Mergers and acquisitions (M&A) activity, which was a key focus for Middle East oil companies just two years ago, has slipped down the corporate agenda.

The appetite among oil majors for pursuing growth through M&A has diminished and bankers predict any activity in the Gulf in 2010 will focus only on small-scale mergers.

In the boom years of 2006-2008, cash-rich UAE companies, such as Abu Dhabi National Energy Company (Taqa), Aabar Petroleum, International Petroleum Investment Company (Ipic), RAK Petroleum and Dana Gas, embarked on a string of M&A deals.

Increased caution

Taqa led the way. In less than five years it acquired more than $24bn in assets in upstream, downstream and power operations.

In September 2007, Taqa acquired Canada’s PrimeWest Energy for $4.9bn, then in August 2008 it acquired Canada’s Northrock Resources for $2bn. In March 2009, it paid $320m for a 50 per cent stake in Japan’s Marubeni Corporation.

The grim economic news of the past 18 months has stalled this growth phase, but some big deals are still being done.

In February 2009, Ipic acquired a majority stake of 71 per cent in Abu Dhabi’s Aabar Petroleum, the UAE’s first publicly listed oil company. In April, it acquired a 32.5 per cent stake in Spain’s oil refiner Cepsa for E3.3bn ($4.8bn), which gave Ipic a total stake of 47 per cent in the firm.

However, most Gulf oil firms are refraining from further deals due to the uncertain economic climate. This is largely due to the lack of liquidity in the global financial markets, which has impacted on the ability of Middle East oil companies to carry out leveraged acquisitions.

There were some attractive pricings towards the end of 2009, however. For example, in September 2009 the Libyan Investment Authority paid just $295m for Canada’s Verenex Energy, which had been valued at $414m by China National Petroleum Corporation in 2008. However, the Dubai World debt crisis, which began in late November when the company requested a standstill on debt repayments worth billions of dollars, only served to raise companies’ caution about M&A deals.

“Banks are still sitting on the sidelines. What happened with Dubai World has put us back six months in terms of recovery. I do not see acquisition finance returning for another six to 12 months,” says Karim el-Solh, chief executive officer of UAE-based private equity firm Gulf Capital, which bought 79.2 per cent of offshore UAE oilfield services group Gulf Marine Services in 2007.

In October 2009, Taqa drew a halt to its spending spree in the wake of the surprise departure of Peter Barker-Homek, its chief executive officer. After completing its E285m [$413m] purchase of DSM Energie Holding from Netherlands-based Royal DSM, Taqa announced that its strategic focus would shift away from M&A to investing in its existing network. Taqa is now seeking to integrate its acquisitions and build its business organically.

“We want to focus on building these large-scale acquisitions, and see where we can grow from them,” says a company spokesperson. “We are not saying no to new acquisitions, but the priority is to grow the company organically. We can still be entrepreneurial without just being an investment company.”

Tough climate

There were always risks associated with Taqa’s high-spending M&A strategy. The decline in commodity prices left it with expensive assets in the oil sector, which were less likely to contribute to the company’s profits due to lower oil prices. Taqa’s third quarter 2009 results revealed the damage, with profits falling 88 per cent year-on-year to AED90m ($25m).

The Middle East’s energy sector has always been a difficult one for asset-hungry oil majors to penetrate, given the overwhelming dominance of national oil companies.

A major portion of the Middle East and North Africa (Mena) M&A activity of the boom period focused on companies with assets in emerging markets, such as North Africa, or peripheral Gulf markets, such as Oman, or regions much further afield, such as the North Sea, Canada and Asia.

For example, in 2007, the UAE’s Dana Petroleum bought US firm Devon Energy Corporation’s upstream petroleum business interests in Egypt for $375m.

Given the near impossibility of breaking into the main Middle East oil and gas exploration and production fields, M&A activity will remain focused on sub-sectors, such as service companies which support the national oil companies in regional oil and gas production.

“Your typical M&A deal is not going to include buying a field and going prospecting - that activity is typically dominated by the state-owned national oil companies,” says El-Solh.

“Any acquisition opportunities in the Mena region in 2010 will be on the service side, such as drilling, fabrication and vessel chartering firms,” adds El-Solh. “That is why Gulf Capital has invested in service companies, such as Gulf Marine Services [the largest regional operator of jack-up barges, used for installing offshore equipment] and Maritime Industrial Services [the region’s biggest builder of  mobile drilling platforms].”

Despite cheaper valuations, the market looks less ripe for M&A activity in 2010 than during the oil boom years, largely on account of the lack of ready access to finance. According to a MEED survey of bankers and advisers in July 2009, 52 per cent of respondents said accessing finance for acquisitions was the biggest hurdle to M&A deals in the region. This is still the main sentiment in early 2010.

Share swaps

“The big bottleneck right now is acquisition financing, so you are more likely to see share swaps, mergers or all-equity deals, but you are not going to find a typical leverage deal, as lending is simply not available in this environment,” says El-Solh.

Although oil prices rose through the second half of 2009, ending at $78 a barrel compared with $58 a barrel in July, energy assets dropped and finally reached realistic pricing levels, unlike the stratospheric figures seen in the peak 2006-07 period.

“In 2009, things started to get back to reality,” says El-Solh. “There is typically a one-year lag between the correction in the public and private markets, which meant that in late 2008, in the midst of the economic downturn, sellers of private companies were still looking for 2007 prices. Now, reality has sunk in and the asking price for private energy assets has become much more realistic, in line with the public markets.”

In November 2009, consultant Deloitte predicted that the decline in M&A activity in the global energy sector was expected to end in 2010 and, while a dearth of suitable acquisition targets is likely to obstruct M&A opportunities for the biggest companies in the region, smaller firms may find conditions more favourable.

While a return to the boom years of 2006-08 is unlikely in 2010, the flow of smaller M&A deals in the region may start again in the middle of this year.