There was a time when if a Canadian exploration and production (E&P) company bought out a foreign-controlled competitor, it was not only good for the country but financially beneficial because it qualified for government incentives. That Canada’s E&P industry was in the hands of too many foreign operators was regarded as a big problem in the National Energy Program of 1980. Patriating this key industry became a priority if not an obsession.
Thirty-seven years later, this is clearly not an issue. However, industry watchers must reflect upon the multitude of responses to the announcement by Canadian Natural Resources Limited (CNRL) it was purchasing effectively all (except 10 percent of Athabasca Oil Sands Project or ASOP) of the oil sands production operations and leases held by the Shell Canada affiliates – Shell Canada Energy, Shell Canada Limited and Shell Canada Resources (Shell) for cash and shares totaling $11.1 billion.
The reaction was varied and, incredibly, almost universally negative. Some comments read this was a continuation of the exodus of global companies from the oil sands, a high cost resource that clearly nobody wanted any longer. Bloomberg News wrote Shell was going “green” by replacing high carbon oil sands production with no future with lower carbon natural gas from its earlier massive $US50 billion acquisition of BG Group, more commonly known as British Gas. Bloomberg called the future of oil sands “stranded assets”. Conservative politicians claimed this was proof that thanks to an NDP government in Alberta and a Liberal government in Ottawa, the investment climate had been soured to the point that foreign companies like Shell no longer wanted to own assets in Canada.
That’s a lot of drama for what in a normal environment would be a simple oil property sale.
Shell wrote it was simply fulfilling a commitment to sell assets to pay down debt from the BG deal stating, “The proceeds will accelerate free cash flow and reduce gearing (leverage) and make a meaningful contribution to Shell’s $30 billion divestment programme”. In the real world of commerce you can only sell things people want to buy. Shell had a lot of stuff for sale. And CNRL, a proven bargain hunter, found the Shell package irresistible.
Shell wrote it was selling, “…upstream production averaging around 160 thousand barrels per day. For the year ended December 31, 2016 the gross reserves associated with the assets being divested to CNRL were 2 billion barrels and the gross assets at that date were approximately $US12 billion.” Shell estimated it would be booking a loss of $US1.3 billion to $US1.5 billion.
That works out to $69,375 per “flowing” barrel for the existing production which is the upper end of recent transactions for producing oil properties, particularly those with high operating costs like oil sands. But proven reserves sold for only $6 a barrel. With a zero decline rate and a massive undeveloped resource base. Also included is the Peace River properties such as the partially completed Carmon Creek plant and the carbonate oil sands leases west of Fort McMurray that Shell paid big for only a few years ago. The Alberta government estimates the province’s carbonate oil sands reservoirs hold a staggering 447 billion barrels of oil. But recovery has been commercially challenging to this point. Related: Is A Russian-Iranian Energy Pact In The Making?
What nobody called this transaction was a great day for the Canadian oilpatch, which is really too bad. Because it is.
The E&P sector in Canada has been built for decades by domestic outfits buying the unwanted assets of international operators that, for a variety of reasons, no longer fit their portfolios. Back in the 1950s, 1960s and 1970s the industry was largely developed by E&Ps from other countries, because they had the essential tools that Canadians did not such as capital and expertise. Sixty years ago successful Canadian upstart Pacific Petroleums ended up being controlled by American E&P Phillips Petroleum (48 percent) because legendary entrepreneur Frank McMahon (namesake of Calgary’s football stadium) could not raise any money in Toronto. Then Canadian investors were focused on mining and saw no future in oil and gas.
The 1970s, 1980s and 1990s saw a period of ownership transition when foreign operators began to sell out. Part of it was “Canadianization” when federally-funded state oil company PetroCanada bought Atlantic-Richfield, PetroFina, Pacific, and BP’s gas stations, all allegedly in the nation’s best interest. They paid big and the sellers put up little resistance.
But most of the switch of ownership took place on a smaller scale as individual, formerly prolific conventional oilfields saw their production fall to the point where they were no longer economic for multi-national operators with multiple global options. By the 1990s, the Canadians buying mature assets from the foreign operators had money and, as importantly, tremendous technical expertise. Fortunes were made when local owners bought these properties and increased production, reduced costs and exploited overlooked pay.
Perhaps the greatest “Canadianizer” of them all, and a company rarely recognized as such, is CNRL. CNRL’s corporate mission is, "To develop people to work together to create value for the Company's shareholders by doing it right with fun and integrity." Make a little money. Have a little fun. That reads like a bunch of guys from Calgary with access to capital, some basic management smarts, and the entire Western Canadian Sedimentary Basin as their backyard.
Shell, better known as Royal Dutch Shell, has a history dating back to 1907 in the Netherlands. Its mission reads, "To continuously deliver shareholder value by: Manufacturing and supplying oil products and services that satisfy the needs of our customers; Constantly achieving operational excellence; Conducting our business in a safe, environmentally sustainable and economically optimum manner; Employing a diverse, innovative and results-oriented team motivated to deliver excellence".
