In Conversation with KPMG in Canada’s Aleksei Dremov on M&A vs. organic growth

Aleksei Dremov is a partner, Deal Advisory, for KPMG in Canada

Aleksei Dremov is a partner, Deal Advisory, for KPMG in Canada. He has more than 15 years of experience in Deal Advisory. His areas include buy-side due diligence, sell-side due diligence, IPO support, preparation of long-form reports and working capital reports, often involving work on complex carve-out assignments. Aleksei has extensive international experience running cross-border deals in Canada, U.S., Eastern and Western Europe and Asia.

The Daily Oil Bulletin/JWN Energy engaged Aleksei to provide insight into whether higher prices would result in a shift from M&A activity to organic growth, and how operators would manage costs through technology and human resource management.

Over the last five years we have seen a major consolidation throughout the industry with productive assets, proven reserves and acreage concentrated in fewer and fewer hands. Organic growth has been minimal. With higher prices do you expect to see a return to growing reserves and production through the drill bit?

The oil prices recovery undoubtedly has a transformative impact on the M&A landscape. In 2021 we observed a pronounced increase in deal value and deal flows. While 2022 year to date is not as active as the prior year, we still see a steady amount of deal flows including consolidations and acquisitions.

High prices can be a double-edged sword in the context of M&A. On one hand, they can fuel the deal sentiment with further consolidation. On the other hand, they can widen the bid/ask gap to defer deal closure, as valuation consensus may vary between buyers and sellers. Overall, there is enough “dry powder” to support the M&A activity.

Higher commodity prices continue to support organic growth to generate meaningful free cash flow (whilst still meeting the objectives to return capital to investors) helping to fund the M&A initiatives. With the capital discipline lessons learned from the two previous cycles, operators are no longer solely focused on “growing production at all cost” as seen in the 2000s. In fact, more companies are leaning towards a more balanced step change approach to scale their production both organically and inorganically to synchronize with the continually evolving commodity outlook taken into consideration of the supply and demand equilibrium.

There has been a lot of discussion in recent years of how the Canadian industry has lowered its operating cost structure to become more globally competitive. Much of the cost decline occurred across operating categories and all operators in the aftermath of the early 2015 oil price decline. Do you see further opportunities to continue to reduce costs by improving productivity through technology or innovation and, if so, where? 

I am very fascinated by the efficiencies that can be achieved through data analytics and digitized workflows. I feel that the key potential lies in process automation, “just-in-time” asset monitoring and production management involving robotics. Canadian companies have always been at the forefront of technical progress when it comes to the use of robotic technologies and artificial intelligence. Continued R&D collaboration between oil & gas industry’s subject matter experts, the high-tech entrepreneurs and scientists proves that the potential in this space is not yet exhausted, and further disruptive innovation will come to fruition in just a matter of time. At the end of the day, servicing firms and producers will look to direct capital on technologies which improve competitiveness, however many operations still require the human element of being creative, effective, and safe. Synergies can be unlocked when humans and machines work together.

As further technology and innovation becomes proven overtime to improve the operational efficiencies, we anticipate the per barrel opex will in turn be reduced and can be recycled towards further R&D with a net neutral cost impact in the long run.

G&A costs saw a significant decline after massive layoffs in corporate offices in 2015-2017. We’ve seen a shift to remote work due to the pandemic that impacted G&A short term as companies invested in technology and workers adjusted to a changing work environment. Do you see this shift to more remote work as a more or less permanent change and how will organizations respond to make it work? Do you see further investments in technology on the horizon and what types of technology will be deployed?

I have spoken to dozens of companies every year and the “hybrid” work environment seems to be the most popular answer these days. However, we have yet to figure out what this definition implies, particularly for the new generation of employees, whose careers started remotely. I feel that technology progress in this case is just a function of human behaviour and adaption over time, something that is extremely hard to predict. There is no doubt though that we will see some unprecedented work arrangement proposition in the market going forward. Employers would have to be creative and flexible in order to stay competitive and to keep their staff engaged and motivated. It is very early in the process to determine if the hybrid work environment will result in a lower G&A cost structure.

Much of the cost savings industry has enjoyed the last few years came from lower service pricing. Operators are now seeing cost inflation, largely due to service companies passing through higher fuel and materials costs. Service companies say they still need net pricing increases to return to sustainable margins that allow them to reinvest in operations while providing a return to investors. What actions can operators take to manage cost inflation while ensuring service companies can invest in operations and continue to innovate?

With rapid inflation, quantitative tightening, and supply chain disruption on the horizon, both service companies and operators are feeling the pinch. On one hand, servicing companies want to balance profitability and returns to shareholders. On the other hand, they try the best to leverage relationship with the operators to partially absorb supply shock or flow through the inflated cost to the customers wherever they can to maintain bid competitiveness. Opportunities exist for service companies to strengthen relationship with their customers by maximizing the “non-price” levers such as expanding the quality of work to ensure value surpasses expectations. Thankfully, commodity prices are now back at decade-high levels which helps to alleviate any macro-driven cost inflation seen in the market. Within their control, the operators can manage the efficiencies and effectiveness of their operational processes through robust planning to minimize any rework/cost inefficiencies as a proxy to withstand the inflation impact overtime.

Our industry needs ready access to high-performance, high technology energy services companies to enable the efficient and environmentally responsible extraction of resources. We cannot lose sight of the critical role and needs of the service companies that have provide key advancements in the extraction process and we need that innovation to continue.

Many service companies and some operators are reporting challenges recruiting workers as activity rebounds. Do you see access to talent as a constraint to potential growth and if so, what can the industry do to attract necessary skillsets?

Competition for talents is a topic of paramount importance in a whole variety of industries these days, but it is particularly relevant for oil & gas. Global hiring has always been a great solution for Canadian companies as a response to shortage of skilled labour in the periods of peak activity. A longer-term solution could be a more intense cooperation with high schools and universities, to maintain the attractiveness of the industry for recent graduates and to ensure that young specialists can bring relevant skillsets and be successful in their careers.

Editor’s note

The last five years have been a hard ride for Canadian oil and gas producers.

Wild price volatility, a pandemic-induced price crash, ongoing market access issues, oil production curtailment, the rise of the ESG movement, and finally a geopolitical crisis are just some of the challenges industry faced.

The end result of this period of instability is a reinvigorated industry – forged in fire so to speak – and ready to take on the world as the commodity cycle turns once again.

The 2022 Top Operators Report examines the 2017-2021 timeframe, identifying key trends that shaped the present energy landscape and what lies ahead for the 62 Canadian headquartered public operators tracked this year. 

To sort through these challenges we are once again leveraging the experience of professional services firm KPMG in Canada to provide insight into the last five years of change and what strategies operators could pursue to thrive in the inevitable turbulence ahead.

Data analysts from Evaluate Energy are providing context to the stream of information coming from corporate financial reporting and other relevant documents. Analysts from geoLOGIC systems ltd. offer context into trends in activity and technology to manage costs. 

We’re also tapping into a broad swath of the insights and opinions from industry leaders gleaned from Daily Oil Bulletin coverage.

To download the 2022 Top Operators Report, click here.

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