Merger Mania
by Bill Powers, Editor
Canadian Energy Viewpoint
July 01, 2004
In the past three months there have been five significant mergers by independent firms in the North American oil patch. Such a high level of merger and acquisition (M&A) activity provides a great deal of insight into how the industry’s most knowledgeable participants view the industry’s current state of affairs. In this issue we will briefly review the five recent mergers and what this M&A activity means for investors.
Kerr-McGee (NYSE:KMG) of Oklahoma City got the ball rolling in early April with its $3.4US billion purchase of Westport Resources (NYSE:WRC). As of December 31, 2003, Westport had 1.8 trillion cubic feet equivalent (tcfe) of proved reserves which were 76% natural gas and primarily located in the Rocky Mountain and Texas Gulf Coast areas. Westport’s most attractive asset was its approximately 900 billion cubic feet (bcf) of natural gas in its Natural Buttes field in the Uinta basin in northeast Utah. The area is similar to Kerr-McGee’s Wattenberg field and will allow KMG to apply its proven expertise in tight-gas recovery to maximize the value in the field. The all stock acquisition will result in Westport shareholders receiving .71 shares of KMG for every share of WRC held.
In mid-April, EnCana Corporation (TSE:ECA) announced it agreed to acquire Tom Brown (NYSE:TBI) of Denver for $48US a share in cash or $2.7US billion in total consideration. As of December 31, 2003, TBI had 1.13 tcfe of reserves concentrated mostly in its signficant land holdings in the US Rockies and East Texas. Through the purchase of Tom Brown, ECA further solidified its already significant operational base in the US Rockies.
In early May, Pioneer Resources (NYSE:PXD) agreed to acquire Evergreen Resources (NYSE:EVG) in a cash and stock merger valued at $2.1US billion. As of December 31, 2003, EVG had 1.5 tcfe of reserves concentrated mostly in its coal bed methane (CBM) producing properties in the Uinta Basin of Utah and the Piceance and Raton basins of Colorado. Pioneer will keep Evergreen as a subsidiary based in Denver. The combined company hopes to use EVG’s technical expertise to further delineate promising CBM projects in Kansas and Alaska.
In late May, Denver-based Forest Oil (NYSE:FST) announced its intention to purchase Wiser Oil (NYSE:WZR) for $330US million or $10.60US per WZR share. FST will be paying cash for WZR’s shares.
In mid-June, Petro-Canada (TSE:PCA) announced it is acquiring Prima Energy (NASDAQ:PENG) for $534US million. PCA will be acquiring all of the outstanding shares of Prima for cash at $39.50US. At year end 2003, Prima had proven reserves of 152 billion cubic feet of equivalent (bcfe) and a substantial acreage position in the US Rockies. Petro-Canada said buying Prima will give it both the "physical assets" of nonconventional gas, such as CBM, in the western United States as well as the "human assets" of technical knowledge to develop the resource in Canada, where it now has no CBM operations.
What are these five recent mergers telling the marketplace? I believe there are three distinct conclusions we can draw. First, all five mergers indicate that the industry’s most informed participants believe that today’s independent exploration and production (E&P) companies offer outstanding value. While many market observers do not think that today’s commodity prices are sustainable, clearly these acquiring firms have a different opinion. Also, given the escalating costs associated with finding and developing hydrocarbons in North America, acquiring firms know that absorbing the remaining large capitalization independent firms is the best way to grow production and reserves.
The five recent significant acquisitions, which involved four firms active in the US Rockies, speak volumes about the maturity of the area. According to the May 3, 2004 Oil and Gas Journal (page 58), prior to 1980 only 2,900 natural gas wells had been drilled in the state of Wyoming. By the end of 2003, approximately 26,000 natural gas wells had been drilled. The story is the same in Colorado. Prior to 1980, only 4,600 natural gas wells were completed in Colorado and by the end of 2003, over 20,000 natural gas wells were in place.
While the US Rockies region, with its very prospective CBM plays and tight gas areas, can support much greater well density than other petroleum producing regions, there is a strong likelihood that production growth in the area will slow down. This thesis is supported by the fact that owners of four of the fastest growing CBM and tight gas producers in the US Rockies decided to sell their businesses. Very rarely do owners of high growth E&P businesses sell out during times of record commodity prices unless past growth cannot be sustained.
Today’s high levels of M&A activity also has implications for investors who have not yet recognized the outstanding values available in the oil and gas sector. The mergers discussed here will result in billions of dollars of equity being removed from the market. Similar to the leveraged buyout boom in the 1980’s that greatly reduced shares outstanding in many US industries, I believe today’s level of merger activity and volume of share re-purchases will help push stock prices much higher in the near future.
Uranium on the Move
On June 16th, Cameco Corporation (TSE:CCO), the world’s largest supplier of uranium, announced that it has amended its agreement with its Russian partner, Tenex, to receive less uranium than previously agreed upon due to Russia’s increasing internal needs. I find Cameco’s announcement a strong indication that Russia will be dumping less uranium on the world market.
Uranium prices have continued to strengthen in recent weeks. On June 14th, Ux Consulting Company, LLC (a leading uranium consulting firm) reported that uranium prices reached a 20-year high of $18.10US a pound. With supply and demand fundamentals continuing to improve, look for the price of uranium to head much higher in the very near future.
Russia Revisited
While violence in the Middle East has been the focus of many market observers’ attention in recent months, I believe the story that is unfolding in Russia will have an equally significant impact on world oil supply. With Russian oil production averaging approximately 8.6 million barrels per day in the first quarter of this year (Source: US Department of Energy), the country has regained the title of the world’s largest oil producer. Therefore, anything that might hinder oil production from the country could have a substantial impact on world oil prices.
