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Financial Post (Canada): Oilpatch envies miners’ slew of mergers

But eventually Canada’s oil seniors will be swept up by consolidation trend 

Claudia Cattaneo, Financial Post
Published: Tuesday, August 22, 2006

Big, scrappy deals in Canada’s mining sector are giving oil investors a bad case of takeover envy.

The same forces that are driving consolidation in mining — a global scarcity of commodities — exist in energy today. Yet Canada’s oil and gas industry hasn’t seen a major deal since January, 2002, when Alberta Energy Co. joined PanCanadian Energy Corp. to form EnCana Corp.

It’s a long time out for an industry that used to love its wheeling and dealing.

Sure, there have been lots involving juniors and trusts. Many senior companies made so-called tuck-in acquisitions — purchases to enhance their positions in certain areas or to add new core positions.

But the top tier of the sector, which controls the great majority of oil and gas production, remains entrenched under the same leadership group.

Some deals would have made a lot of sense. The EnCana model — a huge independent based in Canada — could have worked well for companies Nexen Inc. and Talisman Energy Inc. with similar international strategies.

Some argue it’s a shame that BP PLC didn’t scoop up an oilsands firm such as Suncor Energy Inc., giving it a position in the Athabasca oilsands. Or that Total SA couldn’t come to terms to buy Husky Energy Inc., a company that has more than doubled in price since those negotiations broke off five years ago.

The longer the Canadian scene goes without a big deal, the lower the expectations, to the point that senior Canadian oil and gas companies are not seen as realistic takeover plays — at least not imminently. The momentum just isn’t there.

It’s a surprising situation, considering the sector is swimming in cash and the long-term commodity-price outlook is the strongest in history. Not even the recent dip in natural gas prices, which depressed the stock of natural gas producers, has given the takeover-minded a push.

Jiri Maly, a partner at McKinsey & Co. specializing in energy, said there are key reasons supporting consolidation among Canada’s big miners that aren’t there in the oilpatch.

Mining companies tend to be more complex, both geographically and in terms of products, making their value less obvious and encouraging restructuring strategies once they’ve been acquired. In oil companies, value is more transparent and they are fully valued, he said.

“If somebody came in and bid for Suncor, there isn’t a whole lot more room in terms of how far that share price could go,” he said.

Canadian mining companies have more aggressive, less sophisticated cultures, while big oil companies are more conservative, he said.

“The Unocal [Corp.] acquisition by Chevron [Corp.] and ConocoPhillips [Co.’s] acquisition of Burlington [Resources Inc.] didn’t receive a huge amount of support from the investment community. People looked at that and said, ‘Why make deals at the top of the cycle?’

“And then you have Exxon Mobil Corp. saying, ‘You have to be out of your mind to be buying at this point in time. And it kind of puts a wet blanket on the whole thing.”

As well, there aren’t many large companies left to buy. Only a handful of oil companies have takeover potential: Talisman, Nexen, EnCana, Canadian Natural Resources Ltd., Suncor, Husky. Another two are out of the picture because they are subsidiaries of multi-nationals: Imperial Oil Ltd. (controlled by Exxon) and Shell Canada Ltd. (controlled by Royal Dutch Shell PLC). Petro-Canada is protected under the Petro-Canada Act, a federal law under which no shareholder can own more than 20% of its stock.

Some were built from assets unwanted by larger companies, making them less likely to be courted by that same group. Those that have embraced big oilsands strategies may be passed over until they deliver. Growing oil and gas trusts have driven up acquisition costs. Costs to operate in Canada are high, and so is the Canadian dollar.

Then there is the problem of size. Canadian energy companies have become so large only very large entities, like the super majors, can afford to buy them. It would take a $60-billion cheque to take out EnCana. The largest Canadian mining deals are a third that size.

The biggest unofficial reason is that Canadian oilpatch leaders won’t be motivated to sell until they are ready to retire. Indeed, EnCana’s creation would not have gone forward without the departure of PanCanadian’s chief executive.

Adam Waterous, vice-chairman of Scotia Waterous Inc., the oil and gas mergers and acquisitions arm of the Bank of Nova Scotia, said it’s just a matter of time before large Canadian oil companies are swept into the global consolidation trend.

“Worldwide, the ability for large companies to grow organically has been very tough. It’s climbing Everest. So, they look at M&A as an opportunity as part of their tool kit,” he said.

“When you look at the Canadian scene, the Canadian companies have been themselves somewhat less challenged to grow organically, primarily because of big oilsands solutions, which set them apart from some of the larger foreign oil and gas companies.

“However, the probability that these companies consolidate and get outright bought, in our view, remains high.”

Besides, friendly corporate-governance laws in Canada make it difficult for corporate boards to say “no” to attractive takeover offers, Mr. Waterous said.

Short term, the status quo will probably prevail. Canadian nationalists will be happy, since lack of consolidation means the top tier of Canada’s energy sector remains safely in Canadian hands.

But it’s also a missed opportunity. Without the possibility of consolidation, companies lose an important exit strategy and a value-creation tool.

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