Royal Dutch Shell Group .com Rotating Header Image

Total Kicks Up A Sands Storm

Mergers And Acquisitions

Christopher Helman and Jonathan Fahey 02.27.09, 02:15 PM EST

A pushy takeover bid may force consolidation in Canada’s busted oilpatch.

0227_oil_sands_alberta_canada_565.jpg

HOUSTON–No corner of the global oil industry has been hurt by the plunge in prices as much as the Canadian oil sands region. Most producers are struggling just to cover operating costs–forget about paying off billions of dollars invested in strip mines and bitumen refineries.

So in late January it seemed reasonable for Christophe de Margerie, chief executive of French oil giant Total (nyse: TOT– news – people ), to lob in a hostile takeover bid of $500 million for oil sands player UTS Energy (nyse: UTS – news people ). The move nearly doubled the price of UTS shares overnight. But UTS Chief Executive William Roach wasn’t impressed. “I was quite surprised by the price of the bid,” he says. “It is wholly inadequate.”

A bare minimum value of UTS would be $900 million, Roach figures. After all, UTS has $230 million in cash and is owed $600 million by its partners in the Fort Hills oil sands project, which has all the permits it needs and is ready to begin construction. Add prospective reserves of oil-laden bitumen from UTS’ other prospects and, says Roach, he’s sitting on 2.25 billion barrels, enough to eventually produce 200,000 barrels per day (bpd), by his estimates.

That day will never come as long as the price of oil stays below $70 a barrel–the minimum needed to justify building out new oil sands mines or underground recovery projects. In the past six months oil sands players have postponed $70 billion worth of investments in mines and refineries, out of a total $100 billion. Those not postponed have slowed to a crawl. The slowdown has decimated Alberta’s one-time boomtown Fort McMurray. At its peak, the town boasted nearly 40,000 oil sands workers; now that number is below 20,000, and falling.

So why would Total want to pay anything at all for UTS? Because the fourth-biggest publicly traded oil company is convinced that the current oil price downturn is temporary; that Big Oil, Total included, is not capable of delivering enough oil to meet demand; and that within five years rising oil prices will make oil sands economic again. “The oil sands are very important reserves for the long term,” de Margerie says. Total, which holds oil sands acreage near UTS’ projects, wants to consolidate its position while the land is cheap.

UTS’ Roach is stuck in a holding pattern right now, waiting for oil prices to get back above $70 a barrel before he and his partners (Petro-Canada (nyse: PCZ – news people ) and Teck Cominco (nyse: TCK – news – people )) could hope to secure the $10 billion in financing needed to build out Fort Hills.

The site is encircled by acreage that Total already owns. “There are huge synergies between our assets and Total’s,” says Roach, who says he had last spoken to Total representatives in September. “They know our assets very well.” As does Royal Dutch Shell (nyse: RDSA – news – people ), which has four projects nearby.

When Roach joined UTS in 2004 from oil sands pioneer Husky Energy, the company had a market cap of just $50 million, and its only asset was 22% of the Fort Hills acreage. Soon UTS acquired the other 78% of Fort Hills from Koch Industries for $125 million. Then Roach traded out 80% of Fort Hills to Petro-Canada (60%) and Teck Cominco (20%) in exchange for other acreage and $1.1 billion in cash.

Roach invested the money acquiring land and drilling exploratory wells. Canadian law requires companies to make drilling data public one year after leasing the land, so Roach made it a policy to start drilling immediately after signing, giving UTS more time to grab more acres near promising boreholes. UTS has drilled 527 wells in four years, many on the Equinox prospect, which Roach says might have twice the barrels as Fort Hills.

De Margerie says that what he likes about Fort Hills is Petro-Canada’s vast oil sands experience. He also likes that all the permitting for the project is in place. “In two years there has been a drastic change in regulations in Alberta,” de Margerie complains. “It’s gone from totally open to totally closed. Alberta should be concerned by this. Fort McMurray is shrinking.”

