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Big oil profits mean big M&A

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Big oil profits mean big M&A

Wilf Gobert, Financial Post
Published: Tuesday, May 06, 2008

Initial first-quarter profit reports by petroleum companies have, predictably, surged on record crude prices. For investors, the question becomes, what will the industry do with the even-greater balloon of cash flow?

A foretelling for Canadians is that the international oil industry wants more investment in Canada, especially in oilsands. Among Canada’s eight largest public oil companies, seven produce from oilsands. Combined first-quarter profits rose 36% to $6-billion. Cash flow rose 28% to $11.8-billion. This was achieved with oil at less than US$100 a barrel and natural gas prices 20% lower than current prices. Capital spending plus dividends to shareholders for the quarter was $10.1-billion, leaving surplus cash of $1.7-billion, or nearly $7-billion of excess cash if we annualize.

Where will the surplus go? Imperial Oil Ltd. (IMO/TSX) repurchased $590-million of its shares. EnCana Corp. (ECA/TSX) bought back $311-million worth and doubled its quarterly dividend. We expect to see increases to capital budgets, more share repurchases and dividend increases. With all of these companies pursuing an oilsands growth strategy, some excess cash is likely to be used to reduce already low levels of debt, in preparation for new oilsands projects.

The international petroleum picture of financial flows is staggeringly different. Three of the largest international public companies are Exxon Mobil (XOM/NYSE), Royal Dutch Shell (RDS.A/NYSE) and BP (BP/NYSE).

These companies have reported a 30% increase in first-quarter earnings, for a combined US$28-billion. Combined cash flow was US$50-billion.

However, the Big Three’s combination of capital spending and dividend payments was only US$24-billion. That leaves excess cash flow of $26-billion for one quarter, or more than US$100-billion for all 2008! What will these companies and other international companies do? Come calling in Canada.

ExxonMobil is already well-invested in Canada with 69% of Imperial Oil, 25% of Syncrude, and extensive oilsands leases for future projects including Kearl Lake. Royal Dutch Shell bought the 22% minority interest in Shell Canada in 2007 for US$8.7-billion and was the largest buyer of oilsands leases over the past three years.

BP is a different story, reflecting the awakening of international players to the oilsands story. In the early 1990s, BPCanada (now Talisman Energy Inc.) sold its 50% interest in the Wolf Lake, Alta., bitumen (crude produced from oilsands) pumping project to its partner Amoco Canada for just one loonie, as the project was losing money. Later in the decade, BP acquired Amoco Canada’s international parent. It then sold all its heavy-oil assets in Canada to Canadian Natural Resources Ltd. for a price that was less than today’s annual cash flow from those assets. One asset was undeveloped oilsands leases called Horizon. which will begin producing 100,000 barrels per day in late 2008.

But BP woke up. In December, 2007, BP announced it was entering into a partnership with Husky Energy Inc., under which it contributed its Toledo, Ohio, refinery and Husky contributed its Sunrise oilsands project, which will eventually produce 200,000 barrels per day of bitumen.

International oil companies are generating enormous cash flows and have few low economic risk projects in the world comparable with the oilsands. The question is will they be cautious by buying oilsands leases? Will they pursue undercapitalized players such as Synenco or UTS Energy Corp.? Or will they become more aggressive and pursue Suncor or Canadian Natural Resources? It wouldn’t be surprising to discover all these strategies played out over the next few years.

— – Wilf Gobert is an independent energy analyst based in Calgary and a senior fellow with the Fraser Institute.

http://www.financialpost.com/story.html?id=494300

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