The Steps of an Evolving Market
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Following the M&A boom in 2012 and its subsequent decline, Canada's energy landscape is going through a period of change, with potential for upside as obstacles turn into opportunities

In May 2017, Shell Canada decided to offload its CAD 4.1 billion stake in Canadian Natural Resources Ltd. (CNRL) it had acquired as a part of a deal it had made earlier this year to withdraw from the Canadian oil sands. Despite this divestiture, the long-time player and pillar in the Alberta oil patch maintains a strong presence in the province; however, the deal does signal a changing energy landscape in Canada, particularly over the past several years. Factors that drive mergers and acquisitions (M&A) include efforts to increase market share, expansion/changes to asset portfolios (diversification), a desire to gain entry into new markets, efforts to improve efficiencies and profitability, execution of corporate strategies and, in some cases, basic survival. Analyzing in parallel the Canadian upstream mergers and acquisitions between 2012 and the first half of 2017 and the price of oil, we will note that these M&A have occurred in a context that has deteriorated crude oil prices (see chart on page 61). The price of oil declined substantially from mid-2014, from a WTI market price of USD 105/bbl in June 2014, to a low point of USD 30/bbl in February 2016, before rebounding and settling at USD 47/bbl in July 2017. While less reported, the price of natural gas also declined considerably, from USD 6 per MMBtu in February 2014 to a low of USD 1.73 per MMBtu in March 2016—the latter being the lowest since December 1998. Similar to crude oil prices, gas prices have stabilized in 2017 and are hovering just below the USD 3 per MMBtu level. There is little doubt that crude oil and natural gas prices are impacting M&A activity in Canada. Over the past five years, Canadian M&A activity can best be described in two parts, before mid-2014 and after mid-2014, the point at which commodity prices began their decline.

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After the crisis, a record level is reached in 2012

