TORONTO DAVIES WARD PHILLIPS & VINEBERG LLP 155 WELLINGTON STREET WEST TORONTO ON CANADA M5V 3J7 TELEPHONE: 416.863.0900 FAX: 416.863.0871 MONTRÉAL Acquiring Canadian Public DAVIES WARD PHILLIPS & VINEBERG LLP 1501 MCGILL COLLEGE AVENUE 26TH FLOOR MONTRÉAL QC CANADA H3A 3N9 Oil & Gas Companies TELEPHONE: 514.841.6400 FAX: 514.841.6499 NEW YORK DAVIES WARD PHILLIPS & VINEBERG LLP 625 MADISON AVENUE 12TH FLOOR NEW YORK NY U.S.A. 10022 TELEPHONE: 212.588. 5500 FAX: 212.308.0132 dwpv.com If you are interested in receiving more information on Davies Ward Phillips & Vineberg llp, please contact us or visit our website at www.dwpv.com. Acquiring Canadian Public Oil and Gas Companies: A Guide for Foreign Oil and Gas Companies, Foreign Investors and Investment Banks, 1st edition – February 2010 For additional information with respect to this guide or assistance in any transaction, please contact us directly: Corporate and M&A: Patricia L. Olasker Tel: 1.416.863.5551 Email: [email protected] Peter Mendell Tel: 1.514.841.6413 Email: [email protected] Vincent A. Mercier Tel: 1.416.863.5579 Email: [email protected] Ian R. McBride Tel: 1.416.863.5530 Email: [email protected] Environmental and Energy: Sarah V. Powell Tel: 1.416.367.6931 Email: [email protected] Alexandria Pike Tel: 1.416.367.6989 Email: [email protected] Foreign Investment Review: Mark Katz Tel: 1.416.863.5578 Email: [email protected] Canadian Tax: K. A. Siobhan Monaghan Tel: 1.416.863.5558 Email: [email protected] Acquiring Canadian Public Oil and Gas Companies_1st ed_new address_Layout 1 22/01/2013 12:46 PM Page i At Davies, we focus on the matters that are the most important to our clients, in Canada and around the world. The more complex the challenge, the better. Our strength is our people, who blend proven experience, deep legal expertise and business sensibility to generate the outcomes you need. We measure our achievements by one simple standard: Your success. TORONTO MONTRÉAL NEW YORK DAVIES WARD PHILLIPS & VINEBERG LLP DAVIES WARD PHILLIPS & VINEBERG LLP DAVIES WARD PHILLIPS & VINEBERG LLP 155 WELLINGTON STREET WEST 1501 MCGILL COLLEGE AVENUE, 26THFLOOR 625 MADISON AVENUE, 12THFLOOR TORONTO ON CANADA M5V 3J7 MONTRÉAL QC CANADA H3A 3N9 NEW YORK NY U.S.A. 10022 TELEPHONE: 416.863.0900 TELEPHONE: 514.841.6400 TELEPHONE: 212.588.5500 FAX: 416.863.0871 FAX: 514.841.6499 FAX: 212.308.0132 Acquiring Canadian Public Oil and Gas Companies_1st ed_new address_Layout 1 22/01/2013 12:46 PM Page ii PROVEN. FOCUSED. INNOVATIVE. Davies has been named Canada's "Best M&A Team" and "Best Banking and Finance Team" by World FinanceMagazine. The awards are WORLD FINANCE Davies awarded Best M&A part of the 2010 World Finance Legal LEGAL AWARDS Team and Best Banking & Awards, which are given to those 2010 Finance Team in Canada demonstrating innovation and originality, market leadership and the ability to keep ahead of the competition. The 2010 IFLR 1000 - Guide to the World’s Leading Financial Law Firms ranks Davies' The 2010 IFLR 1000 - Guide to Mergers & Acquisitions practice as the top the World's Leading Financial tier in Canada and states "While megadeals Law Firms ranks Davies as the have disappeared from the market, the Top Tier Canadian firm for expertise harboured at Davies has not. Peers Mergers & Acquisitions still regard the firm's M&A group as one of the most capable in Canada." The 2010 LEXPERT®/American Lawyer Davies ranked as leading Guide to the Leading 500 Lawyers in Canada Canadian firm for ranks Davies as the leading Canadian firm corporate transactions for corporate transactions relative to firm relative to firm size size. Chambers Global 2010: The World’s Leading Lawyers for Business, recognized Davies as a leading Canadian firm across nine practice Chambers Global ranks areas: Corporate/M&A, Competition & 38 Davies Partners in Antitrust, Public Private Partnerships, Tax, 2010 Edition Banking & Finance, Dispute Resolution, Real Estate, Restructuring, and Energy & Natural Resources. Acquiring Canadian Public Oil and Gas Companies_1st ed_new address_Layout 1 22/01/2013 12:46 PM Page iii About this Guide • We at Davies have extensive experience advising Canadian and foreign bidders, targets and investment banks in multi-jurisdictional merger and acquisition transactions. We have produced this guide to assist you