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Lance Mortlock
Ernst & Young

Most Canadian investments by Asian national petroleum companies have been non-operational, to date, but as the growing trend of taking on operator roles continues, various integration challenges are expected to arise. To ensure long-term success in Canada’s oil and gas industry, operational acquisitions require significant emphasis on integration management. This means national oil companies and their local Canadian partners will need to embrace a more international corporate culture, decentralize business models, and integrate applicable processes quickly in order to create and maintain mutually beneficial relationships.

In 2010, the number of inbound oilsands-focused transactions from Asia tripled, as countries including China, Japan, Thailand and South Korea actively sought to secure natural resources by completing several major deals in Western Canada.

Though Asian investment in Canada's oil & gas sector was virtually non-existent in 2008, it rose significantly to $5.9 billion in 2009 and to $10.9 billion in 2010. Rising oil prices has been responsible for this development, but so too has been growing international recognition of Canada’s massive oil & gas reserves, its stable financial and regulatory environment as well as its proximity to the US and world-class infrastructure. Moreover, the influence of national oil companies — including, of course, those in Asia — has increased in the wake of the recent recession so that Canadian oil & gas companies have turned increasingly to them for assistance in funding large scale projects.

This year already looks set to be a buyout year, with the Sinopec and Enbridge Northern Gateway pipeline deal in January and, more recently, PetroChina’s $5.4 billion bid to acquire a 50% working interest in EnCana’s Cutbank Ridge business in BC and Alberta.

Though the transition from foreign investor to operator is a relatively new trend in Canada’s unconventional oil and gas industry, many new opportunities will abound if companies can proactively address the issues.

Korea National Oil Corporation’s (KNOC’s) deal to buy Harvest Energy in early 2010 for $4.1 billion is one example of a foreign investor transitioning to an operator role. After the takeover, KNOC retained local employees to run the company while keeping the local brand and external image of Harvest Energy. And in November 2010, KNOC also set up a global technology centre in Calgary.

The measures taken by KNOC suggest an emerging shift in investment toward Canada’s unconventional oil and gas industry, with a new realm of opportunity for potential mergers and acquisitions. Nevertheless, such positive investment prospects undoubtedly carry a variety of structural, regulatory and cultural challenges, which can provide new obstacles for potential partnerships between Canadian companies and foreign investors.

Foreign integration can be a challenge

Canada’s ability to maintain control of its own resources is an important, and ongoing, topic of regulatory debate. As national oil companies expand and build an international portfolio of exploration and production investment, decisions are often made outside the country, giving Canadians less control of the pace of development and growth. This has raised flags for environmental and political groups alike, as it means more of Canada’s strategic natural resources can ultimately become controlled by other countries from a capital allocation and development perspective.

In terms of structural challenges arising from partnerships between Canadian companies and foreign operators, both parties may have difficulty adapting to a new work environment. More specifically, as foreign owners take over Canadian companies, local companies and experts may be resistant to taking advice on the oilsands from their new operator. Although this problem stems mostly from the fact that mining oilsands in Western Canada is different than most conventional oil and gas exploration and development methods around the world, it is very relevant when considering the potential cultural friction and regulatory concerns.

Environmental regulatory concerns also surround foreign integration, including the manner in which oil is extracted from the oilsands, and the way that shale gas is produced via hydraulic fracturing methods. There is also the question of whether there are benefits to Canada if national oil companies choose to use engineering, construction and procurement services from companies in Asia — where Canadians have built relationships and signed preferred supplier agreements.

Also, local employees may find it difficult to adapt to foreign systems and processes after having worked in a traditional Canadian business environment. Business systems and processes vary distinctly between the many potential investing Asian countries, and although some may be more similar to Canada in nature, each can cause some degree of cultural confusion and adjustment. At the same time, foreign investors may have difficulty adapting to Canadian business paradigms, and may need time to familiarize themselves with work practices, local laws, regulations, and environmental and security guidelines.

