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Shape of things to come in UK M&A market

MOVING ON: Some of the oil majors are trying to sell off their UKCS assets.
MOVING ON: Some of the oil majors are trying to sell off their UKCS assets.

Following a period of relatively low deal activity, in 2018 we started to see an uptick in deals – but that has paused slightly since the oil price fall at the end of 2018.
Are there more deals to be done, or has oil price volatility cooled off the M&A market? What do the trends and themes seen in some of the latest UKCS M&A deals tell us?

Recent Market Trends
Recent years have seen relatively few completed UKCS deals. Many assets are for sale, with some majors seeking to exit the UKCS.
Others want to streamline their operations, adopting core asset strategies and divesting non-core assets, like BP increasing its interests in Clair while divesting interests in Magnus, Sullom Voe Terminal and the Bruce-Keith-Rhum area.
By contrast, some established independent exploration and production firms like Premier Oil appear to be looking at asset acquisition. They are joined by a raft of new private equity (PE) backed players, such as Siccar Point, and Zennor. This growing appetite for acquisitions has fuelled competition, promoted further by a perceived rise in the availability of finance, including debt finance.

The Driving Forces
Oil price volatility has meant potential buyers are cautious about value. These issues persist, but the industry has developed solutions. Buyers and sellers have tried to bridge the gap with deals that don’t require full payment upfront. Deferred payments let a buyer defer part of the consideration until a specified event, like first oil. Elements of consideration may also depend on future production from the assets.
Liability for decommissioning remains a stumbling block, especially given the emergence of smaller PE-backed players. UK regulation leaves sellers potentially liable for costs even after sale so traditionally they have sought full security.
But the economics of older reservoirs may mean remaining reserves will not cover decommissioning costs. Smaller firms are limited in their ability to give guarantees to satisfy requirements for security.
But some sellers recognise they are unlikely to achieve a “clean break” from the assets and will retain certain decommissioning risks. We have seen various innovative deal structures including:
• Retransfer of the assets to the seller at cessation of production
• Retention of the liability to pay costs for decommissioning only
• The seller still providing all or some of the security to other co-venturers on behalf of the buyer
• Negative consideration (i.e. paying an agreed amount into a trust for the buyer’s benefit so the seller can obtain a clean break)
• Trust fund build-up (the buyer takes decommissioning liability but security is built-up out of field revenue).
The UK Government helped by introducing transferable tax history (TTH). This is crucial to allow tax relief on decommissioning costs. New entrants have no such history, which means their decommissioning costs are higher than for the seller. Until now, a seller could not transfer any of an asset’s tax history.

A View to the Future
What does the future hold for oil and gas M&A in the UKCS? We anticipate the following in the short to medium term:
• A continued drive by oil and gas majors to simplify their portfolios and divest non-core fields and assets
• Sellers will still accept the retention of certain liabilities and work with buyers to find innovative solutions to bridge valuation gaps
• Taking advantage of some majors’ desire to exit the basin, PE backed companies will still pursue acquisitions in 2019 and will form a key part of the next phase of oil and gas operations in the UKCS
• But given the nature of PE investment, some investors may re-deploy their capital in other markets so secondary buy-outs will become a greater feature
• We expect PE firms with large portfolios acquired from majors in one “swoop” to look to spin off parts of such portfolios to other PE entities or independents
• As the oil price settles, debt finance will become more available. This may open up acquisition opportunities in the UKCS for established independent E&P firms and smaller independents with experienced management teams
• We anticipate that TTH will become increasingly prominent.
As ever deals will hinge on one of the items parties cannot control – the oil price and its volatility.

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Craigmill, Pitcaple, Inverurie, Aberdeenshire, United Kingdom, AB51 5HP
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