in understanding the legal regime applicable to Canadian oil and gas companies, the steps involved in acquiring an interest in a publicly traded company in Canada, and current issues affecting oil and gas M&A transactions. • We have also produced other guides that may be of interest to you, including the following: o the Davies Canadian Mergers & Acquisitionsguide provides an insight into the steps involved when conducting a variety of acquisition transactions in Canada; o the Davies Investment Canada Actguide describes the federal legislation governing foreign investments in Canada, including the impact of amendments in March 2009 that changed the thresholds for review and implemented a national security review process; o the Davies Doing Business in Canadaguide provides general legal information about doing business in Canada based on our firm's extensive experience helping North American and international clients seeking to do business in Canada; o the Davies guide to Going Public in Canada and the United Statesprovides detailed information about the process for becoming a public company and the reporting obligations of public companies; o the Davies Investors' Guide to Mining in Canadaprovides information for foreign investors interested in investing in the Canadian mining sector, either by acquiring Canadian mining companies or by acquiring and developing Canadian mining properties; and o the Davies Acquisitions of Canadian Income Trustsguide provides potential acquirors and other interested parties with a summary of the principal legal and regulatory considerations relevant to acquisitions of Canadian income trusts. • All of our guides are available on our website www.dwpv.com or you can contact us directly for copies. • All of our guides are also available in Chinese. • This guide is intended to provide the reader with an insight into the legal considerations involved in acquiring a Canadian public oil and gas company. The information in this guide should not be relied upon as legal advice. We encourage you to contact us directly with any specific questions. About this Guide iii Acquiring Canadian Public Oil and Gas Companies_1st ed_new address_Layout 1 22/01/2013 12:46 PM Page iv S TABLE OF CONTENTS 1 INTRODUCTION TO OIL AND GAS IN CANADA 7 T CURRENT ISSUES IN OIL AND GAS M&A 13 OIL AND GAS LAW IN CANADA N 25 ACQUIRING CONTROL OF A PUBLIC OIL AND GAS COMPANY 37 ACQUIRING AN INTEREST IN AN OIL AND GAS COMPANY 49 E CONDUCTING DUE DILIGENCE ON OIL AND GAS COMPANIES 55 ENVIRONMENTAL AND SOCIAL MATTERS 63 GLOSSARY OF COMMONLY USED TERMS IN THE CANADIAN OIL T AND GAS INDUSTRY 71 APPENDIX A: ROYALTY CHART N O C Table of Contents iv Acquiring Canadian Public Oil and Gas Companies_1st ed_new address_Layout 1 22/01/2013 12:46 PM Page 1 Introduction to Oil and Gas in Canada 1 Acquiring Canadian Public Oil and Gas Companies_1st ed_new address_Layout 1 22/01/2013 12:46 PM Page 2 Introduction to Oil and Gas in Canada CANADA IS A LEADER IN THE OIL AND GAS INDUSTRY • Canada has significant oil and gas reserves. According to the Government of Canada: o Canada has one of the largest proven oil reserves in the world, accounting for 14% of the world's proven oil reserves, second only to Saudi Arabia; and o Canada is the world's second largest exporter and third largest producer of natural gas. • Canada is home to more public energy companies than any other country in the world. According to the Toronto Stock Exchange: o the Toronto Stock Exchange and the TSX Venture Exchange are home to 43% of the world's public energy companies; and o at the end of 2008, 138 oil and gas companies with an aggregate market capitalization of $260 billion were listed on the Toronto Stock Exchange and 271 oil and gas companies with an aggregate market capitalization of $3.2 billion were listed on the TSX Venture Exchange. CANADIAN OIL AND GAS M&A ACTIVITY • Mergers and acquisitions ("M&A"), joint ventures, minority investments and other corporate transactions involving foreign investors and Canadian oil and gas companies are relatively common given Canada's significant oil and gas reserves. • Following a recent period of uncertainty as a result of the financial and economic crises and the high volatility in the price of oil, M&A activity in the oil sector, and in particular M&A involving assets in the oil