Commodities

David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

Never believe a chief executive who professes to pay no attention to share prices.

Back in July, the forward price-earnings ratio of Australia's Woodside Petroleum drifted above that of its smaller rival Oil Search for the first time since 2008. Within six weeks, Woodside CEO Peter Coleman had made an $8 billion stock-based takeover offer.

Picking Their Moment
Forward price-earnings ratios of oil & gas companies
Source: Bloomberg data

The proposal was well-timed. For most of the past decade, Oil Search's valuation has been so much higher than Woodside's that a non-cash bid would have been rejected out of hand. In takeover deals as in life, the idea is to marry up, not down.

That makes it somewhat surprising that Coleman has now backed out without even trying to sweeten the deal. The original proposal to exchange one Woodside share for every four in Oil Search would have left the suitor's shareholders better off in the first year after about $150 million of cost savings, according to data compiled by Bloomberg. Improve the terms to one-for-three and you only need to defer the benefit by a year and lift the cost savings to $300 million -- equivalent to about 6.4 percent of the two companies' $4.68 billion operating costs during 2014.

Still, Coleman's decision to walk fits the pattern this year of the oil and gas industry failing to consummate its deals. Leave out Shell's pending $79 billion offer for BG, which alone accounts for about one-third of the value of takeovers in the sector this year, and this is the second-weakest year for deals since 2009: 

A Slow Year
The size of the Shell/BG takeover is covering up a lackluster picture for oil & gas M&A
Source: Bloomberg data

Australia's Santos in October knocked back a $5.2 billion proposal from Middle Eastern investors and elected to sell new shares to cut debt instead. Latin America's largest independent oil producer, Pacific Rubiales, rejected a C$2.1 billion ($1.6 billion) bid from a group of companies in July. Meanwhile, the management of Canadian Oil Sands is telling shareholders to stay away from a hostile C$4.5 billion offer from Suncor Energy that's still open.

Uncertainty about the future of the industry is leaving potential buyers sitting on their hands, according to Bloomberg Intelligence's Salih Yilmaz and Philipp Chladek. The CBOE/Nymex Oil Volatility Index, a measure of expected fluctuations in the oil price over the next month, has averaged 45 so far this year, about double its level during 2014. That's made it hard to work out what valuations should be.

The drought can't last forever. An increase in U.S. interest rates at this month's Federal Reserve meeting will make it harder for exploration and production companies to roll over their debts, making it more likely they'll come to the table at a price acceptable to buyers, according to Bloomberg Intelligence. Oil's tumble to a six-year low Monday, after Opec failed to agree on a production target last week, will also inject a bit of realism. Indeed, there already are hints that sellers are getting more enthusiastic: Takeover premiums this year have averaged 27 percent, their lowest level since 2009.

Buyer's Market
There are fewer oil & gas takeovers, and asking prices are lower
Source: Bloomberg data
Spending the Inheritance
Oil & gas companies' reserve replacement ratios, %
Source: Bloomberg data
Note: Mid-sized companies have been charted; median is for all oil & gas producers with annual sales above $5 billion

It can't come too soon. As Gadfly columnist Liam Denning has pointed out, petroleum companies have to add new assets through exploration or acquisitions or else the well quite literally runs dry. That's particularly the case with Woodside, whose reserve replacement ratio over the past year was 4.2 percent, compared with a healthy median of 101 percent among the 45 producers with more than $5 billion in annual sales. At current production levels, its oil fields will be all tapped out by the end of 2026, the shortest reserve life the company has recorded since at least 1998. Coleman may have walked away from this deal, but he'll be back.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
David Fickling in Sydney at dfickling@bloomberg.net

To contact the editor responsible for this story:
Paul Sillitoe at psillitoe@bloomberg.net