Company News: PanCanadian, AEC to form EnCana in 'merger of equals'

Feb. 4, 2002
Canadian independent oil and gas companies PanCanadian Energy Corp. and Alberta Energy Co. Ltd. (AEC) announced plans for a "merger of equals" that would form a company worth $27 billion (Can.).

Canadian independent oil and gas companies PanCanadian Energy Corp. and Alberta Energy Co. Ltd. (AEC) announced plans for a "merger of equals" that would form a company worth $27 billion (Can.). The new energy firm, to be called EnCana Corp., will be based in Calgary.

In addition, the UK's Centrica PLC last week said it will acquire the energy services operations of Calgary-based Enbridge Inc. for $1 billion (Can.) cash.

In other company news, Oklahoma City-based Devon Energy Corp. has set February as the sale date for its oil assets in southern Sumatra. Indonesian state-owned oil company Pertamina, in partnership with the local provincial government in Jambi, has emerged as the most likely purchaser.

PanCanadian-AEC merger

Under the merger agreement, AEC shareholders will receive 1.472 shares of PanCanadian common stock for each AEC share. On completion of the transaction, PanCanadian shareholders will own 54% of EnCana and AEC stockholders will hold 46%.

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The boards of both companies have endorsed the deal, which is subject to stockholder approval and clearance from the Court of Queen's Bench of Alberta and other regulatory authorities. The transaction is expected to close in early April.

The merger of PanCanadian and AEC is unique in many ways, PanCanadian Chairman and CEO David O'Brien said in a Jan. 28 conference call. First, "Neither company is being sold here," he said. Second, the deal is "a merger of equals in a business sense, bringing together the best of each of the companies. In other cases, companies created mergers of equals because they wanted to get pooling accountingellipse[which] is no longer available. This [merger] is not for accounting purposes, but for business purposesellipse," O'Brien said.

Deal details

Based on the merger agreement, O'Brien will serve as EnCana's nonexecutive chairman and Gwyn Morgan, AEC president and CEO, will fill the same posts at the combined company. EnCana's board will consist of an equal number of directors from each company.

AEC and PanCanadian said the merged company would be the world's largest independent oil and gas company in terms of enterprise value, reserves, and production.

Within Canada, the new firm would be the third largest publicly traded industrial company, with one of the largest capital investment programs of any Canadian-headquartered company, according to the companies.

"EnCana will have one of the most attractive internal growth profiles in the industry, given the excellent strategic asset fit and the magnitude and complementary nature of our growth prospects," O'Brien said. "AEC brings unparalleled near-term and medium-term internal growth from North America and Ecua- dor, while PanCanadian brings near-term growth in Western Canada and prospects for very strong long-term growth from eastern Canada and the North Sea."

Morgan added, "Our strong balance sheet will enable us to both optimize our capital investment program through the drillbit and to pursue selective acquisitions. We will have the size and technical capabilities to manage the challenges associated with developing high-impact North American and offshore projects. I am extremely confident that we can manage our combined assets and resources to create more profitable growth and higher shareholder returns than either company could achieve on a stand-alone basis."

The companies said that within a year the merger will result in a pretax cost savings of $250 million/year from efficiencies in overlapping operations, streamlining business practices, improving procurement practices, building a common information technology base, and incorporating best practices.

The companies also expect to achieve capital program synergies of an additional $250 million/year.

The combined company will have six core growth areas: the Western Canadian Sedimentary Basin (natural gas and oil), offshore East Coast Canada (natural gas), the US Rocky Mountain region (natural gas), the US Gulf of Mexico (oil), the UK Central North Sea (oil), and the Oriente basin of Ecuador (oil).

EnCana also will have exploration activities in the Canadian North, Alaska, Australia, Azerbaijan, the Middle East, and Brazil.

The combined company will have reserves of 7.8 tcf of gas and 1.3 billion bbl of oil and liquids, equaling 2.6 billion boe. Production targets for 2002 are 2.7 bcfd and 255,000 b/d of oil and liquids, or 700,000 boe/d. The 2005 goal is 1.1 million boe/d, a 55% increase from the 2002 production forecast.

EnCana's 2002 capital investment program will be $3.8 billion.

In North America, the merged company will be the largest independent gas producer and the largest independent gas storage operator.

It will have an exploration land base of 23 million acres, including large positions in the Western Canada Sedimentary Basin and East Coast Scotian Shelf. The combined company holds interests in more than 200 blocks in the deepwater Gulf of Mexico and has significant oil sands and coalbed methane interests. It plans to drill more than 2,800 exploration and development wells in 2002.

