The lack of approval by the Canadian federal government of the Progress Energy Resources (OTC:PREX) takeover by Malay national oil company PETRONAS is bound to roil the intermediate energy stocks today.
Bargain hunting and short seller covering will probably limit some of the damage, but I would advise caution here. Although some pundits expect this is merely a delay in approval, the populist Stephen Harper administration is most concerned with voter optics down the road, even though an election is still a few years away.
The Canadian intermediate gas-weighted producer stocks have been bid up lately, especially by last Wednesday's takeover bid by Exxon Mobil Canada, the local subsidiary of Exxon Mobil (NYSE:XOM), for Celtic Exploration (OTC:CEXJF), which operates in the prolific Duvernay and Montney shale gas formations in British Columbia and Alberta.
There will certainly be a downdraft in the stocks of Progress Energy and Nexen (NXY), whose deal to be bought by Chinese-controlled CNOOC (NYSE:CEO) is subject to its own Canadian federal approval application, slated to be decided by November 11. The Nexen-CNOOC deal is also seeking approval in the U.S. and the U.K.
These companies will become buys again depending on the downdraft (my rule is the third day of selling is usually the nadir) as non-SOE (State Owned Enterprises) are deemed to be potential buyers that could step in and take advantage of the situation.
I've looked over Progress, Celtic and other intermediates in the Montney. We owned NuVista Energy (OTC:NUVSF) but sold that as low natural gas prices have hammered cash flow and required a restructuring.
We own Talisman Energy (NYSE:TLM) in the space for specific reasons. But I wouldn't be running out to buy these other names, at least not right away.
Let's look at the big picture.
It's not about one deal or the other. It's about our laughably weak corporate takeover laws in Canada and its provinces.
It's about the certain loss of a number of Canadian energy companies if the Harper government lets the Petronas deal go through. The lineup includes Talisman, Encana (NYSE:ECA) and other major "tight" natural gas acreage holders in the foothills of the Canadian Rockies.
Only leading Canadian bellwether Suncor Energy (NYSE:SU) is officially protected by law, as they inherited takeover protection by the PetroCanada Public Participation Act of 1991, which precluded a foreign takeover.
The Harper government is facing a problem similar to that of the income trust explosion back in 2006. Companies could convert to trusts and become flow-through vehicles similar to limited partnerships, which was wildly popular with income investors (and investment bankers).
I was there in the very early days of the income trust conversion revolution, attending presentations by small energy players such as NCE Petrofund and Enerplus (NYSE:ERF) were in their infancy in the mid-1990s. When the reigning Liberals let one past the gate, three more stepped up, and ten years later major companies such as BCE were being contemplated for trust conversions.
The populist Harper Conservative government saw the enormous income tax leakage coming, and Minister of Finance Jim Flaherty put the kibosh on the whole sector in the infamous Halloween of 2006 SIFT ruling.
Naysayers say, hey, if PETRONAS can buy Progress, why shouldn't Suncor conceivably buy PETRONAS? The Malaysian government currently owns 100% and won't allow a 51% ownership stake in any domestic company. Or shouldn't a Nexen or other Canadian major hypothetically be able to turn the tables and buy into CNOOC?
The answers, of course, are NO. Never. There will never be any reciprocity.
National Oil Companies were originally set up by governments to defend the energy interests of small countries being invaded by the "Seven Sisters" - the multinational companies, primarily American.
What about Human Rights? Should we deny the takeovers because of lousy human rights records or lack of personal freedoms?
It wasn't long ago that then Prime Minister of Malaysia, Mahathir Mohamad, decided he didn't like what his Deputy Minister, Anwar Ibrahim, was saying about his dictatorial government.
So he put him in jail without due process, charging him with corruption. He was incarcerated for five years and when he got out, he was reimprisoned this time for sodomy. (Happy Ending - Ibrahim got out finally and is back as a Member of Parliament and leader of the opposition).
What does this have to do with letting PETRONAS pumping tight gas out of Northeastern British Columbia and compressing it into LNG for the world to buy?
Asian SOE's have so far been allowed to enter into Joint Ventures (JV's) the Canadian energy patch, but not buy them outright, unless they were so small and dysfunctional (Opti Canada, Daylight Energy), they obviously weren't worth protecting.
But it appears the traditional foreign owners of much of our natural resource have carte blanche to buy back in if they choose. Shell Canada, which being a long-standing good corporate citizen, was allowed to buy Duvernay Energy in the exact same area that Celtic is operating in, for $5.9 billion in 2008. There was little opposition to this deal by same Harper government.
So Petronas struck a JV deal with Progress to exploit just some of its assets in B.C., for $1 billion in capital infusion.
A key word here is "infusion." The JV's actually provide capital directly to drill wells, build pipelines and other projects and create jobs.
The takeover of the equity of a company sends the money to the shareholders, who may or may not reinvest. So the "net benefit" is largely the jingle in the pockets of investors. The Feds might collect some tax revenue on the capital gains.
The problem with the JV's is, they poison the ability for another suitor to come in and make a better offer.
Exxon would surely take a look at Progress Energy, except that PETRONAS has already locked up some of its assets in the JV, and has a right of first refusal on a number of its other assets or capital raisings.
The Canada Pension Plan Investment Board is in the awkward position of having its own government deny its pensioners (i.e. all Canadian workers) a premium for its participation in recent Progress share issues.
I'm surprised the Premiere of British Columbia Christy Clark hasn't chimed in on this deal and speculated as to whether there would be royalty tax leakage if PETRONAS were to own all of Progress's substantial assets and production potential, without shareholder accountability.
Since PETRONAS will capture the Progress assets and sell the production 100% for export under the planned LNG project (if it is built within 5 years), you could argue they might manipulate the transfer price of the resource. However, I think provisions could be made to monitor and prohibit this.
I think a lot of people forget that the major multinationals used to own much of the Canadian energy resource.
Talisman was once the Canadian subsidiary of BP plc (NYSE:BP), for example. Talisman has a JV with South African energy company Sasol Limited (NYSE:SSL) in the Montney, and with another Chinese SOE, Sinopec, in the North Sea.
I expect Talisman to be split apart and sold to various parties. But the Canadian assets won't go to an Asian SOE.
Not because a commercial reason should disallow the Asian SOE's from buying our energy companies.
The simple fact is, with natural gas trading at such low prices, these companies are being sold at far below what they are legitimately worth.
You have to figure the value gap between natural gas and international oil (which runs almost 10 to 1), will be closed eventually.
Our takeover protection laws are weak (other than industries protected by statute, such as the telecom and airlines), and our corporate governance is weak. I might add, our major pension funds are hesitant to fill the takeover protection gap.
This combined weakness is the reason the Harper government has to step in and disallow deals such as PETRONAS-Progress.
My best guess is, the Harper government is stalling on approvals because of what they have always known: takeovers make for bad optics with voters. And there are more voters than shareholders and investment bankers.
Another sub-text is that the Canadian feds are sensitive to the U.S. administration's criticism of Canada on national security issues and the supposed leakage of terrorists into Canada, leakage of intelligence information, etc.
Since the US would not entertain these kinds of acquisitions, you wouldn't expect the Harper government to allow them without some consultation with the White House.
Don't expect an Asian takeover deal to go through and expect a previously-signed JV will impede a follow-up bid from the traditional "sanitized" U.S. and non-SOE buyer's.