Cenovus-Husky merger to create Canada's third-largest oil and gas producer

Dubai — Cenovus Energy announced Oct. 25 it will acquire Husky Energy for $2.9 billion in an all-stock deal to combine their operations and create Canada's third-largest oil and natural gas producer with output of about 750,000 boe/d as the merger wave in North America sweeps into Alberta.

The merger agreement comes as crude oil prices have generally stabilized, with front-month NYMEX WTI lingering around $40/b since July, and Western Canadian Select at around $30/b, allowing for a slew of recent dealmaking. Shareholders have been pressing for North American consolidation as investors increasingly lose interest in the energy sector.

Both Cenovus and Husky have seen shares fall by more than 60% this year amid the ongoing coronavirus pandemic.

The two companies with "Canada roots and Calgary values" priced the combined Cenovus at $18 billion, including debt, with the new Cenovus becoming more of an integrated firm and also emerging as the second-largest Canadian-based refiner and upgrader after Suncor. The firm would have total upgrading and refining capacity in Canada and the US of about 660,000 b/d, including 350,000 b/d of heavy oil conversion capacity.

In a conference call, Cenovus CEO Alex Pourbaix specifically highlighted the integrated advantage of combining its Foster Creek and Christina Lake oil sands production with Husky's Lloydminster oil production and refining complex in Alberta and Saskatchewan.

Takeaway capacity from Alberta will be about 265,000 b/d, with about 305,000 b/d of planned pipelines/expansions, the companies said in a statement. They will also have 16 million barrels of crude oil storage and operate on sustained capital of $2.4 billion a year. The production volumes include Husky's assets in the Asia Pacific region.

"We will be a leaner, stronger and more integrated company, exceptionally well-suited to weather the current environment and be a strong Canadian energy leader in the years ahead,” Pourbaix said in a statement. "The diverse portfolio will enable us to deliver stable cash flow through price cycles, while focusing capital on the highest-return assets and opportunities."

Cenovus has valued more integrated diversification for years, Pourbaix said in the call, but there weren't any practical acquisition opportunities until now.

"One of our biggest challenges has been exposure to Alberta heavy oil prices," he said. "In one fell swoop, this deal will almost completely remove our exposure to WTI-WCS differentials."

While refining profit margins are weak now during the pandemic, he said, the long-term outlook is much more positive.

Midwest coking margins for WCS have averaged roughly $4.30/b so far this quarter, down from an average of $12.21/b in 4Q 2019, S&P Global Platts Analytics data shows.

The Canadian oil industry has struggled for years -- before the most recent demand collapse during the pandemic -- with weaker crude prices, high transportation costs, pipeline shortages and concerns from non-Canadian firms over the environmental impacts of producing the heavier oil sands crude.

This year during the pandemic, Canadian crude-by-rail exports plunged from a record high of 411,991 b/d in February down to an eight-year low 38,867 b/d in July before stabilizing at 51,052 b/d in August. Weaker demand and tighter pricing differentials have made much of the crude exports uneconomical.

The expanded Cenovus would be the third-largest Canadian producer after Canadian Natural Resources and Suncor Energy.

Production cap

The deal, which is expected to close in the first quarter of 2021, follows Alberta's decision to end a production cap for large oil producers in December as the pipeline squeeze that sparked the program has eased.

The provincial government retained the authority to reinstate the quotas through December 2021, although the government said in an Oct. 23 press release that it does not intend to do so. Even without the quotas, 16% of Alberta's production is offline in the wake of the coronavirus pandemic, the government said. The curtailments were brought in at the beginning of 2019 to stem over-production that swamped Canada's export pipelines.

The Canadian merger follows a series of tie-ups in the US of companies mainly operating in the shale patch of the Permian Basin.

In a series of all-stock deals, ConocoPhillips scooped up Permian pure play Concho Resources for $9.7 billion on Oct. 19 and, one day later, Midland Basin leader Pioneer Natural Resources snagged Parsley Energy for $4.5 billion in a more familial deal. Chevron closed on its $5 billion acquisition of Noble Energy early in October and, last month, Devon Energy agreed to buy WPX Energy for $2.56 billion in a so-called merger of equals.

In the Cenovus transaction, Husky shareholders will receive 0.7845 of a Cenovus share plus 0.0651 of a Cenovus share purchase warrant in exchange for each Husky common share, giving Husky an enterprise value of about $10.2 billion, at a 21% premium. Pourbaix will be CEO of the new company, which will stay Cenovus Energy and remain based in Alberta.

Cenovus shareholders would own 61% of the combined company.

The deal is supported by Hong Kong billionaire Li Ka-shing, who controls nearly 70% of Husky's shares. Under the deal, Li Ka-shing's firms would hold about 27% of the new Cenovus.

In the call, Husky CEO Robert Peabody emphasized that its largest investor isn't planning to divest.

"They are retaining their level of investment in the company," Peabody said. "But they clearly see this combined company as a better investment vehicle."

The combined company is expected to yield annual run rate synergies of $1.2 billion, largely achieved in the first year, with $600 million from corporate and operating expenses including workforce reductions and $600 million from capital allocation synergies.

The companies will aim to achieve net zero emissions by 2050, with specific environmental, social and governance targets and plan to be announced after the deal closed expected to in Q1 of 2021.

The estimated proved reserves life of about 33 years, consisting mostly of very low-cost reserves, is expected to result in reduced re-investment risk and eliminate the need for future large-scale capital projects to sustain production at current levels, the companies said.