Cenovus Energy Inc.'s $3.8-billion takeover of Husky Energy Inc. this past week shows a Canadian oil industry turning away from expansion and instead embracing mergers and cost-cutting to weather a brutal downturn.
Seven months after the already-struggling sector was blindsided by the COVID-19 pandemic and a global crude oil price war – including a brief but painful brush with negative prices – Calgary’s energy companies are rolling out survival strategies. In the face of predictions that crude prices will remain depressed for years, they are bulking up and laying off staff to satisfy lenders and potentially win back investors. The Husky takeover is symbolic of an industry embracing austerity, rather than finding new oil and gas projects, and forcing Albertans to do the same.
Some days, it feels as if there’s a “Kick Me” sign pinned to Alberta’s back. The bad news just keeps coming. Along with the prospect of 2,000 jobs disappearing when Cenovus buys Husky and up to 2,000 layoffs at Suncor Energy Inc., the oil patch has lost some of its favourite watering holes. The owner of Ranchman’s Cookhouse & Dancehall put the Macleod Trail nightspot up for lease in September, ending 48 years of line dancing and mechanical bull riding. Ranchman’s eclectic decor included the Jamaican bobsled from the hit movie Cool Runnings, set at the 1988 Calgary Winter Olympics. This week, someone stole the sled.
The crisis is reflected starkly in the 13 million square feet of vacant office space in downtown Calgary – enough for 130,000 workers, according to Calgary Economic Development. In Fort McMurray, the heart of the oil sands, a typical three bedroom home sells for $450,000, a third less than at the peak of the oil boom in 2014, while larger houses that commanded $1-million or more are now selling for half of what they did then.
“CEOs I talk to have a positive outlook, they can see a path forward. But for any working person in the energy industry, they can see things are tough, and they’re worried,” said Tom Buchanan, Calgary-based senior adviser at investment bank Origin Merchant Partners and former chief executive of Provident Energy Trust. Mr. Buchanan and other industry experts say more mergers and asset sales are inevitable. Weak oil and gas companies, struggling with debt taken on in better times, now have limited access to capital. They will be forced into deals with just a handful of strong remaining players. The buyers won’t include deep-pocketed foreign oil companies – Royal Dutch Shell PLC, BP PLC and Total SA – because they will continue to exit Alberta’s oil sands.
There are currently 240 oil and gas companies listed on domestic stock exchanges. If this downturn lasts another two or three years, as most experts expect, the ranks of junior companies will be thinned. The foreign-owned players will largely be gone. Canada’s energy sector will be dominated by a handful of domestic companies. Cenovus wants to be one of them, and that’s why it’s buying Husky.
For Husky, last week’s deal marks the end of the road for a company that began selling gasoline in Wyoming in the late 1930s, built the Calgary Tower in the 1960s, then expanded into refining, the oil sands and massive platforms off Newfoundland and the South China Sea. At its peak in 2008, Husky, which is majority-owned by companies controlled by Hong Kong billionaire Li Ka-shing, was worth $47-billion. Son Victor Li is Husky co-chairman, and the family will retain an interest in the combined entity.
“Consolidation needs to happen to lower the cost base for the industry, but more particularly for us. And in the case of Cenovus, they have the same driver,” Rob Peabody, Husky’s CEO, said this week. The plan for the merged company is to reduce spending and overhead by much as $1.2-billion annually, and up to a quarter of the current work force is expected to be eliminated. Mr. Peabody, who won’t be moving to the new company, said slashing costs “makes more and more difference if the oil price is lower.”
The pandemic did not cause the problems that have led to oil industry mergers and acquisitions; those were building for years before. But it did add urgency. Indeed, the marriage of Cenovus and Husky may not be the deal investors, or even employees, wanted, but it is one the industry sorely needs.