I believe Russian President Vladimir Putin’s efforts to push the country’s largest oil firm, Yukos, into bankruptcy are more than a political maneuver to gain popularity with the proletariat. It is becoming clear that Mr. Putin intends to use the tax evasion trial of Yukos CEO Mikhail Khodorkovsky as a way to retake control of the country’s largest oil producer. Re-nationalization of Russia’s largest oil firm would have a devastating impact on oil production in the country.
Historically, Russian oil production has fallen when investment in the industry has dried up. In the December 2003 issue I wrote an article entitled “Russia: Going on a Catastrophe!” that contained the following passage:
“Years of over production and poor reservoir management techniques, along with the fall of the Communist party, were behind the steep decline in oil output from the early 1990s through 1997. At its nadir, the former Soviet Union’s output was slightly above half its peak levels. The privatization of Russia’s oil industry was directly responsible for halting the country’s production declines. The newly privatized Russian oil companies were able to stem the decline by spending vast sums of money on drilling new wells and working over existing ones. Since the new owners of Russia’s oil assets paid a pittance for control of what are now some of the world’s largest oil companies, investing capital to keep their firms from wasting away was an easy decision….
I see several significant problems facing Russia’s oil industry. Far and away the biggest problem in Russia’s oil patch is capital investment. The arrest of Mikhail Khodorkovsky, the CEO of Yukos, slammed the door shut for foreign capital investment in Russian oil companies. Without fresh capital from Western oil companies, I seriously doubt that Russian oil companies will make the capital investments necessary to keep production flat, much less grow it from current levels.”
Recently, one of the world’s largest silver producers experienced the sticky fingers of the Russian government. It is hard to believe that any Western oil company would get involved in Russia without talking to the folks at Pan American Silver (TSE:PAA NASDAQ:PAAS). The below passage was copied from Pan American’s website (See URL)
“Dukat is the world's third largest primary silver deposit, containing nearly 500 million ounces of silver in reserves and resources, and is located in Magadan State, Far Eastern Russia. From 1996 until 1999 Pan American was actively involved in financing and constructing a new mine at Dukat. In 2000 this activity was frustrated and, after significant legal action, Pan American Silver and Russian company OAO MNPO Polimetall agreed to form a new company owned 80 percent by Polimetall and 20 percent by Pan American. Pan American's interest required no further contributions to project expenditures. Due to the loss of control of the Dukat deposit, Pan American wrote off its $37 million investment in Dukat in 2000. In November 2002 Polimetall announced that it had started production at the mine but no silver sales were actually made in 2002. In 2003, Polymetall reported production from Dukat of 9.7 million ounces of silver and sales of silver amounting to 6.6 million ounces. At this time, Pan American is unable to determine when or if it will receive financial benefits from its ownership interest in Dukat. As a result, Pan American did not include its 20 percent share of Dukat production (1.94 million ounces) in its production totals for 2003.”
I think it is safe to say that the Dukat mine was nationalized. A very knowledgeable silver mining executive, with whom I discussed the Dukat fiasco, informed me that the Russian government got involved at the last minute and reneged on an operating license to Pan American based on a fabricated technicality. PAA does not ever expect to see a penny from the millions it spent on mine development at Dukat.
BP is likely to become the first foreign oil company to have its Russian investments nationalized since the Communist party seized control of the industry in 1920. BP, which formed a joint venture with Russian producer TNK in 2003, faces problems on three different fronts. In late May 2004, the chief executive of a subsidiary of the TNK-BP joint venture, OAO Saratovneftegaz, was arrested for producing oil at its Saratov field without a license. TNK-BP has acknowledged exceeding the scope of its licenses in Saratov and is waiting for additional information from the government as to the status of its license.
The TNK-BP joint venture also finds itself involved in a dispute over production quotas at its most valuable asset, the Samotlor field. Samotlor, discovered in 1965, is the largest oil field ever found in Russia. It has been estimated that the field once contained over 50 billion barrels of oil in place. Today, Samotlor, which experienced steep production declines in the 1990’s, currently produces approximately 600,000 barrels of oil per day (bopd) and accounts for over 40% of TNK-BP’s total production. Much of the dispute over Samotlor is based on the Russian government’s interest in having the oil industry explore and discover enough reserves every year to replace production. In early June, the Russian energy ministry threatened to revoke TNK-BP’s operating license for Samotlor due to alleged over production from the field.
Russian legislation stipulates that any information about the volume of oil deposits as well as geographical maps of oil deposits is considered a state secret. Foreign citizens are forbidden access to any such information. However more than 100 foreigners work in TNK-BP’s head office alone and have access to information about all of the company’s fields. While it is still unclear what the government’s intentions are with respect to foreigner activity in Russia’s oil fields, I believe BP could be the subject of selective enforcement of the law since the company has already dumped billions of non-recoverable dollars into the country.
While only time will tell whether BP will fall victim to governmental nationalization efforts or if Yukos will be forced into bankruptcy and ownership given back to the government, it should be clear that the Russian oil industry is an awful place to invest. Without investment from foreign or domestic sources, oil production in Russia will head into a steep and irreversible decline. Production declines from the world’s largest oil producer should be considered very bullish for oil prices.
© 2004 Bill Powers, Editor
Canadian Energy Viewpoint
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Bill makes a good point, it seems that nobody's gonna be too excited about investing in Russia for awhile.
The folks calling for the imminence of world peak oil production may turn out to be right, not because of physical limitations to production but because of geo-political limitations. |
