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?

Contractor Survival

The infrastructure business shifts as the economy reels

This article appears in the March 2009 issue of Oilsands Review; photo from here.

By Peter McKenzie-Brown

Infrastructure reflects the times in which it is created. In Alberta, a literally off-the-wall example can be found in the control panels at the Turner Valley Gas Plant – a mothballed facility now being prepared for restoration as a historic site. Made in Germany during the 1930s, its control panels sport swastikas welded into the steel – a reflection of the political turmoil of the day.

The network of firms that create and maintain roads and industrial facilities make up the infrastructure business. Combined, they represent a huge segment of the modern economy. In Alberta in recent years, this business has been increasingly dominated by efforts to develop oilsands infrastructure, but since the beginning of the global financial crisis that has changed.

Infrastructure firms with contracts to design, engineer and construct massive projects like Petro-Canada’s postponed Fort Hills project have led to layoffs in professions where, a year ago, the demand was almost desperate. However, these cases have not yet been large. Indeed, many companies sense a need to rebalance the sector. Once that’s done, they say, demand for new and revitalized infrastructure will remain strong. Indeed, there is even a sense among some firms that both the province and the oilsands industry itself can benefit from the breathing room the slowdown is providing. Perhaps the irrational exuberance of the last few years really needed a pause for serious contemplation.

Spider webs and feeding chains: The infrastructure business consists of a spider web of design, engineering, manufacturing and contracting firms working with owners to build and install roads, pipes, wires, vessels and related technology. And in recent decades, the business has changed in dramatic ways. For example, said Bernie McAffrey, “It used to be that electrical and instrumentation was maybe 10 percent of the cost of a compressor station, say. Today that part of the equation I would guess is over 23 percent. A typical project now needs more than twice as much automation technology as it did a couple of decades ago.”

McAffrey founded Ber-Mac Electrical and Instrumentation in 1981. As last year wound down, a largely unnoticed item in the news – the acquisition of Calgary-based Ber-Mac by Swiss multinational ABB – received regulatory approval to proceed. More than three times larger than ABB’s previous western Canadian operation (built up through a combination of organic growth and small acquisitions), the new entity is an especially big player in the oil patch. McAffrey is now a vice president of ABB Ber-Mac, which employs about 750 technical and field people in the three western provinces, including 715 in Alberta.

Even though the financial crisis became apparent while the acquisition was in the works, ABB did not pause in its efforts to acquire the Canadian firm. According to ABB Ber-Mac’s new vice president and general manager, Marcus Toffolo, “This acquisition was not for cost-cutting but for growth. Long term, we may take skills out of Alberta to the rest of the world but that’s not feasible just yet because of regional demand.” He added, “When we looked at this acquisition (we were impressed with Ber-Mac’s) basic business model of vendor neutrality, regional distribution, customer satisfaction. We don’t want to change that.”

In broad terms, the infrastructure business applies technical and scientific knowledge and uses resources to build systems that benefit the economy. It employs a feeding chain that begins with minnows – firms of just a few technical staff – but ranges up to large multinationals like Zurich-based ABB. That global giant has more than 100,000 employees and annual revenues in the tens of billions of dollars.

McAffrey, whose company has successfully risen from the bottom toward the top of the feeding chain, has seen huge changes in the entire business since he set up his firm. “The amount of installed technology in Alberta has grown by leaps and bounds. In the beginning there were only two oil sands plants. In terms of magnitude and sophistication (infrastructure in Alberta) has grown dramatically.” The good news for the business is that these huge amounts of installed infrastructure have to be maintained and continually upgraded. Nowhere is this truer than in the oilsands.

Colleaux Engineering vice president Al Striga sketches out the size of the challenges. “It’s very unusual to see so many huge facilities packed into such a small area as (the Fort MacMurray area). If you throw in the need for cold weather operation, you don’t see anything else like this anywhere in the world. You have to specify cold-weather compatible equipment, instrumentation and metallurgy. Enormous pieces of equipment have to move at temperatures ranging from -40 to +30, and everything has to be reliable. The challenges are huge.”

His company is one of the minnows at the bottom of the feeding chain, but has done some oilsands work. “Large firms get the project. We get involved as subcontractors to the big firms. We get awarded a module or component of a facility.” Like other firms, Colleaux Engineering has been hit by the postponement of oil sands projects. “Within 72 hours of the time Fort Hills went down, we got a call saying our part of the action was all over.”

Like everyone else interviewed for this article, the principals at Colleaux Engineering are optimistic about Alberta’s medium-term outlook. “We’re hearing everything from doom and gloom to an optimum environment,” said Striga’s sidekick and the company president, Steve Colleaux. “We aren’t too worried about the future. We’re in an interesting part of the market. We don’t need a lot of work to stay busy. A company with a thousand people needs 200 hours per person per month. That's a lot of hours.” His 20-year-old company only employs ten technical staff.

What’s hot, what’s not:Although many oilsands projects are disappearing into the black holes of indeterminate postponement, opportunities for the infrastructure business in Alberta still abound. The amount of effort needed for infrastructure maintenance is vast. Consequently, there will be a rebalancing of the infrastructure industry in the province, with the slack from project cancellations being shifted toward these other areas.

The construction of new oil sands projects is an area of disappearing opportunity, and the business is alive with reports of large-scale oil-sands related layoffs. Some projects are staying the course, however – notably Imperial Oil’s Kearl project.

