Q&A: Credit Suisse Banker Osmar Abib
The managing director of the energy group talks about the hot sector
By Aleksandrs Rozens July 28, 2008
Osmar Abib, managing director of the energy group at Credit Suisse, is based in Houston, but as an investment banker he covers oil and gas companies globally.
Prior to studying at Harvard's business school, he was a chemical and petroleum engineer for ARCO Oil & Gas for almost five years. Abib started his career as an investment banker within the oil and gas sector at Lehman Brothers in 1987. He left Lehman for Credit Suisse in 1995 and has since worked out of Credit Suisse's offices in New York and Houston. How did he decide to shift career paths?
"As I got more experience as an engineer, I was doing a lot more economic and financial analysis. I wanted to stay with the industry I knew. I thought the MBA would help as I moved up in the [oil and gas] industry. When I got out of business school I thought investment banking was a better fit for both my technical and MBA credentials," Abib recalls.
Osmar Abib
His work as a chemical and petroleum engineer took him to natural gas fields of Oklahoma, Prudhoe Bay in Alaska as well as offshore platforms in the Gulf of Mexico. Following are excerpts from an interview with Abib.
IDD: How do today's energy issues compare with those of the late 1970s and early 1980s?
Abib: Ultimately it is a supply and demand issue, but the dynamics today are very different than what we have had in the past. Clearly we are at much different commodity price levels today. Demand continues to increase and oil and gas are finite resources. The world has not found all of it, but at some point in time all of the easy-to-find fields that you can access have been found. As demand continues to grow it becomes harder and harder to find new reserves.
Depending on which part of the oil value chain you are in, there are different impacts. What is quite new this time around is how big some of the developing countries have become. China and India, for example, are consuming much greater amounts of energy than they ever have.
The other thing that is going on is the US and others have a much higher importing percentage of oil than we did in the past as reserves in the US have dropped. There are economic issues related to that as well as national security issues which are different than in past periods in this business.
IDD: What are the needs of the oil and gas businesses? Are they calling on you to do fund raising or M&A work?
Abib: The vast majority of what we do is helping companies finance across the entire debt and equity spectrum, whether it's public or private markets. We also help companies with M&A, buying and selling assets or businesses or entire companies.
With the upstream companies, their biggest strategic challenge is finding incremental reserves and production. Some of the more developed oil and gas provinces have extracted a substantial amount of the available reserves and so they have two challenges.
[One challenge is] In the older fields they have to figure out new technologies to get at incremental reserves. Generally that is more expensive and some of these technologies are still in development. There is a fair amount of capital being spent to come up with new technologies. Even if you have it [the capital], the amount of remaining reserves is smaller than when they [the companies] first started and the economics are not as good.
The other challenges are places that have harder-to-extract reserves, like deepwater offshore, are located in places that are difficult for political and other related reasons.
The technology is for new and old fields. On the old fields the technology that is being implemented is to go find incremental reserves. Let's say there is a billion-barrel field, that does not mean they are going to be able to take out the entire billion. The amount that they are technically able to take out is a fraction of that. They go in with more advanced technologies after the primary method of taking the oil out happens. They go in with more advanced technologies to take out an incremental amount and that is much more expensive. They'll never get 100% of the oil. On the new fields, the technology is more sophisticated because they are drilling in tougher areas to get to, such as deep water.
Technology is a huge part of the business. It is getting more expensive because the easier-to-find oil has already been found.
IDD: As news of the oil and gas shortage becomes more amplified, has the pace of dealmaking increased in the last year to three years?
Abib: Yes. There is a debate as to whether there is a shortage or not.
One camp says 'there is an absolute shortage and we better do something about it.' There is another camp, that says 'there is not a shortage and the reserves are there, it just takes time to go properly find them, develop them and put them on production. The system is just tight because there are only so many tankers, refineries, and people.'
