Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

Alliances between Americans and the French usually only happen when there's a real crisis. That's where FMC Technologies and Technip, two oilfield services firms that just announced plans to throw in their lot together, find themselves today.

Thursday's announcement carries echoes of the mega-mergers between the majors that created the likes of Exxon Mobil at the nadir of the oil market in the late 1990s. Like those, this is an ambitious deal, stitching together two global, industrial firms each valued at roughly $6.5 billion and headquartered seven time zones away from each other. And, like those, this is an all-stock deal, with little or no premium for either side and a carefully choreographed allotment of the top jobs to executives from both companies.

Coming in the same month Halliburton called off its acquisition of Baker Hughes due to antitrust objections, FMC's and Technip's announcement is also a bold move. Schlumberger's recent $14.8 billion acquisition of Cameron International offers useful precedent on that front. Still, the modest break-up fee of $250 million seems sensible, in light of the $3.5 billion charge Halliburton had to eat.

Fraternité
Indexed stock-price performance
Source: Bloomberg

But these are desperate times for the companies that serve the oil and gas industry and, in particular, the companies operating offshore. More than half of revenue for the combined firm, TechnipFMC, will come from providing subsea equipment and services, which deal with operations on the seabed and their connections to surface ships and rigs. And demand for this has, well, sunk.

Surf's Down
Spending by oil companies on offshore development has fallen by almost a third since 2014 and isn't expected to bottom out until next year
Source: Rystad Energy
Note: Data for 2016 through 2020 are projected

Deep-water drilling has suffered in particular because those are complex projects requiring a lot of upfront spending, spread over several years, before a single barrel of oil is produced. That is just about the worst proposition you can bring to an oil major's planners right now, given that there isn't enough cash flow to even cover dividends. When they are tendering for bids, the majors are driving the hardest of bargains. On BP's recent earnings call, its chief financial officer said there was "no question" that leasing rates for deep-water rigs had dropped by half in the past couple of years.

That's the sort of pressure that produces nil-premium, cross-border mergers such as TechnipFMC. The cost synergies are a relatively conservative 2.5 percent of forecast 2019 combined revenue, based on Bloomberg data; all the better, perhaps, to counteract any political grumblings. Even so, taxed and capitalized at ten times and with upfront costs taken off, they still equate to about 14 percent of the companies' combined market capitalization -- which should help FMC's shareholders swallow the fact they are getting only half the company, despite having more highly-rated stock. In addition, the companies' plan to keep operational headquarters in Paris and Houston but move their legal incorporation to the U.K. could yield tax savings. 

Besides the defensive nature of the deal, however, its success or failure will provide an important litmus test for the entire oil and gas business.

The current oil crash is different from previous ones because of structural changes in supply and demand due to shale and conservation efforts, respectively. As I wrote here, simply slashing costs any which way and hunkering down until the oil price starts another big rally is no longer a sustainable strategy. Oil majors need to not just squeeze discounts out of service providers, but change the way they work with them.

This was a big theme in a recent presentation by Schlumberger's chief executive, and it featured heavily in the one given by FMC and Technip on Thursday morning, too. While it is easy to dismiss talk of integrated offerings and "redefining the industry," there is a point of substance in this case.

One of the reasons the oil majors' return on capital has plummeted is because of a terrible track record with delivering large, complex projects to specifications -- which is kind of the main reason they are supposed to exist in the first place. In a recent presentation, Chevron said only 8 percent of oil and gas projects sanctioned by the industry between 2007 and 2010 had come in on time and on budget and met their production targets.

Timing, especially, is critical. Imagine a simplified oilfield that takes three years and $3 billion to develop and then spits out $1 billion of free cash flow every year for 20 years, discounted at 15 percent. Now, without changing the costs, assume that various snafus delay the development timetable by an extra year. That one change wipes 13 percent off the net present value of the project.

TechnipFMC is hoping that, by offering an integrated service, it will eliminate friction in the tendering and planning process, letting it help oil majors get to production of their sub-sea reserves more quickly -- thereby persuading them to actually go ahead with projects despite the tough environment. It helps that the two companies have an existing joint venture, Forsys Subsea, that they claim has already helped reduce breakeven prices for projects by $5 to $7 a barrel. Certainly, there should be some value in coordinating in-house the deployment of the giant underwater and surface equipment required by deep-sea projects, rather than having it come from separate suppliers.

The majors, on the other hand, historically liked to use multiple contractors, theorizing that competition kept costs down. The question for TechnipFMC now is whether, in a changed world, their clients are willing to break with tradition.

Update: This story has been updated to add details about the tax benefits of the deal.

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

To contact the author of this story:
Liam Denning in San Francisco at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net