sands industry, is once again heating up with a number of announced acquisitions and large investments by foreign oil and gas companies. However, natural gas prices remain depressed due to oversupply from technological enhancements in shale gas extraction. As a result, we have seen less M&A activity in the gas sector, although we expect activity to pick up later in 2010. • Many M&A deals involve Canadian targets that have little to no connection to domestic production and are instead focused on oil reserves in such places as Syria, Kazakhstan, Egypt, Tunisia, the United Kingdom, the Netherlands, Mexico, the Philippines, China, Australia and offshore West Africa. • Many oil and gas entities, despite having non-Canadian assets, are established in Canada to take advantage of Canada's proven legal and regulatory regime, and access financing in Canada's strong, mature capital markets. The acquisition of these Canadian companies can be an efficient way to acquire operating assets in foreign jurisdictions. OVERVIEW OF OIL AND GAS RESOURCES IN CANADA COMMONLY USED TERMS • In Canada, the term "oil and gas" generally refers to hydrocarbons extracted from below the surface of the earth, including oil, bitumen and natural gas. Oil and gas are "fossil fuels" because they have been 2 Introduction to Oil and Gas in Canada Acquiring Canadian Public Oil and Gas Companies_1st ed_new address_Layout 1 22/01/2013 12:46 PM Page 3 formed from plant and animal matter that has undergone transformation through heat and pressure over the course of millions of years. • "Oil" is a naturally occurring, flammable liquid hydrocarbon found in rock formations in the earth. "Conventional oil" is free-flowing oil that can be extracted by drilling oil wells into reservoirs. • "Bitumen" or "oil sands oil" is distinct from free-flowing conventional oil because it must be heated or diluted before it can be extracted, for example by using strip-mining or, more recently, with advanced in situwells that inject steam, solvents or hot air into the ground to liquefy the bitumen, allowing it to flow and be pumped out of the well. The Canadian "oil sands" are naturally occurring mixtures of water, clay and sand containing bitumen. • "Natural gas" is a fossil fuel that naturally occurs in a gaseous state under normal atmospheric conditions. Natural gas can be found in isolated natural gas fields, together with oil as "associated gas" or in coal beds as "coal-bed methane". Natural gas can be transformed into "liquefied natural gas" ("LNG") by cooling it to a temperature of approximately -160ºC (-260ºF) at atmospheric pressure to reduce it to about 1/600th of its volume, allowing large quantities of natural gas to be stored and transported in a more efficient and economic manner. • Additional commonly used terms in the oil and gas industry in Canada are explained in the Glossary at the back of this Guide. OIL • According to the Government of Canada, Canada's remaining established oil reserves amount to 179 billion barrels, of which more than 95% are in the form of bitumen in the oil sands. • A significant portion of these oil reserves are in the Western Canadian Sedimentary Basin, which covers the eastern border of the Yukon Territory and British Columbia, Alberta, Saskatchewan, Manitoba and part of the Northwest Territories as shown below in the "Map of Oil and Gas Resources in Canada". • Additional oil reserves are located off the east coast of Canada, on the Atlantic Margin, which has recently become a major producing region. The first major offshore project, Hibernia, is located on the Grand Banks in 80 metres of water, 315 kilometres east-southeast of St. John's, Newfoundland and Labrador. Oil production from the Hibernia project began in November 1997. • The Arctic Islands, Beaufort Sea and Mackenzie Delta in Canada's North also contain significant reserves, although they remain largely unproduced. • The Intermontane region in British Columbia and the Yukon between the Rocky and West Coast mountains contains smaller reserves. • The Pacific Margin, off the coast of British Columbia, is believed to contain sizable oil and natural gas reserves. However, a federal moratorium currently exists on all offshore oil and gas activities in the region. The Government of British Columbia is working to lift the moratorium, with