by Scott R. Cochlan, Neville Jugnauth and Leah Dickie
In March 2013, Torys LLP, in association with mergermarket, released the Canadian Oil & Gas 2013 Outlook (the mergermarket Report),1 which provided an analysis of certain key challenges and opportunities for companies in the oil and gas sector. The analysis was based on interviews with 100 senior corporate executives and investment bankers. In this article, we look back at how such challenges and opportunities manifested in the first quarter of 2013 with regard to the capital markets and what new trends may be developing for the remainder of the year.
As 2012 came to a close, commentators noted the general scarcity of traditional financing available for issuers in the oil and gas sector. Equity markets had steadily declined over the past three years. Between 2010 and 2012, equity financings conducted by oil and gas issuers listed on the TSX decreased from $11.2 billion in 2010 to $8.9 billion in 2012, a drop of 20%.
The first quarter numbers for 2013 show that these trends appear to have continued or even worsened. According to the TSX’s market intelligence group report, the equity capital raised by oil and gas issuers listed on the TSX and TSXV in the first quarter of 2011 was approximately $3 billion, declining to $2.3 billion and $568 million for the same period in 2012 and 2013, respectively.2 Deal volume has declined correspondingly, from 142 deals in the first quarter of 2011 to 98 deals and 68 deals over the same period in 2012 and 2013, respectively.
Further, low natural gas prices and the gap between Canadian crude oil prices and West Texas Intermediate (WTI) have reduced the cash flow available to producers. By some estimates, as many as half of the resource issuers listed on the TSXV have less than $200,000 in working capital, potentially putting these issuers in the position of having to find alternative sources of financing for their operations.
With the lack of equity and working capital available to resource issuers, commentators have been left to speculate on how these issuers will fill the void in 2013. A number of common theories emerged at the end of 2012, including an expectation of increased foreign investment in the Canadian oil and gas sector through less traditional structures, an expectation of increased merger activity involving junior and intermediate companies and selective private equity investment in the oil patch through both acquisitions and financing.
The year 2012 ended with the Canadian government’s announcement of its more stringent review policy for foreign enterprises seeking to invest in the oil sands. As stated in the mergermarket Report, the commonly held view among commentators at the time was that this change in policy would lead to more joint ventures with Canadian partners or other similarly structured transactions as an alternative to the takeover of Canadian oil companies.
To date in 2013, no blockbuster takeovers have occurred like those of Nexen or Petronas, and the transactions that have been concluded have mostly, as predicted, been structured as joint ventures. The most notable deal in the foreign investment arena in Q1 2013 was the asset disposition by Suncor Energy Inc. of its conventional natural gas properties to a partnership owned by the U.K.’s Centrica PLC and Qatar Petroleum for $1 billion. Other transactions involving foreign investment announced in the first quarter included joint ventures between AltaGas and Idemitsu, and Progress, Petronas and Japex.
Perhaps more notably, though, is the absence of foreign players in Q1 2013. Commentators have speculated on the reasons for their non-appearance. China’s growth slowed in the first quarter of 2013, and there is some sense that foreign investors are taking a wait-and-see approach in light of the pending approval of TransCanada Corp.’s Keystone XL pipeline.
Bill C-60, which will implement changes to the Investment Canada Act with regard to investment by state-owned enterprises (SOEs), had its first reading on April 29, 2013. If passed unamended, the bill will broaden the definition of SOE to include entities influenced by a foreign government or agency and will give the Minister of Industry the ability to apply control-in-fact tests to determine whether an entity is an SOE. The level of discretion given in the bill has been noted by some commentators to vary substantively from the position asserted in December 2012 and to further raise the level of uncertainty about the federal government’s treatment of SOEs. Foreign investors may be waiting to see how the application of the new restrictions will affect the industry, or they may be taking the time to readjust their investment strategies to focus on investments in smaller players or alternative assets such as shale gas, which may be subject to less scrutiny.
There is also speculation that foreign investors have been deterred by the price differential between WTI and Canadian heavy oil. Though it has historically hovered near $18 a barrel, in December that gap surged to more than $40. More recently, the differential has settled to normal levels, with June deliveries seeing a differential of $16.50, as of April 26, 2013.
