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The Calgary Herald: Marathon effort may not entice Western

Deborah Yedlin, Calgary Herald
Published: Saturday, August 04, 2007

Even though Western Oil Sands has a respectable bid on the table, in the form of the $6.6-billion offer made Tuesday by Marathon Oil Corp., the betting is this isn’t a done deal.

Western’s primary asset is a 20 per cent interest in the Athabasca Oil Sands Project, together with Royal Dutch Shell Group (60 per cent) as the operator and Chevron holding the remaining 20 per cent.

It’s easy to see why Marathon wants Western; it’s the perfect, low-risk approach to getting involved in what is the future of North American oil production. With Royal Dutch as the operator, all it needs to do is write the multimillion-dollar cheques and learn how an operation, which is expected to produce 770,000 barrels a day, comes together.

It also dovetails nicely with Marathon’s significant refining presence in the U.S., where it ranks as the fifth largest.

This all makes perfect sense. Except if you are Royal Dutch Shell, and have just announced your intent to build the largest upgrader in the country.

How likely is it that you want a gorilla-sized partner with its own refining agenda?

Another bit to ponder is how the debate over what is the best approach when it comes to maximizing value in the oilsands is evolving: is it better to own the underlying resource, the upgrading infrastructure, or both?

The conclusion gradually being reached is that when it comes to a mining-type of operation, it’s the integrated version — where a company owns both the resource and has the ability to upgrade the goo — that makes the most sense from an economic standpoint.

By all accounts, this appears to be where Royal Dutch is going. In fact, it’s one of the reasons it chose to buy in the 22 per cent minority of Shell Canada earlier this year. And don’t forget Shell Canada bought BlackRock in May 2006 for $2.4 billion, which added 604 million barrels to Shell’s heavy oil base.

In fact, FirstEnergy’s Mark Friesen points out in a research note that Royal Dutch has initiated more than $40 billion in oilsands investment in the last two years.

The last piece of evidence to support Royal Dutch’s move to a fully integrated approach to the oilsands is that this business unit is now part of the company’s downstream operations; the part responsible for refining and marketing of energy products.

From a valuation standpoint, there is also room for a higher bid from Royal Dutch if one looks at what it paid for the minority interest in Shell Canada — $8.7 billion, or $45 per share it didn’t own.

According to an analysis by Friesen, if the same parameters that were used to value the minority stake in Shell Canada are applied to Western Oil Sands, it’s clear there is room for a higher bid.

Consider, too, that when Shell Canada bought BlackRock, it valued the resource at $4 a barrel; according to an analysis by Peters & Co., Marathon is offering $2.53 per barrel. The analysis also shows a valuation as high as $45 per share, which also supports the notion that a higher bid is more than a remote possibility.

As always, much depends on what a company’s long-term view on oil prices is, as well as the need to consider the scarcity factor in the oilsands world. There’s isn’t much out there to buy these days; prices are only going one direction — up.

What all this says is that no one should count Royal Dutch out of the bidding game.

Even as the board of Western Oil Sands has accepted the $38-per-share offer, it has to be noted that this isn’t what analysts or investors would call a “clean deal.” There’s cash for investors who don’t care about taking a tax hit, shares in Marathon for those who want to defer the taxman until they sell the shares, and for good measure there’s a share/warrant combination should anyone feel inclined to get involved in an oil play in Kurdistan.

Suffice to say another player coming in with a clean, straightforward bid could easily steal the scene, even if it isn’t at a huge premium to what Marathon has on the table.

The obvious question is that if buying Western’s stake makes so much sense to Royal Dutch, why have they yet to come forward?

One reason might be that there’s nothing like a competitor’s valuation to set the stage for a competing bid. Another explanation is simply that Royal Dutch wanted to finish with the integration and reorganization that resulted from the purchase of Shell Canada; now that it’s done, they can begin to look at other opportunities.

Marathon might have put its best foot forward in its quest to get into the oilsands, but the company might well find it has just kicked off a bidding war that could, well, turn into quite a marathon.

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