Private equity-backed oil companies are now dominating the UKCS M&A market, as rationalisation amongst IOCs and supermajors opens up new space for leaner, localised players. Wireline talks strategy with some of the leading new producers.
A new hierarchy is emerging on the UK Continental Shelf (UKCS). The $2.68 billion deal announced this April, which will see Chrysaor take on ConocoPhillips’ portfolio of North Sea assets, cements a so-called “changing of the guard” underway in the basin as international oil and gas operators and supermajors pull back from regional operations in favour of US shale and other core portfolios. At the same time, it presents substantial opportunities for a relatively new breed of E&P company.
The deal will see private equity-backed Chrysaor emerge as the largest producer in the region, with expected production of 185,000 barrels of oil equivalent per day (boepd) and 2P reserves of over 600 million boe. More than this, it demonstrates the viability and attractiveness of the UKCS for smaller, leaner businesses looking to grow – many of which have been capitalised by private equity (PE) investment.
Although no stranger to the North Sea, perceptions of PE within the industry vary. For some, the uptick in interest is a response to the recent price downturn, with hawkish fund managers picking up assets at knock-down rates. For others it represents a new, leaner blueprint for explorers and producers in the North Sea, as the conventional incumbents are replaced by companies that more closely resemble financial start-ups than E&P majors.
Nevertheless, the influence PE has had in recent years is undeniable. According to a 2018 Wood Mackenzie report, £7.7 billion in PE investments (together with debt finance and other capital) have helped fuel over £9.3 billion in M&A activity in the North Sea since 2014. Based on funding disclosed at the time of writing, the energy consultancy estimated that a further £10.5 billion could yet be invested. OGUK also expects that the influence of PE will continue to grow. PE-backed companies are on track to double their share of UKCS investment from around 12% to 24% between 2019 and 2025, making them the second-largest funders of activity. Much of the UK’s future production therefore hinges on their success.
Wireline met with three of the basin’s newer PE-backed players to learn more.
“We’re looking to build a business that is not just successful in the UK but has a much broader geographic footprint.”
Building a business
Neptune Energy illustrates how PE houses are pursuing new businesses with a global outlook. Founded by executive chairman Sam Laidlaw in 2015 with investment from the Carlyle Group and CVC Capital Partners, in just four years Neptune has established a hub of North Sea assets spanning the UK, Norway, the Netherlands and Germany, as well as interests in North Africa and East Asia. Director of corporate affairs Julian Regan-Mears explains that Laidlaw’s intention was to create “a gas-weighted, global E&P business of scale that had organic growth opportunities…but also had a strong enough balance sheet that it could go out, be acquisitive, and do transformational deals.”
For Neptune, the most transformational of these was the $3.9 billion acquisition of ENGIE E&P International (EPI) in February 2018, which catapulted the group into the spotlight as one of Europe’s largest international independent E&P companies. The transaction also brought in a new equity partner in the form of China Investment Corporation (CIC) which became Neptune’s largest single shareholder, with 49% of the company. This ownership structure, he says, “gives us a pretty long-term view.”
The result is an independent E&P company which, as of the end of 2018, had production of around 162,000 bpd and 2P reserves of 638 million boe. In the UK, activity is currently focused on the Cygnus gas field with partner Spirit Energy, but will include its operated 50,000-boepd Seagull development from 2021. There are also plans to drill exploration wells at Isabella and Darach this year – two of seven wells it plans to drill in 2019.
Where Neptune has targeted big-ticket acquisitions, Verus Petroleum has worked to a smaller and more strategic blueprint. Formerly Bridge Energy, it was acquired by Norway-based PE fund HitecVision and delisted from the Oslo Stock Exchange. The group’s Norwegian assets were folded into Spike Exploration, while Bridge was relaunched as the UKCS-focused Verus in 2014. Rather than taking over large portfolios, the team’s approach has been to buy into strategic assets with solid production, using the revenue to fund larger acquisitions. “We are essentially a business development deal-making team and that’s what we were formed to do, to build up a portfolio over a period of a few years,” explains chief executive Alan Curran.
