Introduction
Under a merger, two business entities come together and become a new business with a new name. On many cases, the mergers bring together firms, which are equal in size and stature. On the other hand, an acquisition involves a larger and more powerful company buying another business; a smaller business. The purchased business may be fully absorbed by the parent company or in some occasions, may be operated as a subsidiary. The use of mergers and acquisitions may take place during any economic environment meaning that it may take place when the companies involved are both performing well, and the economy is strong. However, on many occasions, the merger and acquisition deals mainly take place when one or both companies involved are sailing through tough economic headwinds. There are various reasons why it becomes easier to acquire a target during tough economic times that is one important reason why the oil and gas sector experienced increased mergers and acquisition deals over the period between 2014 and 2015 when the oil prices lost 60% of their value (Cimillica, Mattioli, and Raice). In light of this introductory information covering what mergers and acquisitions are, the paper will focus on discussing mergers and acquisitions as one of the most important strategies applied by players in the oil and gas sectors. The analysis will focus on the period beginning 2014. The paper is organized into two major sections that include the environmental scan analysis looking into the external environment factors and the internal environment factors as they apply the oil and gas sector. The second section will focus on strategy analysis, which will focus specifically on mergers and acquisitions as an appropriate strategic positioning tool employed in the oil and gas sector.
Environmental Scan
Mergers and acquisitions deals in 2015 peaked at about $323 billion worth of deals (Deloitte). This placed the oil and gas sector in the third position of the most active sectors for the mergers and acquisitions for the year. The dollar values of the mergers and acquisitions may not necessarily increase in 2016. However, analysts from Deloitte, JP Morgan and KPMG have expressed their opinions on the possible trends in the oil and gas sector (KPMG). According to their separate reports, the activity may increase with increased volumes or numbers of deals (JP Morgan Chase & Co.). This is because there are various environmental factors pertinent to the oil and gas sector M&A activity as analyzed herein.
External Environment
The oil and gas sector has been facing various challenges to their long-term strategy. The disruptions brought to the sector by falling prices for oil in the industry. The prices in the oil and gas sector have fallen 60% since 2014. The implications of this are that many firms, especially the smaller oil and gas sectors have found it difficult to operate with the falling revenues. The falling oil prices resulted in many business firms gasping for air and hence triggering the need for strategy reconsideration. The sensitivity of the oil and gas companies to the dipping in oil prices exposed the soft underbellies of one of the robust sectors of the global economy especially considering the many companies reporting losses in the sector.
The dipping in oil prices was a precipitation of increased supply of oil from shale production. Some analysts have indicated that the cheaper production costs from flaking, especially in the United States has been the major source of dipping in the oil and gas prices. While the companies in the United States can produce oil at a lower cost than those in the major oil producing OPEC countries, the prices in the oil and gas factors are also increasingly suffering from increased release of oil into the black markets (Masi). The supply of oil into the black market has mainly been as a result of regime failures in Libya, Syria, Iraq, and Yemen among other countries (Rascouet and Lee). The implications of this are that the control of oil fields in these regions by rebel forces formed a market for cheap exports of oil alongside increased competition amongst themselves hence resulting in oversupply and putting pressure on oil prices. Notably, the various rebel groups have been in competition amongst themselves hence making worse an already bad situation in the oil and gas sector. Additionally, the rebels groups in many oil-producing nations where wars are still continuing are increasingly taking control of more oil fields and as a result, it is highly likely that the pressure on oil prices may continue until 2018, and this would mean the room for more mergers and acquisitions in the sector.
Other than the involvement of the rebel groups in oil supply into the black markets, the United States and Russian oil companies have been increasing production (Burgess). The increased production prompted the OPEC countries also to increase competition and talks to control the production of oil has been facing difficulties (Rudnitsky, Mazneva, and Khrennikova). The players in the previously oligopolistic market are increasingly getting drawn into the perfect competition market structures. Consequently, the quotas used to stabilize oil prices in past years no longer work in the new market structures; hence, the sellers attempt to make the best out of the current crises in the oil and gas sector. If continued, the oil prices may stabilize in the long-run, but this may not be at the highs they were before the current oil and gas sector crises began.
Other than the above-mentioned external factors, OPEC has been unable to hold talks on how the oil prices ought to be controlled especially due to the many disagreements on how much each member ought to produce. The implications of this are that the current oil crises continue without control considering that the disagreements and discord in OPEC continue to support increased and growing production. Notably, some of the oil producing countries, such as Saudi Arabia are now in debt. This is due to the oil price crises and unless the prices of oil rises, such countries would still be required to increase the oil production to be able to meet their debt and other obligations (Moscow Calls Saudi Bluff After Riyadh Threatens to Boost Oil Output-RT Business.). The increased production has direct implications on the performance of companies, and this is the reason why there is the increased pressure on companies to merge.
In 2015, Iran signed a nuclear deal that would result in the lifting of oil exportation bans. Iran is one of the main oil producers in the world and as a result of the agreement, the oil will be finding its way into the market (Kharpal). This will lead to increased supply in the market especially considering the amount of oil in her reserves. The implications of this are that there will be more pressure on the oil prices and as a result, the prices may take longer to reverse the current trend, and it may be more difficult to get to $50 a barrel which is half the price at which oil was trading two years ago (Egan). Notably, factors such as the signing of the Iran deal may not be in the control of the companies in the oil and gas sector and as a result, the mergers and acquisition deals in the sector are set to continue.
