A PROLONGED low oil price environment, which may cut demand for offshore oil and gas (O&G) exploration assets and drive down rates, could raise red flags for O&G firms with weaker financial muscle.

Against this backdrop, industry analysts and observers foresee a wave of consolidation in the O&G industry soon, as cheaper valuations and plunging share prices create bargain opportunities for companies with deeper pockets.

Nevertheless, there have been mixed views on whether mergers and acquisitions (M&A) would solve the core problem of the industry, which is the supply and demand dynamic in the offshore segment, should oil prices continue to stay low.

Some players explain that although the sale of assets from weaker parties to stronger ones would help relieve the former of financial pressure temporarily, M&A do not reduce the prevailing industry capacity in terms of the number of vessels.

“M&A would help fend off the competition and protect margins, but they won’t help restore the industry because the main issue revolves around the global oversupply in O&G and O&G assets,” an executive in a local O&G company tells The Edge.

“Even if companies do merge, the number of vessels in the market would still remain the same. It will be a burden to own these vessels as there is still a slowdown in contracts,” he adds.

“As a result, charter rates will fall and eventually hurt all players,” another player says, referring to companies that own and charter offshore support vessels such as anchor handling tug supply (AHTS) vessels and platform supply vessels (PSVs).

Compared with the operator of big assets, such as floating production, storage and offloading (FPSO) vessels, which are production assets tied to long duration contracts of 10 to 20 years, AHTS vessels and PSVs are chartered on short-term contracts.

Furthermore, unlike FPSO vessels, which are ordered as new builds or converted from old tankers only when contracts are secured, the building of AHTS vessels and PSVs have mostly been based on anticipated demand.

The slowdown in contracts has particularly affected companies that charter such vessels. Currently, some offshore support vessels’ rates have dropped to about US$30,000 (about RM105,044) per day compared with US$40,000 per day last year (the rates vary according to the vessels’ features).

Charter rates for other facilities, such as oil rigs, have also softened. The rates for deepwater rigs have declined to between US$375,000 and US$500,000 from last year’s peak rate of US$650,000, while the rates for jack-up rigs have fallen to US$150,000 per day compared with the average of around US$160,000 per day. Jack-up rigs are used as exploratory drilling platforms.

With unattractive rates affecting companies’ earnings, those with high gearing and debt will most likely look to M&A.

Domestically, there have been a number of O&G companies that have bulked up their asset base as well as borrowings to pursue more contracts.

Nevertheless, while gearing for some firms may be high, it is not a concern as long as the borrowings are backed by income-generating assets and secured with long-term contracts with pre-determined rates and cash flow. Having said that, some companies, which rely on contracts that are short term in nature and that are up for renewal, could face problems.

Such concerns are reflected in the share prices of companies operating in the segment.

MIDF Research’s Aaron Tan notes that in the past few years, the valuations for mid to large-cap O&G services firms have been priced at price-earnings ratios (PERs) of between 20 and 30 times. But since the recent slump in global crude oil prices, their PERs have come down to the teens.

Firms that have seen their PER falling to the teens include UMW Oil & Gas Corp Bhd at 14.14 times, Icon Offshore (11.5 times) and Dayang Enterprise Holdings Bhd (12.8 times).

Tan says investors could see the more tepid PER becoming the “new norm” in the valuation of O&G service providers. He believes a more modest valuation would begin to spur M&A within the industry, seeing that “some small service providers will merge among themselves or with the larger ones”.

While in the short term, such M&A activities may not change the immediate supply and demand scenario in the industry, they could eventually create better-managed and stronger entities that become regional service providers in future.

Already, the global O&G industry has seen a few big oil companies in M&A talks, such as the US’ Halliburton and Baker Hughes. There is speculation that the UK’s BP plc will merge with Royal Dutch Shell.

Nevertheless, it remains to be seen whether the potential M&A scene could develop into something bigger, similar to the one that took place in the 1990s when oil prices fell to US$16.50 per barrel from US$40 per barrel a year earlier. During this time, BP went on a bold acquisition spree, which doubled its size and made it a global giant.

This article first appeared in The Edge Malaysia Weekly, on December 15 - 21, 2014.

Save by subscribing to us for your print and/or digital copy.

P/S: The Edge is also available on Apple's AppStore and Androids' Google Play.