This was cemented in late 2016 when it acquired additional stakes in the Boa field, buying 9.8% from Maersk Oil and bringing its total hold to 11.3% – the whole UK portion of the Norwegian/UK cross-border field. “That transaction has proven to be a fabulous deal in that it’s exceeded our expectations,” he says. “We’ve drilled two wells since we bought the stake and the field continues to outperform our expectations. That was a very important step.”
A tranche of subsequent deals in 2018 saw the company buy 17% of the Alba field from Equinor, a 47% interest in the Babbage field from Premier Oil and acquire the assets of Cieco Exploration & Production (UK) Limited from Itochu, which granted a 23.1% stake in Western Isles, among other fields. By the end of 2018 Verus’ production was around 18,000 bpd, with a resource base in excess of 60 million boe, and average lifting costs of $8/bbl.
Zennor Petroleum has also sought to establish a solid bedrock of production, but places much more focus on its in-house technical expertise to provide a competitive edge. Formed by a management buyout of MPX in 2014, it secured an initial $100 million investment from oil and gas-focused fund manager Kerogen Capital in 2015, largely to enable the appraisal and subsequent development of its keystone Finlaggan development, in which it holds a 100% interest. “What we’ve been trying to do is build a business of scale, but organically rather than just through acquisitions,” notes managing director Martin Rowe.
However, early 2016 saw Zennor acquire its interests in the Mungo & Monan fields (part of ETAP), Bacchus and Cormorant fields from First Oil and following this successful start Zennor secured an additional $200 million equity investment from Kerogen and its investors in 2016 to enable the company to build out to a scale in excess of 100 million boe 2P + 2C and 10,000 boepd net.
Whilst Finlaggan remained the focus, 2018 saw the acquisition of Mitsui’s interest in Britannia, taking the company to production of 4,400 boepd and around 107 million boe of 2P and 2C reserves. This transaction has also given Zennor a foothold in the infrastructure that Finlaggan is tied back to, which the company intends to use to support further activity. Martin explains: “We saw the power of having ownership in both the infrastructure as the satellite development local to it. We now have an ownership stake in two key CNS [central North Sea] hubs and we’re able to focus our appraisal and development activity in and around those two pieces of infrastructure. That helps concentrate the business going forward.”
All three companies have clear visions of business growth, but their exact routes vary. For Verus, the plan was first and foremost about establishing a solid foundation. “Our goal was to build a business with a strong production base,” Alan explains. “We did not have multiple billions of equity to invest at the beginning, so it meant that our business model had to be different in that we would be very careful about the production assets we bought… But we were very clear-headed, our model was production: build out the production portfolio, generate cash and then start to extend ourselves into growth opportunities with a much stronger development and exploration content as well.”
With this cash-generating phase now largely complete, the team is looking towards more targeted growth investments, which he likens to “rifle shots”. These could be either greenfield or development opportunities, but ultimately any new venture would have to provide Verus a say in the asset’s future plans. “We need to get our hands on opportunities where there is still some running room in terms of defining the path of the development,” he continues. This may or may not include becoming an asset operator – for Curran, the question is purely about “when it makes sense in terms of adding value” – but the company is under no pressure to swoop in to take operatorship of new or existing developments on principle alone.
With Kerogen’s support Zennor has been able to play a more opportunistic game, picking up valuable assets during low-price periods while maintaining what the company has referred to as an “owner mentality”. Martin adds: “We see real value generation as being through the drill bit and so we have focused on trying to capture those assets that would give us future growth in the portfolio at the time in the cycle when they were very cheap.” Finlaggan was a central part of that strategy, further enabled by subsequent awards from the 30th Licensing Round around both ETAP and Britannia.
“We did not have multiple billions of equity to invest at the beginning, so it meant that our business model had to be different.”
Martin also credits Zennor’s small, technically focused team when it came to acquiring its early assets. Swift action and a detailed understanding of the Mungo/Monan, Bacchus and Cormorant East fields allowed it to rapidly present a business case to Kerogen, leading to a deal in just six weeks.
With its focus on size, diversity and scale, Neptune has larger ambitions in the UKCS and beyond. “We are trying to build a business for the long term,” Julian says. “We’re not trying to build it up and sell it on. We’re looking to build a business that is not just successful in the UK but has a much broader geographic footprint.”