In the context of cultural divides, language and cultural barriers involving different working styles and decision-making approaches can create feelings of estrangement between teams if handled improperly.

Though this problem seems menial in theory, such breakdowns of team communication can pose far more severe problems when left unattended. For example, foreign companies might require detailed reporting and performance management systems since many of them are national oil companies with obligations to their governments. In this regard, local employees and leaders might consider some of the processes and procedures to be arduous or unnecessary, due to their lack of cultural experience and understanding.

Another example of communication breakdown relates to the language spoken in meetings. In cases in which groups are communicating in their native language and not speaking directly to the other party, anxiety can arise for those who cannot follow or engage in the conversation.

Building strong partnerships can spark opportunity

Canada’s oil and gas companies must adapt quickly to change and welcome diversity, so they can seize the global opportunities that foreign interest brings. More specifically, national oil companies and their local Canadian partners will need to embrace a more international corporate culture, decentralize business models, and integrate applicable processes as soon as possible. And organizations will need to look closely at their operations and within their own teams to better understand what needs to be done to facilitate such change.

To achieve successful partnerships, oil and gas companies should build a well-planned and structured merger-integration approach into their respective business models. It should include a dedicated project management office, detailed integration planning, organized communications, leadership engagement, governance, regular checkpoints, proper issue and risk management, and dedicated resources to support the overall integration process. Companies should uncover the key integration issues and risks early in the due diligence and integration-planning process.

In cases in which company cultures are very different, those companies may want to pursue a detailed cultural assessment to build a deeper understanding on both sides. This will enable them to address potential issues head on without letting them fester or exacerbate.

Another essential stage for successful partnership ensuring that information about the integration and future strategic intentions of the company is well communicated to everyone involved. Company leaders can help stakeholders understand the reasons such a change will bring success, the challenges and barriers that exist, and, ultimately, how employees can support such change. The company should also provide stakeholders with the tools and opportunities to ask questions, communicate their concerns and offer their opinions, to minimize any confusion about the merger process.

Establishing a structured mentorship and support program can also be a great tool for successful integration, as it can help engineers from national oil companies learn and apply their knowledge in their home country, or vice versa. Furthermore, keeping the local brand of the acquired company (as KNOC did with the Harvest Energy brand) can help decrease employee anxiety over risk of losing employment, and the perception of large-scale change in general. This will undoubtedly ease the transition process for both parties during a time of great uncertainty and insecurity.

Developing a strong workforce drives innovation

To address inevitable cultural divides during the merger process, both parties should strive to proactively recognize cultural differences and look for common ground for operating and running the overall business. By embracing diversity of thought at every level of management and focusing on an inclusive workplace that ensures everyone’s voice is heard, companies can realize an environment of continual innovation, growth and profound change.

Though these recommendations seem viable in theory and practice, they are largely ineffective if national oil companies and potential Canadian partners fail to understand that there are different ways of working. Co-ordinating ways of thinking and leadership practices can only go so far, so both parties must integrate business processes and systems on a global basis.

Canadian companies should be aware that Asia-based national oil companies might look for more process-based thinking and formal structure, while companies entering the Canadian market may have to adapt to a more ad-hoc and flexible approach to problem-solving. Furthermore, Canadian companies should understand that a more structured degree of reporting and performance management than was previously used may be necessary.

On the other hand, it is important for company leaders to understand that the acquisition process is about results and value creation, and not simply about integration; by communicating the strategic intent and transaction value drivers behind the deal, the resulting partnership can gain further stability and competitiveness going forward. Also, by encouraging leaders to fully participate in the integration management office, weekly status meetings and reviews of decision-making, both parties can maintain active senior management involvement, enhancing communication of specific expertise and best practices in the wake of the merger process.

Strong governance is key to success

A robust governance structure is a key requirement for a successful integration, especially when different cultural norms are at play. Governance challenges arise when there are a lack of primary roles, responsibilities, accountabilities and authorities — all of which occur during an operational acquisition. Objectives of key performance indicators and incentives need to be clear and consistent within the defined governance structure. Ultimately, the company needs to address any areas of responsibility that are not accounted for, and ensure there is sufficient management time to integrate responsibilities. In this light, it’s important to align the integration governance structure with the operational management structure.