One of the issues the industry has that is very serious is the aging of the workforce. There has not been a substantial amount of new engineers coming out of the schools to meet the demand. Meanwhile, the current workforce is aging and there is a substantial amount of people close to retirement. I think the industry has enough capital, particularly at these high commodity prices, but there are only so many rigs and so many systems out there to go find the oil. And, there are only so many people available to do it.
So, it is not really a capital constraint. It is really more of a technology, technical services, and people constraint.
IDD: Does this prompt more in the way of M&A activity?
Abib: Yes, there have been people who have said that issue alone can create M&A activity.
IDD: Has that already started?
Abib: I don't think anybody said they are doing a deal because they want to add staff. M&A activity generally happens in one of two environments. It generally happens when the industry is performing well, people have capital flexibility and they want to increase returns and grow their businesses quickly. When there is a constraint in people, technology, services and equipment, one of the ways to grow the company is to make an acquisition. There is no question there is a lot of M&A activity going on across the entire oil and gas spectrum.
IDD: When it comes to raising capital where are the proceeds being directed to? Hiring staff or luring staff from competitors? Technology?
Abib: It takes money to acquire the leases, acquire the wells, buy all the equipment, hire the service firms to go do those sorts of things. It takes money to build new pipelines. Some of that capital is used for M&A as well. It is very situation-specific as to how they use that capital.
IDD: When you raise capital how are you raising the money? Secondary offerings of equity? Or debt?
Abib: The markets are pretty open for oil and gas companies. You are seeing a fair amount of equity offerings, IPOs and follow-ons. You are also seeing some debt financings, both investment grade and high yield. There are some private placements of debt and equity going on as well. The bank market is pretty active in oil and gas. The industry is pretty well-capitalized. It is performing well and despite all the issues in the [credit] market, oil and gas companies have pretty good access to financing.
IDD: So, despite the fact we have a credit crunch, they are getting money? $140 a barrel for crude oil must help.
Abib: It is not just the $140 a barrel. I'd say the oil and gas industry has ample access to the financing markets if they have the need. It depends on your rating and size. But, generally speaking, the oil and gas industry has access to capital.
IDD: Who are the investors being drawn to different transactions--IPOs, follow-on offerings and debt issues?
Abib: It is pretty conventional investors. Most want exposure to the oil and gas industry. It's a who's who of the institutional investor base on the debt and equity side.
IDD: Are valuations being bumped up by the $140-a-barrel headline number? Is there a way to measure how the price rise in oil changes the valuation of a business?
Abib: It is not a direct one-for-one. People are valuing companies on what they think the long-term commodity price is going to be and the resulting cash flows and earnings of companies that will be affected by that. Not everybody agrees that because it has gone up to $140 that it will stay there, or where it might be a year, five years or ten years from now.
Generally speaking, as commodity prices have gone up people have taken a more optimistic view of where they think the commodity price will be. However, there are two schools of thought on this.
There are people who think that if oil prices go up too fast, that could be a negative because it will cause demand destruction and people will start looking at other energy technologies and sources. A high commodity price scenario could actually create a bigger drop when the cycle turns. Most oil and gas companies and people involved in the oil and gas industry would prefer a more stable price. One of the problems with being an oil and gas company or being a banker to an oil and gas company is the volatility of commodity prices as people try to figure out their financing needs, their capital needs, how they might value an acquisition or the economics they might use to evaluate a new field.
IDD: If you have a lot of volatility in the oil price that makes it tough to value a business.
Abib: Nobody will assume oil prices will remain at $140 forever or they'll go up forever. Most people who do economic analysis in this industry are assuming they will either flatten or at some point there will be a drop. If you look at its history, it is a volatile commodity. When oil and gas companies do their economic planning or look at M&A projects, the price deck or price forecast they use is generally substantially lower than what the commodity price in the trading market suggests it should be. Anybody that's been in this business knows it is volatile and knows at some point there will be a drop, a meaningful drop. They want to try to capture that in some way. People do a sensitivity analysis of a high commodity price case and a low commodity price case.
