Focus

Seeking Alternative Forms of Industry Consolidation

In their efforts to withstand the low oil-price environment, oil and gas players may wish to embrace non-traditional approaches of industry consolidation in order to address the particular realities facing the Malaysian market.


Traditional consolidation

Historically, a reduction in the price of oil has caused the global market to enter a consolidation phase. For large companies, this consolidation has frequently come in the form of mergers and acquisitions (M&A), primarily as a result of their extensive financial resources and drive for risk. For instance, the oil price downturn in 1998 was followed by a wave of M&A as players sought to gain economies of scale, exemplified by the creation of a number of new oil companies, including the world’s largest, ExxonMobil.

Despite the industry continuing to face a challenging environment following the 2014 oil-price downturn, consolidation in the global oil and gas sector remained strong throughout 2016. During that 12-month period, upstream capital expenditure dropped for a second consecutive year, oil prices fell to a 13-year low, and oil and gas bankruptcies exceeded those registered after the 2008 Financial Crisis. Concurrently, both M&A activity and the total value of M&A deals rose from 2015 levels (see fig. 1), with seven separate deals of over US$10 billion each being signed, representing the highest amount ever.

According to Deloitte, certain factors are set to prolong this consolidation trend among global oil and gas companies, including: OPEC members complying with agreed production cuts; expectations of more stable oil prices of between US$50-60 per barrel in the short term; credit availability and improving demand prospects due to upward revisions of the value of oil and gas reserves caused by higher price decks; and a greater conversion of uncompleted U.S. wells into production-ready operations.

The rise of strong fundamentals in the global oil and gas sector is one reason to evoke greater consolidation in the sector as a whole. Moreover, resource depletion is another factor incentivising oil and gas companies to consider the M&A approach. Significantly, the increasing difficulty in the exploitation of new wells as a result of dwindling reservoirs provides an opportunity for resource-rich countries, such as Malaysia, to strengthen consolidation efforts and bolster competitiveness among relevant players.

Furthermore, M&A, in addition to other forms of consolidation, can provide several advantages for oil and gas companies, including facilitating access to new markets, increased funds for research and development, and greater innovation that has the potential to strengthen an existing product line specifically related to technology.

 

 

An alternative option for Malaysia

Despite the potential positives of traditional consolidation approaches, such as M&A, it is important that all parties involved in such a process consider the specificities of each market, and the Malaysian oil and gas sector is a pertinent example of this.

Due to the low oil-price environment, consolidation in the Malaysian oil and gas sector may prove inevitable. However, players are beginning to look beyond traditional notions of equity-based consolidation, which includes M&A, and focus on practical ways of addressing the pressing issues.

This is critical in the Malaysian context because the local sector is facing one particular challenge that is influencing all industry consolidation efforts: the existence of an excess capacity of commoditised services and specialised assets across multiple segments, each with its own priorities and concerns. Notable examples include excess capacities in the fabrication yard, specialised vehicle and drilling segments.

Significantly, the challenge of excess capacity cannot be resolved via equity-based consolidation. While that approach has proved successful in other industries, including banking, it is less translatable to the Malaysian oil and gas sector. This is due to several reasons, including the fact that the business of, for instance, fabricators in the country comes directly through PETRONAS, rather than the general public, as is the case with the banks.

An example of the challenge is as follows. If two oil and gas companies that each operate 100 barges merge to form a new company with 200 barges in a market where demand only exists for 100 barges, the excess 100 barges will still require some form of financing. Therefore, an M&A approach can be both expensive and unfeasible since it fails to address the excess capacity element.

Consequently, market stakeholders are actively seeking new ways forward. They realise that part of this process requires a firm understanding of existing market capabilities and that once this has been achieved, solutions can be devised.

 

A more collaborative approach

One possibility is to identify the specific areas in which players are able to collaborate and for them to enter into some kind of mutually beneficial partnership. This could be done via memorandums of understanding or joint ventures in which they work together on a particular project. In the fabrication segment, for example, players are openly espousing their willingness to collaborate by means of working performance consolidation.

In practical terms, such working performance consolidation could involve rival companies dividing workflow between them and conducting modular fabrication in which equipment is built off-site at one fabrication facility prior to its worksite delivery. Installation and integration could be carried out at another yard or directly into field operations.

Working performance consolidation is simply one example of how players can increase the utilisation of the excess capacity in the market. By following this approach, the mutual collaboration and joint pooling of expertise will enable oil and gas companies to overcome the downturn and increase their likelihood of becoming competitive global players on the upside. It will also help them to function with improved efficiency and greater innovation. That is essential to ensure the most appropriate, viable and practical form of industry consolidation moving forward.

 

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