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Rethinking joint ventures Analysts say collapsed Encana-PetroChina deal shows offshore investors won’t pay premium for stake in Western Canada shale gas By Gary Park For Petroleum News
Those sifting through the debris of the failed Encana-PetroChina deal are starting to reach a consensus that China is far from being the easy route to unlocking Western Canada’s stranded shale gas resources.
In fact, the soul-searching raises questions about the future role of offshore partners in the region’s massive oil and gas assets, coming after two years of direct investments running to about C$20 billion by mostly state-controlled companies from China, Japan, South Korea, Thailand and Malaysia.
Now attention has shifted from a landmark transaction to what it means for hopes that Canadian producers could secure premium-priced LNG contracts in Asia and end their reliance on U.S. gas pricing.
More than just embarrassing The collapse of the US$5.4 billion agreement with PetroChina involving the Cutbank Ridge properties of British Columbia is more than just embarrassing for Encana, which had spent a year of what it termed “exclusive” efforts to pin down the terms of a partnership.
With Encana renewing its search for a partner, other shale gas owners are left to wonder about the value of their own holdings as they look for a relief valve to their losing battle with the Marcellus, Eagle Ford and Haynesville basins in the U.S., where costs are lower and big markets are closer.
Providing it gained both corporate and regulatory approval, including clearance by Canada’s foreign investment review agency, the Encana-PetroChina arrangement would have marked the first time a Chinese company had owned and operated Canadian production. Until now, in the wake of China National Offshore Oil Corp’s failed bid in 2005 for Unocal, China’s stable of oil and gas companies has confined itself to minority stakes in early-stage projects.
Discussions between Encana-PetroChina had highly symbolic beginnings, through a memorandum of understanding announced a year ago when Chinese President Hu Jintao visited the Canadian capital of Ottawa.
In February, the two companies released the barebones of their US$5.4 billion plan — set to become the largest Chinese energy investment in North America — which assumed production would eventually be shipped to Asia through the Kitimat LNG project, 30 percent owned by Encana.
Hints progress stalled Although there were hints of stalled progress toward an operating pact, Encana chief executive officer Randy Eresman had voiced confidence only two months ago that a deal would close.
UBS Securities analyst George Toriola told Reuters that Eresman had been left with “egg on his face,” having been forced to concede that a “big deal was not going to happen.”
Meantime, the Canadian government had twice delayed approval of the transaction, although Encana, without getting into the specifics beyond conceding there was a “significant misalignment” between the two companies, insisted the negotiations failed for business, not regulatory reasons.
A spokesman for PetroChina flatly declared his company walked away after the two sides were unable to agree on a price for the assets.
Significant blow to Encana Scrapping the planned joint venture will be a “significant blow” to Encana’s 2011 cash flow, said an investor note from Ticonderoga Securities, adding that “could potentially slow their drilling program, which could result in further cutbacks” to already trimmed production guidance.
The firm said the loss of proceeds from the joint venture could increase Encana debt by US$800 million this year and US$1.6 billion in 2012, prompting it to issue a sell rating on Encana.
However, Encana said that apart from revising its net divestitures to between US$1 billion and US$2 billion all other components of its 2011 guidance remain unchanged.
Barclays Capital analysts wrote that Encana would be about US$2 billion underfunded for the next 18 months.
Observers say… Eresman said Encana expects gas prices to reflect the forward price curve and return to a long-term level of US$6 per thousand cubic feet, with supply costs easing from US$3.70 this year to US$3 over the next three to five years.
Encana remains upbeat about its chances of attracting a new partner to its “large potential” British Columbia holdings, where the potential far exceeds the growth rate it can fund from internal cash flow.
Observers suggest the test may come down to whether Encana is willing to lower the price tag on its assets from the US$17,000 per acre PetroChina originally committed to pay to US$14,000 pegged in the Progress Energy Resources-Petronas joint venture.
IHS Herold analyst Michael Wang said the higher figure would apply to liquids-rich gas plays such as Eagle Ford rather than the drier gas of Cutbank Ridge, suggesting someone in the Chinese government cabinet decided it was not a prudent deal.
Other observers said PetroChina was also unhappy that Encana had sharply reduced its production targets for the next five years.
Among analysts, there is a feeling that Encana will not be able to sell assets in Cutbank Ridge, Horn River or Greater Sierra for the same price PetroChina offered, with Gordon Kwan, an analyst with Mirae Asset Securities in Hong Kong, estimating Encana would have needed to trim its price by 20 percent to retain PetroChina.
Randy Ollenberger, an analyst with BMO Capital Markets, has no doubt there will now be “downward press” on the value of Encana’s properties, even if Royal Dutch Shell and BP see an opening to expand their presence in the shale gas sector.
Regardless of what success Encana has in attracting a new partner, there might be an early indicator from Nexen and Devon Energy, which are also exploring joint ventures for their Horn River deposits.
Progress Energy chief executive officer Michael Culbert said Canada needs continued investor interest in its natural resources to “help the pace of development.”
Chris Theal, president of Kootenay Capital Management, and Wenran Jiang, research chair at the University of Alberta’s China Institute, do not believe PetroChina’s pullback is evidence that China will not expand its search beyond overheated LNG exports such as Australia.
“In Australia, there are so many projects on the go it’s a lot like the oil sands in Canada five years ago in terms of labor and material inflation,” Theal said.
Jiang said it appears the Encana deal crumbled “because many of the technical arrangements were not satisfactory to either or both sides.”
He did caution that Chinese investors are becoming “choosier” about international resource deals, having already bailed out of other big minerals and gas opportunities.
But Jiang said it is “no longer the case that China is prepared to “scope the earth for pots of energy resources and overbid anybody to grab on at any price.”
Gordon Houlden, director of Jiang’s institute, said there is no reason to think China has lost interest in North American energy assets.
“As we know, there is a lot of shale gas in China and they need the know-how, the tech transfer, to harvest it more efficiently,” he said, adding North America will remain on China’s radar so long as there is political uncertainty in the Middle East and North Africa.
Brian Tuffs, the head of acquisitions and divestitures at Calgary-based investment dealer Peters & Co., said the Encana-PetroChina experience will put paid to any belief that offshore investors are not savvy when it comes to executing a deal.
“The power is in the hands of those who have the money,” he said.
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