With oil prices near three-year highs, 2018 may be the long-awaited year for a jump in M&A deals according to attorneys Gibson Dunn. The firm recently hosted a webcast that focused on the state of M&A in the oil and gas business.

When oil prices dove in late 2014 and throughout 2015, many analysts predicted the downturn would bring with it a significant jump in M&A in the oilfield, as companies that could secure financing would be able to find assets at bargain prices.

This was not immediately the case, however, and there were fewer, and smaller deals than expected in 2015 and early 2016. M&A in late 2016 and early 2017 was characterized by the Permian land rush and a shakeup in Canadian oil sands assets.

In general, firms “cored up,” buying assets in the Permian and other core locations while monetizing legacy and non-core assets. Some play consolidation also occurred, such as the EQT-Rice merger in the Marcellus.

With shale plays entering the development phase, the “lease, drill and flip” model of M&A is much less common. Much of the tier 1 acreage in plays has already been drilled, and unleased unconventional plays are few and far between.

For oilfield service companies, 2017 M&A was difficult to judge. Activity picked up early in the year, but fell off in the second half of 2017.

2018: price stability likely to be the M&A trigger

According to Gibson Dunn, one factor that could provide a large boost to M&A is not a return to high oil prices but price stability.

Clear signals of bounds on the oil price would encourage deals as company price forecasts could converge. High price volatility means companies may have very different expectations of future prices, resulting in very different estimations of fair asset values.

“Nobody wants to buy an asset in a falling market, and nobody wants to sell an asset in a rising market,” Gibson Dunn Partner Michael Darden commented. “It’s human nature, an individual does not want to look foolish and companies do not want to lose their investment or their upside if they are sellers. Price stability really allows companies to go out and conduct their business.”

Gibson Dunn predicts oilfield service companies will see some consolidation, but mostly among the smaller players in the business. For larger companies, the main driver for M&A will be to plug gaps in product offerings and strengthen service lines, rather than consolidate the sector.

Midstream companies may see a rise in deal activity, especially from private equity. Several funds have recently been raised for the purpose of acquiring midstream assets, but only a few deals have taken place so far. “There is a large amount of capital chasing opportunities, but those opportunities are finite,” Gibson Dunn Partner Justin Stolte remarked.

Headwinds to M&A: current investor sentiment

One factor that may rein in deal activity is current investor sentiment.

Shareholders of E&P companies have shifted from prioritizing production growth to emphasizing returns and capital discipline. These priorities will dis-incentivize making deals, as companies will need a very strong business case to convince investors that would prefer share buybacks or other means of directly returning cash, the attorneys said.

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