Q1 2017 saw a record US$73 billion of energy M&A, mostly upstream producer related and hot on the heels of a robust $29.6 billion of oil field services deals in the fourth quarter of 2016, the highest amount since 2014. I don’t know about you, but it seems to me that that’s a lot of deals.

Of course, it isn’t unusual for a lot of deals to happen in any industry, but this feels a bit different, more deliberate. Which begs the question, what does all this deal-making mean for the industry in general and, more importantly, for Canada?

One of the big differences between this iteration of the M&A cycle and the deals that were happening in the middle of the downturn (particularly on the upstream side) is that the deals in 2015 and early 2016 were very much opportunistic and often driven by balance sheet issues. This current phase is much more strategic in nature and represents a bit of redrawing of the energy map.

It is entirely par for the course that as an industry starts to emerge from a protracted downturn, companies will look to their existing asset base and reorient themselves to what they see as the major trends that will affect their business as this new energy cycle plays out.

We believe there are two key, related, themes that are driving M&A in the energy industry for a good length of time, namely Short Cycle Upstream and Infrastructure.

Short cycle upstream is basically the tight oil phenomenon, fast and easy to drill and complete wells that are high in number and relatively lower in production compared to conventional wells. These wells are very responsive to commodity prices and the capital spend can be regulated as the price moves, so very sensitive to commodity pricing and cost. For many companies, this reset is focused on the immediate opportunity to generate cash flow provided by short cycle plays like the Permian basin in the United States and other tight oil and liquids plays like the Montney and Duvernay in Canada. As opposed to larger mega projects, like Canadian oilsands, capital can be quickly deployed, breakevens are currently lower and results can easily be communicated to an impatient capital market.

Nowhere is the short cycle strategy more apparent than in the Exxon purchase of Permian Basin acreage and their commitment to billions in drilling as they attempt to shore up flagging reserves and declining production with hundreds of small and easy to drill wells. But it’s not just Exxon, it’s a lot of the other majors too, as evidenced by the recent divesting of high quality, producing, BORING, Canadian oilsands assets for the siren song of West Texas.

And while the current land rush into basins like the Permian (it will expand, rest assured) will no doubt lead to companies over-paying on an acreage and per flowing BOE basis relative to commodity prices, these companies and their management teams can be forgiven for taking the money thrown at them by eager investors.

From an oilfield service perspective, the short cycle strategy is a gift that keeps giving. As you may recall from the graph from last week on the drilling services price index, the rise of the unconventional sector spurred significant cost inflation mainly because while short cycle tight oil is less expensive than oilsands for example, it’s still relatively expensive to drill and high intensity.  This of course is good news for anyone providing services to the short cycle industry including drillers, trucking companies, mud companies, fracers, fluid management, consulting, optimization, sand, construction and remediation. How intense is this drilling? As per World Oil, in 2014, the Saudis maintained their 10 mm barrels a day of production drilling some 300-odd wells, Russia maintained the same drilling about 8,000 and the US? Well they got there with a mere 30,000 wells. That kind of intensity is good for the service sector. And it is good for service sector M&A, which will accelerate along with drilling as providers consolidate services and purchase market share.

As the short cycle reorientation plays out, established traditional players are able to strategically add to their core businesses as less committed players exit, hence the rebalancing of the Canada’s oil patch, particularly the oilsands into the hands of key Canadian producers. As I’ve suggested before, this isn’t necessarily a bad thing, as it helps build Canadian powerhouses who, to be completely truthful, are all too happy to pick up these assets at a relatively reduced price. Note to analysts – I get that you all think that CNRL and Cenovus may have over-payed or are now over-levered (at least when compared to Canadian companies), but you are also predicting oil to trend to $60 and higher over the next year – I don’t get it, did you really want them to wait? Doesn’t fate favour the bold?

In addition to all these upstream deals and opportunity for service companies, all this new short cycle development requires delivery infrastructure. The simplest example being that the Permian has in place infrastructure to deliver about 1.8 mm barrels a day and is predicted to soon exceed 2.5 mm bpd of production, so they will need additional pipeline capacity to get their product to market (raise your hand if this seems vaguely familiar). Meanwhile, on the other side of the country, the Marcellus in Pennsylvania produces some of the cheapest and most prolific natural gas on the continent, but there is a lack of infrastructure to effectively deliver it to the massively populated New England, New York and eastern seaboard markets, who pay some of the highest prices for natural gas in the United States and, of course, are resisting a pipeline. With the new Trump administration, it is assumed that bidding, permitting and building these projects will likely become easier, hopefully spurring new construction.

For the last several years, particularly in Canada, we have also been seeing a pretty robust market amongst midstream asset owners and downstream pipeline operators who have been taking a look at the energy landscape, the projects they have in their plans and their respective portfolios to adjust to the new industry dynamics, whether it is greenlighting projects to service gas to the coast for LNG , acquiring strategic transmission networks in key producing areas or trading assets that no longer fit the current and mid-term strategy. In the last two years alone, both Enbridge and TransCanada have transformed themselves into continental powerhouses.