Weeks before lockdowns began in Canada, Teck Resources Ltd. cancelled its $20.6-billion Frontier oil sands project. CEO Don Lindsay said that, to proceed, Teck would need a partner to help shoulder the risks, oil prices would have to be higher and an export pipeline would have to be in operation. None of those conditions were met. Last year, Imperial Oil Ltd. indefinitely postponed its planned $2.6-billion Aspen oil sands project, north of Fort McMurray.
“In the near term, none of these projects are happening,” Mr. Buchanan said. He said crude prices would have to rise to more than US$50 a barrel before anyone breaks ground on a new development – and rise right now. ″Everyone’s focus is on running existing projects efficiently." Investment bankers such as Mr. Buchanan say if Canadian oil companies want to attract capital from institutional investors who can deploy money anywhere in the world, they need to demonstrate they can make money by keeping costs down while increasing production. The proven path to hitting both goals is to bulk up.
The oil sands require major upfront capital, though existing projects can generally operate at breakeven costs with crude prices around current levels of about US$40 a barrel, depending on the configuration at the site. That is why the industry has shifted from new megaprojects to expansions of operations that are already pumping. But even those are now on hold.
In March and April, oil prices sank to historic lows as Russia and Saudi Arabia waged a price war while global energy demand tumbled because of restrictions on transport aimed at preventing the spread of COVID-19. Those prices squelched corporate cash flow and even large companies such as Cenovus and Suncor had to turn to banks for more credit to shore up their finances. Now, producers’ debt levels are elevated as still-weak oil prices require them to keep slashing costs.
All of this is a recipe for consolidation, especially with capital markets unwilling to invest new equity in the industry. The problems are not exclusive to the Alberta oil patch. In the United States, returns from shale oil production, which had largely been financed through debt, had been tailing off even before pandemic lockdowns put the brakes on spending. In recent months, the U.S. industry has played host to billions of dollars of transactions, including Pioneer Natural Resources’ deal to buy Parsley Energy, ConocoPhillips' acquisition of Concho Resources, Devon Energy Corp.'s takeover of WPX Energy and Chevron Corp.'s buyout of Noble Energy.
Not all major players are keen on acquisitions. Suncor CEO Mark Little, head of Canada’s largest energy play, told an investor call this week the company will only make them if it can pick up high-quality assets it can fold into current operations to increase value for shareholders. “I can’t overstate it enough – we did not cut our capital budget, operating costs and reduce our dividend to leverage up our balance sheet to do M&A,” he said.
Even so, Suncor and Canadian Natural Resources Ltd. are seen as the natural buyers of foreign companies' stakes in projects that those two operate. Paris-based Total owns a 24.6-per-cent interest in the Fort Hills oil sands project, which Suncor controls. Shell, the Anglo-Dutch oil major, said Thursday it plans to raise up to US$4-billion annually by selling properties, and released a map of regions where it expects to continue operating. The company’s Scotford refinery in Alberta was on that map. Shell’s 10-per-cent stake in the Athabasca oil sands project was not featured – Canadian Natural operates the mine.
Cenovus and Husky are promoting their deal for some of the same reasons. Companies and projects need to be large enough to interest global investors. At the same time, oil sands producers are struggling to send the message they are serious about reducing carbon emissions and their disturbance to land and water.
The deal also aims to smooth out the volatility in Cenovus’s cash flow because of its exposure to Canadian heavy oil markets. Husky is known for its heavy oil upgrading and refining operations on both sides of the border, and that provides a hedge for Cenovus’s oil sands output.
“You have to be a low-cost producer, and the combination of these two companies will create one of the lowest-cost producers in North America. You have to have a strong balance sheet, and the combination will allow both of us to de-lever at a far faster speed than we would have been able to do on our own,” Cenovus CEO Alex Pourbaix told The Globe and Mail after announcing the takeover. “We really think resiliency is just so important and we really think that’s what this combination delivers for investors.”
