Martin McAspurn-Lohman, head of oil and gas utilities at Santander Corporate and Investment Banking, estimates that in 2015, the larger international oil companies have had to fill a post M&A cash flow gap of more than $45-billion to fill.

However, he believes that in 2016 and 2017, the annual gap can narrow through opex and capex reductions to around $25-billion, supported by anticipated $20 billion of divestments each year.

‘The challenge will be that IOCs will have to find buyers for these divestments which may become a struggle in itself, as the gap between buyers’ and sellers’ expectations keep widening,’ McAspurn-Lohman said

He said while the current situation was nothing new, in that in the past decade the global E&P sector was also not able to generate sufficient cash from operations to cover their growth projects and dividends, even at an oil price above US$100.

The big difference was that the capital markets had ample appetite to support the oil & gas sector and its spiralling cost base. Debt markets were enthusiastic across the whole risk spectrum, whilst equity markets were selective in seeking quick and high return stories.

‘Today, this appetite has substantially changed. New oil and gas issue volumes in the global public equity markets are down by more than 25%, while UK is down by 70%. Private equity has seen an influx of commitments in their oil and gas funds, but deal activity so far has been predominantly in the US and this increased spending power has yet to spill over into Europe or other regions,’ he said.

‘In the debt markets, investment grade companies continue to find ample liquidity, but have a strong focus on managing their credit metrics to maintain their desired credit quality. In the non-investment grade segment the air seems to be getting thinner though. Volumes in the US high yield market are still just about holding up, but in Europe the sector is carried first and foremost by banks.’

In addition, many E&P companies were getting close to their covenant levels and were reliant on lenders loosening these levels to avoid defaults, he said.

‘These reductions also spill-over into the services sector, having a detrimental effect on oilfield service companies, particularly for those active in exploration and development and asset heavy business models such as drillers.’

McAspurn-Lohman believed that M&A was not the ‘sole’ answer.

‘E&P M&A volumes fell severely by nearly 35% in the first nine months of 2015 and total transaction value has only been held up by a few elephant deals.

Buyers and sellers are not aligned and it will likely require at least another round of adjustments of the asset base through impairments as well as mounting balance sheet and liquidity pressure, before we see activity picking up.

‘However, we believe that the universe of buyers will be substantially reduced compared to what we saw in previous years and shifting assets is going to remain a struggle. Meanwhile, integrated players will be able to attract funds and private equity for infrastructure assets that are less oil price sensitive. While divestments continue to be an important source of liquidity, there is no guarantee for timely and successful execution of transactions to fill the substantial liquidity gaps.’

McAspurn-Lohman, whose insights into the industry are increasingly valued at oil conferences around the world, said the key to creating additional sources of liquidity was to monetise future cash inflows and spread cash outflows.

‘The monetisation focuses on the one hand on working capital management, in other words, faster inflow of receivables, reduction in inventory and longer payment terms; on the other hand, future revenue streams can be monetised by pre-payments of production, which can also have the added benefit of being ‘off-balance sheet’.’

He said Santander had witnessed growing activity of the latter and had successfully structured and led an increasing number of pre-payment transactions in various parts of the world.

‘The working capital topic is still one that has been somewhat neglected by the industry when it comes to external solutions, but we believe that it is only a matter of time until companies start seeking advice from financial institutions. Interestingly, we see a by far stronger cash conversion in the US than in Europe, expressed by very low cash-to-cash ratios in the last years.

‘Often this is part of using negotiation power differently, but it can put pressure on the supply chain. We have been using supply chain finance structures to create a win-win situation for companies and suppliers alike and this seems to be a good formula for the future.’

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