In 2023, the M&A story looks to remain the same: Public companies need inventory, which could augur a busy year for dealmaking, private equity firms said Jan. 19 in Houston at an Independent Petroleum Association of America (IPAA) event.

Executives at Opportune, Kimmeridge and other private equity firms said 2023 could be active, although it remains unclear how commodity fluctuations in commodity prices will drive deal dynamics and how public companies will afford acquisitions.

“We anticipate 2023 to be an active year for A&D, though publics’ ability to pay up for inventory is still limited,” Kimmeridge Managing Partner Henry Makansi told the attendees at IPAA’s private capital conference in Houston. He said a “reload cycle for new inventory will eventually come, with publics having to pay up for drillable locations.”

The A&D market remained strong in 2022, Daniel Kohl, Opportune co-head and managing director, said during the conference, noting that “private equity played a critical role and will continue to play a critical role,” he said.

In recent years, oil and gas companies from independents to integrated majors have demonstrated capital discipline and increased share buybacks and dividend distributions amid the COVID-19 pandemic and the Russia-Ukraine war that started in Feb. 2022.

Kimmeridge doesn’t expect companies plans to deviate much from their 2022 plans.

“The U.S. E&P sector is expected to maintain the disciplined approach it demonstrated in 2022, with limited capital reinvestment, modest supply growth and elevated returns,” Makansi said. “Despite a likely economic deceleration and weakened demand, oil prices are likely to stay above $70/bbl.”

In the U.S. Permian Basin, the discipline amongst public E&Ps has impacted production. Growth among private operators, which represent 25% of U.S. supply, now appears to be decelerating while the majors, who represent just 13% of supply, appear to be ramping up growth, Makansi said.

From a valuation perspective, Nuveen Portfolio Manager Don Dimitrievich expects to see some correlation this year between increased costs and higher commodity prices and expects a declining shale inventory will likely support increased A&D activity.

Multiples to drive M&A activities

While the upstream sector saw a lull in deals in December due to a decline in commodity prices, public E&Ps will pursue efforts to replenish inventory, analysts say.

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The energy sector remains attractive on a price-to-earnings multiple basis as well as in comparison to pre-COVID valuations relative to virtually every other sector, according to Dimitrievich. “Energy is still trading at a 49% discount to pre-COVID valuations while the broader S&P is trading at just a 6% discount,” he added.

Despite being the best performing sector the past two years, energy stocks are still cheap versus the broader market, Makansi said, while valuations for small-cap E&P stocks remain further dislocated relative to the rest of the sector.

“The significant disparity in multiples between large caps and SMID caps in upstream will continue to drive M&A activity with large caps buying SMID caps due to a limited inventory and wide multiple spread,” Makansi said, “Multiples are expected to remain compressed but expand from 2022.”