Cold Winter Temperatures Give Rise to a Hot M&A Market for the Canadian Oil and Gas Sector

It was the biggest deal of 2012: Chinese state-owned firm CNOOC Limited’s takeover of Calgary oil and gas producer Nexen Inc. Although there were a total of 260 deals closed over the course of the year, it was CNOOC Limited’s CDN$14.95 billion transaction and another megadeal — PETRONAS’ CDN$5.5 billion acquisition of Progress Energy — that helped lift 2012 transaction values to approximately CDN$49.5 billion.

Analysts suggested that transaction deals and values in 2013 would build on the successes of 2012. However, that was before the CNOOC Limited – Nexen and PETRONAS deals attracted attention from the media, regulators, policy makers and the public at large that changed the trajectory of deal-making in the Canadian oil and gas sector.

Following the CNOOC Limited-Nexen deal, the federal government solicited feedback from a broad spectrum of stakeholders, the results of which prompted the government to amend the Investment Canada Act for Industry Canada’s State Owned Entity (SOE) guidelines. These guidelines restricted the amount of investment allowed by SOEs in Canadian companies by broadening the definition of an SOE and clarifying certain other aspects of definitions of control. These changes, enacted in June 2013, cast a pall over the sector for potential Asian investors. From CDN$27.3 billion in 2012, Asian investment in the Canadian oil industry fell to CDN$1.2 billion in 2013.

Although Asian investment explains part of the decline, uncertainty surrounding pipeline approvals to expand Canada’s ability to export oil to foreign markets exacerbated what amounted to an 80% drop in deal values in 2013.

So where does this leave us in 2014?

SOE guidelines are still in place and the pipeline uncertainty continues. Yet, both equity financing and merger activity are on the rise. To date, the merger activity in the Canadian oil and gas sector has already reached CDN$15 billion, exceeding the CDN $13 billion in activity for all of 2013.

Canada’s cold winter has helped to heat up the transaction landscape as plummeting temperatures gave rise to gas demands. After years of depressed prices based on an oversupply of natural gas, extreme cold weather in Eastern Canada and parts of the U.S. caused by the polar vortex pushed down storage levels and increased prices to as much as CDN$38 a gigajoule in early February, 2014. Add volatility in the Middle East and a lower Canadian dollar to the mix and all of a sudden shale gas has become the new transaction darling. Major deals to date include Canadian Natural Resources Ltd.’s purchase of a significant portion of Devon Energy Corp’s natural gas assets valued at CDN$3.13 billion and Encana Corp’s sale of Western Canadian exploration property to a private equity (PE) suitor.

Just as rising natural gas prices may have sparked interest in shale gas assets, the increasing use of rail to resolve the oil sands transportation woes has boosted oil prices and by extension investor confidence. This, in turn, is attracting M&A activity and now private equity (PE) investment with more PE players seeking to set up shop in Calgary.

Some funds, including giant Kohlberg Kravis Robert, have seen opportunity in the difficult capital markets of the past few years. They have looked for opportunities to provide capital, where the public markets have not been available. The same fundamentals and geo-political considerations are driving other PEs to turn their interest toward North American oil and gas opportunities. These PEs are looking for service companies with unique features and value-add products and services. With low interest rates, PEs are able to raise funds from their limited partners and are seeing higher levels of leverage from lenders. This enables the PEs to aggressively pursue high quality assets.

Also hot are Canadian exploration and production (E&P) companies with high-quality unconventional and light-oil assets. According to global market information and analytics company IHS Inc. (IHS), there have been eight E&P transactions worth more than CDN$10.9 million each, with the market on pace to reach 15 corporate acquisitions valued at approximately CDN $7.63 billion by year’s end. A majority of these buyers will be Canadian E&Ps. However, despite SOE guidelines, the Chinese and others are showing interest.

Where foreign investors are beginning to show interest in E&P, U.S. companies have shown renewed interest in Canada after years of selling their investments amid softening oil and gas prices. The draw? Liquefied natural gas (LNG). Yet, although there are as many as 16 LNG gas plants proposed in British Columbia, the number that will come to fruition will depend on finding suitors willing to accept the significant capital costs, seek the required regulatory approvals, and forge alliances with First Nations and other parties that would be crucial to a project’s success.

With five months still to go before year’s end, Canadian oil and gas companies are well-positioned to acquire and be acquired. Whether it’s shale gas, LNG or E&P, companies from all segments of the oil and gas sector will continue to attract investors, far surpassing both deal numbers and deal values set in 2013. Moreover, as Canadian companies receive regulatory approval to ship product through pipelines to the U.S. and offshore, the Canadian industry will only become more attractive to investment for the foreseeable future.