Low Oil Prices: how business buyers can profit

Thu, 09 Apr 2015

Plummeting oil prices have dominated the news of late as supply and demand issues continue to conspire to drive the price of crude to near historical lows.

As prices hover around the $60 a barrel mark, with talk of the world potentially never seeing prices climb over the $100 threshold again, confidence in the sector has fallen to worryingly low levels and businesses both directly and indirectly involved in the oil and gas industry are reporting increasing levels of financial distress.

But is it possible that there is still a light at the end of the tunnel? Could there still be a profit to be made in the industry or is it nothing but renewables from here on in?

The Longest Downturn in Two Decades

Firstly, it's worth noting that the oil industry has recovered from tougher times than these. In 1998 prices dropped to as low as $11 a barrel, while in 2008 when the recession hit they were hovering around the $30 mark. But what's troubling the industry about current low prices is the protracted nature of this downturn.

Following the June 2014 peak of $116, prices have been falling for their longest-running decline for two decades. Now in February 2015 prices are almost 50 per cent below that June marker point and they're still falling.

But what's the cause of this somewhat epic market decline? It's a pretty simple and well reported case of supply versus demand: increased production levels of new types of extraction (namely US shale oil) coupled with the return of Libyan oil to the market, have pushed up supply, while demand, particularly from China and the EU, has reduced. There is plenty of argument over the extent to which the prices are being affected by supply issues or demand issues, but that's the basic state of play.

Alarming Increases in Distressed Businesses
Unsurprisingly, the price drop is having a massive effect on one of the biggest industries in the world. In the UK alone, the number of oil and gas businesses experiencing 'significant' distress rose by 17 per cent between the third and fourth quarters of 2014, and by an alarming 69 per cent between the fourth quarter of 2013 and the same three months in 2014, according to the latest data from the Begbies Traynor Red Flag Alert.

The figures are even more pronounced when you look at the businesses that provide services to the oil and gas industry, rather than the main players. In this area, the number of 'significantly' distressed companies has more than doubled year-on-year with a massive increase from 93 to 201 recorded.

This means that some 486 oil and gas industry businesses and over 200 supporting businesses are at serious risk of succumbing to their financial distress as they start to consider the realities of calling in the administrators or selling business assets to stay afloat.

But that's not all. Further research from financial risk management group Company Watch has indicated that it believes 70 per cent of the UK's publicly listed oil exploration and production companies are failing to turn a profit, with an ever-increasing debt and risk of bankruptcy on the horizon due to the low price of crude oil.

Is there Light at the End of the Tunnel?

It's clear that times are tight for those deeply invested in the industry. But what about the promise of the light at the end of the tunnel and the potential for profit? Well the potential for profit may still be there for businesses open to investment and new direction or even a complete fresh start under new ownership.

A recent report from PwC indicated that the current situation should not have been quite the surprise that it was. The paper noted that had the industry heeded the warnings of 30 to 40 per cent cost reductions that surfaced towards the end of 2013, it would now find itself in a significantly stronger position to “weather the oil price maelstrom”.

Unfortunately, much of the industry failed to take pre-emptive action and there's no denying that for those considering buying into the oil and gas sector the road ahead is far from clear. But for the smarter buyer all the current state of affairs has done is reduce costs and competition when it comes to making a distressed acquisition, and there's no denying that there is an abundance of distressed oil and gas businesses and assets about to enter the market.

Furthermore, PwC has suggested that many healthy SMEs either directly involved in the industry or operating in the services sector adjacent to oil and gas companies are looking to sell non-core areas of their business as part of damage control plans in the onslaught of the industry downturn.

For those giving serious consideration to these acquisition opportunities, the immediate negative outlook is of little concern. They have a low purchase price in mind and a solid acquisition strategy in their pocket; their eyes are firmly on the profits that could be made when things pick up again. And pick up again they will if market predictions are anything to go by.

We must clarify that nobody can say for certain when or even if oil prices will increase. But current analysis is genuinely hopeful. Saudi Arabia's oil minister, Ali al-Naimi, is among those to have indicated that a revival is on the cards. Speaking to the Middle East Economic Survey, he said: “As a policy for Opec [Organization of the Petroleum Exporting Countries] ... it is not in the interest of Opec to cut their production, whatever the price is.”

His remarks are born out of the theory that it is the decline in demand rather than the increase in supply that has resulted in the low price of crude – something that will correct itself as the global economy evolves. In fact, some analysis has even suggested that low oil prices will contribute to an economic boom, albeit with a major shift in industrial and geographical focus.

Depending on how things play out, business buyers focusing on the transport and logistics sectors in particular could be looking at an interesting phenomenon in prices in the M&A market as a result of the oil prices and the economic shift. For many of these companies, oil products represent a large proportion of their operating costs, meaning that profitability, should all other factors remain equal, should be on the rise.

The interesting option for buyers arises when one of these companies changes hands and a valuation is given based at least in part on historical accounts. These historical accounts will demonstrate a higher oil price, potentially bringing down the forecast profitability and sale price of the business. A bargain arises for buyers who foresee a much higher level of profitability than that forecast in the valuation if they are willing to bank on oil prices remaining low.

It is however tricky to forecast exactly which way things will go, but this is certainly one outlook.

As far as Mr al-Naimi appears to be concerned, the answer for the markets is simply to wait it out. This approach came as quite a shock as many had expected Opec to step in and stabilise prices by cutting production as it has done many times in the past.

Mr al-Naimi and Opec's view is supported by others including Danny Gabay of Fathom Financial Consulting, who told the BBC that the drop in oil prices was "overwhelmingly, predominantly, if not entirely, a demand shock. It's China slowing down. The supply element is more of a reaction".

Opportunity Rising

As smaller businesses in the industry in particular find themselves facing insurmountable pressure from the price crunch, so the number of opportunities for buyers looks set to increase. Whether buyers are considering a fresh entry into the industry, the buyout of a rival or simply the acquisition of assets for use in another engineering or manufacturing business, now is the time to get serious.

For those looking to take on an entire company, clearly defined strategies will prove essential. A rise in prices may be on the cards, but it's certainly not on the immediate horizon. Anyone looking to make a profit from a distressed acquisition within oil and gas industry will need to have a solid plan in place to allow them to weather the uncertainty that still has its grip on the sector.

Standard efficiency procedures as suggested by PwC, such as offloading surplus assets and tightening up on costs across the board, will take you some way, but as always in successful distressed acquisitions, it's a solid turnaround strategy and perfect timing that will deliver the real profits.

This article was originally printed in the February 2015 edition of the Business Sale Report.

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