Oil price has been a significant aspect used as a determinant of creating value in the energy sector. Therefore, the recent drastic drop of oil prices in 2014-2016 periods has been a major hit to oil and gas industry. The oil prices started falling in 2014 has continued all the way to 2016 and has caused the energy sector to experience a difficult time. The level of oil prices has major influence on the different aspects of the performance of the oil and gas industry. The oil price level is used as a determinant of the company’s profitability, its spending on various projects and the competitive position of the energy industry in the market. The decline in oil prices has affected the production of oil and gas resulting to reduced supply of the energy products and increased demand thus affecting the market balance. The drastic decline in oil prices calls for immediate solutions to be provided to address the oil price fall and promote efficiency of capital within the energy sector (Baffes, Kose, Ohnsorge & Stocker 2015).
This paper seeks to discuss the adoption of Merger and Acquisition as a strategy to address the oil drop prices of 2014-2016 within the energy sector. The paper will also discuss the internal and external factors that contributed to fall of oil prices as well as the challenges and benefits of using M&A as a Strategy within the Energy Sector.
Internal and External Factors that contributed to Drop of Oil Prices
The sharp fall of oil prices in the period of 2014-2016 has been contributed to by both internal and external factors. Understanding the internal and external factors of oil drop prices is significant in assisting the energy sector to understand the macroeconomic effects. Internal factors such as the numerous fights among OPEC members have affected oil production and exploration process thereby contributing to drop of oil prices. For instance, studies have shown that Kuwait and Saudi Arabia have engaged in constant war on oil price. They have been reducing the oil prices to maintain their market share and competitiveness in the Asian market. Therefore such fights have made significant contributions to the drop in oil prices in the recent years (Griffin & Teece 2016).
The various external factors that have contributed to decline in oil prices are discussed below. The U.S oil boom has contributed to a drop in oil prices in the global economy. The U.S Shale oil production has shown significant improvement in oil production and profitability since 2008. Studies reveal that the U.S has been producing more than 9 million barrels of oil every day. This has generated availability of large volumes of oil in the global market. The increased availability of oil production in the global market has caused the U.S to stop importing oil from the Organization of the Petroleum Exporting Countries (OPEC) thus facilitating the fall in oil prices. The lifting of Iranian sanctions has generated new supplies of oil in the global market. This has lead to increased volume of oil production thereby promoting OPEC to reduce its price to match that of its competitors increasing their sales and profitability (Arezki & Blanchard 2014).
The slow growth of the European countries economic growth has led to development of a negative outlook on the European economy. The slow growth has raised concerns among investors thus causing them to fear investing in the European countries. Therefore, reduced investments have contributed to reduce their oil subsidies (Baffes, Kose, Ohnsorge & Stocker 2015). Similarly, the slow economic growth and the growing concern on the depreciation of currency in some Asian countries have led to energy subsidies. The energy subsidies have raised the fuel costs in these countries despite the decline in oil prices in the global economy. These have resulted in low demand for oil in these nations. For instance, China is known as the largest consumer of oil in the world. Therefore, its slow growth has reduced the demand of oil supplies thereby impacting adversely on the global economy. Slow growth of the economy of a country means a slower growth in demand for oil and gas therefore a major contributor to the decline in oil prices (Kilian 2006).
The use of Merger and Acquisition as a Strategy to Address the Oil Drop Prices
The significant drop of oil prices in 2014-2016 has caused adverse impacts on the energy companies. It has generated a lot of constraints on big energy companies’ prospects and impacted adversely on the profits in the energy sector. Additionally, the sharp oil drop has affected the expenditure of the energy companies on the established projects. The energy companies are therefore focused on eliminating the effects of oil drop prices by adopting strategies that would enhance their ability to achieve a balance between short term goals and effectively sustain their long term objectives and investments. The energy companies have adopted different strategies to improve their present financial situations and stabilize their companies. Examples of these strategies includes technological advancement, acquisition of more resources, accessing new markets and engaging in merger and acquisitions activities (Burns, McLinn & Porter 2016, pp.26-31).
Merger and Acquisition (M&A) has been determined as one of the best strategy to be used to address the financial crisis in the period of 2014-2016 when the oil price has experienced a drastic drop. M&A has been used in the previous years during oil prices collapse and these has shown significant improvement in the energy sector leading to the rise of oil prices until it started to fall in 2014. Mergers and Acquisitions involve the transfer of ownership of a company to another or combination of ownership between two or more companies. A merger is the joining of two companies to form a new business with a new name. For instance, the merging of shell and BG was a significant approach of respond to decline in 2014-2016 oil prices. In acquisition, one company purchases another business entity and acquires new ownership. The aim of the energy companies is to adopt M&A as a strategy in order to change the current situation of the oil price decline and allow the energy companies to grow, and obtain a competitive position in the global market (Phillips & Zhdanov 2013, pp.34-78).
Reports from the Wall Street Journal indicated that $323 billion were proposed for merging of energy companies in 2015. The energy industry was ranked the third sector that is active in suing M&A as a strategy to address challenges within the industry. For instance, the Energy Transfer Equity purchased the Williams Cos., which is a pipeline operator. Similarly, the Schumberger Ltd (the leading oil industry in the world) purchased Cameron International Corporation (its smaller rival).The Royal Dutch Shell PLC has also merged with the BG Group PLC (Mattioli & Cimilluca 2015).
The use of M&A strategy to address oil prices drop generates both benefits and challenges in the energy sector.
