Risk Evaluation Critical in Oil and Gas M&A Negotiations

Thursday, 24 June 2021

Risk Evaluation Critical in Oil and Gas M&A Negotiations

Probabilistic Simulation Models Guide Sound Decisions

ITHACA, N.Y. (June 24, 2021) – The oil and gas exploration and production industry is rife with inherent risk fostered by shifting landscapes of uncertainty. The unique volatility can be challenging when evaluating merger and acquisition opportunities. Informed decisions require probabilistic simulation models examining a range of possibilities rather than deterministic “best guess” methods.

At a recent energy conference, the U.S. Energy Information Administration told the audience that long-term projections will be wrong because of uncertainty in fuel pricing, demand growth, consumer preferences, technological progress and breakthroughs, and shifting policies and regulations. Uncertainty is magnified by the recovery from a global pandemic and a rising amount of debt that exploration and production companies are taking on to take advantage of rising crude oil prices.

B. Riley Advisory Services helps oil and gas companies with transaction advisory, litigation support, and valuation services. The firm used @RISK simulations to evaluate a range of possible outcomes and what is most likely to happen when setting a price to sell an anonymous oil and gas company, “OilCo,” facing a second bankruptcy, also known as a “Chapter 22” bankruptcy.

“Financial restructuring in this industry is difficult with top-line revenue driven by oil and gas prices,” said Dan Daitchman, director at B. Riley Advisory Services. “Bankruptcy work must be done differently to account for this, and assumptions that drive the cash flow models used to restructure an oil company in distress should be simulated.”

The work involved simulating critical key performance indicators over five years. For OilCo’s negotiation, B. Riley simulated, tested, stressed, and presented the following elements:

  • Crude Oil Prices
  • Natural Gas Prices
  • Natural Gas Liquids Prices
  • Production Volumes
  • Lease Operating Expenses
  • Capital Expenditures
  • Floating Interest Rates
  • Asset Divestitures
  • Covenants
  • Seniority Waterfalls
  • Debt Service Coverage Ratios
  • Bank Recovery Levels
  • Probabilities of Default

Monte Carlo simulations using @RISK is an indispensable tool in the oil and gas industry where multiple variables can interact and shift in unpredictable ways. “There were a lot of moving parts in this transaction, and each stakeholder had a unique viewpoint,” said Daitchman. “@RISK helped us navigate all of the various outcomes and provide clear solutions that all stakeholders could use to negotiate.”

The company was able to successfully negotiate a deal with a buyer and continues to avoid a Chapter 22 bankruptcy today.



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