Saturday, October 31, 2009

Melting Away

Like the Wicked Witch of the West, Petro-Canada has met its demise, and few are around to mourn

An obituary of the company's rise and fall, this article appears in the November 2009 issue of Oilweek

By Peter McKenzie-Brown

About 20 years ago I wrote a speech for Bill Hopper, who was then chairman and CEO of Petro-Canada. He had just taken on a one-year term as chair of the Canadian Petroleum Association (the CPA; now CAPP), which I then worked for.

The process was strange beyond imagination. Instead of simply going to his office to find out what he wanted to say, I learned at the last minute that I was to go with an entourage: CPA president Ian Smyth; vice president Hans Maciej; and my boss, Norm Elliott. Among the other members of the CPA’s board of governors, Hopper alone demanded that amount of attention. The interview took place in Hopper’s palatial offices in Petro-Canada Centre. Not surprisingly, the interview was a flop – a waste of time for all concerned.

This vignette is a reasonable caricature of the early years for the most controversial petroleum company in Canadian history. Especially under Hopper’s leadership, Petro-Canada set the national standard for self-importance, arrogance and underperformance. Although the worst times are long behind us, the company’s epitaph cannot be written without reference to those bad old days. In some ways, they were with the company to the end.

For example, if you believe that markets are inherently rational, try graphing the company’s share price to those of its peers. Every large Canadian oil company has done better than the People’s Oil Company, as it was once unaffectionately known.

When the crash came a year ago, Petro-Canada collapsed more deeply than most. This left it vulnerable to regime change, which quickly came in the form of a takeover encouraged by complaints from a large shareholder, The Ontario Teachers’ Pension Plan, which wanted to increase shareholder value.

The company and oilsands pioneer Suncor Energy soon announced a friendly merger, consummated on August 1st. The transaction created Canada’s largest oil and gas producer, with a market value of more than $50 billion. By the time the companies merged, Petro-Canada had nearly doubled in value from its 52-week share-price bottom, set last November. Clearly, the rational markets felt that with the takeover a better manager was in charge of its assets.

Few people will miss Petro-Canada the oil company. Its corporate history is a bit like the story line for “The Incredible Shrinking Man” – the 1957 movie in which protagonist Scott Carey, who had been contaminated by a radioactive cloud and pesticide, shrank slowly until he was reduced to living in a dollhouse.

In real, inflation-adjusted terms, Petro-Canada was the incredible shrinking company. Notwithstanding infusions of additional cash through equity sales, in real terms Petro-Canada’s market capitalization at the time of its merger with Suncor was less than the federal government’s original investment. In nominal terms (unadjusted for inflation), it lost nearly half the money its founding shareholder, the government of Canada, poured into its maw. And as the shackles of government ownership were slowly removed, it lost a combination of hard cash and opportunity for its second round of shareholders, a long-suffering gaggle of private investors.

The Background
Petro-Canada was founded as a Crown Corporation in 1975 by an act of Parliament and started operations the following year. The company was created upon noble ideals. In a period of intense energy insecurity, the left wing of Ottawa’s political establishment – the minority Liberals supported by the NDP as kingmakers – proclaimed the need for a national presence that would go boldly into the Canadian frontiers, which supposedly were being overlooked by the international players who then dominated Canada’s oil and gas sector. As importantly, the company would serve as a “window on the industry” through which policymakers could peer through clear glass. At start-up, the federal government transferred its 45 percent stake in Panarctic Oils and its 12 percent interest in Syncrude to the newly established company.

While the political issue of the day was ownership of Canadian resources – especially oil – Petro-Canada quickly went into acquisition mode by buying integrated companies rather than pure E and P operations. The idea was to wave the Canadian flag to consumers (aka voters) across the country. Outside Alberta, the political decision to create a national oil company was popular, and the company was given $1.5 billion in start-up money and easy access to new sources of capital.

