Q&A: Baker Botts upbeat on M&A amid 'elevated' prices

Clint Rancher and Josh Davidson, partners at law firm Baker Botts, spoke with Argus about the outlook for mergers and acquisitions (M&amp;A) in the US energy sector next year. Edited highlights follow.

What is the outlook for M&amp;A next year?

Rancher: Good. Energy M&amp;A tends to be positively correlated with commodity prices. We have seen a return in demand and producers are exercising capital discipline, which we think will keep prices elevated.

How will deals be structured next year — cash or stock, or will we continue to see a mix?

Rancher: Probably a mix. Coming out of Covid-19, you had a bunch of energy companies go bankrupt and emerge from bankruptcy. And so they have clean balance sheets, which means they are in a position to raise capital and pay cash in certain situations. Another driver is that higher commodity prices will lead to higher equity valuations.

Davidson: One big caveat on oil prices is Covid. If there is some major new wave of shutdowns and demand destruction, then prices will go down again as they did before. But we are all reasonably optimistic given vaccination levels and anti-virals that we will be able to manage the next one better than we did the first.

Are valuations too high?

Rancher: Not necessarily. You cannot talk about energy M&amp;A without talking about environmental, social and corporate governance (ESG). You have majors and others who are under a lot of pressure to high-grade their portfolio of assets. And so they may be looking to divest of higher carbon-intensity assets in favor of greener assets. And so there are still buying opportunities for independents and others who may not be as beholden to shareholders and ESG trends.

Davidson: There is an increased difficulty on the part of some smaller players in accessing capital markets. That is due to a lot of reasons, including funds that do not want to put money in fossil fuels. Those companies, feeling more capital-constrained, may have fewer options to grow on their own and may need to seek a partner.

What basins will see the most deals going forward?

Clint: I do not think it will be focused on one basin. There is a consolidation trend where big players in a basin will look to roll up acreage and become a consolidator and cut general and administrative expenses.

Is the outlook for bigger or smaller deals?

Davidson: I suspect we will see both. It is always hard to predict what large deal you are going to see in any given year.

Is private equity a buyer or a seller?

Rancher: It depends on the fund and the asset. Those funds that are committed to ESG initiatives may have prohibitions or restrictions on their ability to buy traditional energy assets. But to the extent they are less focused, or have an investor base that is less concerned about those matters, I think there are still buying opportunities as some of the majors look to right-size or transition their energy holdings.

How would you describe the regulatory climate?

Rancher: There are a couple of drivers there. One is an administration that is less accommodating when it comes to mergers and acquisitions. You can count on mergers taking longer, getting more second requests and being more complicated than they were under a prior administration. You have to look at the impact of the various tax and spending bills that are circulating in Congress. Those will clearly favor greener and alternative sources of energy over more traditional energy, which will change buyers and sellers and change prices.

What about ESG?

Rancher: The SEC is expected to release additional rules around ESG disclosure. As boards are considering what deals to do, it is not enough that your deal makes financial sense. Your deal has to make ESG sense also, and it has to have a good story that can be told in addition to the economics.

By Stephen Cunningham

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