Canada’s oil and gas industry has experienced turbulent times as of late.
With oil prices going from over $100 per barrel to sub-$50 per barrel as result of oversupply, Canadian energy companies have suffered. Total declines in market capitalization among oil and gas businesses from July 2014 to February 2016 are estimated to have exceeded $230 billion, according to data from S&P Capital IQ. Challenged with survival, many producers have been forced to make changes to perform in challenging market conditions.
Additionally, conditions have led many investors to reconsider the market. Sovereign wealth funds and state-owned enterprises, which had a huge appetite for Canadian energy assets just a few years ago, have slowed spending or exited the market, as have some large foreign strategic acquirers.
In March, Netherlands-based Royal Dutch Shell announced its US$8.5 billion oil-sands asset sale to Canadian Natural Resources, which is among the largest in the history of domestic oil and gas transactions.
It is noteworthy, however, that this was part of a previously announced US$30 billion divestment program for RDS. “This transaction is significant for Canadian Natural Resources as it increases the reliability of underlying sustainable cash flows,” President Steve Laut said in a statement published in the Financial Post. “It allows focus on the key operating strengths.”
Also in March, ConocoPhillips agreed to sell its FCCL Partnership interest in an oil-sands play and certain natural gas assets to Cenovus Energy for $12.7 billion. The ConocoPhillips divestment was the third major oil-sands disposition to a Canadian company to be announced or completed this year.
Each of Athabasca, Canadian Natural Resources and Cenovus saw sufficient future value in controlling a broader asset base to justify increasing their oil-sands ownership and, contrary to reports that foreign capital is fleeing the oil sands, each of Statoil, RDS and ConocoPhillips took back significant positions in the share capital of the purchasers who acquired their interest.
There’s no question Canada’s oil and gas industry is experiencing a challenging period after years of growth; however, while some might see this inflection point as a time to get out of the market, others, like Canadian Natural Resources and Cenovus, see it as an opportunity to go deeper into the domestic energy space at the right price and before the market makes a recovery, which is inevitable.
Despite today’s market conditions, there are other positive signs. In early March, Prime Minister Justin Trudeau reaffirmed his commitment to the oil and gas industry after some comments he made earlier in the year were called into question. “No country would find 173 billion barrels of oil in the ground and just leave them there. The resource will be developed,” said Trudeau, speaking at CERAWeek, a conference of global industry leaders and government officials.
Additionally, U.S. President Donald Trump’s granting of a permit for construction of the Keystone Pipeline will be a boon to Canadian’s oil sands as they make their way to U.S. refineries and ultimately to market.
Trudeau also approved the Trans Mountain Pipeline expansion project. In exchange for approvals, Kinder Morgan, the owner, agreed to pay British Columbia’s government between $25 million and $50 million per year for 20 years to go into a fund for environmental protection.
In response to the shake up, and Canada’s commitment to the industry, there are many skilled professionals launching or readying to launch their own energy startups. Highly experienced CEOs, CFOs, COOs and engineers are forming management teams to create new companies that are looking for opportunities to create value in the oil and gas industry. These new companies are also looking for private backing on a deal-by-deal basis. And their strategy is working.
Since private equity investors recognize the energy market is still volatile, but nonetheless ripe for investment, many have shown a steady interest and are backing new companies, frequently with equity lines-of-credit of between $100 million and $500 million. PE firms fund the growth transactions through capital calls, often with a five-year timeline for draw-down. The goal is to be the first money in and, with oil prices low and many assets up for sale, now is an optimal time for that approach.
Many of Canada’s largest pension funds, such as Canada Pension Plan Investment Board and Ontario Teachers’ Pension Plan, have closed deals this way, as have several local and foreign PE firms.
For example, Aspenleaf Energy, comprised of a team formerly from Shell Canada and led by President and CEO Bryan Gould, was founded to acquire and exploit light oil and liquids-rich gas assets in Western Canada.
The business is backed by ARC Financial Corp, a Canadian PE firm, and Ontario Teachers’. The two investors provided Aspenleaf with a $365 million line-of-equity to buy assets and grow them. In 2015, Aspenleaf acquired Arcan Resources, a public company engaged in the exploration, development and acquisition of petroleum and natural gas in the Western Canada Sedimentary Basin.
Similarly, in 2016 RimRock Oil and Gas was founded by a team formerly associated with Talisman and led by President and CEO James Fraser. Warburg Pincus has funded RimRock with US$500 million to seek unconventional oil and gas assets across select basins in Canada and the United States.
Osler, Hoskin & Harcourt acted as legal counsel to both Aspenleaf and RimRock, and several other teams in the recent past, including Northern Blizzard Resources, which completed its initial public offering in 2014, Kanata Energy and Steel Reef Infrastructure.
The formation of these new producers and their unique capital structure is partly a result of how expensive drilling has become due to the use of new technologies. Purchasing a well can cost many times more than traditional wells and, of course, there is always the possibility that any well will not produce results. Companies that formerly drilled alone or without private capital now need the funding that PE firms and pension funds can supply.
Another reason is that these companies often grow by acquisition. Picking up on the trend of talented teams with a need for significant capital, U.S. PE firms, such as Apollo Global Management, NGP Energy Capital Management, Pine Brook Partners, Riverstone Holdings and Warburg Pincus, have all used this strategy to back oil and gas teams in Canada.
Other asset managers are just gearing up for the recovery. At the end of last year, U.S. hedge fund manager Bridgewater Associates starting raising new capital for its Pure Alpha fund, which touts oil and gas as a large portion of this portfolio. Other firms are also gearing up. In March, for example, Fengate Real Asset Investments closed its first fund with $300 million in committed capital. The Canadian investor has already backed Cricket Energy, a provider of residential and commercial energy services and solutions.
Another positive sign is the number of PE-backed energy companies, such as BOS Solutions Holdings (fluids management), Source Energy Services (frac sand) and STEP Energy Services (coiled tubing and fracturing services), that have recently seen fit to test the equity markets with initial public offerings.
All of this suggests that while 2017 is off to a slow start in terms of deal volume, as opposed to the impressive size of announced energy M&A deals, the Canadian oil and gas industry is seeing signs of life and private equity firms are uniquely positioned to take advantage of the emerging opportunities.
Neal Ross is a partner at Osler, Hoskin & Harcourt LLP. He practices corporate and securities law, with an emphasis on mergers & acquisitions, corporate ﬁnance, and company governance matters.
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