The upstream industry and its investors are re-examining the value of oil and gas assets amid a general shift to low carbon energy, potentially leading to an increase in the number of merger and acquisition (M&A) deals in the year ahead, according to research from consultancy EY.

Amid a general consensus that climate action is necessary, the industry has started to nail down its energy transition plans, although the current pressure has yet to manifest in reduced oil consumption.

Oil demand increased by 1 million barrels per day in 2019 and is expected to increase by another 1.2 million bpd this year.

The pressure, however, has led to lower activity and valuations for the industry, reflecting the rebalancing of portfolios away from liquids and toward gas-focused and downstream assets, EY said in a recent webcast.

This week, recently appointed BP chief executive Bernard Looney stamped his mark on the company by setting a target of becoming a net zero emissions player by 2050 or sooner. In December, Spanish major Repsol put a €4.8 billion ($5.3 billion) price tag on its decarbonisation goals of also becoming a net zero emissions company by 2050.

As the industry started its shift, EY’s global oil and gas transactions review for 2019 revealed that, overall, deal value decreased 10.8% to $387.5 billion last year, and deal volume fell 17.7% year-on-year, due, in part, to stagnant commodity prices and disappointing drilling results in some regions.

Deal value in the upstream segment was up by 17.6% to $160.5 billion, but the increase was due to Occidental Petroleum’s $57 billion acquisition of Anadarko Petroleum.

Excluding that transaction, total global deal value decreased 24.2%, while deal volume declined by more than 20%.

EY also found that, last year, interest in US assets fell dramatically, with deal value dropping from $74 billion to $39 billion, accounting for almost all the value reduction globally.

Nevertheless, capital raised by oil and gas companies grew 7% to $617.4 billion last year, with debt (loans and bonds) accounting for a 92% of the capital raised. But while the value of capital raised was at a five-year high, the volume of fund raisings (1324) was down 10% annually, continuing the downward trend of recent years.

“Despite the positive aggregate capital activities, this highlights that conditions are much more challenging for some companies and in some segments of the oil and gas market,” EY said.

“Financial stress in the US upstream is growing, as evidenced by rising bankruptcies, defaults and asset writedowns. Forty-six oil and gas companies in the US filed for bankruptcy in 2019, up from 31 in 2018. More bankruptcies may follow as companies face mounting debt maturities,” EY warned.

According to Moody’s Investors Service, oil and gas companies in North America have more than $200 billion of debt maturing over the coming four years, with more than $40 billion expected to mature in 2020.

Similarly, low profitability and high debt continue to constrain the capital of many oilfield services companies, EY found. These players, the consultancy said, are moving away from building capacity to asset-light and technology-driven models to create more value and greater returns for shareholders.

“The need for new capital is driving consolidation in the oil and gas industry, and alternative funding sources are gaining prominence. Private equity and infrastructure funds are becoming important sources of capital,” EY said.

“Oil and gas producers are also exploring creative ways to raise capital, such as asset-backed securities related to wells or joint ventures, including farmouts and ‘DrillCo’ transactions in which an investor funds drilling costs in exchange for a share in a lease or well,” research showed.

But as investors are backing away from fossil fuels or carefully selecting which carbon intensive projects to support, oil and gas companies are facing the pressure of delivering superior returns while also future-proofing their businesses amid the energy transition.

EY found that companies have responded to the changing energy landscape by shifting their capital allocation strategies, in particular, by increasing investment in downstream businesses — such as chemicals and power and reducing relative investment in the upstream segment.

Oil majors are also investing in cleaner energy, such as natural gas, which comes with increased investment risk as more infrastructure is typically required and gas is exposed to price uncertainty and demand risk, as well as competition from renewable energy.

Looking ahead, the report projects that the M&A landscape will continue to be shaped by energy transition strategies, climate change regulations and the role of natural gas in the future energy mix.

Andy Brogan, EY global oil & gas leader, said: “The oil and gas deal environment continues to reflect uncertainty, as the industry redefines its role and the value of its assets in the face of the growing transition to low-carbon and no-carbon energy.

“Despite this upheaval, we see an environment in which asset attrition outruns whatever reductions there might be in demand. This means the industry will need to attract capital and offer returns that support continued investment,” Brogan said.

For the year ahead, EY also expects to see several private equity companies that held on to North Sea investments through the recovery period explore opportunities to exit as they look to return capital to investors.

“Continued portfolio rationalisation for majors will lead to opportunities for smaller independents and private equity-backed entities to make deals, as well as to access new asset portfolios,” EY said.