The Petro-Canada brand for fuels, petrochemical products and service stations, and the loyalty program were acquired by Suncor Energy (SU).

Petro-Canada

Petro-Canada is an oil and gas company that does most of its business in North America. Petro-Canada sets itself apart from its competitors through vertical integration, controlling every step of the production of its oil from exploration to the gas pump. The firm explores for and harvests oil and natural gas in North America, offshore eastern Canada, the North Sea, and other areas around the world. It owns two refineries and a network of 1,500 retail and wholesale gas stations across Canada. On August 1, 2009, Petro-Canada merged with Suncor Energy (SU).

As oil prices increased throughout 2007, Petro-Canada invested heavily in the costly process of oil sands extraction in hopes of further increasing revenues. Extracting oil from oil sands is an extremely costly process, much more so than traditional onshore or offshore production, and so Petro is betting on continually high oil prices to ensure a return on the capital they will invest in oil sands production. If oil prices decline dramatically, however, oil sands operations will create a major drain on Petro-Canada's balance sheet.

Oil sands are just one piece of Petro's large research and development budget. It has also invested heavily in the conversion of its Edmonton refinery to handle feedstocks made entirely of outputs from oil sands,[1] and it continues to expand exploration efforts in international markets. These growth strategies will serve Petro well if oil prices continue or hold their rapid ascent, but they also make Petro more sensitive to a decline in this market.

Company Overview

Founded in 1975 and headquartered in Calgary, Canada, Petro-Canada is a Canadian integrated oil and gas company with roughly 5,000 employees. Its businesses span both the upstream and downstream sectors of the industry. In the upstream businesses, the Company explores for and produces crude oil, natural gas liquids (NGL) and natural gas in Canada, offshore eastern Canada, Alaska, the U.S. Rockies, the North Sea, and other areas around the world. With oil prices near $100 a barrel as of February 2008, the firm has invested heavily in extraction from oil sands, a mixture of sand, clay, water, and extremely heavy crude oil that is expensive to process and found in large volume in Alberta, Canada. Petro-Canada is revamping one of its two refineries to exclusively process this oil in hopes of adding a new source of revenue. The downstream business refines crude oil and other feedstock, and markets and distributes petroleum products and related goods and services, primarily in Canada [2].

The company owns 2 refineries in Montreal and Edmonton and a network of 1,500 retail and wholesale gas stations across Canada. In 2006, the company produced 345,000 barrels of oil equivalent per day (net of royalties), and had net reserves of approximately 1 billion barrels of oil equivalent[3].

In the first quarter of 2008, Petro-Canada saw year-on-year earnings grow by over C$300 million. Most of this growth came from international expansion in regions like Syria and Trinidad, and from projects off the shore of the East Coast of Canada. The earnings from the company's upstream segment were offset by a weak downstream segment that experienced shrinking margins due to the rising cost of inputs.

Second quarter 2008 operating earnings increased year on year from C$805 million to C$1,151 million; growth was driven by prices, however, as production fell from 425 Mboe/d to 414 Mboe/d.[4]

[5]
2004 2005 2006
Revenue ($B) 14.0 16.8 18.7
Net Income ($B) 1.75 1.94 1.75
Number of Oil Barrels produced from Oil Sand Extraction (millions)[6] 103.2 94.2 111.5
Percentage of Revenue from outside North America[7] 10.3% 7.9% 11.7%


[8]
.
2004 (thousands of barrels/day) 2005 (thousands of barrels/day) 2006 (thousands of barrels/day)
Total Crude Oil Production 230 221 222
Total Natural Gas Production 142 135 123
Other 79 70 6
Total Production 451 425 351

Trends & Forces

To Reduce Operating Costs, Suncor plans to acquire Cash-Strapped Petro-Canada

On March 23, 2009 Suncor announced plans to acquire Petro-Canada for close to $15 billion in stock. The all-stock deal would allow two of Canada’s largest companies, in terms of both market value and production, to merge without using extensive amounts of either company’s cash.[9] Petro-Canada common shareholders will receive 1.28 shares of the merged company for each share they own of Petro-Canada.

