If you want to understand why shareholders are upset with Petro-Canada, look beyond the floundering stock price. Consider, as a starting point, the ramblings of Moammar Gadhafi.
Libya's strongman is tamer than he used to be, but he hasn't lost his ability to confuse and frustrate - as he did two weeks ago when he floated the idea of nationalizing the oil industry as a response to crude's price crash. This left several Western oil companies scrambling, including Petrocan, which only last summer cut Libya's state oil company a $500-million (U.S.) cheque as a down-payment on a new deal that will see the Calgary company invest nearly $5-billion there.
In the euphemistic language of Bay Street, this is called "political risk," even though most students of Gadhafism don't take the threat very seriously. ("Never take Gadhafi's statements at face value," one bluntly told the Associated Press.) The real risk, according to some investors, isn't that Petrocan's deal will be torn up. It's that it won't be.
The North African adventure is a useful illustration of why large investors like the Ontario Teachers' Pension Plan are now banging at the gate of the Petrocan board and chief executive officer Ron Brenneman. Oil company CEOs don't control the price of oil and gas and they don't control what happens to their shares. All they can really control is their company's capital, and their single most important task is to wring as much as they can out of it, especially now that money is expensive and getting more so.
On that score, how does Libya stack up? Petro-Canada is paying a $1-billion signing fee and is promising to spend $3.5-billion on developing oil fields (There's also a $460-million "exploration and appraisal commitment," which we'll exclude for this exercise.)
In return, the joint venture will eventually see a doubling of its oil production, to 200,000 barrels a day. Petro-Canada has a half-interest. But what does it mean to the bottom line? Ah, that's more complicated. The royalties are steep, you see, and when it comes to taxes, the Colonel has not exactly embraced the policies of Ronald Reagan, his old foe. The corporate income tax rate that applies is (gulp) 65 per cent, according to Petrocan's disclosures. The state is taking a lot of the upside.
Helpfully, though, the company has provided some numbers. At prices of $100 a barrel, Petro-Canada's piece is about $15.50 a barrel in cash flow. At $80 a barrel, Petrocan's take is $13.30 - which works out to $485-million a year, which, to oversimplify things a lot, looks like an 11 per cent cash return on the investment.
At the current price of $40 a barrel? Better not to ask.
The point isn't to slam Mr. Brenneman for failing to foresee the incredible plunge in oil prices. It's that in the name of growth, Petrocan has tied up billions of dollars for a payoff that looks too slim, even if oil prices double. (Let's put it another way. Suppose you had to invest a portion of your retirement fund in a Libyan business that the local dictator has mused about seizing for the good of the state. What sort of return would you demand? I hope you said, "At least 20 per cent.")
That problem - too much capital, poorly spent - is why the company is worth more dead than alive. BMO's Randy Ollenberger says that if broken up, Petro-Canada might be worth about $44 a share, or - in the most bullish scenario - $74. (Yesterday, it closed just below $28.)
The question for Teachers and other large shareholders is how to extract the value, because you can't just sell most of the assets or force a takeover - both are prohibited by the Petro-Canada Public Participation Act, which limits ownership to 20 per cent.
The act is also "far more onerous" than regular corporate law in restricting shareholder activity, says Grant Zawalsky, a corporate lawyer at Burnet, Duckworth & Palmer in Calgary. If a group of shareholders owning more than 20 per cent conspired on a scheme to remove the Petrocan directors, the directors - in theory - could force them to sell their shares under an arcane clause in the act. So Teachers must tread carefully.
But, adds Mr. Zawalsky, as long as the pension fund stays onside the letter of the law, "from a practical point of view, I don't think [the act]is a huge impediment to changing the board." Teachers can simply put up a new slate and ask shareholders to vote for it.
Nor is there anything to stop investors from lobbying the Conservatives in Ottawa to rewrite the law. In a minority Parliament, scrapping it altogether isn't going to fly: No one wants to see ExxonMobil bid for Petro-Canada in a depressed market. But would it be so terrible or politically contentious to allow a takeover by a domestic company (say, Suncor)? If nothing else, it would remove the bubble of protection Mr. Brenneman has enjoyed so far.
Political risk in Libya? How about giving investors some political reward at home?