Nevertheless, it is also taking stock, moving now from a raft of acquisitions to an emphasis on value creation. With larger reserves, he notes, “We can be a bit more discerning about what we want to buy.” Moreover, with such a large (and valuable) portfolio acquired via the Engie transaction, “You don’t want to dilute that by paying over the odds for portfolios that inevitably have both good bits and bits that you like a little less.”
In numerical terms, that has meant pushing UK lifting costs down to $7/bbl, nearly half the $13/bbl necessary a year ago. In terms of existing UK projects, the high-risk, high-reward Isabella leads the company’s priorities, and represents “a game-changing opportunity for us in the UK,” he says. “We like opportunities around our existing hubs, we don’t see the need to do frontier exploration or go into areas where we don’t have expertise or capabilities.”
Realising value, however, will also see greater production abroad – at least in the medium term. While 75-80% of the company’s portfolio is in Europe at present (11% in the UK), Indonesia is now its third-largest component, and new output is slated to come online in Algeria this year. New projects are set to bring on around 90,000 boepd worldwide over the next two to three years – more than half its current 160,000 boepd.
Like Verus, however, Neptune is not after production at any cost. “We want to get things done, we’re serious and we’ve got the cash to do it, but we’re not going to do things for the sake of it… There are a lot of portfolios up for sale at the moment, but they would have to fit in, they have to provide balance to the portfolio.” While the company could potentially push towards 200,000 bpd in the medium term, it is in no hurry to raise output to meet shareholder commitments alone. “It’s a delicate balance as a business grows,” he notes.
Trust in PE
All three companies have also had to work to prove their legitimacy in the eyes of an industry known for its conservatism. Even with the backing of well-regarded private equity houses, financial support such as lending and debt facilities did not always come easy for groups like Verus, with Alan recalling a year or two spent in search of a banking partner during the worst of the downturn (a role ultimately filled by Nedbank). For Zennor, there was some wariness during its early engagement with infrastructure partners – Martin characterises the past (mis)perception of the company as “private equity wide-boys” – all of which was laid to rest once the team had demonstrated its subsurface expertise.
The faith in that expertise also led Zennor to conduct its own analysis in projects where it believed partners had missed opportunities – proof, if needed, of PE’s ability to hone-in on extracting value. “We have some specific examples where a small technical team that’s focused and understands what it’s trying to do can demonstrate to the big boys that improvements can be made,” he continues. “We can’t always influence the timeline, but we can demonstrate that we’re adding technical value to these groups.”
Nevertheless, being new entrants does allow them to think and operate differently. Julian describes Neptune’s “mature start-up” mentality, where a flat management structure enables speedy decision making, reduces costs and unnecessary process. As well as empowering individuals to make decisions – a point echoed by Alan Curran – it enables the company to be more open to new technologies and ways of working.
In turn, a lean structure also allows these companies to engage with the supply chain in ways that larger E&P groups cannot. In Zennor’s case, that meant offering contractors deadline flexibility in installing the pipelines and umbilicals that will tie Finlaggan back to its host. Final installation cannot be completed until a period of shutdown in mid-2020, meaning the company is in no rush to hit arbitrary short-term goals. In return, Martin says the contractors were able to work to their own schedule and offer a competitive price. “It’s not rocket science,” he says, “We just have to keep doing things in a simple, straightforward manner that works for all parties.”
For Curran, these kinds of cost-saving engagements – whether behavioural or technological – and trusting relationships will pay dividends to both E&P companies and their supply chain partners. This emphasis on business collaboration as a net benefit, rather than as an antidote to tough market conditions, is something he is keen to put across. “I think as we go forward you’ll see more and more of that. You’ll start to see more business models in companies like Verus that are different from those that have gone before, models that are more efficient, more cost effective and will result in more activity and MER in the long run.”
“We have some specific examples where a small technical team that’s focused and understands what it’s trying to do can demonstrate to the big boys that improvements can be made.”
