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Evaluating a gigantic partnership Jury out among analysts on whether Conoco/EnCana JV a deal or steal; Alberta premier’s likely successors ease tough talk on upgrading Gary Park For Petroleum News
It wasn’t a case of EnCana thumbing its nose at Alberta’s current and future political leadership, but the big independent’s precedent-setting decision to team up with ConocoPhillips in an integrated oil sands joint venture made nonsense of all the tough talk about forcing producers to upgrade their bitumen in the province.
Despite the insistence by outgoing Premier Ralph Klein and those vying for his job that more of the value-added benefits of upgrading and refining should remain in Alberta, EnCana and ConocoPhillips played the free market card in forging their US$26 billion partnership.
The pact will see the two companies operate on a 50-50 basis to achieve an eight-fold increase in oil sands production from 50,000 barrels per day to 400,000 bpd by 2015 at EnCana’s Foster Creek and Christina Lake leases (which have a total 44 billion barrels of bitumen in place).
In return for trading off 3 billion barrels of high-quality bitumen, EnCana will get an equal partnership in the Wood River, Ill., and Borger, Texas, refineries owned by ConocoPhillips, the No. 2 U.S. refiner. The bitumen upgrading capacity at those plants will be boosted from 60,000 bpd to 275,000 bpd, with combined throughput of the two plants climbing to 600,000 bpd.
In addition to rolling assets worth US$15 billion into the bundle, the two companies are committed to spending US$5.5 billion each over the next two years to achieve their goals.
Deal or steal? Since the unveiling of the plan, there has been a lot of flailing around among analysts over whether the transaction was a deal or a steal.
Ben Dell, with Sanford C. Bernstein in New York, said EnCana paid a “very high price” for what it gained, estimating the 3 billion barrels of bitumen in the ground were traded away for about $1 a barrel, about half the value of other recent transactions.
He also suggested that profit margins at refineries were high during the negotiations and have since collapsed.
Adam Zive, with Desjardins Securities, said the deal did not achieve the expectations EnCana set a year ago when it started a fresh search for a partner after the break-up of an earlier plan to run its oil sands production through Premcor’s Lima, Ohio, refinery (since acquired by Valero).
On the flip side, Tom Ebbern, research director at Tristone Capital, said that once the arrangement is up and running EnCana will become the second-largest integrated oil producer in Canada next to Imperial Oil, while UBS analysts Andrew Potter and Michael Rimmell said the joint venture could see EnCana’s shares climb to the higher level accorded integrated companies.
Martin Molyneaux, with FirstEnergy Capital, said that having solved the differentials between heavy and light crude for two-thirds of its oil sands operations frees EnCana to take a more aggressive posture in all aspects of its business.
Jeff Martin at Peters & Co. said in an update that based on his firm’s long-term pricing assumptions of US$40 per barrel WTI and US$6 per thousand cubic feet Nymex the transaction “will add US$5.36 per share to our existing base case conventional net asset value of US$42.81 per share.”
EnCana: JV will reduce risks EnCana Chief Executive Officer Randy Eresman said the joint venture will reduce “execution risks, enhance value, accelerate development and improve returns for both partners.”
His ConocoPhillips counterpart Jim Mulva said the strategic alliance allows his company to reposition 10 percent of its U.S. downstream business to “access a large upstream resource base” and ensure a “stable, long-term” supply of crude that can be refined into gasoline, diesel and other products needed in the U.S.
Because there is no certainty that the producing side of the joint venture will ship to the refining partnership, no transportation arrangements were announced.
But it is thought likely that TransCanada’s proposed Keystone pipeline will take a leading role since ConocoPhillips has already reach a long-term shipping contract with a system that would deliver directly to Wood River and might have a connection to Cushing, Okla., bringing it close to Borger.
The two companies indicated that other oil sands properties could be fed into the mix later, notably ConocoPhillips’ Surmont project which could yield 100,000 bpd by 2012 and EnCana’s Borealis property, also slated to produce 100,000 bpd, but because of its heavier gravity bitumen (7 degree API compared with 10 degrees API at Foster Creek and 9 degrees at Christina Lake) is likely to be better suited to upgrading in Alberta.
Other potential EnCana projects, such as Steepbank, East McMurray and Cheecham, are close to Borealis, with all four representing about one-third of EnCana’s oil sands development potential beyond Foster Creek and Christina Lake.
Political debate over loss of upgrading capacity Off on the side, another debate is occurring over the loss of upgrading capacity that was so recently coveted by the Alberta government, with Klein, in his final two months in office, unhappy that EnCana is taking its upgrading to the U.S.
He has insisted that bitumen “ought not to leave the province. ... We should try to add value to it.”
Of the candidates to become premier, the hot favorites, Jim Dinning and Lyle Oberg, have taken up the cry.
Dinning has declared that if he lands the top job he will “ensure that bitumen is upgraded in Alberta to the best ability of the industry.”
His message to the industry is: “If you mine it here, you upgrade it here.”
Oberg has taken a similar line: “If there are upgraders built, then they will be here.”
But, in the aftermath of the EnCana announcement, Dinning was less adamant, saying only that he would have looked for a chance to “sit down and talk.”
Oberg said his previous hard-line stance was merely designed to “find ways” to keep the bitumen upgrading in Alberta.
However, he did ask, if upgrading in Alberta is viable for other companies, “why wouldn’t it be viable for EnCana?”
Jerry Bellikka, a spokesman for Energy Minister Greg Melchin, said the government was more than satisfied with the chance to collect the royalties from 400,000 bpd of production, along with the job creation and economic spin-offs.
He said the government’s primary objective is to continue promoting Alberta’s royalty structure, low taxes and access to skilled workers in a bid to ensure that eight upgraders now in various planning stages are built in the province.
But there is no desire by the government to take draconian measures, such as banning bitumen exports or imposing tariffs, because of the challenges that would be triggered under the North American Free Trade Agreement.
Bellikka suggested only that once a new premier and cabinet are in place there could be some tweaking of oil sands policies, although he said there has been no talk about solutions such as separate royalty structure for those who upgrade in Alberta and those who send their production elsewhere.
The next test of Alberta’s patience and resolve is not likely far away, with Husky Energy targeting 200,000 bpd from its Sunrise project by 2010-2012 and setting its sights on 500,000 bpd from the oil sands by 2020.
Chief Executive Officer John Lau, in opening the 30,000 bpd Tucker project on Oct. 5, said Husky will decide where to upgrade its future production based on “what is economically sustainable.”
For Husky and others the pull is strongly toward the U.S., given that BP plans to invest US$3 billion to adapt its Indiana refinery to almost exclusively process Alberta heavy crude, and Marathon’s ambition is to use some of its refineries as a bargaining chip to possibly strike a similar deal to the EnCana-ConocoPhillips partnership.
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