It is uncertain when foreign investment will again ramp up in the energy industry. However, when it does, it is almost expected to be a buyer’s market. Several of British Columbia’s Montney shale gas players, including Talisman Energy Inc. and Canadian Natural Resources Ltd., are contemplating the disposition of their assets. Murphy Oil Corp. had been seeking to sell its share in the Syncrude Canada Ltd. oil sands project and its Montney shale assets, but recently took the assets off the market, presumably after failing to find an acceptable buyer. Such a large availability of assets and potential transaction parties allows bidders to take their time and apply pressure to pricing.
At the end of 2012, commentators noted their expectation that the dearth of capital raising opportunities available to junior and intermediate companies would lead to consolidations as a means of achieving economies of scale through the reduction of general and administrative expenses and as a way to possibly attract investment to the larger resulting entity.
Overall Canadian M&A activity is significantly down in the first quarter of 2013. Statistics from mergermarket show the value of Canadian M&A at US$14.4 billion in the first three months of 2013 compared with the US$35.5 billion worth of deals in the same period of 2012, making it the lowest first quarter by value since 2010. The number of Canadian M&A deals completed was also down in the first quarter of 2013, sliding to 124 deals from 140 deals in the first quarter of 2012. According to PricewaterhouseCoopers, the energy sector’s share (which includes infrastructure and renewable energy) of total Canadian M&A shrunk in the first quarter of 2013. In comparison with the fourth quarter of 2012, energy deals in Q1 2013 fell from 28.5% to 19.4% of deal value and from 15.1% to 11.9% of deal volume.
The top deal in the oil and gas sector in the first quarter of 2013 was Imperial Oil Ltd.’s $1.98 billion purchase of a 50% stake in Celtic Exploration Ltd. However, there is a sense that many of the factors currently deterring foreign investment – poor commodity prices, glut of and uncertainty regarding necessary infrastructure expansion – may also be tempering M&A activity between junior and intermediate companies. A value gap has emerged between sellers who are looking at long-term potential and buyers who are looking at the current economics of the deal.
While the consensus at the end of last year was that private equity would rise to fill the some of the cracks left by the evaporation of the pool for equity financing, it was generally thought that such funding would only be offered selectively. As stated in the mergermarket Report, the majority of senior executives and investment bankers surveyed expected that private equity would concentrate on the companies valued in excess of $500 million. Additionally, it was expected that firms with strategies focused on distressed buying opportunities would be interested in both large midstream activities and companies with non-conventional gas assets hurt by low natural gas prices.
Private equity investment in Canadian oil and gas players had been relatively static last year after a significant drop between 2010 and 2011. In 2010, total private equity investment in the Canadian oil and gas sector was $2.6 billion, slipping to $1.4 billion in 2011 and $1.6 billion in 2012.3 To date in 2013, private equity investment in this sector has been approximately $0.6 billion.
A significant number of these deals were going-private transactions for companies seeking to leave the markets, a trend that has gained traction in recent weeks. In the first two weeks of May 2013, at least three going-private transactions were announced in the Canadian oil and gas sector. Most recently, Wenzel Downhole Tools Ltd. announced that it had entered into an agreement with Basin Tools L.P. according to which Basin will acquire all Wenzel’s shares.
It also appears that investment in private equity funds focused on Canadian oil and gas is seen as an attractive option for investors. In 2012, ARC Financial Corp. closed its ARC Energy Fund 7 with $1 billion raised and is currently in the process of investing the fund. Camcor Partners recently announced the closing of its Camcor Energy Fund VII, which is focused on oil and gas issuers based in the Western Canadian Sedimentary Basin, at its cap of $350 million, including its largest contribution yet from foreign participants.
As we look ahead to the remainder of 2013, there is no sign that there will be a rapid resurgence of the public equity markets or commodity prices. However, as evidenced by the announcements in recent weeks, it does appear that private equity, including some funding from foreign investors, may be emerging to fill those cracks for certain players in the oil and gas sector.
1. Available here(http://www.torys.com/Publications/pages/ar20135_Canadian_oil_and_gas_2013_outlook.aspx).
2. Unless otherwise noted, all dollar amounts refer to Canadian dollars.
3. ARC Financial.