Oil sands jolted awake

Suncor, Petro-Canada merger all about oil sands; stalled projects could restart

Gary Park

For Petroleum News

For all the talk about a fresh-minted, globally diversified, supermajor based in Canada, the real thrust behind the merger of Suncor Energy and Petro-Canada kept breaking the surface in conference calls on March 23.

In the words of Suncor Chief Executive Officer Rick George — who will carry that title into the new entity provided it gets regulatory and shareholder approval — the merger will create a huge “oil sands-centric” corporation.

“This will obviously be a company that is very focused on Canada, very focused on oil sands,” he said, while paying homage to the fundamentally changed nature of Suncor by acknowledging: “We are going to look at all of the assets. Our future investments will really be tied around … return on capital, near-term cash flow and efficiencies,” such as a C$300 million reduction in annual operating costs and a C$1 billion cut in capital spending by eliminating redundancies, such as duplicate upgraders and pipelines.

While breaking away from its pure-play role in the oil sands, Suncor is far from turning its back on the resource.

The two companies, according to independent analyst Wilf Gobert, bring a combined 7.5 billion barrels of economic reserves to the merger (81 percent of the total from the oil sands, conventional oil and natural gas) and 26.4 billion barrels of economic-plus-contingent reserves (85 percent of the total).

Current joint oil sands production is 297,900 barrels per day, with another 243,900 bpd of conventional crude and 908 million cubic feet per day of gas (with 208,000 barrels of oil equivalent per day of conventional output derived from Petro-Canada’s foreign assets).

Anchor in oil sands

That might be a surprise to those who were gathering around the oil sands gravesite in recent months, eager to bury a resource that had seen billions of dollars of planned investment in extraction and refining projects shelved or cancelled and was bracing for the full impact of whatever greenhouse gas measures were introduced by the U.S. and Canadian governments.

“I don’t know if this is a marriage made in heaven or not, but what I will tell you is it certainly is a match made in Canada,” George said.

“The oil sands is the second-largest oil basin in the world,” he said. “And this is going to be more and more important. The combined company will have a position that won’t be able to be duplicated by anyone.”

Without indicating whether any of Petro-Canada’s scattered global pieces — such as those in Libya, Syria or Trinidad and Tobago — might be sold off, George said the emphasis will be on investing in “areas that get us the highest return on capital, the near-term cash flows and the lower-risk profile that we need on a go-forward basis.”

That suggests Petro-Canada’s reliable producing assets making solid returns on capital will remain in the fold, used as cash cows to finance costly oil sands projects.

Early project revival possible

But no one is talking about a full-scale revival. After all, Suncor slashed its 2009 capital spending to C$3 billion from an original C$10 billion, suspending work on its C$20.6 billion Voyageur upgrader and a third phase of its Firebag in-situ venture, while Petro-Canada’s partnership put its C$25 billion Fort Hills mine on hold.

George said Voyageur would be “an obvious one on that list.”

“We expect increased investment … which will actually create more construction jobs near-term, more operating jobs in the mid- to long-term and wealth creation in Canada in terms of investment employment and taxes paid,” he said.

Pointing to ExxonMobil and Royal Dutch Shell as examples of what is possible, George said those supermajors have invested through the “bottom part of the cycle and are improving their position in Canada.”

“We at Suncor had two options: We could pull back (on capital spending), which we obviously did, or do something that would really strengthen our position and allow us to look at investing and coming out of this cycle stronger than ever,” he said.

Analysts positive

Mike Percy, dean of business at the University of Alberta and a former member of the Alberta legislature, said the merger will create a “Northern Tiger” in the Alberta oil sands region because of the confidence shown by directors and management in the resource “as a long-term play.”

Voyageur and Fort Hills are now suddenly much closer to being restarted, he said.

Lou Gagliard, J.S. Herold’s senior vice president of equities, said the merger is all about the oil sands, noting that Petro-Canada — through Fort Hills, the Mackay River in-situ project and a major conversion of the company’s Edmonton refinery — was on its way to becoming a “dominant oil sands company,” while “Suncor has always done what Suncor does best.”

“It’s a good way to get around the dilemma of how you grow in a low-price environment,” he said.

James Cole, senior vice president at AIC Ltd. and a “peak oil” supporter, said that if oil falls to US$30 per barrel in 2010 Suncor has a major problem on its hands.