Since the plunge in oil prices beginning in July 2008, Canadian oil producers have cut capital spending in an effort to conserve cash and reduces cots (many analyst predict Canada oil-sands will be economically viable at $75 US to $100 per barrel).[10] Prior to the merger, both Petro-Canada and Suncor were expected to cut capital spending by about a third in 2009 and postpone building on many oilsands projects.[11] This merger would allow the two companies to save close to $1.3 billion in annual costs through reduced capital spending and job cuts.[12] As a result of the merger, Suncor and Petro-Canada have the potential to operate more efficiently and prevent Canada’s oil sand from foreign takeovers.[13]

Recent investments in oil sand extraction depend on high oil prices to be cost effective

The Company has an estimated 15.9 billion barrels of oil equivalents (boe) of total resources from which to develop new production. Approximately two-thirds of total resources are located in Alberta's oil sands.[14] The largest and most important piece of Petro-Canada's oil sands strategy is its Fort Hills mine, which could add 280,000 barrels of synthetic crude oil in two phases by the middle of the next decade. However, severe cost inflation in northern Alberta has made profitability from these types of projects dependent on sustained high oil prices, in addition to efficient project execution and management. It is significantly more expensive to extract oil from oil sands than it is to extract oil from typical oil wells. Alberta's revised royalty payout, whereby a portion of Petro-Canada's production must go to the Canadian government, will add an extra burden to an already uncertain undertaking. This is one reason Petro-Canada is stepping back and re-evaluating its Mackay River oil sands expansion, which could add 40,000 barrels of oil per day by 2012 [15]. With oil prices at the current figure, oil sands extraction has the potential to be very profitable, as companies like Royal Dutch Shell (RDS'A) have already proved.[16]

Canadian Government Attempts to Reduce Greenhouse Gases will Force Oil Sands Players like Petro-Canada to Incur Large Costs

Soon-to-be-implemented government regulations to curb greenhouse gas emissions are focusing on implementing reductions in the oil sands, Canada's fastest-growing source of greenhouse gases. As of yet, the total costs that oil sands operators will pay is uncertain, but estimates range from C$0.14 to C$9 per barrel for bitumen and C$0.23 to C$15.60 per barrel of syncrude[17]. Companies like Petro-Canada, who are not yet entrenched in the oil sands but will have operations coming online by 2012, may have to pay more, because they may have to install costly technologies like carbon sequestration.

Alternative energy and environmental concerns pose a threat to Petro-Canada's demand.

As oil prices continue to climb, governments and lobbyists feel pressure to take measures to ween their countries off of oil. Going "green" is becoming more and more popular as scientists release more compelling evidence describing the harmful effects of burning fossil fuels. Although rising oil prices reflect an increase in worldwide demand and signify higher profits in the short run for oil companies, demand for Renewable Energy and Hybrid and Alternative Energy Technology is rising, potetentially undermining revenue and profits for oil companies in the long run. As long as worldwide demand for energy rises faster than demand for alternative energy, oil companies like Petro-Canada should continue to experience healthy growth.

Government regulations like emissions caps, renewable energy subsidies, and carbon trading schemes all facilitate transitions away from dirty, nonrenewable fuels. Natural gas is being touted by a number of sources (few of them environmental advocates) as "the" alternative to oil and coal. While natural gas does burn more cleanly than either oil or coal, and releases fewer greenhouse gases than either, natural gas is still a carbon-emitter. The current international focus on slowing carbon emissions is very likely to slow the market for both oil and natural gas, hurting Petro Canada's fossil fuels business immensely. In 2007, the Company expected to spend roughly $100 million on environmental regulatory compliance and expects this number to grow in 2008.[18] However, as long as worldwide demand for energy rises faster than demand for alternative energy, oil companies like Petro-Canada should continue to experience healthy growth.

A strengthening Canadian dollar against the U.S. dollar negatively impacts earnings.

Because energy commodity prices are primarily in U.S. dollars, Petro-Canada's revenue stream is affected by Canada/U.S. exchange rates. As a result, the Company's earnings are negatively affected by a strengthening Canadian dollar. As the Canadian dollar strengthens, revenue in U.S. dollars translates to fewer Canadian dollars. The Company is also exposed to fluctuations in other foreign currencies, such as the Euro and the British pound. Generally, Petro-Canada does not hedge foreign exchange exposures, although the Company partially mitigates the U.S. dollar exposure by denominating the majority of its debt obligations in U.S. dollars[19].

Natural disasters can impede production.

Natural disasters can significantly disrupt Petro-Canada’s oil production operations, preventing the firm from meeting demand. For instance, hurricane activity can damage and destroy refineries, oil rigs, pipelines, and other equipment. Also, potential shifts in weather patterns, such as warmer-than-normal temperatures, can drive down demand for heating fuels. Above average natural gas prices in 2005 reflected the severe impact of hurricanes on U.S. Gulf of Mexico production. In 2006, the Canadian natural gas price fell after production levels jumped to compensate for perceived shortages after the 2005 hurricane, resulting in prices that averaged almost 18% below its 2005 level. [20]

PCZ’s vertically integrated operations allow it to maximize profit margins at each step in the supply chain.

