This weekend's deal that will result in a merger of Cenovus and Husky should help the combined company have a home for most of its heavy oil production, and result in one of the more "integrated" oil companies in several decades. But it also may hit the "pause button" for consolidation in US refining as two of the potential buyers of on-the-market Midcontinent refineries focus on internal cost-cutting as well as the daunting energy transition.

The key to the deal is the excess upstream production held by Cenovus, which will retain its name on the new combined corporation and benefit from Husky's extensive downstream operations in the US. Cenovus is a 50-50 partner with Phillips 66 at the 500,000 b/d Wood River refinery in Roxana, Illinois as well as the 146,000 b/d Borger, Texas refinery.

Hence, based on the 50% interest, one might say that Cenovus has a home for about 325,000 b/d of its 475,000 b/d of upstream output. Husky has 275,000 b/d of upstream capacity and is the owner/operator of a 179,000 b/d refinery in Lima, Ohio and also boasts a 50% interest in the BP/Husky Toledo refinery that processes 160,000 b/d. A 45,000 b/d plant in Superior, Wisconsin is being rebuilt after a spectacular fire and explosion in April 2018.

Top brass for the new company spoke often of the value chain created by the merger, suggesting that the combined company - - to be known as Cenovus Energy and located in Calgary - - would remove much of the risk associated with highly volatile and often huge discounts for heavy crude oil in Alberta. Essentially, much of the pricing risk for Alberta will be removed and molecules produced there by Cenovus and Husky will have a home in North American refining.

However, M&A experts note that the merger comes at an extremely inopportune time for the many US refineries that have been aggressively or casually shopped by investment banks. ExxonMobil's 60,000 b/d refinery in Billings, MT is believed to be for sale, as is the 30,000 b/d Calumet refinery in Great Falls, MT. Several other Rocky Mountain refinery operators have been waiting for the end of COVID-related shutdowns to entertain Canadian producers as potential buyers, sources add.

Meanwhile, M&A watchers wonder whether BP is interested in maintaining its half of the Toledo Refining venture, as the company targets an aggressive carbon neutral plant. Some color on BP plans will come with its earnings release this week.

The two Canadian companies were valued for tens of billions of dollars less than twelve years ago but price collapses and ESG investor avoidance severely damaged valuations. Much of that damage came as prices for Western Canadian Select (WCS) and other heavy blends traded at drastic discounts to Brent and WTI in recent years.

A first quarter 2021 closing is targeted, and the deal targets an eventual $1.2 billion in synergy savings.

Cenovus CEO Alex Pourbaix will retain the helm once the merger is completed and he described the combined firm as a "leaner, stronger and more integrated company, exceptionally well-suited to weather the current environment and be a strong Canadian energy leader in the years ahead."

Upstream production is anticipated to be 750,000 barrels of oil and gas equivalence with Cenovus contributing 475,000 b/d and Husky 275,000 b/d.

Refining capacity will be around 660,000 b/d. Takeaway capacity from Alberta should total 265,000 b/d and pipeline expansions could swell that number by 305,000 b/d.

The dedicated home for much of the combined company's heavy crude output should substantially reduce its break-even numbers. The WTI number cited as break-even in 2021 is $36 bbl, but it drops to $30 bbl in 2023. Executives believe that the WTI benchmark will normalize around $45 bbl in the post-COVID environment and see the WCS discount at $14.75 bbl next year; $15 bbl in 2022; and $13.50 bbl in 2023.

One projection challenged by an investment margin related to Chicago cracks.

The presentation sees Chicago 3:2:1 cracks at $10.15 bbl, $11.50 bbl, and $13.50 bbl for 2021, 2022, and 2023, respectively. OPIS measured the Chicago crack on Friday at less than $8.50 bbl. The combined company will have exposure to the region thanks to its interests in the refineries in Roxana, IL and Lima, and Toledo, OH.

Debt is predicted to drop drastically for the merged firm with a pro forma targeting debt at just two times EBITDA by 2022. That ratio is not dependent on asset sales, and Cenovus also believes that the transaction will help its credit rating return to investment grade.

Only one investment house questioned the eventual disposition of the 500 or so Husky retail sites that come with the deal. Husky has a retail network of c-stores, travel centers and card locks that stretch from Vancouver Island, British Columbia to the Atlantic provinces. Back in January 2019, they talked about selling that network but execs on the Sunday conference call hinted that the process was suspended thanks to COVID. Retail was described as a "non-core asset" for the company and execs said that they will always regularly review the performance of assets across the company.

 

-- Reporting by Tom Kloza, tkloza@opisnet.com

-- Editing by Tom Galatola, tgalatola@opisnet.com

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