All things considered, the 2022 mergers and acquisition activity wasn’t all that bad. While deal flow did not reach the overly optimistic expectations, given the headwinds, things could have been much worse.

The highest inflation since the 70s, combined with the worst bond market on record (primarily due to a Federal Reserve intent on snuffing out the inflation) and a Europe on the brink of a major war, all wreaked havoc on financial markets and even deal-making.

The O&G sector had enough on its plate to begin with. Caught between political attacks on one end from those clamoring for green and renewable energy and jawboning on the other end about record profits while costs soared and a lack of refining capacity, there weren’t too many places for O&G executives to hide.

Ironically, the European conflict and international isolation of Russia may be a saving grace for 2023 M&A activity in the oil and gas sector. With the rising influence of ESG investing mandates, the demand for and transition from fossil fuels to renewable energy sources has had significant implications for investment and capital allocation in the energy, natural resources and chemical (ENRC) space.

While international policy has centered around phasing out fossil fuels, oil and gas companies have been investing in carbon capture technology and renewables. However, the Russian-Ukraine conflict and Germany’s dependence on Russian gas have left policy- makers scrambling to source “secure” energy. PwC Energy US Deals 2023 Outlook writes, “Europe’s search for alternative energy supplies that aren’t dependent on Russia could benefit U.S. producers.” The report further notes that many countries are watching the investment in U.S. LNG assets, and “this is likely to be a key driver of demand for natural gas exports for decades to come — and it could encourage investment and deals around the natural gas space.”

Another influence on 2023 deal activity in oil and gas is the Inflation Reduction Act (IRA), signed into law in August.

Speaking on the KPMG Houston Trend Talks podcast, M&A tax partner Bruce DeMyer said that the IRA will significantly drive investment and deal activity. More important than the technologies eligible for incentives, congress is trying to “make it easier for developers to access the cash” these credits provide.

Most incentives for green energy have been through the use of tax credits. The drawback has been that many green projects already include significant depreciation and don’t fully benefit from the tax credits. “This has historically required some very highly structured financial instruments done through tax equity structures,” DeMyer said.

Now, some of the benefits are more along the lines of direct pay and also transferable. Companies can sell the credits without the need for complex structures. DeMyer notes this is “a massive change to the tax landscape,” and that we already see “that transition to a massive change in the M&A landscape… there’s been a significant uptick in M&A in this space ever since the IRA came out.”

DeMyer continues that the IRA provides additional incentives in 2025. Rather than targeting specific technologies, the incentives allow that a “technology [which] achieves a zero-carbon result, you’re going to get incentivized,” and that “we’ll see a lot more investment in new technologies that maybe we don’t even know what they are yet.”

Additionally, PwC expects that “rather than the historical use of debt to finance transactions, energy companies are likely to invest free cash flow back into strategic deals with a focus on longer term returns.”

Given the political environment for green energy, Upstream PwC said E&P companies with healthy margins will look to acquire renewable assets, while private companies may look to acquire non-core assets from larger E&Ps. Downstream PwC said deal activity may be slow due to political risk and expenses surrounding refinery capacity, though the IRA may spur some deals involving private equity. As we move further into the new year, M&A trends continue to follow the lead of the IRA, as well as investments geared toward making green energy competitive.