What sets Petro-Canada apart is its vertical integration. The firm explores for and harvests oil and natural gas in North America, offshore eastern Canada, the North Sea, and other areas around the world. It owns two refineries and a network of 1,500 retail and wholesale gas stations across Canada. This integration insulates it from volatility in the market – if crude prices go up, for example, it can compensate for the lower margin with higher prices at the gas pump; if gas prices go up, but crude stays the same, the company simply makes more profit. Vertical integration does not negate the effects of oil prices on the company's profits, however, as most of the company's margin comes from oil exploration and production and these profits are directly tied to the price of crude.

Competition

Although it remains a mid-sized global company as measured by production levels, Petro-Canada is well positioned to compete in the petroleum product refining and marketing business in Canada. The Company accounts for 13% of the total refining capacity in Canada and has a 16% share of the petroleum products market in Canada. Its 1,312 retail service station network has the highest gasoline sales per site in Canada among the national integrated oil companies. It also has Canada's largest commercial road transport network, with 219 locations[21], and a lubricants plant that is the largest producer of lubricant base stocks in Canada [22].

Petro-Canada's major competitors in the North American oil and gas market, as well as in the growing Canadian oil sands market include: Suncor Energy (SU), Encana (ECA), Imperial Oil (IMO), Nexen (NXY) and Canadian Natural Resources (CNQ). Suncor Energy was the first company to mine oil sands in 1967, however, Petro-Canada has emerged as a major competitor. Petro-Canada trails only Imperial Oil in sales.

Global Oil Industry Operational Data

Global firms like ChevronTexaco (CVX) and Exxon Mobil (XOM) represent stiff competition in Petro-Canada's global expansion efforts. The tables provided below compare the operational metrics for Petro-Canada vis-à-vis its global competitors in 2006.

Comparison to Competitors
SUNOCO CHEVRON VALERO EXXON MOBIL WESTERN REFINING Petro-Canada
Refinery Capacity
(Million BPD)
0.95 2.11 3.10 5.72 0.223 0.255
Number of Refineries 5 19 18 N.A. 4 2
Number of Retail Gas Stations 4,691 25,000 5,800 35,000 155 1,300+

Source: 2006 Company Data


Company Reserves (MM boe) Current Years of Production Oil & Gas Production (1000s boe/d) 2006 Oil & Gas Production Growth (%) 2006
Petrobras 11,458 14.2 2,287 4.5
BP 17,368 10.4 3,926 -1.9
ChevronTexaco 11,020 10.9 2,667 6.1
ExxonMobil 21,518 11.3 4,238 3.8
Royal Dutch Shell 11,108 6.7 3,474 -1.0
Hess 1,243 7.9 358 7.0
BG Group 2,149 6.2 601 19.0
ConocoPhillips 6,676 8.7 2,359 29.7
ENI 6,406 11.2 1,770 5.8
Marathon 1,262 7.1 377 9.0
Norsk-Hydro 1,916 9.3 573 2.0
Petro-Canada 1,301 8.4 345 -3.1
Repsol YPF 2,600 5.2 1,128 -3.0
CNOOC 503 3.0 455 11.7
Gazprom 144,668 39.7 9,965 6.0
LUKOIL 18,144 27.2 1,838 4.5
PetroChina 16,260 15.6 2,907 5.0

Notes

  1. Morningstar Analysis 1/31/2008: PCZ
  2. PCZ 2006 40F, Business of Petro-Canada, pg. 3 - 4.
  3. Morningstar Analysis 1/31/2008: PCZ
  4. Petro-Canada News Release, Second Quarter 2008 Results
  5. Reuters: PCZ Financial Statements
  6. PCZ 2006 40F, Description of the Business, pg. 25.
  7. PCZ 2006 40F, Description of the Business, pg. 14.
  8. PCZ 2006 40F, Description of the Business, pg. 32.
  9. WSJ: Suncor to Buy Oil Rival, March 2009
  10. cbc.ca: Suncor, Petro-Canada announce merger, March 2009
  11. WSJ: Suncor to Buy Oil Rival, March 2009
  12. cbc.ca: Suncor, Petro-Canada announce merger, March 2009
  13. cbc.ca: Suncor, Petro-Canada announce merger, March 2009
  14. PCZ 2006 40F, Description of the Business, pg. 8.
  15. Morningstar Analysis 1/31/2008: PCZ
  16. [1]
  17. SeekinAlpha: "How Will Greenhouse Gas-Related Costs Affect Oilsands Players?"
  18. PCZ 2006 40F, Description of the Business, pg. 9.
  19. PCZ 2006 40F, Description of the Business, pg. 12.
  20. PCZ 2006 40F, Description of the Business, pg. 8.
  21. PCZ 2006 40F, Description of the Business, pg. 8.
  22. PCZ 2006 40F, Description of the Business, pg. 53.


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