As published in Finance et Investissement on 6 March 2024 (in French).
For the past three years, technology firms have dominated mergers & acquisitions activity. Last year marked an inflection point with the U.S. energy sector at the head of the leaderboard. U.S.-based, mega-cap energy firms, such as Exxon Mobil, Chevron Corp and Occidental Petroleum have been leading the charge by acquiring large competitors, particularly those in the Permian basin region in the U.S. Canadian oil and gas majors have not joined the tsunami of takeovers, however 2024 is likely the year that could change due to several catalysts.
Canada’s top senior energy firms are in pole position. With solid balance sheets, cash ready to deploy, and reserves to build, they’re starting to eye smaller neighbors (“Howdy, neighbour!”) with mergers on their minds in such key regions as Western Canada’s Montney shale formation situated in northern Alberta and British Columbia, and the smaller Duvernay and Clearwater basins. With the market slow to revalue the sector, strategic buyers may ascribe a premium to competitors with hefty, quality reserves and operational scale which reduce overhead expenses, enhance resource depth, improves portfolio diversification, lowers the cost of capital, and provides a larger index weighting.
After what felt like an eternity of challenges to long-only investors in the energy space, Canadian energy companies now boast solid balance sheets. Through the lean years, Canadian producers achieved efficiencies employing new methods and technologies to grow production with less capital spending.
Today, they boast significant free cash flow to return to shareholders via dividend increases, special dividends and stock buybacks. They also have the financial resilience to fund acquisitions with ample cash flows and excess capacity on their balance sheets to add debt. After witnessing their neighbours to the south announce a frenzy of deal, Canadian energy company management teams and investors are itching to do deals. Companies cannot be expected to stay on the sidelines while their competitors gain scale. One major deal will likely lead to a competitive response and a wave of M&A as we saw in the US last year.
Canadian energy producers do not have many advantages over U.S. peers which benefit from high-quality, low-cost resources and less regulatory oversight, but one key advantage is the long-life reserves particularly for oil sand producers. Decades of oil reserves may finally be a strategic advantage. With the completion of two major energy infrastructure projects—government-owned Trans Mountain which can move 590,000 barrels-per-day of crude takeaway capacity with start up expected later this year and Westcoast Canadian LNG which will export 14 million tonnes of LNG per year—Canadian oil and gas producers can find buyers for their excess inventory in international markets and at international pricing. For years, Canadian energy producers were forced to accept significantly discounted prices due to restricted market access, the “heavy oil” discount, and congestion in export pipelines.
Today the picture has changed. At the same time opportunities are closing south of the border from dwindling reserves and President Biden’s pause on LNG export licenses ahead of the November U.S. election, development and optionality are rising in Canada. With additional capacity coming soon, American, and international majors will be motivated to lock in the excess inventory and secure future production which should act as a major catalyst for M&A activity in Canada.
