What Canadian politeness means for M&A in the oil patch

Consolidation was picking up in Canada’s energy patch prior to Cenovus Energy’s (CVE.TO)(CVE) $3.8 billion deal to acquire Husky Energy (HSE.TO) last month. The headline-grabbing announcement was confirmation for some, including top executives, that a long-awaited M&A wave was gathering momentum. What remains to be seen is the scale at which companies will band together, and if the battered sector has the stomach for more large-scale deals.

The pace of dealmaking slowed to a crawl in the first half of 2020 as the COVID-19 pandemic wreaked havoc on global energy markets. Companies went into survival mode, slashing spending plans, cutting dividends and reducing workforces to weather the storm. Energy M&A in Canada fell to a historically slow pace in the first six months of the year, according to data firm Evaluate Energy. That was followed by US$900 million in new upstream deals in the third quarter, nearly as much as the three previous quarters combined.

“A lot of what you are seeing in the industry right now is accretive M&A to gain scale and try to wring a few extra dollars out of each business as you drive synergies,” said Matt Murphy, an energy sector analyst at Calgary-based Tudor, Pickering, Holt & Co. “

ConocoPhillips (COP) reaffirmed that Canadian oil and gas is part of its strategy with a US$390 million purchase of liquids-rich Montney acreage from Kelt Exploration (KEL.TO). Canadian Natural Resources (CNQ.TO)(CNQ) diversified its oil-heavy portfolio, buying natural gas-weighed Painted Pony Energy (PONY.TO) for $461 million. Whitecap Resources (WCP.TO) acquired NAL Resources in an all-stock deal worth $110 million.

All of these pale in comparison to Cenovus’ takeover of Husky in the final quarter of the year, a transaction that will create the third-largest Canadian oil and gas player. Tourmaline Oil (TOU.TO) continued the trend into November, snapping up two privately-held oil and gas companies in deals collectively worth $770 million, including debt.

Analysts peppered energy executives with questions about how the trend will continue during the latest round of earnings calls. Canadian Natural Resources president Tim McKay predicted “there will continue to be some consolidation here over the next year.” Suncor (SU.TO)(SU) CEO Mark Little said buyers will be selective, demanding synergies, upside for shareholders and a compelling price.

“I can't overstate it enough,” he said on the Oct. 29 conference call. “We did not cut our capital budget, operating costs and reduce our dividend to leverage up our balance sheet to do M&A.”

Greg Taylor, chief investment officer at Purpose Investments, sees the M&A trend as sorely needed and long overdue in both Canada and the U.S., with the latter realizing this more recently, and boldly springing into action.

Taylor counts Exxon Mobil’s (XOM) removal from Dow Jones Industrial Average (^DJI) after nearly a century as a meaningful sign. Building scale through deals, he said, is part of the “quest for relevance” underway at the American energy heavyweights.

“[Oil and gas] is a sector that has fallen out of favour more recently in the U.S. In Canada, it’s been out of favour for a number of years,” he said. “Americans are just kind of waking up to that, especially on the senior producer side. It’s created urgency for them to get some greater scale going.”

Recent U.S. energy deals include Chevron’s acquisition of Noble Energy for US$13 billion including debt, and Devon Energy and WPX Energy’s merger worth US$5.7 billion including debt.

Murphy points to a number of reasons why energy M&A in Canada will lag the action south of the border. For one, several years of weak prices for Albertan crude have forced many in the oil patch to continuously tighten their belts, leaving fewer efficiencies to be gained by joining forces with other companies.

“Your average Canadian upstream business, for example, will tend to run fairly lean already. There’s just not the same ability to drive upside to cash flow by relying on synergies,” he said.

“Another thing that I think is getting missed in these M&A discussions is the incentives to transact in Canada are different, in that some of the change of control incentive packages in the U.S. are pretty significant. The incentive to combine from a management standpoint is just different [in Canada].”

Energy commentator Vincent Lauerman recently cast doubt on more deals rivalling the scale of Cenovus-Husky, pointing to a lack of obvious targets the size of Husky, among other factors.

“Is unlikely the management teams of any of the largest Canadian firms would be amenable to a takeover even if an external suitor emerged,” he wrote in a piece for Petroleum Economist titled “Husky deal not the trigger for Canadian consolidation wave.”

Lauerman also notes fear of a possible hostile takeover likely motivated Husky’s largest shareholder, multi-billionaire Li Ka-shing, to entertain the Cenovus offer, rather than financial necessity driven by low oil prices.

Taylor sees yet another reason why this country’s energy companies may resist the pursuit of aggressive M&A deals: stereotypical Canadian politeness.

“The comment has been around Calgary that it has been hard to see deals done because the CEOs and management are all friends. Nobody wants to do a hostile deal, or a deal that is going to put everybody out of work. They’re all friends at the petroleum club,” he said, referencing the job losses that often follow deals aimed at cutting costs.

Cenovus said it would cut its workforce by up to 25 per cent once the deal with Husky is complete, potentially resulting in more than 2,000 lost jobs.

However, the current cozy relationship among energy executives noted by Taylor could be cast aside if economic conditions worsen and companies are forced to fight to survive.

“Trying times call for desperate measures,” Taylor said. “We could see some more deals come that would be not traditionally what happens in Western Canada.”

Jeff Lagerquist is a senior reporter at Yahoo Finance Canada. Follow him on Twitter @jefflagerquist.

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