During its first ten years, Petro-Canada purchased Atlantic Richfield Canada; Pacific Petroleums; Petrofina; most of BP’s Canadian refineries and service stations; and Gulf Canada’s retail and refining operations. The irony was not lost on the oil and gas sector: there were no shortages of refining capacity or retail operations, yet the company paid premium prices for assets which brought considerable liabilities with them. Other companies – BP and Gulf, for example – were selling them partly because the 1980s were a period of consolidation for retailing assets. The era of having a gas station on every corner was morphing into the present era of service stations only in heavy-traffic locations. And with service station closures came significant environmental liabilities, since product leakage from underground storage tanks was endemic across the country. That collective mess had to be cleaned up, and doing so was expensive.

The company did become an important purveyor of gasoline and motor oil at the service station, and one of its few unadorned successes was to develop the trusted and respected Petro-Canada brand of petroleum products. The single biggest boost to that brand came when the company sponsored the 1988 Olympic torch relay – a sponsorship that Ed Lakusta, at the time the company’s president, called the finest thing his company had ever done. Even sceptics began to believe Petro-Canada had a place in the oilpatch, and its gasoline sales soared.

Because of its many acquisitions in Western Canada, the company became one of the largest players in western Canada’s traditional oil fields, in the oilsands and in the east coast offshore. Did this lead to the discovery or development of more oil in the west? Certainly not. In 1927 John Bertram, an American Oil Company operative investigating the energy scene in Alberta, wrote a succinct description of what geologists now call the method of multiple working hypotheses.

“We know from our own experience,” he said, “that the geologists and also the officials of a company that operates in one area for a long time, tend to think along the same lines and to accept the same theories of oil occurrence. When other groups of men invade the same territory, the newcomers work with different methods, use different theories and drill structures the others condemned.” Through its acquisition of numerous companies on the government’s dime, Petro-Canada actually slowed oil development in western Canada – or so says the tried-and-true multiple working hypothesis method.

With the changing of the political winds, governments gradually began privatizing the company. Begun in 1991 under Brian Mulroney (who had ordered the company to act like a profit-driven company when he was first elected), this process was completed in 2004 by the Liberal government of Paul Martin, which sold more than 49 million shares for about $3 billion, bringing the government’s total recovery from its investment to $5.7 billion.

Petro-Canada acquired valuable offshore interests during the Hopper era. These included Hibernia, which is Canada’s most prolific ever oilfield. The company was the operator behind the Terra Nova discovery, which is now Canada’s second-largest offshore oilfield. Also in the offshore, Petro-Canada was the operator of the White Rose oilfield.

But the company did not truly begin operating like a profit-driven private company until 1993, when Hopper was replaced by Jim Stanford. During Stanford’s stewardship, the company made efforts to grow in important ways. Its east coast assets went on production, and the company went international, acquiring and developing in the North Sea, Libya, Syria and Trinidad and Tobago. At the end, those offshore and international operations were its biggest sources of income. After decades of rationalization, its refining and marketing operations – the second-largest in Canada – became a stable and reliable source of cash flow.

For investors, though, the bottom line is the bottom line, and Petro-Canada shares never performed close to the level you might expect from a company with its assets, image and cash flow. An important factor was the Petro-Canada Public Participation Act – Mulroney-era legislation dictating that no single entity can hold more than 20 percent of the company. This made the likelihood of a takeover remote, greatly weighing on Petro-Canada’s stock price. Call it the last curse of public ownership.

The Legacy and the Merger
The storied tale of Petro-Canada is an object lesson in the failures of government interference in the economy. Journalist Peter Foster’s 1992 book, Self Serve: How Petro-Canada Pumped Canadians Dry, won that year’s National Business Book Award and was a factor in unseating Bill Hopper.

At the end of a chilling chronology of hubris and mismanagement during the company’s first 15 years of operations Foster writes, “It can fairly be claimed that Canada is at least $10 billion deeper in debt because of Petrocan, a debt for which there is no corresponding asset. The money has gone….But although the original investment has been largely destroyed, the debt lives with us. We are like bad gamblers in debt to loan sharks, our obligations growing geometrically. The annual interest cost of the Petrocan-associated debt is about $1 billion, and all the income tax from 100,000 average Canadian families will have to go to pay that annual charge.”

