Three reasons why private equity isn't afraid of low oil prices

Since OPEC members failed to reach a deal on an oil production freeze in April, low oil prices, nudged down yet again following Brexit, continue to signal bad news for exporters desperate to see the price of crude oil rise after months of uncertainty.

Three reasons why private equity isn't afraid of low oil prices

However, private equity investors have recognised for some time that low oil prices are an attractive money-making opportunity. Now that prices appear set to remain low for the foreseeable future, the chance to profit from an eventual recovery may be all the more tempting – if investors are willing to make the bet.  

In the 'new reality' of low oil prices, we consider three reasons why private equity will continue to invest:

Picking up quality assets 'on the cheap'

Low oil prices have an inevitable impact on a company's ability to generate revenue and attract finance.  Upstream oil field services and exploration and production companies seeking to improve their financial position continue to strip back their businesses to focus on core activities, selling off assets to bridge cash shortfalls.  This means that investors are able to acquire and develop quality assets (and even entire companies) at bargain prices.  In fact, Wood Mackenzie's recent '2016 Upstream M&A Outlook' report predicted that upstream M&A activity would increase in 2016, with counter cyclical private equity buyers, willing to bet on an eventual recovery, poised to take action.

Easier deal valuation

Ironically, the consensus that oil prices will remain low for the foreseeable future means that parties' agreement on deal valuations in 2016 could be simplified.  Price stability reduces the need to structure transactions to mitigate the risk of sharp price changes, and is key to bringing transactions to a close.  In a buyer friendly market simplicity matters, and consistently low oil prices are expected to act as a catalyst for M&A activity in the oil industry this year.

Financing at sky-high interest rates

As oil prices have crashed, conventional banks have been forced to scale back lending in the energy sectors.  They have faced regulatory pressures to reduce risk, adding millions to their reserves in anticipation that many of the loans made to energy companies will turn sour.  Cash strapped borrowers running out of financing options are likely to be forced to seek out a costly alternative to normal bank lending: borrowing from private equity firms and other non-traditional lenders.  We expect to see energy companies accepting higher rates of interest and other lender friendly terms in order to refinance debt that they are currently unable to repay.

We certainly don’t pretend to be qualified to predict the future of oil prices, but it does appear that current market sentiment about the future bodes well for deal making in the near term.  The next six months should be very interesting from this perspective.

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