Oil Sands Universe Just Got Simpler (SU, PCZ, TOT, ENY)

Two of the largest players in the Canadian oil sands, Suncor Energy Inc. (NYSE: SU) and Petro-Canada (NYSE:PCZ) announced that Suncor will acquire Petro-Canada in a deal valued at $15.5 billion. Shareholders of Petro-Canada will get 1.28 shares of the new company for each share of Petro-Canada they hold, and Suncor shareholders will get one share for each share of Suncor they hold.

According to the joint press release, the deal represents a 25% premium over the 30-day weighted average of Petro-Canada stock. Once the share exchange is completed, Suncor shareholders will hold 60% of the new company and Petro-Canada shareholders will hold the remaining 40%. The new company will retain the Suncor name, as well as the Petro-Canada brand in the refining and marketing end of the business.

Suncor’s president and CEO said, “The combined portfolio boasts the largest oil sands resource position, a strong Canadian downstream brand, solid conventional exploration and production assets, and low-cost production from Canada’s east coast and internationally.” Petro-Canada’s president and CEO, who will become the Executive Vice Chairman of the new company, said, “The merger will be good for shareholders of both companies with reduced capital requirements, operating efficiencies and complementary integration opportunities between upstream and downstream assets. The increased scale provides more stability in volatile markets, plus the financial and organizational capability to successfully take on large-scale projects in the future.”

The merged companies expect to save $300 million a year in operating expenses. Combined production totals 680,000 barrels of oil equivalent annually, and refining capacity totals 433,000 barrels/day. The merged companies will control approximately 7.5 billion barrels of oil equivalent proved and probable reserves, along with nearly 19 billion equivalent barrels of “contingent” reserves.

It’s no secret that low prices for crude have hit the oil sands hard. Suncor had approved a capital spending budget of C$20.6 billion for the four-year period beginning in 2009. In October, that budget was cut by C$6 billion, and was further cut early this year by another C$3 billion. Per barrel prices of $40 only barely cover costs of production from the oil sands. Suncor’s cash operating costs per barrel were $38.50 in 2008 and the costs are projected in the range of $33-$38/barrel for 2009. And new build projects need prices of more than double that amount to be economically viable.

The oil sands development centered around a little town named Fort McHenry, Alberta, has produced a boom-town environment over the past few years. Costs for employees, materials, and equipment have skyrocketed, although prices have moderated somewhat in recent months. Consolidation is expected to slow the number of competing projects planned for the region.

France’s Total SA (NYSE:TOT) launched a $478 million hostile takeover bid for Canada’s UTS Energy Corporation in January. UTS Energy has agreed to join Petro-Canada in a major oil sands project that has now been delayed. Will the new company honor that agreement? The project, known as the Fort Hills project, is really the only big, new project on either Suncor’s or Petro-Canada’s plate.

Overall, the Canadian merger makes a lot of sense. The outlook for operational savings seems a bit rosy, but there’s no question that costs will come down, if for no other reason than the new company will rein in spending.

Petro-Canada shares are trading up more than 25% before the market opens this morning.

The ETF which covers the Canadian oil sands sector is the Claymore/SWM Canadian Energy Income (NYSE: ENY).  It closed at $9.94 Friday, down from a high of over $36.00 last year.

Paul Ausick

March 23, 2009