While obviously Shell is a great and successful company, there were a few too many professional managers in whatever meeting created the latest version of the company’s mission. It is interesting to see if you can actually “continuously deliver shareholder value” and the rest of the mom-and-apple-pie commitments at the same time.
CNRL’s first major growth leap came in 1999 when, along with PennWest Petroleum, it bought most of the oil properties in Canada from BP which had previously acquired Amoco. CNRL’s 1999 annual report read, “The catalyst for this accelerated growth was the completion of the largest asset acquisition in our Company’s history. The $1 billion purchase of all BP Amoco’s heavy oil and oil sands properties in Alberta has provided us with low cost growth and long-life reserves in core heavy oil areas where we have significant experience and expertise. Through the addition of these world-class assets, we are confident that we will achieve double-digit production growth into the 21st century.” This included the oil sands leases which its Horizon project currently exploits.
This property acquisition filled CNRL’s plate for some time. But in terms of liberating foreign owners of their unwanted or neglected Canadian assets, this was just the beginning. Only seven years later, in 2006, CNRL bought Anadarko Canada Corporation (ACC) and all its production and assets for US$4.1 billion. Primarily gas in northwest Alberta and northeast B.C., the CNRL News Release read, “The properties acquired strengthen Canadian Natural’s long term Canadian natural gas strategy by significantly increasing its land and facilities infrastructure in key areas in Northwest Alberta and Northeast British Columbia that are tightly held and very competitive. These are also areas where Canadian Natural has a strong understanding of the geology and production performance. The ACC assets contain significant upside, with over 1,500 new drilling locations identified.”
In 2014 CNRL bought substantially all of Devon Energy’s Canadian gas production for $3.1 billion. Shortly thereafter it purchased $374 million worth of producing properties from Apache Corporation. In 2015 CNRL bought 2,000 producing gas wells from ConocoPhillips. Of interest is that Devon said the sale was driven by a desire to get out of natural gas and into oil. No mention was made of getting out of Canada as Devon still owns significant oil sands assets. Apache said it would use the cash to increase its dividend. Nobody thanked CNRL for being the country’s “Canadianization” machine because the nationality ship of the country producing Canada’s oil had sailed. Related: The Single Biggest Threat To An OPEC Deal Extension
Unless of course the buyer was Chinese, but that’s for another column. Market forces, lack of pipeline access and moribund buyer interest have certainly solved the Chinese ownership problem which emerged from the CNOOC acquisition of Nexen in 2013. Those were the days.
Which brings us back to the CNRL/Shell transaction. Willing buyer, willing seller. One which has bought a lot of cheap gas in the past few years to cut the cost of oil sands production. That’s about the only aspect of this business story that has received little commentary. Once the Shell deal closes, CNRL’s production will exceed 1 million b/d which, according to website oilandgas360.com, makes it the 17th largest publicly traded oil and gas producing company in the world behind China’s Sinopec at 1.32 million b/d and ahead of ONGC of India at 1.07 million b/d. CNRL will have greater output than better known names such as Anadarko, Devon, Occidental, EOG and Repsol.
As for the oil sands, CNRL’s operatorship of Shell’s assets is likely good for the business. As anyone in the service business knows, one of CNRL’s claims to fame is that of a low-cost operator. CNRL is careful with its cash but they do pay their bills. Based on some of its more regrettable operational failures such as surface oil production breakthrough at Primrose and the tragic loss of life on the Horizon site tank installations, critics could say CNRL is too low cost. But it would be wrong to call CNRL anything other than a responsible operator. The more things you do, the more likely it is something will go wrong.
While Shell is also a highly responsible operator, few use the words Shell and optimal capital efficiency in the same sentence. Off-the-record grumblings from ASOP partners in the past have revealed Shell is not as effective as others in the region in mining oil sands at a competitive cost. There is a great opportunity for CNRL to review Shell’s operations and combine best practices from both organizations. If CNRL can streamline Shell’s oil sands production processes and more effectively exploit this massive resource base and ensure its operations are as competitive as possible in the current oil price environment, this is good for the economy of Alberta and the massive regional and provincial supply chain.
The historical pattern when Canadians buy foreign producing assets is they figure out how to make them more profitable. No reason to believe this won’t happen again.
At a time when greenfield oil sands projects are out of fashion, the obvious first step is to ensure existing operations are as profitable as possible. Maximizing free cash flow from current production is the absolute first step to exploitation of the rest of the resource base. Perhaps over time CNRL will revisit the Peace River deposit and assets and revive that massive and promising reserve base.
When it comes to the oil sands in the current environment, commentators seem to talk about everything to do with this resource except making money. CNRL is all about making money. This is a good ownership change for Canada.
By David Yager for Oilprice.com
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