efficient new technologies.  While M&A activity in the sector is high across the board, the biggest growth area has been in global M&A activity.

SOURCE: PricewaterhouseCoopers