The other thing people do is they hedge. There is a liquid market now in oil and gas [futures] where they can go try to hedge their commodity price risk. That allows them to take a little more aggressive view on looking at buying somebody or doing a drilling project. They don't want the technology risk and the price risk at the same time. They'll try to hedge out the price risk.
IDD: So if I am buying somebody or financing a new technology I would go to an exchange to buy some futures contracts to offset a sharp decline because at this point I may be overpaying at this lofty level?
Abib: Yes, there are people that believe some level of hedging is a prudent thing to do.
IDD: The concept of demand destruction is interesting.
Abib: The view is people are concerned if there is too big a run-up in commodity prices that could cause a problem with demand. It could potentially cause a recession. Even if they benefit in the short term, it could have a long-term negative impact. At some commodity price point, people will figure out some other way to secure their energy supplies. Some of these [alternative] technologies are available and some need to be developed. The biggest problem we have now with these high commodity prices is there is really no short-term solution that is going to dramatically change the current picture. All substitute energy sources will take time and capital to be developed. Even if you go to wind, there are only so many manufacturers of those products and it takes time to put those products and systems in place.
IDD: When it comes to investors in these debt and equity offerings, are you getting any hedge funds or private equity buyers? Infrastructure funds?
Abib: Yes, all of those.
IDD: How about sovereign wealth funds?
Abib: Yes.
IDD: What does each investor class hope to achieve?
Abib: Hedge funds are investing in every sector so I am not sure there is any particular dynamic [with them] that is different. They like sectors that have volatility and they like sectors that are growing. Private equity views it as a sector that is growing, that has very strong fundamentals. These investors have been in the sector for a long time. There have been PE funds focused on the oil and gas industry for the last 40 years.
However, there have been more PE firms looking recently. The reason for that is diversification. Some of the other sectors that they have invested in have not been doing as well. The fundamentals here look good. People feel the fundamentals will be good for some time. That's why we will see additional private equity funds come in to the sector. PE funds have raised their money and they need to put it to work. This is a sector where they feel they can get a pretty good return.
Sovereign wealth funds understand the sector well given that they understand the fundamentals. They are interested in putting a substantial amount of money to work. It is as much a geographical diversification opportunity for them.
IDD: Away from the fund raising aspect of your investment banking business, what is driving M&A?
Abib: M&A is driven by a company's desire to grow. They only have a certain number of internal opportunities so their options to grow are to use capital for new projects or buy companies and businesses. These companies are doing quite well and they are limited in their internal ability to grow so they going externally.
IDD: Are they mid market or large cap names?
Abib: More in the small to middle. There are some big deals out there too. There are more middle market deals primarily because there are more middle market companies. We do spend a lot of time with the middle market in addition to large cap companies.
IDD: Away from oil and gas, you are involved with oil services?
Abib: They are providers of equipment and technology that help producers find oil and gas and take it out of the ground. Given the high level of activity in this sector there is a substantial level of demand for their services.
IDD: Is there a shortage of these products because of higher energy prices and greater demand?
Abib: People have to go to more difficult places and that generally requires more specialized equipment and more specialized technology. That's one reason you have seen day rates on offshore drilling rigs go up dramatically. There are only so many rigs out there, particularly for the deepwater. There is a limited number and there is a big demand by oil and gas companies for these rigs. It will take more time for new rigs to show up. As they move to tougher places to drill like offshore or deepwater, those types of companies are benefiting from that.
IDD: I'd imagine this brings in venture capitalists into this area?
Abib: Some. The venture capitalists are more focused on the new technologies.
IDD: Do you see us staying at $140 a barrel? Does business stay as lively?
Abib: It is hard to predict what will happen to commodity prices without knowing how political issues like Iran and the Middle East develop. In addition, if China and India continue to grow rapidly that will continue to put pressure on the demand side. I think oil prices are going to remain high but they could move within a band of $20 to $30 either way.
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