According to another, highly hypothetical version of this analysis, Canada would be debt-free if, instead of spending $10 billion on petroleum assets during the high-interest-rate 70s and 80s, the federal government had instead reduced its debt by that amount. More to the point, the creation of Petro-Canada generated few if any useful results. To the extent the company contributed to the policies of the hated National Energy Program, it caused unnecessary and inestimable damage to the country and its oil industry.

Petro-Canada danced into the arms of Suncor with a tremendously deflated cash flow stream and dramatically lower profits after 2008’s oil-pricing bubble. During the company’s last quarter as an independent operator, its net earnings decreased by 95 percent to $77 million, compared with $1.5 billion a year earlier. The company cited the deadly combination of lower commodity prices and volumes plus higher costs and expenses. The recession-related collapse of oil and gas prices was clearly the most important source of this financial disaster.

Disaster that may have been, but for Suncor, with its high-cost oilsands production, the impact was far worse. In the second quarter the company suffered a net loss of $51 million, compared to net earnings of $829 million a year earlier. The financially weaker of the two companies – Suncor – was the acquisitor because of the strength of its management. The company, which at time of writing is trading at about $35 per share, started life in 1993 at about a buck. That’s serious growth – especially compared to Petro-Canada’s original $13 issue price, which had grown to only $41 at the time of the merger. Petro-Canada’s shareholders were a long-suffering breed.

Petro-Canada’s Jim Stanford and Suncor CEO Rick George first discussed merging in 1999, but the negotiations went nowhere. In the crisis atmosphere of the latest recession, though, the players were more motivated to get results. The announcement came less than two months after Petro-Canada’s big shareholder, The Ontario Teachers’ Pension Plan, began agitating for better shareholder value.

At a stroke, the merger between the two companies created Canada’s largest oil company, and the fifth largest in North America. Post-merger, Suncor controls 26.5 billion barrels of oil; the largest suite of oil-sands holdings in the world; daily production of 680 million barrels of oil equivalent; and an international reach that embraces the North Sea, Libya, Syria, and Trinidad and Tobago. The joint Canadian operations of the merged company cover the energy sector, from the Arctic to the east coast offshore, shale gas, refineries and a vast chain of retail outlets. The gas stations and other marketing operations are the only visible remains of what was once Canada’s national energy company.

What is the effect on the new, combined company? The most immediate impact is greater operating efficiency. The designers of the merger – Rick George and Petro-Canada’s Ron Brenneman, Stanford’s successor – forecast that joining forces will save $300 million a year in operating costs and about $1 billion in annual capital spending by eliminating duplication of pipelines, power and water infrastructure for oil-sands operations. In addition, Petro-Canada’s light oil assets are far less vulnerable to another oil price collapse, and will thus stabilize the combined company’s cash flow stream. Also, Petro-Canada brought with it a suite of non-core overseas assets that the company can sell to finance its core oilsands developments, like the Firebag SAGD expansion that went on hold last year.

Professor of economics and academic director of the University of Calgary’s School of Policy Studies Robert Mansell says the deal makes sense in many ways. “In a world with great uncertainty, where we don’t know what is going to happen with climate change policy, it gives you an ability to mix and blend and do all kinds of things that you wouldn’t be able to do if you were just oil sands. Long term, if you can maintain a very efficient, integrated operation that is better than a very narrow, specialized operation. And when you are talking about billion-dollar projects, being a large company is a lot better than being a small company. I see that as being an excellent strength that they can build on.”

If the new company has an Achilles heel, perhaps it is a relic of the Petro-Canada years. As a result of the merger, Suncor is now subject to the Petro-Canada Public Participation Act, which weighed so heavily on Petro-Canada for so many years. That law, which restricts ownership in the company by any single entity to 20 percent, will protect Suncor from predation during the period of consolidation. Longer term, though, will the last curse of public ownership weigh on Suncor’s shares, as it once did on Petro-Canada’s?
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