MEG is one of the biggest beneficiaries of the Trans Mountain pipeline expansion, with China emerging as the largest buyer of oil.JASON FRANSON/The Canadian Press
To understand why MEG Energy Corp. MEG-T confidently turned down a hostile takeover bid from oil sands rival Strathcona Resources Ltd. SCR-T on Monday, track the tanker traffic in Burnaby, B.C.
Almost every day, a ship loaded with crude from the Trans Mountain pipeline leaves the port. The most important destination is China, which has emerged as the largest buyer of Trans Mountain oil since the federal government-backed expansion of the project as completed last year.
Chinese refiners bought 46.5 million barrels of oil from the Burnaby facility in 94 tanker shipments over the past 17 months, according to a recent study by RBC Capital Markets. The investment bank’s analysts, who include baseball fans, called China “the big catcher’s mitt” for Canadian oil exporters.
Oil sands exports to China and other Asian markets, including South Korea and Japan, have quietly solved the long-standing pricing issues that resulted from Alberta producers being entirely dependent on U.S. customers.
The RBC team said increased traffic at the B.C. terminal has permanently narrowed the discount between the price paid for Alberta oil sands crude and North American prices.
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Calgary-based MEG is one of the biggest beneficiaries of the Trans Mountain expansion, with 20,000 barrels per day of contracted capacity on the pipeline. The project was rightly criticized for cost overruns that drove its price tag to $34-billion. However, access to Trans Mountain now qualifies as a competitive advantage for an oil producer targeted in a multibillion-dollar takeover battle.
On Monday, MEG’s board published a detailed rebuttal of Strathcona’s cash-and-stock bid that started with the company’s strong growth prospects.
By boosting oil sands production and getting premium prices on Trans Mountain shipments, MEG projected its free cash flow over the next five years will roughly equal its $6.75-billion market capitalization. The board pledged to return all that cash to investors through share buybacks and dividends.
MEG then revealed Strathcona has been stalking the company for four years, and consistently been spurned for making lowball offers. Part of MEG’s takeover defence is that Strathcona covets access to Trans Mountain, but isn’t willing to pay for it. In a regulatory filing, MEG pointed out: “Strathcona has not secured any long-term pipeline commitments to access premium markets and instead owns rail capacity.”
In urging shareholders to reject Strathcona’s offer, MEG pointed out its oil sands properties are all located near rivals’ established operations. The MEG board said: “Strathcona’s assets are scattered, lacking in scale, and located in less prolific areas.”
In Monday’s filing, MEG’s board said financial adviser BMO Capital Markets has reached out to potential bidders. Geography, along with pipeline access, is likely to play a critical role in how the takeover battle plays out.
“MEG’s high-quality assets and technical expertise would fit well and complement the portfolios of many peer companies,” said MEG’s board. “Other operators would be well positioned to realize significant, and potentially materially larger, synergies through a combination with MEG.”
The largest oil sands producers – including Canadian Natural Resources Ltd., Cenovus Energy Inc. and Imperial Oil Ltd. – all own properties located closer to MEG’s projects than Strathcona’s operations.
These energy companies could extract significant costs savings from combining MEG’s projects with their own. And all three stand to benefit from boosting Asian exports.
To beat out these potential rivals, Strathcona will likely have to improve an offer timed to win MEG before it can take advantage of further improvements in Western Canada’s energy infrastructure.
Strathcona cannily made its bid for MEG ahead of potential increases in both the amount of oil moving through the Trans Mountain pipeline and increased tanker traffic.
If Trans Mountain’s engineers receive regulatory blessing for relatively simple, safe improvements such as further diluting oil sands bitumen, they can increase the pipeline’s capacity by 25 per cent or more, said analyst Robert Hope at Bank of Nova Scotia in a recent report.
In May, 25 tankers cast off from Burnaby’s Westridge terminal, on par with recent months. The RBC analysts estimated the facility is only operating at 80 per cent of its capacity.
Trans Mountain cost taxpayers a breathtaking amount. The project is now paying off. The pipeline achieved a key policy objective, narrowing the gap between what Alberta producers receive for oil and world prices. That is boosting provincial royalties.
Trans Mountain’s expansion, and the prospect for further growth in exports to Asia, have also kicked off the latest round of consolidation in the oil sands. The suitor that wins MEG will be counting on sending a steady stream of tankers into China’s big catchers mitt.