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Merger hints at oil-sands revival

The merger of Suncor and Petro-Canada may be the first of many deals in the oil sands, with the majors looking to build positions while share prices are low, writes WJ Simpson

Suncor Energy, Canada's pioneer oil-sands company, is to take over one-time state-owned Petro-Canada in a deal the two sides code-named Quantum. The transaction will create North America's fifth-largest oil and gas producer, with a market value of about C$50bn ($41bn). Apart from their own quantum leap forward, the two companies have also stirred prospects of consolidation elsewhere in the floundering oil-sands sector.

For the two companies the prize is controlling 26.5bn barrels of oil; the largest suite of oil-sands holdings in the world; daily production of 0.68m barrels of oil equivalent; and an international reach that embraces the North Sea, Libya, Syria, and Trinidad and Tobago. Their joint Canadian operations cover the energy sector, from the Arctic to the east coast offshore, shale gas, refineries, a chain of retail outlets and even wind power. The deal is expected to receive approval from shareholders, regulators and courts before the end of the third quarter.

The idea of a merger was first proposed in 1999, when the companies explored and gave up on a union conceived to challenge Imperial Oil, 70% owned by ExxonMobil. And after last year's collapse of stock markets and oil prices the companies' chief executive officers (CEO), Suncor's Rick George and Petro-Canada's Ron Brenneman, began to reconsider. While the markets were in disarray, Suncor posted its first quarterly loss since 1992 and Petro-Canada investors were agitating for change because of a lacklustre share-price performance.

Just to survive in such tough times, amid the ever-present threat of a take-over attempt, George decided Canada needed a company with size and financial might. "The supermajors, particularly ExxonMobil [with $30bn in available cash] and Shell, can invest through the bottom part of the cycle and are improving their position in Canada," he said. "Suncor had two options: pull back on capital plans, which we did [by shelving the company's C$20.6bn Voyageur and Firebag upgrader and bitumen mine expansions], or do something that would allow us to invest and come out of this cycle stronger than ever."

Great leap forwards

George, who will be CEO of the new entity, said Quantum will generate the leap forward by channelling profits from Petro-Canada's highly profitable conventional oil assets into what he calls an "oil-sands-centric" corporation. The designers of the merger estimate that joining forces will save C$300m a year in operating costs and about C$1bn in annual capital spending by eliminating duplication of pipelines, power and water infrastructure for oil-sands operations.

Regardless of the unknowns facing the oil sands, above all impending climate-change legislation in the US and Canada, George has no doubt the resource will become "more and more important. This combined company will have a position that cannot be duplicated by anyone." To that end, he is eager to start choosing between Suncor's Voyageur and Firebag projects and Petro-Canada's stalled C$25bn Fort Hills mine and upgrader, and "invest in ways that will get us the highest return on capital".

George's focus on the oil sands is a clear demarcation from the old Petro-Canada, which had pushed into new global frontiers, but may now sell off its assets in Libya and Syria. China National Petroleum Corporation is said to be interested in these assets, which are valued at about C$5bn. "You might see a bit of rationalisation," says Kam Sandhar, an analyst at investment dealer Peters & Co. "Petro-Canada may sell its international assets and funnel that cash back into the oil sands."

Until the late March announcement of the Suncor/Petro-Canada take over, Canada's mergers and acquisitions (M&A) market had been quiet. Last year, the value of upstream deals fell to $14.5bn from a record $45.5bn in 2007, with oil-sands transactions slumping to $2bn from $18bn, according to the latest global upstream review by IHS Herold and Harrison Lovegrove.

Weakened oil and gas prices have led to severe devaluing of oil-company shares and reserves to the point where the gap between the cost of buying rather than drilling for new barrels is larger than ever, says analyst Ben Dell of Sanford C Bernstein & Co, a US research firm. He says the cost of buying an average company and, by extension, its undeveloped reserves is about $11 a barrel, compared with the $21/b it cost the industry to find and develop new reserves in 2008. "It appears the energy industry is on the cusp of an M&A boom," Dell claims, predicting the majors will soon be hunting for prey to fill gaps in their exploration portfolios.

And there is cause to rethink what the oil sands have to offer prospective buyers, in contrast to the last wave of foreign take-overs that were made at hefty premiums, often for marginal properties. Total, BP and ExxonMobil are all looking for top-shelf assets at today's cheap share prices, or are ready to take advantage of the sector's downturn. "If you are a major, this is a once-in-a-generation opportunity to build a huge position," notes one investment banker.

Total made its move with a revised, C$0.83bn hostile bid for UTS Energy's 20% stake in Petro-Canada's Fort Hills project and could buy out the 20% held by financially strapped Teck Cominco. BP concedes Canada was a "bit of a quiet corner" for the company until it formed an oil-sands joint venture last year with Husky Energy. Since then, the UK major has been rated as a contender for a large in-situ position, which is more environmentally acceptable than open-pit mining. Against that backdrop, CEO Tony Hayward said: "The future is not cancelled."

Meanwhile, Imperial Oil is often talked about as a potential buyer of Canadian Oil Sands Trust, which holds 37% of the Syncrude Canada consortium. That would boost its stake in the venture to 62%.

But consistently topping the list of take-over targets is Canadian independent Nexen, which increased its share of the Long Lake project in late 2008 to 65% from 50%, but faces a daunting task to finance expansion plans. Its 35% partner, Opti Canada, has enough cash to last only until about mid-2009. Total was briefly rumoured to be preparing an offer for Nexen – and possibly all of the Long Lake project. In addition, there is no shortage of speculation that Shell and Eni might all be ready to pounce.

Also on the lookout is Abu Dhabi's state-owned Taqa, which has acquired three Canadian energy companies in the past two years for a total investment of C$6.7bn. It aims to build a Canadian operation worth C$20bn. Peter Barker-Homek, Taqa's CEO, is now considering an entry into the oil sands, suggesting "you could get some good acreage" at a time of low asset values and declining operating costs. He believes oil prices are close to recovering and that oil-sands projects could be back "into the money by the end of 2009. What was profitable at $70/b oil last year, could be profitable at $50/b this year."

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