By all accounts, 2012 was an exceptional year for M&A activity, not just in Canada but globally. Emerging from the financial crisis of 2008-09, national oil companies (NOCs) and large international oil companies (IOCs) continued to invest aggressively in global oil and gas assets. The value of transactions increased, reaching a record value of USD 55 billion in 2012, with the highest value transactions being China National Offshore Oil Corporation’s (CNOOC) USD 17.9 billion acquisition of Calgary-based Nexen and Malaysian-giant Petronas’ purchase of Progress Energy for USD 5.85 billion. Well-funded Asian NOCs secured energy supplies to satisfy increasing demand for energy resources to fuel economic growth while IOCs gained access to reserves through acquisitions and joint ventures. Generally targeting unconventional reserves, such as Canadian oil sands and shale gas plays (i.e. Montney and the Duvernay), both types of companies helped build momentum for upstream M&A activity. The record value of global upstream M&A deals reached in 2012 was largely the result of five high-value corporate acquisitions. Aside from the CNOOC and Petronas acquisitions, other notable M&A included: ExxonMobil acquisition of Celtic Exploration, which held assets in the Montney and Duvernay basins, for USD 3.2 billion and Encana sold 40 percent of its Cutbank Ridge assets, located in British Columbia, to Mitsubishi for USD 2.9 billion. However, the wave of NOCs and IOCs securing assets in Canada subsided in 2013. With the exception of the USD 1.44 billion purchase of Talisman’s Montney acreage by Petronas and Centrica/Qatar Petroleum’s purchase of Suncor Energy’s Alberta gas assets for USD 1 billion, there were no significant acquisitions in either oil or gas. The global market, as well as Canada, lacked a mega deal, with the global deal value dropping to USD 136 billion in 2013 from USD 192.5 billion in 2012. The lack of Canadian M&A activity, particularly in the oil sands, is likely due in part to the Investment Canada Act (ICA), a federal law regulating large foreign direct investment. With the acquisitions of Nexen, Progress Energy, Celtic and NAL Energy Corporation, foreign ownership was increasing dramatically in the oil and gas sector, spurring debate amongst Canadians about foreign ownership in Canada. The Act and Regulations advises the legal responsibilities of non-Canadians investing in Canada. Marked by the rapid decrease in oil prices, 2014 was a tale of two parts, with the majority of value deals occurring in the first half of the year. Before prices plummeted in mid-2014, Canadian M&A activity was highlighted by CNRL’s purchasing of Devon’s Canadian portfolio for USD 2.8 billion and a portion of Apache’s gas portfolio for USD 0.4 billion. Encana sold 54 percent of PrairieSky Royalty to institutional investors for USD 2.3 billion and Encana again sold production assets in the Alberta region to Apollo Global Management for USD 1.8 billion. By the end of Q1 2014, the deal value doubled to USD 8.4 billion from USD 4.1 billion in 4Q 2013. There were almost USD 30 billion worth of acquisitions in 2014. Many buyers and sellers, however, sat on the sidelines in 2015-16, as the oil markets were deemed weak and volatile. M&A transaction stood at over USD 30 billion in 2015 and only USD 17 billion in 2016. The former was highlighted by the takeover of Repsol of IOC Talisman for USD 15.5 billion while the latter was highlighted by the acquisition by Suncor Energy of 36.7 percent of the Syncrude project (Alberta oil sands) from Canadian Oil Sands for USD 6.25 billion. The low-price environment had a profound impact on the oil sands, with many international/multinational oil companies divesting their assets. An interesting trend with the exit of the international companies saw Canadian operators enter frequently to purchase their assets. As illustrated by CanOils M&A Database, notable acquisitions by Canadian companies since mid-2014 include (with announcement date in parenthesis):
1. ConocoPhillips sold 50 percent non-operated interest in Foster Creek Christina Lake oil sands partnership for USD 17.7 billion to Cenovus (March 2017)
2. Shell Canada sold 60 percent interest in Alberta Oil Sands Project (AOSP), 100 percent interest in the Peace River Complex in-situ assets and a number of undeveloped oil sands leases for USD 10.9 billion to Canadian Natural Resources (CNRL) (March 2017)
3. Marathon Oil sold 10 percent interest in AOSP for USD 1.638 billion to CNRL (March 2017)
4. Statoil ASA sold its oil sands business to Athabasca Oil Corporation for USD 0.578 billion (December 2016)
5. Murphy Oil divested 5 percent of its stake in the Syncrude project to Suncor Energy for USD 0.937 billion (April 2016)
6. Shell divested its Orion Oil Sands Project to OSUM Oil Sands Corporation for USD 0.325 billion (June 2014).

The bituminous sand business is Canadian

As illustrated by Figure 1.2, as per end-2016, the aggregate of the aforementioned M&A activity has resulted in Canadian companies owning and operating 80 percent of oil sands production; this is up from 55 percent in 2014. And this number could increase, with Canadian producers in the oil sands waiting for opportunities to purchase additional assets at a reduced cost. Many international/multinational oil companies are shifting their capital from the oil sands into other investments, such as U.S. shale. And with oil sands players already operating in an environment of downsized capital budgets, this will likely dampen growth in the industry. As this shrinkage will also have negative impacts on employment and tax revenue for different levels of government, it is not surprising that, in a recent trip to China, Natural Resources Minister Jim Carr suggested that “minds are open” to renewed Chinese investment, taking a step back from the ICA. Lower oil prices are not the only factor motivating companies to sell off assets in the oil sands. Other reasons for leaving the Canadian oil sands include high operating costs, limited access to market (highlighted by the well-documented, intense scrutiny of the proposed Keystone XL) and regulatory constraints. Other examples of M&A activity driven by corporate strategy include Shell Canada and Norway’s Statoil ASA. Shell is divesting its oil sands assets, shifting their focus from the oil sands to natural gas and electricity. This shift is punctuated by its massive USD 70 billion merger with BG Group in April 2015. Shell is not leaving Canada, but rather shifting its  portfolio, keeping shale gas assets, liquefied natural gas (LNG) assets, a refinery and an upgrader. With regard to Statoil ASA’s exit from the oil sands, the company divested its oil sands assets to change focus from the oil sands to core activities, including offshore Newfoundland. While no longer an oil sands operator, it remains an investor in the oil sands, with a 20 percent share of equity in Athabasca Oil Corporation. On the flip side of the coin, Canadian companies are purchasing international assets in the oil sands for several reasons. First, they are securing assets at a reduced cost, likely from multinationals fueled by either a pessimistic outlook or the desire to pursue higher returns on investment in other oil and gas plays. Second, their outlook is more optimistic, not just in terms of the price of crude oil but also  in the opportunity to take advantage of the cost and operational efficiencies of the acquired assets. Some of the purchasers of the assets include Canadian majors such as Cenovus, CNRL and Suncor Energy. All possess core expertise in the extraction and development of the oil sands, reflecting higher efficiencies, those sometimes realized in low steam-oil ratio and lower operational costs. These companies will likely utilize cost efficiencies, economies of scale and application of their core expertise. Companies could focus operations by basin, taking advantage of synergies between existing sites that lead to spurs of innovation that can reduce operating costs and emissions. CERI estimates the potential of new technologies to reduce emissions by 18 percent and costs by 61 percent in brownfield projects. The implications are thought-provoking. 

