KNOC Snaps Up Harvest Energy for US$3.9 bil.

Hungry KNOC Reaps Harvest

KNOC has agreed to buy Canada-based Harvest Energy Trust for C$4.1 billion in one of South Korea's largest overseas acquisitions to date. The C$4.1 billion marks a 37% premium over yesterday's closing price on the Toronto Stock Exchange. KNOC will pay C$10.00 for every Harvest Unit, or about C$1.8 billion in cash, and assume C$2.3 billion worth of Harvest's debt. Harvest's income trust’s board approved the agreement with KNOC and recommended it to unit holders. The board plans to vote the 7 million units it holds in favour of the deal, although 180.6 million units will still be outstanding while the acquisition is still subject to regulatory and court approvals. KNOC and Harvest are planning to complete the purchase by the end of December 2009.

The acquisition reflects KNOC's efforts in recent years to step up its overseas acquisitions to meet its "KNOC 3020" strategy of becoming a top 50 global oil company and securing a daily production level of 300,000 b/d and reserves of 2 billion barrels by 2012. In 2008 KNOC purchased Petro-tech, owned by private U.S. firm Offshore International Group, which has shallow-water offshore blocks in Peru covering more than 5 million acres, in one of its largest overseas acquisitions. KNOC also acquired development rights for five large onshore exploration areas in the Kurdish region of Iraq. Since the global financial crisis, the company has been looking to take advantage of the weakening in global stock markets as well as the fall in crude oil prices and asset valuations to step up its overseas acquisition spree, although the company has suffered a few setbacks. Back in June 2009 China's Sinopec outmanoeuvred KNOC in its attempts to purchase Swiss-based Addax Petroleum, which had assets in the Kurdistan region of Iraq and in Africa, forcing the company to look elsewhere (see World: 25 June 2009: Sinopec Agrees to Acquire Addax Petroleum for US$7.2 bil.). Thus another move by KNOC to boost its overseas acquisition base was expected, particularly given comments by the company earlier this month that it was eyeing between five and ten companies for overseas acquisition (see South Korea: 9 October 2009: South Korea's KNOC Eyeing Five to Ten Oil Companies for Acquisition).

KNOC's interest in Canada-based Harvest Energy was rather unexpected as KNOC had previously announced that it had prioritised acquisitions in the Middle East, Central Asia, South America, and Australia. However, KNOC had also hinted that it was interested in exploiting alternative sources of crude oil, such as oil sands, abroad to develop technical expertise which points to one of the motivations behind the acquisition. Indeed, KNOC's premium offer is likely prompted by Harvest Energy's interests in the giant Alberta oil sands, where it has 187.2 mmboe net of proved and probable reserves that promise to give KNOC a foothold in this huge-potential area. KNOC may also have wished to build on its oil sands assets after purchasing a project from gold producer Newmont Mining Corp. in 2006. Harvest Energy's production level of between 35,000 b/d and 50,000 b/d is rather modest, although perhaps not for KNOC, which itself only has a current production capacity of around 72,000 b/d and Harvest Energy's conventional oil reserves, which could potentially provide a production boost for KNOC over the medium term, will help it to achieve its mid-term strategy.

This acquisition marks the second foray by an Asia-based player into Canada in under two months, after PetroChina's announcement in late August of its intention to buy 60% stakes in two projects run by the Athabasca Oil Sands Corporation (AOSC, see Canada: 1 September 2009: PetroChina in C$1.9-bil. Deal to Enter Canada's Oil Sands). In that particular case, AOSC had been facing difficulties financing planned investments, so was happy to let PetroChina share the burden. For its part, the Chinese firm played it safe by merely taking project majority shares, rather than gunning for complete ownership.

For KNOC however, the move to purchase Harvest outright seems a bit more aggressive, but is unlikely to pose regulatory problems. In terms of what KNOC is getting for its money, in 2008 Harvest generated net revenues of around C$5.5 billion, but had net income of just C$212 million. On top of the trust's modest production base, KNOC will also be buying exposure to Newfoundland and Labrador's downstream sector, via Harvest's ownership of the 115,000-b/d North Atlantic refinery in Come-by-Chance Bay—the province's only refinery. This facility is in dire need of upgrade and had previously had a C$2-billion expansion programme in place. Harvest was, however, forced to cancel the programme as the financial crisis and economic downturn killed demand and thus margins. This cost adjustment should thus be added to KNOC's final bill. Of the deal, Harvest's CEO John Zahary said; "we are extremely pleased to announce this transaction…Harvest has a considerable portfolio of opportunities including large oil in place assets coupled with production and throughput expansion opportunities in the upstream and downstream segments respectively. Continued investment by KNOC will supplement this growth".

More generally, Canada's attraction as an investment destination for Asian energy companies is driven partly by the country's reputation for its political stability, but also because of its substantial oil and gas reserves. With company asset valuations near all-time lows, the time has rarely been better for cash-rich foreign companies to seek exposure to Canada's potential, particularly with regards to its unconventional resources. This is unlikely to be the last deal we see of this kind in the coming months.

Outlook and Implications

Interest in buying Harvest Energy was reported to be low from domestic buyers so any rival bid for the company is likely to come from an overseas company. However, by itself the KNOC offer will be attractive to Harvest Energy's shareholders given the 37% market premium and given that KNOC has agreed to take on Harvest’s debt. KNOC also appears committed to completing the transaction as it has agreed to pay a US$100-million break-up free if the deal does not go through. However, the company is still raising the necessary funds to complete the transaction, which KNOC has said will come from bond issues and from further investments in pension funds. However, KNOC is not likely to encounter significant problems raising the necessary finances, the government would likely free up sovereign wealth funds to support KNOC in its overseas acquisition plans if KNOC could not raise the money in time (see South Korea: 12 August 2009: South Korean Government Considers Using Sovereign Wealth Funds for Overseas Energy Acquisitions).