Internal Environment
The above external environment factors are not the only factors necessitating increased mergers and acquisitions in the oil and gas sector. Notably, the oil and gas sector involves various players who operate in different sub-sectors. For instance, there are the producers whose revenues are directly exposed to the oil and gas prices and; hence, taking the heat directly as the prices of oil fluctuate. There are also the explorers and those that manufacture oil-drilling equipment. Entirely, the oil and gas business is capital intensive, and this means that on many occasions the players in this industry will have debt on their balance sheets. The meaning of this is that as the prices of oil dip, the companies make losses and at times, they are unable to meet debt obligations. The direct implications of this on mergers and acquisitions in the sector is that there are deals that are entered due to the pressure of the creditors.
The cost factor is one of the major concerns in the oil and gas sector. Irrespective of the subsector in which a company operates, the costs are extensive. Consequently, the dipping in oil prices without similar declines in the costs of operations results in a lot of pressure on the bottom lines of the companies. At the moment, the only companies that are surviving the industry are only those with enough liquidity to enable them to survive the tough times in the oil business, and this includes the large multinational companies. On many occasions, these companies have diversified business lines, and this has been the reason why some have been able to survive the tough times. Even then, some of the companies in the sector have been forced to consider holding the pause button on their long-term strategies (Mattioli and Cimilluca).
Other than the above-mentioned factors, the oil and gas sector involves many companies operating in different business lines within the same industry. Some sectors of the industry are affected more than others with many firms especially in exploration and production of mining equipment being forced to stop their processes as the customer base in the business declines. Such are the major companies being taken over by larger players in the sector even as the big firms in the sector continue struggling with their business. Notably, there has been past calls for the consolidation of business in the oil and gas sector in the past with the period of the past financial crises being one in which most calls were made to have the industry consolidating its business. Consequently, the need for consolidation as necessitated by the many firms in the sector ought to be seen as one of the internal factors necessitating the current trends in mergers and acquisitions in the oil and gas sector. This trend is most likely to continue until the prices of oil continue to recover, and the firms in the sector are big enough to influence movements and business in the sector (Mattioli and Cimilluca).
Mergers and Acquisition Strategy
The mergers and acquisition as a strategy are widely being applied in the oil and gas sector. As a strategy, M&A comes with various advantages that can simply be regarded as a synergy of the creation of synergistic relationships. Synergy is the concept that the value and the performance of two companies combined will be greater than the sum of the separate individual parts (Scharf). Under strategic management, synergy gets referred as the potential financial benefit that would accrue to a firm through the combination of businesses and often, this is the driving force behind mergers and acquisitions. Synergy results to the creation of additional value for the shareholders of both companies. The best indicator of the estimated value of the synergistic relationship is the increase in share prices upon the announcement of a merger and acquisition deal. The post-merger prices also reflect the value of synergy as an effect of the deal (Mattioli and Cimilluca).
Synergistic relationships after mergers result from various factors. In the oil and gas sector, for instance, the combination of business interests has resulted in the handling of debt obligations in exchange for the handling of debt obligations in the target company. The business combination under such circumstances has often used a strategy to prevent the target from defaulting on the loan and preventing creditor liquidation process and even hostile takeovers (Scharf). Notably, this has been a key strategy for the oil and gas players in the years 2014 and 2015 and as the time progresses, it is highly likely that many business firms are likely to seek the reconsideration of their business strategy for mergers to avoid similar circumstances (Mattioli and Cimilluca).
The other major interest in a strategic combination of two businesses through a merger and acquisition is the issue of cost reduction. The strategy has been in wide application in the industry with several companies combining their business interests to respond to the sharp rises in the costs of operations as revenues dip. As a cost management strategy, mergers and acquisitions come into play especially considering that the acquirer may bring in additional experience in the management of costs. It also helps in the creation of a larger business enterprise with a higher bargaining power, and one that can enjoy economies of scale hence allowing for the reduction in costs. In a cost intensive business such as oil exploration and production of associated equipment, the strategy is appropriate for managing the costs of operations (Mattioli and Cimilluca).
The third major focus necessitating mergers and acquisitions in the oil and gas sector is the issue of the combination of talent and technology. The oil and gas sector is increasingly finding itself under pressure to improve its technology and acquire new technology. For instance, there are some businesses under the pressure to get better technologies but due to the high costs, it became difficult to acquire such technologies in well-performing markets. The difficult environment in the oil and gas business offers bargains for the acquisition of talent and technology, and this has been one of the reasons why it became important for the businesses to increase the deals in mergers and acquisitions as a strategy of acquiring new talent and technologies. For instances, some businesses were able to take control of businesses controlling the production of oil production equipment (Mattioli and Cimilluca).
The last major concern relates to the mergers and acquisitions as a market penetration and revenue growth strategy (Scharf). Notably, this has been in wide application especially across the industry with large multinational using the strategy to extend their reach to other markets and increase their revenues. Notably, acquiring a target in a market where oil and gas multinational corporations such as Shell BP ensures that the business can extend its reach into new markets (Riley). The timing of the deal is made important by the fact that during times of declining revenues, the valuations of the target corporations slightly declines and this provides a unique opportunity for the business combination deals (Mattioli and Cimilluca).
Conclusion
In conclusion, this paper discussed the mergers and acquisitions as an important strategic decision adopted by business entities in the oil and gas industry. Notably, the creation of mergers and acquisitions in the oil and gas sector has been necessitated by the tough environmental conditions. From the external environment perspective, the increased production, increased supply, and falling oil prices have been the main contributors. These resulted from increased supply of oil in the black market, increased production of oil in the US and Russia, as well as the disagreements in OPEC (Masi). With the recently signed Iran, nuclear deal and the lifting of the ban on oil exportation, the supply of oil in the global markets is set to increase (Kharpal). From the internal environment, the costs of operation form the major reason for the mergers and acquisition deals.
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