Natural gas, a radically transformed market

The natural gas side of the equation is equally interesting. The North American natural gas and oil market has been transformed by the emergence of the so-called "shale revolution." Advances in horizontal drilling, 3-D seismic technology and hydraulic fracturing have enabled gas and tight oil  production growth from basins that were once thought uneconomic. In 2016, U.S. total natural gas production averaged 77 Bcfpd (billion cubic feet per day), led by shale gas production. As of May 2017, the Marcellus Shale alone produced nearly 17.6 Bcfpd, accounting for approximately 40 percent of the total shale gas production in the US. The production of the underlying Utica Shale is 4.4 Bcfpd. While this is positive for Pennsylvania, West Virginia and Ohio, this growth in production has not only changed the flows of natural gas within the US, but also on a continental scale, with a resultant impact on  western Canadian gas producers. Lower cost Marcellus gas is closer to markets in central Canada, the U.S. Northeast and U.S. Midwest, giving it cost advantages over western Canadian gas and displacing it from traditional markets. With increased competition in key markets, western Canadian producers continue to look towards LNG, particularly on the west coast of British Columbia, as potential access to new markets in Asia. This is reflected in Canadian M&A activity, as large Asian national companies, such as Petronas, Mitsubishi, and Petro-China merged and acquired assets in unconventional gas plays in British Columbia and Alberta. In addition, companies such as Sinopec, Korea Gas Corporation, Mitsui & Co., as well as the aforementioned players, bought into LNG projects and negotiated various natural gas and LNG value chain agreements. Much of this activity, however, preceded the drop in natural gas prices in mid-2014. There are currently 19 LNG export proposals along the west coast, following the recent decision of Pacific Northwest LNG to withdraw its application and cancel the project. Despite receiving approval from the Canadian government in October 2016, as well as crossing various other regulatory hurdles, Petronas and its partners (Sinopec, JAPEX, Indian Oil Corporation and PetroleumBRUNEI) made the decision to cancel the CAD 36 billion megaproject in July 2017, citing uncertainty in the global energy markets. With only a single LNG project, the small Woodfibre LNG facility, announcing a positive final investment decision, sharp eyes will be on other export proposals over the next year or so. There are other LNG proposals but no concrete signals as of yet for a final investment decision. Natural gas M&A activity since mid-2014 has been characterized by smaller value deals, including the presence of private equity investment. The latter is perhaps a sign of a medium term bet on higher gas prices and improved competitiveness in Canadian plays. The recent move by Petronas and its partners to invest is certainly an interesting sign with regard to the growth of the market. M&A activity has been quiet over the past couple of years and will likely remain so for the remainder of 2017. This is contrary to the U.S. shale gas market, which continues to attract foreign companies in various unconventional plays such as the Marcellus and Utica. In Q1 2017 alone, there have been 32 deals worth USD 36.6 billion in the U.S. shale patch. To be certain, the energy landscape is changing in Canada. However, where one may see obstacles, others will see opportunity.