As Wood Mackenzie’s analysis suggests, the recent spike in M&A activity has largely been driven by an influx of private equity. This trend is expected to continue in 2019 as majors and even larger PE-backed buyers spin off pieces of their portfolios to independents or other PE-backed companies, according to a recent update from law firm CMS.
Perhaps inevitably, much of the concern around the influence of PE hangs over the question of what will happen when fund managers look to exit their investments. Although the routes for doing so are well established – either a trade sale, a flotation or merger, or potentially a combination of all three – PE-backed companies often face greater scrutiny over the potential for sales or acquisitions than their independent rivals.
For those at the helm of Verus, Neptune and Zennor such speculation is largely par for the course, but the prospect of an equity exit also helps guide their teams in how to build these businesses. All three executives spoke of the focus provided by this mindset, given that every strategic decision will inform how the business looks in five or ten years’ time. “[PE funds] are always mindful about what they are creating,” adds Alan, “Because eventually they are always looking to crystallise their investment and reinvest in something else – but the oil and gas company doesn’t go away. It’s about creating successful, sustainable businesses that will go on to support the delivery of MER and ultimately increase revenues for the country, beyond private equity exit.”
For Zennor, the direction is clearer still. “Private equity is fairly ubiquitous in that it’s nearly always looking for an exit in a six- to seven-year timeframe,” explains Martin. Kerogen’s investment in 2015 points to an exit point around 2021/22 – most likely via a trade sale, owing to Zennor’s smaller size – and so, he says, “Everything we’ve done has been towards creating the right kind of vehicle at that exit point.” In the meantime, he believes that private ownership allows the company space to focus on growing the business, rather than on public filings and managing shareholders.
Neptune’s team benefits from similar freedom, and Regan-Mears talks of the ability to concentrate on long-term planning, and not on production tomorrow but on “reserves two, three, five years down the line.” Dialogue and support from its PE shareholders allow it to focus on “building a business that is going to last, rather than one where we’re looking to the next quarter all the time,” he says.
“There is going to be a lot more local investment – the money might be coming from overseas but it’s local players who are at the heart of the investment.”
In contrast with the smaller players, while the prospect of an exit informs Neptune’s strategy in terms of its reputation for growing reserves and delivering profitable projects, it does not guide decision making in quite the same way. “I think that in some point in our future we will see an IPO, but we’re not going to do anything against the clock. We’ve only been in business a year, we had a solid year both operationally and financially, but we have a lot more to do.”
Ultimately, all three companies are bullish on the positive impact that PE has had on the UKCS, particularly as the industry emerges from a low-price cycle. “I think private equity went into a place that not many other businesses would have gone into,” says Julian. “I think it’s safe to say that it’s made a considerable difference in the North Sea, and still does.”
Leaner business models, combined with a willingness to commit capital to both greenfield projects and reappraisal activity, will be crucial in driving the future of the North Sea. For Alan, it will also mean the basin is increasingly managed by smaller UK-based companies, rather than within larger international portfolios: “There is going to be a lot more local investment – the money might be coming from overseas but it’s local players who are at the heart of the investment.”
Companies like Zennor also show that PE will benefit long-term infrastructural planning too. Investment in operations at ETAP by operator BP have already extended life to 2035 and beyond, and will continue to enable future development activity. “This tying back of additional resources, appraisal of discoveries to tie back, this is what is going to keep certain parts of the central North Sea going,” Martin adds.
Alongside peers like Chrysaor, Hurricane Energy, and Siccar Point, these PE-backed companies are steadily reshaping the UKCS market. What is clear is the extent to which they are laser-targeted on growth and the development of profitable businesses that are sustainable for the long term. Far from quick cash-generating schemes or financial engineering exercises, they are entirely preoccupied with the survival and prosperity of their businesses – and of the North Sea –well beyond five- and even ten-year horizons. In doing so, the challengers are fast becoming part of the establishment. Their support and investment will therefore be critical to delivering MER and in achieving the ambitions set out in Vision 2035.
“If you look at what we’ve been about, it’s purely been about good solid subsurface work and sensible commercial strategy,” Rowe affirms. “And if you do those things, you’re basically just a regular oil company but using a different source of equity to deliver growth. That’s all we’re trying to do.”