As new pipelines are announced in the United States to deal with the anticipated production growth in the Permian and major Canadian projects advance, the market landscape for the companies that build, inspect and maintain these massive interconnected pipeline networks continues to improve. And as this happens, the M&A environment improves as well, something we are already seeing as contractors react to this new reality through strategic acquisition.

Moving further downstream, the petrochemical industry is enjoying a bit of a renaissance, with major projects and expansions occurring in both the Gulf area and in Western Canada, all of which requires, you guessed it – infrastructure, inspection and maintenance.

Even further downstream we are seeing deal activity with two recent announcements regarding fuel service centre acquisitions, specifically Parkland Fuel of Red Deer Alberta buying Chevron Canada’s service station business for $1.5 billion and a subsidiary of Berkshire Hathaway purchasing the service station business of Loblaw’s for $540 million.

All of these active sectors and deals provide further evidence of an industry in play from the drill-bit right through the pump filling a soccer mom’s minivan (or a lonely M&A guy’s Kia Sedona).

Sitting in between these two extremes is a vast and complex industry of upstream service providers, infrastructure and construction companies, engineering, technology, rental, transportation and logistics providers that are all of them at the same time adjusting and figuring out how best to play the cycle.

Whether it’s the specialized rental company adopting a “broader is better” approach to procurement departments or an upstream construction company formerly involved in oilsands mega-projects now contemplating getting into plant and pipeline maintenance, industries adapt and transactions are happening.

The final piece of the puzzle is the capital question. More specifically, will there be enough capital to fund all this M&A and reorganization? The short answer is yes. As we have seen with the all of the M&A in Q1 2017, there is debt and equity capital on the sidelines ready and willing to finance pretty much any deal. And when it comes to private service companies, particularly those with the right short cycle and infrastructure exposure, there is an abundance of institutional private equity capital to get deals done, particularly if the news releases regarding completed transactions we have received over the past few months are to be believed.

Ultimately, there are a lot of smart people working in the energy industry (sometimes I like to think we’re in that group) and while quite often I like to mock the herd mentality that seems to take root, the reality is that a major reset of the industry is unfolding in front of us and there is tremendous opportunity inside of that to create great businesses, and this is what the recent M&A frenzy is all about.

We aren’t declaring an end to volatility in the oil patch and we do believe the road ahead will continue to be bumpy, but we also think that if you are a buyer or a seller, the next few years are going to be quite interesting.

Prices as at April 21, 2017 (April 13, 2017)

• The price of oil held steady early in the week before falling dramatically on mixed strorage signals.
  • Storage posted a less than expected decrease
  • Production was up marginally
  • The rig count in the US continues to grow, although at a slower pace

• Natural gas was weak early in the week on milder weather but rallied toward the end of the week

• WTI Crude: $49.55 ($53.18)
• Nymex Gas: $3.101 ($3.227)
• US/Canadian Dollar: $0.7407 ($ 0.7511)

Highlights

• As at April 14, 2017, US crude oil supplies were at 532.3 million barrels, a decrease of 1.1 million barrels from the previous week and 25.0 million barrels ahead of last year.
  • The number of days oil supply in storage was 32.1, behind last year’s 33.3.
  • Production was up for the week by 17,000 barrels a day at 9.252 million barrels per day. Production last year at the same time was 8.953 million barrels per day. The change in production this week came from a small decrease in Alaska deliveries and increased Lower 48 production.
  • Imports fell slightly from 7.878 million barrels a day to 7.810, compared to 8.187 million barrels per day last year.
  • Refinery inputs were up during the week at 16.938 million barrels a day
• As at April 14, 2017, US natural gas in storage was 2.115 billion cubic feet (Bcf), which is 15% above the 5-year average and about 15% less than last year’s level, following an implied net injection of 54 Bcf during the report week.
  • Overall U.S. natural gas consumption was down by 6% during the week – a rise in power demand was offset by weather related declines in retail and commercial demand
  • Production for the week was flat and imports from Canada fell by 5% from the week before
• As of April 17, the Canadian rig count was 101 (16% utilization), 78 Alberta (18%), 17 BC (24%), 6 Saskatchewan (5%), 0 Manitoba (0%)). Utilization for the same period last year was about 10%. With breakup now on, this count isn’t expected to rise significantly for the next month or so.
• US Onshore Oil rig count at April 21 was at 688, up 5 from the week prior.
  • Peak rig count was October 10, 2014 at 1,609
• Natural gas rigs drilling in the United States was up 5 at 167.
  • Peak rig count before the downturn was November 11, 2014 at 356 (note the actual peak gas rig count was 1,606 on August 29, 2008)
• Offshore rig count was down 1 at 20
  • Offshore rig count at January 1, 2015 was 55
• US split of Oil vs Gas rigs is 80%/20%, in Canada the split is 56%/44%

Drillbits

• Really slim pickings this week. Stuff and things. Rumour is that BP is also looking to join the oil majors “sheeple” movement and divest some oilsands assets
• The US suddenly noticed what a great deal Canada gets on dairy. Well not suddenly, just now they are starting to care a bit more. Stay tuned for any mention of energy.
• Trump Watch: The White House Easter Egg Roll was apparently not the greatest ever, but at least it happened. In the meantime, a little less controversy this week, although Trump did mention something about being visited by the spirit of Pavarotti