It's Not Me It's You

Conoco And Cenovus Just Want Different Things

One is betting on a big oil-price rebound, the other is more realistic.
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There's a time for reaping and a time for sowing -- except in Canada's oil sands industry. There, the reaping and the sowing happens simultaneously and at a ferocious rate.

The $13.3 billion sale of most of ConocoPhillips' Canadian assets to Cenovus Energy Inc., announced late on Wednesday, is a perfect example of two companies operating in the same business expressing utterly opposing views on the future of that business.

Cenovus is the sower in this instance. As of Wednesday's close, its enterprise value was $12.8 billion and it sported net debt of less than 1.4 times forecast cash flow from operations for 2017, according to Bloomberg data. So this deal effectively doubles its size and, on Citigroup's forecasts, takes net debt to 3.2 times 2017 cash flow.

On top of this financial leverage, oil sands -- the bulk of what Cenovus is buying -- offer higher leverage to oil prices than conventional fields, due to their relatively high proportion of fixed costs. In other words, Cenovus is going all-in on a sustained oil-price recovery with this deal.

Meanwhile, Conoco, not one to shrink away from the idea of shrinking if it makes sense, is reaping with abandon. The company is selling off roughly a fifth of its production and proved reserves, and the proceeds will be used to slash the debt pile that's been hanging over its stock through the oil crash, as well as buy back more of that stock.

Conoco projects net debt to plunge from almost 5 times cash flow at the start of the year to less than 2 times by the end of it. While Conoco will retain some exposure to the sands it is selling, by getting a roughly 20 percent stake in Cenovus and some potential contingency payments as part of the deal, its leverage to oil prices will diminish overall.

Investors gave their verdict on the transaction on Thursday morning with characteristic subtlety:

A Slight Difference of Opinion

Conoco and Cenovus got very different receptions to their deal the next morning

Source: Bloomberg

I'm inclined to agree with the market on this one. The combination of debt, issuing a slew of new shares, and relying on almost $3 billion of future disposals to pull this off shows how much Cenovus is stretching. It will need oil to get back above $60 a barrel and stay there in order to cut its leverage back, especially as Conoco negotiated those contingency payments to keep some of the potential gains for itself.

Cenovus must also lobby hard to make sure pipeline expansions such as Keystone XL get built. For now, there is about 4 million barrels a day of takeaway capacity for Western Canada, according to Bloomberg Intelligence. That is due to rise to almost 6 million by 2020, but projected production growth could lead to bottlenecks developing in the next couple of years, risking wider discounts for Canadian barrels trying to get to market:

Sand In The Gears

Crude from Canada's oil sands trades at a persistent discount to WTI, which can occasionally blow out

Source: Bloomberg

Note: Western Canada Select less West Texas Intermediate crude oil spot prices.

Conoco's worldview runs exactly counter to the sustained price increase Cenovus needs. Speaking at an industry conference earlier this month, CEO Ryan Lance said he doesn't see the declines in legacy oil production that some, such as Saudi Arabia, suggest could result in future price spikes. 

The other bearish trend Lance noted was the ongoing application of technology and efficiency efforts to U.S. shale basins, pushing production costs down there and threatening to shorten any upswing in oil prices. Indeed, asked specifically about doing the same thing with Conoco's oil sands assets, Lance had this to say:

The challenge I put out to our Canadian team is: How do you do that in just a 2- to 3-year cycle time? Because I think the other issue in this business is that you can't get your capital so inflexible in any given year that you wake up in the middle of a downturn without much capital flexibility.

That statement nails what went wrong with the oil majors' business model during the last boom in oil prices. It speaks to why all of them, from Exxon Mobil Corp. down, are shifting capital away from mega-projects such as oil sands toward shorter-cycle opportunities such as shale.

Equally, the majors' need to plan ahead for potential climate-change policies -- beyond the current U.S. administration --  and work in many countries outside of North America provides further impetus to scaling back exposure to relatively carbon-intensive oil sands. Conoco's big step back comes hot on the heels of similar moves by Royal Dutch Shell Plc and Marathon Oil Corp.

Cenovus may rightly feel investors holding its stock are long-term fans of the sands anyway, and so will be fine with just owning more of them. Conoco, however, looks more in tune with the times.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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    Liam Denning in New York at

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