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Canadian Natural bulks up on oil sands assets amid foreign exodus

Canada's biggest oil producer is about to get bigger, stepping in to buy the oil sands assets of Devon Energy Corp. as international companies flee the country's production region amid price, transportation and environmental concerns.

Canadian Natural Resources Ltd. has remained profitable through the turmoil that has roiled the oil sands sector in recent years and plans to pay for the C$3.8 billion deal with a combination of cash flow from its operations, which in 2018 topped C$10 billion, and the addition of some debt. Devon's Jackfish assets, which make up the bulk of the production the Oklahoma City-based company is selling, produce about 108,000 barrels per day and the deal would bump Canadian Natural's output to almost 1.2 million barrels of oil equivalent per day.

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The Canadian oil giant's willingness to pay a premium price for the assets raised eyebrows among investors, many of whom anticipated Devon would realize US$2.5 billion or less for them. The anticipated price works out to just over US$2.8 billion as of May 28. Analysts at Tudor Pickering Holt & Co. described the transaction as a "modest positive" for Canadian Natural stock.

"While the sticker price comes in ahead of recent investor conversations [US$2 billion to US$2.5 billion], financing the deal with [free cash flow] and leverage drives an accretive transaction," the analysts said in a May 29 note. Canadian Natural is expected to reduce overall costs from the integrated operations by about C$135 million per year. The purchase is not expected to interfere with Canadian Natural's share buyback plan, which the analysts noted is another positive for equity investors.

Big buyer

Canadian Natural has been the biggest acquirer of oil sands assets since commodities prices slumped in late 2014, prompting oil majors to sell their holdings of oil sands, which are viewed as expensive to produce and carbon intensive. The company has worked to reduce costs and pollution in its operations and has said the emissions intensity of bitumen production is now on par with many conventional crudes. It anticipates a reduction of operating costs at Jackfish, which are currently about C$13/bbl, by between C$1/bbl and C$2/bbl.

The company has built up its Canadian oil sands portfolio through acquisitions that included Royal Dutch Shell PLC and Marathon Oil Co.'s interest in the Athabasca Oil Sands Project for US$8.6 billion and Cenovus Energy Inc.'s Pelican Lake project for C$975 million. Both deals closed in 2017. The company plans to keep its target of C$15 billion in debt, approximately 1.5 times EBITDA and will use a three-year term loan to cover the Devon acquisition costs. Canadian Natural had long-term debt of about C$19.5 billion at the end of 2018, according to data compiled by S&P Global Market Intelligence.

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The Sturgeon Refinery, which was recently completed near Edmonton, Alberta, will process oil sands bitumen from projects owned by Canadian Natural Resources.
Source: NWRP Sturgeon Refinery

Despite market expectations, the price Canadian Natural paid for the Devon assets was lower than other recent deals. The price of "C$29,425/bbl [US$21,824/bbl] for this deal is well below other heavy oil and oil sands deals done in the past five years," Stephen Kallir, senior analyst at Wood Mackenzie, said in an emailed statement.

The transaction comes as Canadian oil producers struggle to move their product to export markets on the nation's swamped pipeline system. Total crude available for export in late 2018 briefly exceeded Canada's export pipeline capacity of about 4 million barrels per day, prompting Alberta, the nation's largest oil-producing province, to impose across-the-board production cuts on large producers. While the cuts initially boosted prices and reduced brimming storage levels, refinery outages in the U.S. and better-than-average reliability at Canadian production projects have again pushed Canadian storage near its limits. The National Energy Board estimated Canadian storage capacity at 88 million barrels at the end or 2017, although operators have added tanks since then.

A bright spot in late 2018 was demand from the U.S. Gulf Coast where refiners are hungry for heavy oil barrels amid supply disruptions in Venezuela and Mexico. The pre-production-cut price gap made it profitable to ship Canadian crude by rail to the region and exports by train jumped to more than 300,000 bbl/d. As U.S. benchmark prices softened and Canadian prices went up, the price difference made rail uneconomic for much of the first quarter. Canadian Natural anticipates the differential will reach about US$20/bbl, which would make crude by rail profitable again. Executives said on a conference call they anticipate upping their existing shipments once the deal closes.

"Today we're doing 14,000 bbl/d of rail," CFO Mark Stainthorpe said on the May 29 call. "Obviously, going forward here we are talking with various parties on potentially doing more rail, but it's too early to talk anything further than that."

The Devon acquisition will make Canadian Natural the world's 25th-largest oil producer, and eighth among non-state-owned companies, Wood Mackenzie's Kallir noted.

"This continues the trend of Canadian-domiciled consolidation that we've seen since 2016," Kallir said. "In 2020, the oil sands will produce 3.3 million bbl/d and just four companies now account for 85% of that volume. Those companies operate an even larger share — close to 95%."