a mixture of both support and opposition from the federal government, First Nations and the general public. OIL SANDS • According to the Government of Canada, Canada has over 173 billion barrels of proven oil sands reserves and an additional 1.7 to 2.5 trillion barrels of probable or possible oil sands reserves. Probable and possible reserves are not considered commercially producible given current technology, but may be in the future. Introduction to Oil and Gas in Canada 3 Acquiring Canadian Public Oil and Gas Companies_1st ed_new address_Layout 1 22/01/2013 12:47 PM Page 4 • The oil sands reserves are found primarily in Alberta and Saskatchewan. • Rapid technological advances are making the process of extracting the bitumen from the other elements more efficient with fewer impacts on the environment. NATURAL GAS • The Government of Canada states that Canada currently has approximately 58 trillion cubic feet of natural gas reserves, the vast majority of which are found in Western Canada, primarily in British Columbia. Geological evidence projects probable and possible reserves of approximately 424 trillion cubic feet. Half of this projected reserve is located in the Western Canadian Sedimentary Basin, while the other half is located in frontier regions such as the Arctic and the Atlantic Margin offshore. The Mackenzie Delta and Beaufort Sea regions of Canada's North have approximately 22 trillion cubic feet of combined reserves, but are not considered established reserves because of a lack of transportation infrastructure to move this gas to market. • According to the Government of Canada, Canada currently exports approximately 4 trillion cubic feet of natural gas, almost all of which goes to the United States. Additionally, Canadians consume 2.6 trillion cubic feet of gas annually. While the Government of Canada projects that conventional gas reserves will decline in the coming decade, exploration and production of unconventional gas sources such as coal-bed methane, shale gas and gas hydrates, coupled with liquefied natural gas imports, are expected to offset the conventional gas reserve decline and maintain Canadian production capacity. o For example, shale gas is natural gas trapped in semi-porous rock formations, which makes it difficult to extract. Advances in extraction technology during the past decade have resulted in an increase in commercial production of this unconventional gas. In fact, a recent report from Natural Resources Canada referred to shale gas as "the next big oil sands". • Offshore production at the Sable Offshore Energy Project (Sable Island, Nova Scotia) commenced in late 1999 and has amounted to approximately 1.4 trillion cubic feet of natural gas to date. LIQUEFIED NATURAL GAS • North America has historically relied on domestic natural gas supplies, with very small amounts of imported LNG from overseas to supplement domestic production. However, a number of LNG import facilities have been constructed in North America recently and a number of projects are planned. Two projects in the province of Québec and one in each of New Brunswick, Nova Scotia, and Newfoundland and Labrador have been approved, as has an export terminal on the Pacific Coast in British Columbia. SECTORS OF THE OIL AND GAS INDUSTRY • The oil and gas industry can be divided into three sectors, each contributing to a process that begins with identifying commercially producible oil and gas and ends with the consumption of oil and gas products. In general, oil and gas companies specialize and can be classified as operating in one of the sectors outlined below. o The upstream sectorgenerally refers to the process of exploration, drilling and extraction of these resources. Also known as exploration and production or "E&P", the upstream sector is responsible for identifying existing and commercially producible reserves, drilling to extract the oil or gas, and developing field level infrastructure to facilitate transportation to market. o The midstream sectorprocesses and provides storage for conventional oil, bitumen and natural gas and transports the resources through a dedicated pipeline infrastructure from the drill site to refineries and market. o The downstream sectorinvolves refineries that process the crude oil and gas into a marketable 4 Introduction to Oil and Gas in Canada