Benefits of using M&A as a Strategy within the Energy Sector
The use of M&A has proved successful as a strategy of addressing the collapse of oil prices in the oil and gas industry. M&A contributes to the creation of cost synergy. Cost synergy generates creation of value by minimizing costs and improving the efficiency of capital in energy companies thus influencing on oil prices. Additionally, M&A contributes to development of better economies of scale, establishment of effective markets for oil and gas, and effective use of resources. These factors will benefit the energy sector by enhancing growth of the companies through generating better products in the market and investing in new ideas. Therefore, a successful merger or acquisition will foster increased profitability and promote a sustainable competitive advantage. Additionally, M&A will increase strategic transaction and improve capital efficiency within the energy sector (Yılmaz & Tanyeri 2016, pp.110-117).
The use of M&A as a strategy to address the drop in oil prices will increase the number of investors within the energy sector. The drop of oil prices had resulted in decreased willingness of investors to invest in energy companies. However, studies indicate that the adoption of M&A has generated optimism to the recovery of the energy industries. Many investors have recognized the value and capability of M&A in improving the level of oil prices. Therefore, the M&A strategy has increased the positions of investors and their commitment in funding the energy industry projects and improve their performance. Most of the investments are generated towards the derivative of oil products such as petrochemicals and the refined petroleum products. This is because, despite the decline of oil prices, the prices of oil derivatives have not dropped rapidly. Therefore, the energy companies know that the M&A will promote the viability of the energy sector and be able to achieve their short term and long term goals (Yılmaz & Tanyeri 2016, pp.110-117).
Challenges of Using M&A as a Strategy within the Energy Sector
Various organizations have experienced challenges when using M&A as a strategy during periods of oil prices down cycles. Studies indicate that although M&A has been an important strategy in addressing oil prices collapse in the previous years, it might not be an effective strategy to address the current challenges in the contemporary economy. Therefore concerns have been raised on the use of M&A as a strategy to deal will present challenges facing the energy sector. Various deals have been suggested that can be effective in addressing the challenges within the energy sector. These strategies include: mergers of equals, transacting assets and adopting a number of bolt-on acquisitions (Yılmaz & Tanyeri 2016, pp.110-117).
Studies have revealed that the credit crisis has adversely impacted on the goals of mergers and acquisitions thus hampering the effectiveness of this strategy in addressing oil prices collapse. The drop in oil prices has resulted in the drop of valuations of production and exploration and it is believed M&A will play a significant role in recovery the energy sector from the financial crisis. During the time when oil and gas prices were high, most of the energy companies generated most of their investments in production and exploration. Therefore, the drop of oil prices has led to huge loss of money by the energy sector. The credit crisis has caused large transactions to be suspended thus affecting the profitability of the energy sector. Putting the large transactions on hold has generated high levels of debts within the energy sector and paralyzed their projects. Therefore, the global credit crisis has hampered the effectiveness of using M&A as a strategy to address the oil price fall within the oil and gas industry (Shuen, Feiler & Teece 2014, pp.5-13).
The 2014-2016 oil drop prices were a huge hit to the energy sector. Oil price is a significant element in the energy sector because it is used a determinant in creating value in the industry. The energy sector uses the level of oil price to determine the company’s profitability, its spending on various projects and the competitive position of the energy industry in the market. The level of oil price has major influence on the performance of the oil and gas industry. The 2014-2016 oil drop prices were influenced by both internal and external factors. The internal factors include the constant wrangles on oil prices among OPEC members such as Saudi and Kuwait. The external factors that contributed to the 2014-2016 declines in oil prices include: the U.S oil production boom, the negative outlook by investors on the European economy, the slow growth of economy in some Asian countries such as China and the lifting of Iranian sanctions that led to new oil supplies in the global market. Therefore, to address the drop in oil prices, the energy companies have adopted the use of Merger and Acquisition as a Strategy to address the oil drop prices. The use of M&A will benefit the energy sector by enhancing growth of the companies through generating better products in the market and investing in new ideas. Therefore, a successful merger or acquisition will foster increased profitability and promote a sustainable competitive advantage for the energy sector.
Arezki, R. and Blanchard, O., 2014. Seven questions about the recent oil price slump. IMFdirect-The IMF Blog.
Baffes, J., Kose, M.A., Ohnsorge, F. and Stocker, M., 2015. The great plunge in oil prices: Causes, consequences, and policy responses. Consequences, and Policy Responses (June 2015).
Burns, D., McLinn, J. and Porter, M., 2016. Navigating Oil Price Volatility. Chemical Engineering Progress, 112(1), pp.26-31.
Griffin, J.M. and Teece, D.J., 2016. OPEC behaviour and world oil prices. Routledge.
Kilian, L., 2006. Not all oil price shocks are alike: Disentangling demand and supply shocks in the crude oil market.
Mattioli, D. and Cimilluca, D., 2015. Energy M&A Surges Despite Oil Slump. The Wall Street Journal. Retrieved on 15th July 2016 from: http://www.wsj.com/articles/energy-m-a-surges-despite-oil-slump-1443629069.
Phillips, G.M. and Zhdanov, A., 2013. R&D and the Incentives from Merger and Acquisition Activity. Review of Financial Studies, 26(1), pp.34-78.
Shuen, A., Feiler, P.F. and Teece, D.J., 2014. Dynamic capabilities in the upstream oil and gas sector: Managing next generation competition. Energy Strategy Reviews, 3, pp.5-13.
Yılmaz, I.S. and Tanyeri, B., 2016. Global Merger and Acquisition (M&A) activity: 1992–2011. Finance Research Letters, 17, pp.110-117.
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