Photo: SeaRose FPSO; Source: Husky Energy

Husky and Cenovus merger to create third-largest Canadian oil and gas player

Canadian oil and gas player Cenovus Energy has made a move to combine with its compatriot Husky Energy. The combination will create the third-largest Canadian oil and gas player.

In a statement on Sunday, 25 October 2020, Cenovus and Husky announced a transaction to create a new integrated Canadian oil and natural gas company with an upstream and downstream portfolio that is expected to provide enhanced free funds flow generation and superior return opportunities for investors.

The two companies have entered into a definitive arrangement agreement under which they will combine in an all-stock transaction valued at C$23.6 billion, inclusive of debt.

The combined company will operate as Cenovus Energy Inc. and remain headquartered in Calgary, Alberta. The transaction has been unanimously approved by the boards of directors of Cenovus and Husky and is expected to close in the first quarter of 2021.

According to Cenovus, the combination has low exposure to Alberta oil pricing while maintaining healthy exposure to global commodity prices. It will unlock market opportunities by uniting high-quality and low-cost oil sands and heavy oil assets with extensive midstream and downstream infrastructure, creating a global competitor able to optimize margin capture across the heavy oil value chain.

Alex Pourbaix, Cenovus President and Chief Executive Officer, said: “The diverse portfolio will enable us to deliver stable cash flow through price cycles while focusing capital on the highest-return assets and opportunities.

“The combined company will also have an efficient cost structure and ample liquidity. All of this supports strong credit metrics, accelerated deleveraging and an enhanced ability for return of capital to shareholders”.

Third-largest Canadian O&G player

The combined company will be the third-largest Canadian oil and natural gas producer, based on total company production, with about 750,000 barrels of oil equivalent per day (BOE/d) of low-cost oil and natural gas production, including 50,000 BOE/d of high free funds flow generating offshore Asia Pacific production.

It will be the second-largest Canadian-based refiner and upgrader, with total North American upgrading and refining capacity of approximately 660,000 barrels per day (bbls/d), which includes approximately 350,000 bbls/d of heavy oil conversion capacity.

The company will have access to about 265,000 bbls/d of current takeaway capacity out of Alberta on existing major pipelines, as well as about 305,000 bbls/d of committed capacity on planned pipelines. In addition, it will have 16 million barrels of crude oil storage capacity as well as strategic crude-by-rail assets that provide takeaway optionality.

Rob Peabody, Husky President and Chief Executive Officer, said: “The integration of Cenovus’s best-in-class in situ oil sands assets with Husky’s extensive North American upgrading, refining and transportation network and high netback offshore natural gas production, will create a low-cost competitor and support long-term value creation”.

The transaction will result in processing capacity and egress out of Alberta for the majority of the combined company’s oil sands and heavy oil production. The company will have opportunities for margin enhancement through strategically located upstream assets integrated with the upgrading complex at Lloydminster, Saskatchewan, large U.S. refining assets in PADD 2 and PADD 3, and storage and blending operations at Hardisty, Alberta.

The integration of Cenovus’ upstream assets with Husky’s downstream and midstream portfolio will also shorten the future value chain and reduce condensate costs associated with heavy oil transportation.

Cash flow stability is further underpinned by the global exposure of Husky’s offshore Asia Pacific natural gas production interests, which currently generate approximately $1 billion in annual free funds flow through sales largely under long-term contracts.

Savings: reduction of workforce & overheads

The combined company is expected to generate an incremental $1.2 billion of annual free funds flow, comprised of $600 million in annual corporate and operating synergies and $600 million in annual capital allocation synergies, achievable independent of commodity prices.

The vast majority of the annual savings are anticipated to be achieved in the first year of combined operations, with the full amount of the annual run-rate synergies realized within year two.

The companies anticipate additional future savings based on opportunities for the further physical integration of the upstream and downstream heavy oil assets.

The anticipated $600 million in annual corporate and operating cost synergies will be achieved through reductions to the combined workforce and corporate overhead costs including streamlined IT systems and procurement savings through economies of scale.

The company is expected to sustain production levels and downstream operations with an anticipated annual capital investment of $2.4 billion, a reduction of more than $600 million per year compared with what would be required by the two companies on a standalone basis.

The combined company is expected to be free funds flow breakeven in 2021 at WTI prices of US$36/bbl, with a line of sight to reducing its free funds flow breakeven to less than WTI US$33/bbl by 2023. This is lower than either company on a standalone basis.

Management & board

Alex Pourbaix will serve as Chief Executive Officer of the combined company, Jeff Hart will serve as Chief Financial Officer, Jon McKenzie will serve as the Chief Operating Officer and Keith MacPhail will serve as independent Board Chair.

Additional senior executives for the combined company will be selected from both companies and named by the close of the transaction.

The management team will be complemented by a board of directors consisting of eight directors identified by Cenovus and four directors identified by Husky.

The transaction

Under the terms of the definitive agreement, Husky shareholders will receive 0.7845 of a Cenovus share plus 0.0651 of a Cenovus share purchase warrant in exchange for each Husky common share.

This represents a 21 per cent premium, excluding warrants, relative to Husky’s five-day volume-weighted average price per share as at 23 October 2020. Including the warrants, the premium is 23 per cent.

While the transaction was originally conceived as an at-market merger, resulting in a negotiated proportionate ownership level, the respective share values have diverged during the due diligence period over the past months. This resulted in a premium for Husky shareholders based on the current share prices.

Each whole warrant will entitle the holder to acquire one Cenovus common share for a period of five years following the completion of the transaction at an exercise price of $6.54 per share.

Assuming the full exercise of such warrants, the combined company would receive approximately $428 million in cash proceeds.

The aggregate consideration package for Husky shareholders implies a transaction equity value for Husky of approximately $3.8 billion, and a transaction enterprise value for Husky of approximately $10.2 billion.

Immediately following the close of the transaction, and prior to the exercise of any warrants issued to Husky shareholders as part of this transaction, Cenovus shareholders will own approximately 61 per cent of the combined company, and Husky shareholders will own approximately 39 per cent.

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