Both companies have had painful experiences on the M&A front in the past, and it took a toll on their reputations with investors. In 2019, Husky opted not to extend its hostile bid for fellow oil sands producer MEG Energy Corp., partly blaming the Alberta government’s decision to impose production limits on the industry to try to reduce a massive discount on the price of Canadian heavy oil. But Husky’s retreat made other companies question whether the Li family had the stomach to follow through on any oil deal.
Cenovus had a major expansion in 2017 when it paid $17.7-billion for ConocoPhillips’ oil sands and natural gas holdings. But investors had become accustomed to Cenovus’s conservative business strategy, and its shares tumbled after the deal. Within months, then-CEO Brian Ferguson left the company, leading to the appointment of Mr. Pourbaix.
He says Cenovus struggled after it issued plenty of debt and equity to fund the deal, only to watch oil prices fall, which forced it to sell assets to raise more cash. "In this case, we’ve combined two companies at the bottom of the commodity-price cycle, so the values are very, very fair on both sides, Mr. Pourbaix says. “There was no debt taken on. It was an all-paper deal, and because of the way the deal is structured, we do not require any asset sales.”
Another factor expected to prompt more oil sands deal activity is the many properties still held by foreign majors that have already sold off much of their other Canadian holdings. Global giants such as Total and BP PLC have signalled their long-term intention to reduce their fossil fuel operations in favour of renewable energy. In contrast, Canadian companies such as Suncor and Canadian Natural say they can use technology to lower greenhouse gas emissions from the oil sands.
Alberta Energy Minister Sonya Savage, a self-described oil optimist from Calgary who landed her current job after 12 years in the pipeline sector, is convinced the oil sands business will survive. Sure, global demand for crude is projected to plateau over the next couple of decades, but she says consolidation drives cost savings and oil sands projects can survive in a climate of US$36-a-barrel oil.
“Once they’re up and running, they’re low cost and low risk. The reservoirs are secure, and they’re able to continue producing without bringing in new capital,” she says.
The prospects for Canadian natural gas, meanwhile, have improved with a surge in current and future prices for the fuel since the summer. That has exposed targets for takeovers in gas-rich regions such as the Montney and Deep Basin, which both straddle British Columbia and Alberta. This summer, ConocoPhillips bought a spread of Montney assets from Kelt Exploration Ltd. for US$375-million and Canadian Natural bolstered its position in the region with a $111-million takeover of Painted Pony Energy Ltd.
Already one of Canada’s largest gas producers, Tourmaline Oil Corp. has signalled it aims to acquire assets, with CEO Mike Rose saying there’s now a “generational opportunity” for deals. His acquisition ambitions are likely to be funded in part by the company’s spinoff of Topaz Energy Corp., a new publicly traded royalty and natural gas processing firm. Origin’s Mr. Buchanan predicts other oil and gas producers will sell off infrastructure assets – including pipelines – to raise money during the downturn.
While all of these deals may bring in cash, the consolidation is devastating for employment in Alberta. Job cuts have run into the tens of thousands. For Ms. Savage, it’s a double-edged sword; the job losses are “heartbreaking,” but they also allow companies to tamp down their costs and remain competitive. Suncor, for example, is accelerating plans to roll out autonomous trucks for hauling at its Fort Hills oil sands facility.
The challenge for policy makers is finding ways to help unemployed energy workers pivot to new sectors, or to new areas within energy, such as hydrogen and geothermal.
That job falls to Doug Schweitzer, who was recently appointed Alberta’s Minister of Jobs, Economy and Innovation. The province has no intention of giving up on energy in general, Mr. Schweitzer says, insisting it will continue to be a major economic driver long into the future. But he sees Alberta following in the footsteps of Texas, employing a thoughtful and planned diversification strategy, with a swath of programs to help workers rapidly retool for new careers.
His task will be no small feat in a province that has historically leaned heavily on oil and gas for jobs and government revenues. It could be a long time before bull riding and line dancing return to Ranchman’s.
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