The right integration plan

Acquisitions are generally risky, and the majority fail to achieve their goals — largely because of poor integration strategies. When you consider a deal between foreign and Canadian oil and gas companies, keep in mind that the type and size of the deal help define the degree of necessary integration and the challenges that could follow. However, in the context of operational acquisitions, there is a considerable emphasis on the importance of integration management, as more extensive integration measures are often required. We’ve narrowed down the top four causes of unsuccessful integration management:

1. Unrealistic expectations: these could include insufficient proactive planning and inadequate resources to manage the integration process
2. Process disruption: this could include the absorption of management on integration damages rather than day-to-day business operations
3. Poor communication: two-way communication is key to prevent excessive workload, culture clashes and ambiguous management structure resulting in the loss of key people
4. Failure to deliver anticipated synergy savings and other integration benefits can result in the loss of investor confidence, high-profile declaration of failure, and a widening morale crisis throughout company ranks

Lessons can be learned from the automotive sector

Asian car manufacturers are one significant example of successful foreign operations in North America that could provide some valuable in insight for potential partnerships in Canada’s unconventional oil and gas industry. It’s important to note that this industry example can’t be generalized to fit the requirements for successful integration in Canada’s oil and gas industry, or for potential success based on the cultural standards and practices of the Japanese and Korean car manufacturers. However, the lessons are worth noting, particularly with the success that was realized by centrally controlling finance, accounting and reporting functions through the home country with standardized key performance indicators and metrics. This made it easy to establish strong, global hierarchies within the organization, with strategic ways of reporting back to their local company on an ongoing basis.

Furthermore, companies applied applicable standard processes and procedures in all geographic locations, with little evidence of deviation unless specific local requirements existed. The companies didn’t always source parts in North America since they could be procured faster and cheaper locally in Asia, allowing them to focus on the bottom line and remain competitive. Also, new employees were provided cross-cultural training to better understand cultural norms and expectations.

It’s important to carefully consider which leadership roles are filled by the acquirer, creating clarity around decision-making and the level of autonomy, being aware of cultural differences and different ways of working together, as well as always communicating and being transparent around the future company intent.

Asian investment to drive growth in Canada

Foreign investment in Canada’s unconventional oil and gas region can bring many benefits to companies on both sides of the border. It can bolster the Canadian economy by providing jobs and bringing new perspectives into oil and gas businesses, which can spark innovation and help build stronger relationships with neighbouring Asia markets. In fact, many Canadian firms are considering Asian investment as a defensive strategy, to ensure steady sources of capital to fund continued development in the face of fluctuating energy prices and an uncertain economy. For foreign acquirers, investment in Canada can help secure key natural resources and access to the know-how required to meet the demands of their growing economies.

In the longer term, unrest in the Middle East is likely to have an impact on Canada’s oilsands, as foreign investors may be more inclined to favour a country that is more politically stable. It’s also becoming evident that the planned liquid natural gas terminal in Kitimat, BC, will be an attraction for investors in Asia as the product will be able to be shipped directly to the customer.

The 2010 trend of Canadian and foreign entities partnering through strategic alliances and joint ventures looks to continue, which enables risk sharing and the pooling of Canadian technology with foreign financial strength and resources. Technology will also play a strategic role in transactions as foreign buyers look to reap the benefits of Canadian oil and gas advancements to support development of vast oil and gas reserves in Asia.

As long as the expectations between foreign national oil companies and Canada’s oil and gas players clearly identify how the relationships can maximize benefits on both sides, this cross-border investment and collaboration is likely to continue for years to come.

Lance Mortlock is a Senior Manager in Ernst & Young’s oil and gas practice in Canada. As leader of the firm's oil and gas thought leadership centre in Calgary, Lance focuses on global energy industry trends and market dynamics.