M&A in Eurasian Oil and Gas Sector: a Framework
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Ling Chen, Bhuvan Jain, M&A IN EURASIAN OIL AND Sunil Kurien, Daim Shah, GAS SECTOR: A FRAMEWORK Jie Shen and Ke Wei December 2011 EXECUTIVE SUMMARY High oil prices, ongoing economic liberalization and significant increases in global capital flows have opened up a host of new investment and development opportunities, especially for resource-rich countries like Russia, Azerbaijan, Turkmenistan and Kazakhstan. Given their heavy economic dependence on revenues from energy exports, both privately owned and national oil and gas companies (NOCs) of these countries are looking to expand by actively seeking mergers & acquisitions (M&A) opportunities globally. This paper analyzes the scope for outbound M&A transactions by energy companies in the Eurasian region, in particular investments aimed at establishing a market presence in North America and Europe. This analysis is performed through the development of an M&A framework that gauges the likelihood of future outbound activities, focusing on large oil and gas companies in Russia, Kazakhstan and Azerbaijan. The framework identifies 6 key factors that play a vital role in any M&A decision and execution. To account for their differing level of importance in the deal-making process, each criterion is allocated a different weight. The first necessary condition is the availability of financial resources, which is assigned a 20% weight. Possible synergies (20%), which underline the rationale for pursuing some opportunities over others, provide clues as to the areas in which hydrocarbon companies from the CIS will invest. Outbound M&A transactions are also affected by political risk (10%) and a company’s prior experience, captured in terms of past acquisitions (5%). The strategy and vision of a firm’s management (20%) also plays an important, albeit less quantifiable role. The most crucial factor affecting the deal-making environment is the set of legal and regulatory requirements (25%) that need to be met by CIS oil and gas companies in target geographies. Each of these criteria is discussed in detail in the context of real world examples. The weights to each factor are assigned in consultation with leading energy experts and scholars on the Eurasia region. This framework is then applied to two companies—Lukoil, Russia’s largest privately owned oil company, and KazMunaiGaz, Kazakhstan’s state-owned oil and gas company— through a comparative case study that scores each criterion on a scale of low, medium and high. The paper concludes that a company with the characteristics of Lukoil is more willing and more likely to succeed in acquiring targets in North America or Europe relative to a company with a profile more similar to KazMuaniGaz. However, recent trends among less experienced NOCs such as KazMunaiGaz show that the ambition to become regional and internationally competitive oil and gas players may encourage these companies to actively develop such capabilities in the near future. Government relations ............................ 15 Contents PAST ACQUISITIONS (5%) .......................... 15 MANAGEMENT (20%) ................................ 16 INTRODUCTION ............................................ 1 LEGAL AND REGULATORY FRAMEWORK FINANCIAL RESOURCES (20%) ..................... 5 (25%) ......................................................... 17 Market value ............................................ 5 United States ......................................... 18 Cash and debt .......................................... 5 Lesson from past acquisitions ............... 18 Reserves .................................................. 6 Europe ................................................... 18 POSSIBLE SYNERGIES (20%) ........................ 7 EU Third Energy Package ..................... 19 Upstream ................................................. 8 Security concerns ............................... 19 Resource needs? .................................. 8 Socially responsible behavior ............ 20 Efficiency-improving investments: field Governance and transparency ........... 20 recovery and frontier exploration ........ 9 Unfair competition ............................. 21 Mid- and downstream ............................ 10 CFIUS qualification criteria and Infrastructure ..................................... 11 considerations ........................................ 21 Market access supplemented by APPLICATION OF THE FRAMEWORK ............ 22 efficiency-seeking investments ........... 12 CONCLUSION .............................................. 24 POLITICAL RISK (10%) .............................. 13 APPENDIX ............................................... 27 Macroeconomic risk .............................. 13 Ownership structure .............................. 14 This report presents the results of a study by a student team from Columbia University’s School of International and Public Affairs (SIPA), consisting of: Ling Chen, Bhuvan Jain, Sunil Kurien, Daim Shah, Jie Shen and Ke Wei. The Faculty Advisor for the project was Professor Adam L. Shrier. The work was sponsored by the Legal Department of Huron Consulting Group LLP. INTRODUCTION The dissolution of the USSR in 1991 extending their influence across other marked a momentous turning point in the industries as well as the political process. history of global politics. Not only did it By the early 2000s, however, a confluence represent the West’s apparent victory over of factors would help CIS countries embark communism and the formal end of the cold on a more stable economic and political war, it introduced to the world 15 new states development track, the success of which has that would begin a long journey toward led to a rise in regional and global ambitions establishing economic, political and social among CIS oil and gas companies in recent identities independent of the former Soviet times. The emergence of these countries Union. from the initial years of chaos after the fall of the Soviet Union coincided with The first decade, however, was an structural shifts in international oil and gas exceptionally turbulent one for most markets. In essence, enhanced political and countries belonging to the Commonwealth economic stability was in turn reinforced by of Independent States (CIS). The CIS is a a steady flow of oil and gas revenues to the loose regional organization composed of all state as the energy sector became the critical former Soviet republics except for the Baltic engine of economic recovery and growth for countries and Georgia, which withdrew in resource-rich CIS states. Not only did oil 2008. Lacking any experience with full- and gas wealth help states fund budgets, in fledged sovereignty, states such as an era of tight global oil and gas markets, Azerbaijan, Kazakhstan and Georgia had to these countries also assumed a new degree establish new political and economic of global importance, drawing interest from institutions against the backdrop of decades countries such as the U.S., European Union of decay. They also confronted violent (EU) states and an array of international oil secessionist movements, the growth of companies (IOCs). In the words of an Azeri criminal networks to fill power vacuums, national security advisor, “oil is our strategy, and attempts by external forces, including it is our defense, it is our independence.” Western countries and Russia, to exert influence over state policies. Within these countries, macroeconomic conditions stabilized as leaders consolidated Russia, itself, was caught in a whirlwind of political control. The rise of Vladimir Putin economic reform attempts that resulted in in Russia in 2000 lead to a re-centralization the exhaustion of state coffers and a fire sale of state power over the oligarchs and other of key state resources, giving rise to the era powerful stakeholders, as well as a of the oligarchs by the mid to late-1990s. reassertion of state control over the strategic These “entrepreneurs” capitalized on the sectors of the economy, including oil and state’s fiscal weakness to capture control of gas. Notably, Putin saw the strength of natural resource companies, including the Russia’s resource endowment as a key arm hydrocarbon and minerals sectors, before of its economic and foreign policy. 1 In Azerbaijan, “the crossroads of the allowed CIS energy companies to amass Caspian,” the success of Heydar Aliyev’s significant cash reserves while enhancing delicate geopolitical balancing act opened their access to debt and equity-financing. the way to the initial development of its oil reserves, notably the Azeri-Chirag-Guneshli Due to these drivers, by the early to mid- (ACG) field, by a consortium of IOCs led by 2000s, CIS oil and gas companies began BP, resulting in desperately needed looking for new investment opportunities government revenues as early as 1997. abroad. While for NOCs, these efforts are directed at new growth prospects, Meanwhile, Kazakhstan’s growth domestic diversifying and securing markets and product (GDP) has grown at approximately gaining international experience, private 8% per year in the last decade, the strongest companies in the region were also driven among all CIS countries. Nursultan toward outbound diversification to reduce Nazarbayev, its president throughout its 20- the political risk of operating in semi- year history of independence, was among authoritarian states. the first leaders in the region to embrace free markets, moving more aggressively than his While the initial focus of acquisitions began CIS counterparts to establish