Some in the oil sands are starting to get desperate. Connacher Oil & Gas late last year shut in 5,000 bpd of production in its small project because it wasn’t even covering its operating costs. Bigger operators don’t have the luxury of halting production: Many of the newer oil sands projects are not the typical open strip mines, rather they inject steam into the ground to slowly melt the bitumen out of the sands. Because it can take months of steam injection to bring the reservoir up to optimal temperatures, producers are loathe to halt the process for fear of damaging their sands and gumming up their gear.

But how long can they go on? Jackie Forrest, analyst at Cambridge Energy Research Associates, explains that with the spot price for West Texas Intermediate crude at $40 a barrel, oil sands producers have been getting around $34 per barrel for their synthetic crude. That’s not enough. To manufacture each barrel requires some $13 of operating costs. Thinning out their gloopy bitumen requires adding $11 per barrel of lightweight natural gas liquids. Royalties to the government average $1.50 per barrel. Then another $1.50 per barrel to transport the stuff by pipeline to a refining center. That leaves $7 per barrel before taxes. Factor in capital costs and producers are losing as much as $8 on every barrel they sell right now.

Oil sands observers think Total wants Fort Hills bad enough that it will pay up to buy out both UTS’ and Teck Cominco’s stakes in order to partner with Petro-Canada one-on-one. In that setup Petro-Canada would likely oversee the bitumen recovery operations, while Total would build the $10 billion upgrade, which partially refines the bitumen. Petro-Canada’s chief Ron A. Brenneman declined to comment on Total’s potential involvement in the Fort Hills project.

Total plans to invest $14 billion worldwide this year and has earmarked $10 billion for oil sands over the next decade. If Total’s oil sands history is any guide, de Margarie will end up increasing his bid for UTS. In 2005 Total bought into the Deer Creek project for $1.5 billion, 25% more than its original bid, while in 2008 it sweetened its bid for Synenco 14% to $500 million.

Those deals were before the bottom dropped out of oil prices. The industry is watching Total’s hostile UTS bid carefully because it is the first significant takeover attempt of this downturn.

If and when it goes through, a cascade of deals is likely to follow. Oil giants BP (nyse:BP – news – people ), Royal Dutch Shell and ExxonMobil (nyse: XOM – news – people ) plan to invest upward of $30 billion apiece this year to gather assets, either through the drill bit or through buying outfits that run out of cash and refinance options.

“When the temperature starts heating up in Houston, so will the deals,” says a long-time M&A advisor to oil companies. He expects at least 20 notable takeovers this year. “We will see consolidation at all levels.”

The moment of truth for many will come at the end of March, when banks recalculate the value of oil companies’ reserves. That value determines a company’s borrowing base–that is, the amount of loans banks are willing to extend the companies. Those reserve values in many cases are half what they were a year ago; that means banks are likely to demand immediate repayment of some loans. Without enough cash or refinance options, companies will put their assets or themselves on sale.

Other analysts suggest that likely small-cap takeout targets include Rex Energy(nasdaq: REXX – news – people ), Stone Energy (nyse: SGY – news – people ), Delta Petroleum (nasdaq: DPTR – news – people ) and ATP Oil & Gas (nasdaq: ATPG –news – people ), all of which have been struggling with liquidity issues and trading near lows. These pipsqueaks can be a nice meal for mid-sized independents like XTO Energy (nyse: XTO – news – people ), Devon Energy (nyse: DVN – news – people ) orApache (nyse: APA – news – people ), but they are too small to interest the international supermajors, who require larger prey. Which is why the size and scale of oil sands projects are so attractive.

Considering the price environment, it’s good for Roach that UTS’ projects are just in thedevelopment stage. With $280 million in cash he says he can wait three years for the market to turn or a better bid to come along. “We don’t need financing, that’s the absurd thing about this situation.”

But he knows there’s a danger in waiting; if oil is still $40 in three years, Roach will be a beggar, not a chooser. So he’s keeping an open mind. “We have absolutely no bad blood with Total,” he says.

FORBES ARTICLE

royaldutchshellplc.com and its sister websites royaldutchshellgroup.com, shellnazihistory.com, royaldutchshell.website, johndonovan.website, shellnews.net, shell2004.com, shellshareholders.org, don-marketing.com and cybergriping.com are all owned by John Donovan. There is also a Wikipedia article: royaldutchshellplc.com

Comments are closed.

%d bloggers like this: