News last week that the management team behind Rift Oil plc were regrouping to bring a new exploration group to AIM told its own story about the positive expectations for oil and gas mergers, acquisitions and IPO activity in 2010.

Ian Gowrie-Smith, the former Rift boss, enjoys mixed reviews in the City but there was no doubting that his team made a lot of investors happy when the Papua New Guinea explorer was sold for £115m to Canada’s Talisman Energy last summer. Now, Gowrie-Smith is set to raise £6m through an AIM flotation of Kea Petroleum and attempt to repeat the huge success of Rift, this time in New Zealand.

Okay, tried and tested management teams that have a history of making investors a lot of money, tend to find the going easier when it comes to raising cash for new projects. Nevertheless, according to the findings of a recent global oil and gas transactions review by business advisors Ernst & Young, the outlook for 2010 is “positive”.

The prediction follows mixed signs from the industry during 2009, with news that the number of oil and gas mergers and acquisitions (M&A) around the world tumbled to 837 last year, down from 1,152 in 2008. Upstream deals alone accounted for 72% of that figure. However, the total value of oil and gas transactions topped US$198bn, up 10% on 2008, despite the lower average commodity prices in 2009.

Notably, M&A activity in the second half of 2009 was much stronger than the first half with 485 deals compared to 352. Likewise, total deal value in the second half of 2009 was US$109bn compared to US$89bn in the first half. Analysts reckon those improvements reflect better capital market conditions and growing consensus on oil price outlook.

Upstream leads the way

Deal activity during 2009 was underpinned by a strong performance by the upstream sector, with deal volumes down to 605 from 730 in 2008, but with an overall value increase of 33% to US$149bn in 2009.

Jon Clark, an oil and gas director at Ernst & Young, explains: “The oil price has strengthened, equity capital is starting to flow back into the sector, development projects are coming back on stream with increasing frequency, and stronger exploration budgets are being set for 2010.

“However, the year has been uncomfortable for many across the sector and the mixed fortunes of the upstream universe continues to leave a wide divide between the have and have not’s. The increased oil price may have generated a scurry of equity investment, but funding constraints continue to impact many, be it equity or debt, and the success of proposed IPOs in 2010 will be carefully monitored.”

Elsewhere, the picture for oilfield services and the downstream sector of the market was not quite as positive during 2009. Transaction activity plunged in oilfield services by over 60% to 79 deals and total deal value fell 62% to US$11.4bn.

The downstream sector experienced further decline in transaction volumes during 2009, continuing a downward trend that started in the previous year. There were 153 transactions in 2009, down 30% on 2008, and the disclosed value of downstream deals was down 4% at US$38bn.

Ernst & Young’s Clark continued: “The evaporation of funding and the impact of lower oil prices down on average from US$96.87 in 2008 to US$61.54 in 2009 and cutbacks from operators were the chief causes for the slump in transaction levels. However there were buyers who entered this phase in the cycle with strong balance sheets who took advantage of others’ distress to complete opportunistic bolt on deals.”

Andy Brogan, global oil and gas transaction advisory leader at Ernst & Young, predicts that the positive trends seen in recent months are likely to continue into 2010 and the outlook for oil and gas transactions is healthy in upstream and oilfield services. However, he reckons that in the downstream sub-sector, over-capacity in some regions is likely to drive a longer period of uncertainty and transactional challenges.

Ernst & Young’s report notes that stability in the market has triggered increasing market confidence and a return of equity investment into the oil and gas sector. It says that with a number of IPOs planned for 2010, if successful, there will be increased investor interest in the sector again.

Brogan said: “Lessons have been learned regarding the risks of investing in single asset pure exploration companies and we anticipate that companies successfully coming to market will have larger portfolios, probably spread from exploration into production operations.

“Commodity pricing volatility is likely in the short term as global demand is predicted to remain below supply capacity in 2010. As economic recovery drives demand growth, greater pricing stability is expected in the medium term, although the precise timing and shape of recovery remains a subject of much speculation.”

Ben Hobson, SmallCapNews