However, the billions of dollars in capital spending cuts are potentially setting the stage for a major rise in oil prices.

But Peter Tertzakian, chief energy economist at ARC Financial, said that even though the deal is proof that bigger is better in the oil sands “it doesn’t necessarily mean there will be a return to the Klondike mentality of 2007 and 2008. It means the opposite. It means you need to recognize it takes large companies with access to a lot of capital to develop these projects.”

What gives an added boost to the oil sands outlook is early evidence of a downturn in costs and labor that have crippled the oil sands sector.

Cheaper to buy than drill

Until March 23, the operative word in Canada’s M&A and financings scene was “down,” as deal-making slumped to its lowest level in five years.

The North American market went into a tailspin about mid-2008, resulting in a precipitous drop in Canadian M&As to a mere US$14.5 billion from a record US$45.5 billion in 2007, with the number of transactions falling 40 percent to a five-year low, according to a global upstream review by IHS Herold and Harrison Lovegrove.

The report showed 55 deals valued at more than US$10 million were posted in the first eight months of 2008, followed by only 10 in the final four months.

Major round possible

Now analysts and industry insiders are ready for what could be a major round of consolidation.

“These generally are not one-hit wonders,” Andrew Martyn, vice president at Davis-Rea told the Globe and Mail.

The underlying reason stems from the cratering of commodity prices that dragged down share prices and took a large bite out of reserve values.

Ben Dell of Sanford C. Bernstein in New York said in a report that the gap between the cost of buying assets and drilling for them is greater than ever.

He said that buying an average company, including its undeveloped reserves, now costs about US$11 per barrel — about half what it cost to explore for and develop new reserves in 2008.

“It appears the energy space is on the cusp of an M&A boom,” Dell wrote, suggesting that ExxonMobil, with about US$30 billion of available cash, and other majors will be on the prowl for smaller companies to fill gaps in their exploration portfolios and ensure they have enough land to search for discoveries.

“If this isn’t the time for ExxonMobil (which owns 69.6 percent of Imperial Oil, Canada’s largest integrated oil company) to undertake a corporate M&A spree, then investors could be forgiven for asking what the company is exactly waiting for,” he said.

M&A: Up or down?

Canadian companies on the shopping list include the usual suspects — Nexen and Talisman Energy — both of which have attractive, but widely scattered holdings.

The Herald/Harrison Lovegrove survey showed Canadian deals accounted for less than 15 percent of the global M&A value last year, down from 30 percent in 2007 and the lowest point since 2005, with only two exceeding US$1 billion — Royal Dutch Shell’s takeover of Duvernay Oil for US$5.8 billion and a US$1.3 billion all-share merger of ProEx Energy and Progress Energy Trust.

The value of oil sands-related activity plunged to US$2 billion in 2008 from US$18 billion the previous year, the report said.

On a global scale, the weighted-average proved-implied-reserve value rose to US$11.51 per barrel of oil equivalent from US$10.01 in 2007, while the worldwide transaction value for the upstream slumped to US$104 billion from US$160 billion.

Calgary-based Sayer Energy Advisors forecasts M&A activity will remain in the doldrums this year, blaming Alberta’s new royalties, the dive in oil prices and the economic crisis, along with the deadline for changes to income tax treatment of Canadian royalty income trusts.

Sayer estimated the total enterprise value of Canadian deals was C$17.5 billion in 2008 compared with 2007’s C$50 billion.

The firm predicts that corporate transactions will prevail this year, continuing a trend when asset deals dropped to 20 percent of total transaction value in each of the past two years.

Not many companies for sale

He said not many public or private companies are known to be for sale or reviewing strategic alternatives to maximize shareholder value, although it is possible some are “quietly” probing alternatives in order to survive.

In a separate report, Sayer said financings declined last year to C$15.7 billion from a record C$25.5 billion in 2007, with debt financings taking the largest hit, falling 39 percent to C$8.2 billion from C$13.5 billion.

Equity financings declined 27 percent to C$7.2 billion, with issues sliding to 582 from 752, and royalty income trust unit financings dropping 86 percent to C$318 million, said Sayer analyst Ryan Ferguson Young.

He said only six initial public offerings were completed in 2008 compared with 18 in 2007, with the average size declining to C$11.7 million from C$19.2 million.

—Gary Park