Suncor and Petro-Canada – A Sign of Things to Come?

RelevanceSuncor Energy’s acquisition of Petro-Canada in a $15.9B all share deal will create North America’s fifth largest oil and gas producer and give added impetus to consolidation in Alberta’s oil sands. It is the largest M&A deal in the oil and gas industry for several years. Clearly the deal was driven by the respective company’s complimentary assets in the Canadian oil sands, but observers are asking whether this is a sign of a much broader consolidation to come. Much of recent M&A activity has been in uncoventionals (oil sands, shale gas and coal bed methane) as these offer the greatest areas of cost reduction for investors. However, conditions are ripe for further consolidation given the fall in oil price, fall in stock prices and a general difficulty in raising finance. Any further mega deals will be in stock – only ExxonMobil and some of the large NOCs could do cash deals. Consolidation amongst super majors is unlikely due to competition concerns and NOCs are also likely to be active.

AnalysisA recent report from strategy consultancy McKinsey concludes that oil sands production faces “a structural cost disadvantage that is expected to persist for some time even as the price for crude comes down.” Suncor has said that its operating costs are around $35-36/bbl today, a level that does not compare at all favorably with production costs in oil provinces such as Saudi Arabia. McKinsey has calculated that the Canadian sands face a US$15 a barrel price disadvantage to heavy oil from more conventional sources. Other industry estimates (according to the Financial Times) suggest that the Canadian oil sands require an oil price of $40/bbl to cover costs and a huge $100/bbl to remunerate new investments.

Suncor has announced cost savings generated by the acquisition of Petro-Canada of C$300m/year opex and C$1B/year capex. These savings are largely due to the ability to share infrastructure such as pipelines and processing facilities. The combined entity will reduce the competition for resources and have greater purchasing power, allowing it to tackle the issue of industry inflation which has become rampant in Canada in recent years.

Suncor and Petro-Canada were previously the world’s two largest oil sands producers. Indeed, Rick George, Suncor CEO, says new company will be “very Canada and very oil sands focused”. Much its oil sands production will go through its 5 refineries. Investors will be aware that the new entity is not so much an oil and gas investment as a bet on the future of Canadian oil sands. Not only are oil sands developments costly, they are also highly complex and pose environmental issues. This portfolio impact must increase the cost of capital for the combined entity (mitigated somewhat by the greater diversity in assets that Petro-Canada brings to the table). Further risk is brought to bear by Saudi Arabia (a low cost oil producer) that acts as the world’s swing producer. There is much speculation within the industry that the Saudi’s are incentivized to engineer price dips from time to time to make the very large resources found in oil sands (and other unconventionals) uncompetitive.

Companies that have lower costs will face less pressure to do deals in the future. However, a falling oil price generally makes exploration less attractive and taking over weaker competitors more attractive. Further consolidation, both in the Canadian oil sands (which offers long term reserves in a stable country) as well as across the whole industry, is likely.

1 April 2009

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