Total mergers and acquisitions (M&A) activity in Canada was underwhelming in 2012, but, for the oil and gas sector, 2012 eventually shaped up as a bit of a catch-up year. At the end of the third quarter, the total value of oil and gas M&As was $45 billion, up from a total of $15.6 billion for all of 2011. And a busy fourth quarter was expected at the time of writing.
“Volatility in commodity prices impacted the alignment between the market on the buy side and the value expectations on the sell side in 2011,” says Mark McMurray, managing director of RBC Rundle. “In 2012, particularly in the latter part of this year, there was a clearer line of sight around pricing, so that’s helped get some transactions that perhaps were stalled in 2011 to the finish line.”
Foreign interests in Canadian oil and gas assets garnered a lot of attention near the end of 2012. A $5.3-billion bid by Malaysian national oil company PETRONAS for Canada’s Progress Energy Resources Corp. failed to pass the Canadian government’s net-benefit test on its first round. And China National Offshore Oil Corporation (CNOOC) Limited’s $15-billion bid for Nexen Inc. was in extended review by the Canadian government, which promised a decision on December 11.
The size of the CNOOC/Nexen deal, China’s largest overseas acquisition if approved, raises a number of issues for Canada. In 2005, CNOOC’s bid for Unocal Corporation was rejected by lawmakers in the United States, who cited national security concerns. The United States has similar concerns about this deal, and an opinion poll in September showed that Canadians also oppose the sale.
In Ottawa, the opposition New Democratic Party (NDP) demanded that Prime Minister Stephen Harper block the bid, saying approval could trigger “a tidal wave” of foreign takeovers. NDP natural resources critic Peter Julian also called for more clarity on the government’s “net-benefit” rule.
“If this deal doesn’t go through,” says Tom Pavic, vice-president of Calgary-based Sayer Energy Advisors, “it could slow down foreign investment, in the short term, until the Canadian federal government clarifies the ‘net-benefit test’ it uses in assessing these transactions. If approved, I think it will increase foreign interest in Canadian oil and gas.”
Ed Giacomelli, managing director of Crosbie & Company Inc., a Toronto-based provider of investment banking services, emphatic-ally says the government needs to clarify the net-
benefit test, but concedes that the process has to deal with some complicated issues.
“There are certainly issues of reciprocity, whether Canadian companies are being given the same opportunities to buy in other countries, what objectives a foreign state–owned enterprise has in owning an asset in Canada, national security interests and there may also be a realization, with the disappearance of Inco [Limited] and Falconbridge [Limited], that our economy needs international champions,” he says.
Juniors vie for equity
A broader theme in the M&A market, according to RBC’s McMurray, is the reorganization of producer business plans and portfolios in an attempt to capture more attractive rates of return in oil resource plays. While the shift from natural gas to oil has been ongoing for a few years now, McMurray notes that extraordinary premiums have recently been paid for some deals, while extraordinary discounts have been extracted for others.
“This divergence is based on the merit of the commercial returns that can be generated from the capital, as well as the scale of those transactions,” McMurray says. “Most of the larger transactions we’ve seen involved out-of-country interests and have been motivated by scale and asset quality.”
But high premiums put many junior oil and gas producers at a disadvantage because capital markets aren’t paying much attention to juniors these days. Many juniors can’t raise sufficient equity not only to participate in the reorganization of their portfolios through acquisitions, but even to develop the assets they do have.
This lack of support has driven a number of paper-to-paper transactions as juniors attempt to bulk up and gain more focused positions of scale. Some examples at the end of 2011 were Emerge Oil & Gas Inc. merging with Twin Butte Energy Ltd.; Seaview Energy Inc.’s decision to merge with three privately held companies (Charger Energy Corp., Silverback Energy Ltd. and Sirius Energy Inc.); and Storm Resources Ltd.’s acquisition of Bellamont Exploration Ltd.
Pavic notes that the continuing lack of market support for juniors in 2012 had a number of small producers consider swapping growth for yield. Twin Butte and Renegade Petroleum Ltd. are examples of smaller companies that have become dividend-paying corporations as part of a merger or acquisition process.
“The market seems to really like this,” Pavic says. “As dividend-paying corporations, they might be able to raise more capital.”
Financial pundits are cautious in forecasting M&A trends and activity levels, recognizing that many factors play into the mix—the overall health of the economy, commodity prices, the Canadian government’s decisions on Nexen and Progress, and infrastructure.
“All eyes are on infrastructure,” McMurray says. “The timing of those infrastructure projects to the West Coast and Gulf Coast is going to have a profound impact on the pace of capital deployment in western Canadian resource plays.”
Any oil pipeline approvals to either coast could potentially spur M&A activity among oilsands companies. Announcements of interim solutions, such as railing product, might also have an impact.
The prospects of liquefied natural gas (LNG) exports may also drive some M&A activity as companies align strategic resources with British Columbia’s Prince Rupert and Kitimat LNG projects. But McMurray says that activity is still a ways out since the only companies that are actively pursuing these plans are those foreign interests that can afford to take a long-term horizon.
“The uncertainty of infrastructure timing is certainly affecting the pace of capital investment in those ventures,” McMurray says. “You’re drilling today and feeding into a market that has a depressed price and you’re not capturing any arbitrage to foreign pricing as of yet.”
In general, the M&A market thrives on stability, which is something that seems to be in short supply currently, both in the world economy and in commodity prices. Budget deficits in the U.S. and Europe are being addressed at a slower pace than most business people would like to see. With several European countries already in recession, Canada and the U.S. are doing their best to avoid creating conditions that would lead to similar economic declines.
“My personal opinion is that we’re in a period of slow growth,” Giacomelli says. “If you remove the volatility from the marketplace and the concerns related to fiscal imbalances, then I think that gives rise to an increase in M&A activity. But it’s impossible to predict when that will happen.”
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