oil-drums


In Vancouver and Toronto, dinner conversations invariably drift to discussion about how much someone sold their house for, and how much above the listing price.

While generationally low interest rates are often cited as a driving factor, what’s getting the lion’s share of attention these days is an insatiable appetite from foreign buyers.

But that interest doesn’t exist for Canadian energy assets. Instead, foreign buyers have been eager to unload oil sands assets in particular. Over the last couple of years, the oil sands has increasingly become a Canadian industry and a buyer’s market. Supermajors now seem to want to retrench to short-cycle onshore wells outside Canada and eschew oil sands investments, which have long lead times. Why has this happened?

Oil sands ownership, then and now

Back in 2012, one report pegged Canadian ownership of Canadian energy sector production at 24%, with the remaining 71% in the hands of foreign companies. At the time, a prominent Calgary investment banker told me that just over 10% of oil leases had been snapped up by voracious, Chinese state-owned oil companies, hungry for long-term resources. I replied that this was a fantastic soundbite for the business media, to which he retorted, “Let’s keep that out of the media for now—we’d like to do a few more deals with the Chinese.”

One of the largest deals made the following year, 2013, saw CNOOC Limited purchase Nexen in a $15.1-billion deal.

At the time, there was palpable concern among many Canadians that foreign entities were laying claim to huge swaths of the resource, and that our energy sovereignty was under siege.

A few years after Ottawa effectively put the brakes on big foreign ownership deals, the oil sands resource is back in the hands of a few large, domestic Canadian producers. This trend really began to take shape in 2015, with Suncor’s launch of a hostile takeover bid for Canadian Oil Sands. Since then, six transactions, collectively valued at $40 billion, have solidified the theme (subsequent transactions with foreign owners have reduced their Canadian presence; see Table 1). Now, Canadian producers are on course to own 75% of production capacity in sectors that are operating and under construction (see Chart 1).

There’s an upside: larger Canadian entities will likely have greater clout in lobbying the Trudeau government for policies that benefit the beleaguered industry and its thousands of Canadian workers. This is particularly important when the Republicans and Liberals appear to be moving in opposite directions on climate change and environmental regulation.

Table 1: Major oil sands transactions and the exodus of foreigners

Acquirer Seller(s) Asset details Deal value
Suncor Energy Inc. Canadian Oil Sands Ltd. Corporate acquisition (36.74% Syncrude ownership) $6.6 billion
Suncor Energy Inc. Total SA 10% ownership in Fort Hills $310 million
Suncor Energy Inc. Murphy Oil Corp. 5% ownership in Syncrude $937 million
Canadian Natural Resources Ltd.

Royal Dutch Shell PLC and Marathon Oil Corp. 70% interest in the Athabasca Oil Sands project $12.74 billion
Cenovus Energy Inc. Conoco Phillips Conoco’s 50% interest in the FCCL Partnership and Deep Basin portfolio $17.7 billion
Athabasca Oil Corp. StatOil ASA Leismer thermal oil project (24,000 bbl/d of production) $582 million

Sources: Company reports, Raymond James Ltd.

Survival mode and short-cycle projects

The downturn in oil prices imposed tremendous stress on the global energy sector. In a sector rife with losses and write-downs, the supermajors have been fighting to shore up balance sheets and maintain dividends at all costs. As part of this struggle, there has been a renewed focus on only the most economic projects. The appetite for high-risk, capital-intensive megaprojects, which take years to see first production, has been waning. Chevron entered 2017 with a budget of nearly $20 billion, which is 15% below 2016’s and 42% lower than its 2015 budget.

This year’s budget was focused on completing megaprojects already in progress while targeting those where more than 70% of the upstream investment was expected to generate production within just two years. There was a clear shift away from long lead times, like those of deep water projects and the oil sands, and toward projects benefiting from significant improvements in costs and technology—which measure success in months, not years.

Most observers postulate that foreigners are fed up with the oil sands’ lack of competitiveness, particularly considering that development has tended historically to take longer and cost more than expected. But there could be a number of reasons for the lack of interest. There is considerable uncertainty around the trade policy of an inexperienced White House, and there have also been years of uncertainty surrounding much-needed pipelines to get more Canadian crude to buyers outside of North America.

At the same time, European energy companies seem, increasingly, to be pursuing cleaner natural gas and renewables, and moving farther away from Canada’s greenhouse gas-intensive bitumen resource, which across the Atlantic has earned the moniker “dirty oil.”


CHART 1: Overview of ownership breakdown in oil sands sector

Fire sale pricing

While it’s easier to see why the Canadian energy sector has become unloved, the catalysts for a rebound are a little less obvious. Investors have tarred Canada with a malaise that extends beyond the oil sands. Chart 2 shows the valuation of Canadian exploration and production companies relative to their U.S. peers. Many of the oil sands assets that were jettisoned by foreigners actually generate free cash flow at US$35 to US$40 per barrel. What’s more is that the operations of many conventional oil producers have never been strong. They’ve benefited from a reduction in their cost structure that was engineered by the downturn, and a leaner, meaner competitive position.

Investors are increasingly looking for the oil and gas sector to deliver acceptable rates of return at a corporate level and on a per-share basis. Coming out of the energy price crash, the Canadian oil and gas sector has reinvented itself. At the end of May, one of the largest initial public offerings in Canadian history was completed: Kinder Morgan Canada Ltd., for $1.75 billion. Proceeds have been earmarked to partially fund the construction of the Trans Mountain Expansion Project, an ambitious pipeline infrastructure expansion that would get more Canadian energy to tidewater and foreign consumers.

There is also a strong likelihood that rational heads will prevail in the Trump administration and that the Canadian industry won’t be subject to a border adjustment tax. After all, the Trump approval of the contentious Keystone XL pipeline project was a strong signal that the White House recognizes the importance of Canadian energy.

For now, patient investors should focus on companies that generate significant rates of free cash flow.

Enlarge

CHART 2: Canadian E&Ps trading premium (discount) to U.S. independents (greater than $1B)

by D. Mason Granger, P.Eng., MBA, CFA, is a portfolio manager in Toronto.

Originally published in Advisor's Edge Report

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