Canadian Oil & Gas M&A

There have been two major M&A transactions in the Canadian energy space in the last month (JP Morgan being the busiest investment bank, advising on both), with Shell and Marathon selling substantial oil sands assets (Athabasca Oil Sands Project) to Canadian Natural Resources and Cenovus purchasing ConocoPhillips’ share of its Foster Creek/Christina Lake joint venture.

The obvious trend is that the Canadian energy space is becoming more Canadian, with Suncor, Canadian Natural, and Cenovus expanding in their core competency – the oil sands, as they are the only ones who will see sufficient synergies and the appropriate return on invested capital. The only Canadian company which is looking outwards instead is EnCana, who are becoming more of an American company (large stakes in the Permian and Eagle Ford) than the other way around.

This asset rationalization also speaks to international capital flight from Canada (the first abandonment being the LNG projects that were supposed to ramp up in British Columbia), as supermajors such as Shell and Conoco are seeing superior returns outside of the country, especially amidst depressed oil prices and the uncertainty of Canadian energy policy.

An area where supermajors are spending is US shale. Hydraulic fracturing as a technology has improved the economics of shale exponentially, and shale offers immediate payout (quick set up) and certainty of execution (data pertaining to how much oil can be extracted is precise). Shell and Conoco are therefore taking the proceeds from lower returning Canadian assets and using them to generate higher returns on capital in the US. This is unfortunate from the perspective of Canada’s competitiveness in the energy space.

The following M&A trends may continue:

1. Foreign oil and gas companies dumping Canadian assets to invest in the US – these assets being picked up by Canadian corporates who will fund with large debt and equity raises
2. Canadian corporates engaging in outbound M&A in order to diversify earnings and to gain market access synergies (Enbridge-Spectra and TransCanada-Columbia)
3. Consolidation in the industry as Canadian assets require scale efficiencies to generate sufficient returns (oil sands more than shale)

Stronger Oil and Canadian Dollar Weakness?

Trump may be a catalyst for the decoupling of the price of oil and the Canadian dollar due to certain policy consequences.

Trump has a pro-energy policy that is unlikely to be matched by Canada – especially under a Trudeau government. For a developed nation, environmental concerns are a large impediment to development. Trump has brought on a pro-energy cabinet (Rex Tillerson, the Secretary of State, was previously the CEO of ExxonMobil, the largest supermajor oil and gas company) and Republicans are almost unanimous in supporting the US’s path to energy independence and job growth.

Not only does this mean that costs in producing oil will be brought down and projects will be more easily approved, but infrastructure is being pushed through. For example, under the Obama Administration, the Dakota Access Pipeline was in danger of not being approved. With Trump, many of these projects are being fast tracked. This allows for oil to get to where it garners the best price more easily, and boosts the realized price of oil for oil producers.

These two factors will push down the price of Canadian oil as supply is higher in the US – especially if Canada continues to face bottlenecks in energy infrastructure as Canadian pipelines are going through problems in getting approved (a recent example was the rejection of Enbridge’s Northern Gateway project).

On top of this, there is a possibility that Trump may implement a border tax, which will make the price of Canadian oil even less competitive when being sold to its only major export market (which is related to the previous point where Canadian oil does not have access to the ocean and export to demand markets such as Asia due to a lack of pipelines).

As such, even if the global price of oil improves, Canada may see oil as a percentage of exports in dollar terms fall due to the widening differential between Canadian oil and WTI. As such, the price of oil rising may still result in a weakening of the Canadian dollar (especially as the US sells the refined product oil back to Canada due to Canada’s relative lack of refineries, as well as sizable volumes of crude oil – oil from Alberta does not have easy access to the Canadian East, again due to infrastructure constraints – so Canada sells oil to the US and the US sells oil to Canada).

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