A Game of “Pass the Parcel” with Assets

A Game of “Pass the Parcel” with Assets

February 26, 2015
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At the individual field level, the timing of the oil price collapse has in many cases compounded its overall impact. Prices started to fall at the beginning of 4Q 2014 just as joint venture partners all around the world got together to agree budgets for 2015. In many cases capital commitments were made to explore for new fields and to develop discoveries, as well as to rubber stamp the operating costs for fields already in production.

Companies planning to finance those capital costs out of the cash flow from producing assets are now having to think again. Borrowing to finance exploration and development in the current oil price environment is no easy alternative. Nor are shareholders in the mood for shelling out unless there is a compelling case.

If all the joint venture partners in an asset are in the same financial boat it is easy to agree to defer spending until the wind changes direction. But when there is a partner with deep pockets, particularly a major oil company, then it may be not be possible to get agreement to re-write the budget that was signed a few short months ago, particularly when costs, such as rig rates, are falling. In which case a small partner with limited funds may be forced to farm out its share of the project to a third party with the money to meet joint venture cash calls, or relinquish its share of the field to more financially secure joint venture partners.

While major oil companies do not have unlimited funds this provides an ideal opportunity to pick up enhanced shares of the best assets where they have weak partners, and defer expenditure on projects that, while still passing internal hurdle rates, do not hold out the prospect of such a high rate of return.

Trading houses, whose access to cash is not necessarily impaired by low prices, because they can make trading profits from price movements regardless of the absolute level, are well placed to “help out” minority asset owners who cannot fund their spending commitments. The quid pro quo is a share of the asset and usually the right to trade production from the asset in perpetuity.

2015 is likely to be a big year in the M & A market and is likely to see a record number of farm in deals recorded.