John Sloan – Vice Chairman, Partner, Managing Director Allegiance Capital Corporation

NGP Energy Capital Management and Five Point Capital Partners have raised recent energy funds

Now is an opportune time for companies looking to enter the U.S. oil and gas industry, says John Sloan, vice chairman of Dallas investment bank Allegiance Capital Corp. Declining oil prices coupled with stagnant demand are causing trouble for oil drilling operators and their supporting businesses, paving the way for distressed-investment inves-tors and other groups to buy assets on sale. The opportunity should exist for 18 to 24 months, which may be why we have seen private equity firms close funds that are focused exclusively on energy lately. In January, NGP Energy Capital Management closed an energy-focused private equity fund with more than $5.4 billion in commitments, and before that, Five Point Capital Partners closed its inaugural fund, which will also make energy investments, with $450 million in commitments.

Recent oil and gas-related deals include Omega Capital’s purchase of M&M Environmental earlier in January, and Kinder Morgan’s $3 billion deal to buy a pipeline network from Hiland Partners, also in January.

How will low oil prices affect M&A?

The game has changed, but the game’s not over. We are expecting a relatively robust M&A market in the oilfield services sector for 2015. A lot of those transactions will be situations where companies need to merge with another financially stronger business, and some of those will be distressed situations, where companies need to realign their capital structure to accommodate a down market. There will be opportunistic investing in the oilfield services sector – several investors are looking at this as a real buying opportunity. The nature of what is going to happen in M&A is going to change, but we’re going to see a robust level of activity.

Expect to see the next 6 to 12 months remain difficult. We may not have seen the bottom yet in terms of oil prices. As we move into the second half of the year, the consensus is we are going to see oil prices come back up. When that happens, we are not going to go back to the kind of environment we saw in 2012 or 2014; there will be valuations we saw for companies similar to what they were before the cycle really took off. We expect to see a recovery, and that recovery is going to be a new normal. We are not going to get back to the levels we just experienced.

A lot of people look at this as an investing opportunity where they could buy production or assets at low prices. There is always a contrarian investor, and that investor today would say this is a great time to be buying. I can see the attraction of putting together a fund.

This investment thesis hinges on oil prices going back up. Will we see that?

It’s ultimately a supply and demand issue. Over the course of this past year, production with all the shale plays has increased rapidly, yet the demand in the U.S. has been flat. So at some time, supply is going to exceed demand. We’ve seen a dramatic reduction in prices – they have come down farther than we might have imagined. This has historically always shifted back in the other direction.

New drilling is dropping dramatically on a monthly basis, it is uneconomical now to drill oil and gas, but at some point in time the demand will catch back up with the supply. Companies will complete the wells they are drilling now, and then they will only drill additional wells where they have a requirement to do so in order to maintain their property leases. That’s the activity level you will see going forward. It’s not enough to keep prices so low.

What factors are influencing oil demand in the U.S.?

In the U.S. there are new technologies that are impacting the demand for oil and gas. Electric cars are a great example, and we are seeing alternative sources of fuel, including wind energy and solar power. Consumers in general have learned how to be more efficient in their use of petroleum products just because the prices have been high.

Which companies will look to make acquisitions?

There are a number of investors, strategic and private equity groups, that are well capitalized and have the financial resources to invest in a down market. They will look for opportunities to put their capital to work and expand their businesses. They can purchase assets at attractive prices – prices were substantially higher just a year ago. There is also the pure distressed investing world. If a company has trouble with its bank loan, a distressed investor could work out an arrangement to infuse capital into that company.

Are oil drilling companies or energy services companies the targets for these acquisitions?

It will run across the entire gamut of the oil industry.

Do you have any advice for energy companies looking to avoid distress?

Take a hard look at the capital structure – Is it appropriate for a business in a down market? Typically the fundamental question is: Does the company have too much short-term debt, and should it restructure? Non-bank financial institutions provide loans that can be paid out over a longer period of time.