Interest in junior oil sector picks up
The Canadian junior oil and gas sector has been starved for capital during the past five years as U.S. investors reallocated their dollars to the development of their own country’s unconventional resources. Consequently, Canadian juniors have, for the most part, had to rely on internal cash flow to generate growth, which has led many to focus on high netback targets such as light oil.
However, achieving annual historical growth rates of more than 10% can prove very challenging without spending well in excess of cash flow — especially considering just how expensive unconventional wells are to drill and complete. As a result, debt becomes the only course of action for many, but that can only be done for so long before management or the board has to pull out the white flag.
Fortunately, there are those who see opportunities, notably for Canadian junior oil producers. Yangchang Petroleum, China’s fourthlargest oil producer, announced last week that it is acquiring Novus Energy Inc. Then this week started with ORLEN Upstream, one of the largest petroleum and petrochemical companies in Central and Eastern Europe, announcing its intention to acquire TriOil Resources Ltd.
Two transactions don’t define a trend, but we nonetheless find it to be a recent positive development and there could be more of these types of deals because the best deal is sometimes the one that flies under the radar.
For one thing, these transactions are below the $344-million threshold for review under the Investment Canada Act. CNOOC Ltd’s acquisition of Nexen Inc. was a drawn-out process that was very political in nature. We doubt the Chinese wanted that much public attention.
More importantly, there isn’t as much risk to the acquirers in these types of transactions, given the size and what they obtain in return. Smaller acquisitions allow a larger company to acquire Canada’s worldclass drilling, completion and operating expertise and export it to their operations abroad for minimal cost.
For investors looking to profit from speculating on the next takeout target, we would exercise caution. The Novus offer represented a 40% premium for investors, but the offer for TriOil Resources was at a 7% discount to the prior day’s close.
We always recommend investing based on a company’s going-concern fundamentals. Buying underperforming junior oil producers because they are cheap and possibly have some takeout upside is a recipe to lose money.
In conclusion, this pickup i n foreign M&A activity is a potential win-win scenario for the acquirer and acquiree. It brings much-needed capital into the sector for those wanting to grow their businesses, while providing an exit for those looking to pull out their white flags. For the acquirer, it provides a lowcost and potential money-making entry point.