According to a source who requested anonymity, “Kearl is going ahead like crazy…. Rather than scaling back their efforts, (the project team at Imperial) are doing the opposite. They are spending about $1.5 million dollars per day on more than 1,000 engineers to engineer the hell out of it right now while contract engineers are cheaper. (Because of parent ExxonMobil’s strong cash position), they have the option to be greedy when others are frightened and frightened when others are greedy. In a couple of years when the competition is just starting to re-examine their preliminary plans, they will be digging holes and welding steel based on contracts formed in a down market.”

Despite the cancellation or downsizing of some projects (notably two Enbridge proposals to take bitumen to US markets via Ontario and Quebec), transmission is still a solid area of growth. So is the creation of new infrastructure in areas where oilsands operations are strong.

Asked how the shifting sands of the bitumen business have affected his business, Mark Wrightson – president of Whaler Industrial Contracting – was direct and to the point. “We submitted a proposal (for a SAGD project) to Connacher Oil and Gas in the fall. Just prior to the contract being awarded, the project was shelved. When Petro-Canada postponed Fort Hills, half a dozen projects fell off our project board.” However, he said, “our primary focus is on transmission – pump stations primarily. Eighty percent of the work we are doing is in transmission infrastructure, and Enbridge, TCPL, Husky and others have projects to take away bitumen. There is such an infrastructure deficit in take-away capacity that we expect these projects to remain strong.” The downside, such as it is, is that “there will be a lot more competition for that kind of work.”

Similarly, built-up infrastructure needs to be maintained, and basic oilsands maintenance presents tremendous opportunities. According to Pinal Gandhi, a project manager with Whaler, “It’s not going to stop. Syncrude and Suncor have old plants. They have a tremendous need for maintenance. They will cut down on the expansion side, but they will continue to put a lot of money into maintenance.” His enthusiasm is infectious. “Until recently (Suncor’s) upgrader was operating at 150 percent of capacity. Pumps were worn out” and so was a lot of other equipment. The company “wanted production. They didn’t care about the cost. The downturn is an opportunity to slow down on production but put money into maintenance.”

He adds that “Fort MacMurray itself has a huge need for infrastructure. They need (highway) flyovers, all kinds of supporting facilities. Anyone who works outside of the city has to spend a minimum of three hours per day to commute to work.” Again, he believes that the slowdown in oilsands development provides the opportunity for the infrastructure business to work with the city and the province to upgrade roads and develop other infrastructure. Wrightson concurs: “It’s embarrassing how little has been invested in infrastructure at Fort MacMurray.”

A construction manager with the Trotter and Morton group of companies, Mike Dickson has the ironic motto that during construction “contractors are merely an inconvenience to someone else making money.” In today’s environment, he says, “long-term projects that are three to four years out are being cancelled. (That is why our company) sees opportunity and is more interested in the smaller projects involving the necessary infrastructure maintenance and not mega-expansion.”

In general, newer infrastructure employs fewer people than the systems it replaces. According to Colleaux Engineering’s Al Striga, it develops in a virtuous cycle. “The more automation you implement, the lower the cost becomes, and the more automation you want.”

An oilsands automation engineer with one of North America’s largest engineering firms (he requested anonymity) discussed the potential of recent breakthroughs. “Digital automation has been around forever and a day, but the fact remains that if you go to any plant anywhere in the world, you will find that 80 percent of the loops are on manual. So we are not doing our job correctly. Ideally, you should have a plant that operates on automatic 100 percent of the time. We’re missing the boat somewhere, and I just can’t put my finger on why. If we can put more loops on automatic, we can approach that Holy Grail.”

As beguiling as such a development sounds, it’s going to be a long time coming. As Steve Colleaux acknowledges, automation (one of his firm’s specialties) controls processes better than people. “In a perfect world, automation can do everything. However, in the real world things aren’t like that. The system may come up with an alarm that says ‘We have a malfunctioning pressure transmitter. We can’t see what’s happening in this vessel.’ You need operators around to deal with those real-life problems.”

There are other problems in the wind. According to Trotter and Morton’s Mike Dickson construction used to be founded on the “three-legged stool of owner, engineer and contractor.” That changed, he says, with the advent of engineering, construction and procurement (EPC) teams serving as project managers. “Contractors are now the labour, which really means the risk.”

He believes relationships between owners and contractors may become strained in the emerging marketplace. “The sustainable win/win contract philosophy we have been experiencing (which was based upon the owner’s need to woo contractors and the contractors’ need to see repeat or possibly evergreen contracts) has given way to the more win/lose style of heads-up construction.” This, he says, may result in a more litigious environment.

What will mark the infrastructure development of the next few years? Nothing like the swastika in the gas plant – that much is for sure. Perhaps the mark of infrastructure during the next few years will be welded instead on the bottom line. “In the boom,” said Whaler Industrial’s Mark Wrightson, “just-in-time construction didn’t work at all – in fact, it rarely works well at the best of times. You couldn’t get deliverables on time. Everything was delayed. But today you can get turbines and gensets (electrical generators combined with engines). They are now being manufactured for a smaller market. A lot has changed.”

For the infrastructure business, perhaps the real mark of this changed era will be slower-paced, lower-cost, more orderly development. Surely that isn’t all bad.