EnCana will have more than $2 billion in combined North American midstream and marketing assets, consisting of energy services, gas storage, natural gas liquids extraction, pipelines, and power generation.

Heavy oil, CBM assets

Following statements from the companies, analysts on last week's conference call sought to gauge the potential strength behind newly formed EnCana's heavy oil and coalbed methane assets.

Regarding the heavy oil business opportunities for the merged firms, O'Brien noted, "We'll have two of the highest quality resource bases in the business at Christina Lake and at Foster Creek." And with the strongest technical teams, O'Brien said that the first step would be to put these teams together to assess which of the two assets to concentrate on in the near term. "Obviously, we'll want to build the best assets the fastest," he said.

"You can count on this company as being a real oil sands powerhouse as it moves into the future, with a lot of growth over the next number of years, we can see [combined production] getting over 100,000 b/d," O'Brien noted.

A similar assessment process will be conducted by the two firms' CBM asset teams, Morgan added. "I suspect that what will happen there is that both of those projects will carry onellipsebut we will be examining the best near-term place to place the most capital."

Following the companies' merger announcement Jan. 27, Moody's Investors Service placed AEC's senior unsecured ratings (currently Baa1) under review for possible upgrade. Moody's placed under review for possible downgrade PanCanadian's A3 senior unsecured ratings and confirmed the company's P-2 commercial paper rating.

Moody's said the PanCanadian-AEC deal "could have several positive credit implications," citing the combined firms' 2 billion boe (net) proved reserve base, its long reserve life, and a diversified asset base. "Furthermore," Moody's said, "the [newly formed] company will rank among the industry leaders in terms of operating costs and undeveloped acreage in key North American regions."

Centrica transaction

When Centrica's transaction is completed and after the Ontario electricity market opens in May, Centrica will have over 3.5 million product relationships with North American households, doubling its Canadian customer base. Centrica said the acquisition has the potential to market energy and related products and services across a base of over 2 million households.

Centrica presently has more than 1.3 million gas customers in Canada and the US. In addition, it has signed up 600,000 electricity customers in Ontario in advance of the market opening next May.

Enbridge will record a net gain on the sale of energy services of $210 million, after taxes and other costs, upon completion of the transaction. The company said net proceeds from the sale will be used for strategic growth and debt reduction.

Enbridge CEO Patrick D. Daniel said the sale also "increases our flexibility to capitalize on infrastructure growth opportunities. Our plans are to invest roughly $5 billion in capital over the next 5 years." The bulk of the retail energy services business was unbundled from Enbridge Consumers Gas, Canada's largest natural gas distribution utility, in 1999.

Centrica, which has 70% of the UK gas market, was spun off from British Gas PLC in 1997 and plans to have 10 million customers in North America by the end of next year, CEO Roy Gardner has said. The company expects to spend $1.4 billion on acquisitions to quadruple its client base in North America by next year.

In addition to the home services business, Centrica will acquire 90,000 natural gas contract customers, a national business-to-business heating, ventilation, and air conditioning (HVAC) operation with more than 50 national accounts, a start-up residential HVAC business in Pennsylvania, and a consumer loan business that supports its retail and HVAC business. It will also acquire 14 retail outlets in southern Ontario.

The transaction is subject to regulatory approvals, and completion is anticipated in the spring.

Devon divestiture

Devon Energy purchased the Indonesian assets when it acquired Houston-based Santa Fe Snyder Corp. in 2000. The company has confirmed the sale, but has issued no details.

Devon Energy produces about 46,000 boe/d in Indonesia. Credit Suisse First Boston is the adviser for the sale.

Devon Energy is the operator of five production-sharing contracts in the country, two of which are in Jambi Province. One contract is for an area in East Java, and the other two are in the eastern province of Irian Jaya.

The company's Jabung field in Jambi is one of three production areas from which PT Peruhsahaan Gas Negara, Indonesia's state gas distributor, plans to ship gas to Singapore when it finishes a pipeline in 2003.

Gulf Indonesia Resources Ltd., 72% owned by Conoco Inc., operates the other two production areas-which will ship gas to Singapore-and may make a bid for the Jabung contract, said Glen Valk, the company's manager of investor relations in Jakarta.

He said, "At the right price, Jabung is an interesting asset. We're interested in all assets in Indonesia, so we look at everything."

Devon Energy is also selling its stake in Gulf Indonesia's South Jambi block, which is part of the Singapore gas deal.

Indonesia wants to encourage investment in oil exploration to boost reserves, which BP PLC's Annual Review of World Energy has set at 5 billion bbl since the end of 1996. Oil and gas accounted for 23% of the country's total export earnings in 2000.