While the Canadian government frets over whether CNOOC's proposed $15-billion takeover of Nexen Inc. is a good deal for Canadians, maybe we should be asking whether it's a good deal for CNOOC.
Thursday's third-quarter earnings report from Nexen – a profit of 11 cents a share, well below the Bloomberg consensus analysts' estimate of 18 cents – was a stark reminder that the Calgary-based oil heavyweight still has a long way to go to put its chronic performance troubles behind it.
Production, while meeting the company's relatively modest targets, was still down 15 per cent from the second quarter, and the company cut its fourth-quarter production forecast by 15 per cent. Since the end of the quarter, Nexen has ramped up output at its troubled flagship Long Lake oil sands property to 34,000 barrels a day – but that's still less than half of the project's planned capacity.
Nexen's management is slowly righting a ship that looked dead in the water a year ago. The company wasn't having a lot of exploration successes, its operations at Long Lake were stumbling badly, and it lost its lucrative production contract in Yemen. Its stock price had been adrift for years.
Nexen's board quietly conducted a strategic review, under which it considered options ranging from share buybacks to selling specific assets to an outright sale of the company. By early 2012, Nexen had turfed its CEO, Marvin Romanow, installing chief financial officer Kevin Reinhart in the corner office on an interim basis.
Still, the company struggled and its shares languished. Nexen's stock was trading at a puny 8 times earnings, based on forward 12-month forecasts – about half the Canadian energy sector's average.
CNOOC instantly (though artificially) solved the valuation funk in July with its cash takeover offer of $27.50 (U.S.) a share – more than 60 per cent above Nexen's stock price.
Yet you have to have a very long-range, and very rose-tinted, view of Nexen to consider it worth $27.50 a share. Indeed, if the CNOOC deal were to disappear (and today's stock price below $24 implies that investors are pricing in roughly a one-in-three chance that it will fall through), it's debatable whether the stock even merits the $17 or so level it traded at before the CNOOC offer.
Valuations of Nexen's oil sands competitors have been in retreat for weeks, as oil prices slide and the global economic outlook fades. Oil sands typically need prices north of $80 a barrel to break even on their investment and production costs; consensus projections for oil prices five years out are now below $85, according to Bloomberg, down more than $2 in just the past three months.
Nexen looks more at risk than most. A recent Goldman Sachs report identified Long Lake as one of the highest-cost major oil projects in the world, pegging its break-even oil price at more than $120 a barrel (using Brent crude as a benchmark).
Analysts' profit forecasts for Nexen had been slipping for months before the CNOOC bid emerged. While analysts have largely taken a break from publishing their earnings calls while the takeover bid is on the table, it's no stretch to imagine that the earnings outlook has deteriorated since July.
Nexen's big third-quarter earnings miss underlines this. The premium CNOOC is offering for Nexen may be getting bigger by the day.
David Parkinson