DBRS Places Petro-Canada’s R-1 (low) and A (low) Ratings Under Review with Developing Implications

DBRS has today placed the Unsecured Notes & Debentures and Commercial Paper ratings of Petro-Canada (PC) and the Senior Notes of PC Financial Partnership Under Review with Developing Implications. The rating actions follow PC’s announcement that its Board has approved a proposal to merge PC with Suncor Energy Inc. (Suncor) through a share exchange, with no cash component or incremental debt incurred. The new entity (New Suncor) will retain the Suncor name. The transaction, expected to close in the third quarter of 2009, is subject to shareholder and regulatory approvals. PC’s shareholders are expected to receive a premium of approximately 25% on the transaction (based on the 30-day weighted-average trading price of such shares) on a tax-deferred basis, with PC’s shareholders owning approximately 40% of New Suncor, following completion of the proposed transaction. The merged company will continue to be governed by the provisions of the Petro-Canada Public Participation Act, under which no single shareholder or group acting in concert can hold more than 20% of the outstanding shares of the merged company.

The transaction has strong strategic, operating and financial rationales and would likely generate cost synergies, estimated at approximately $300 million of operating expenditures and $1 billion of capital expenditures per annum, as a result of significant overlaps in certain operating assets and growth projects. It also provides diversification and a vast resource base for future developments, mitigating PC’s relatively weak upstream conventional reserve replacement and reserve life index metrics. DBRS estimates proforma debt-to-capital of approximately 30% and debt-to-cash flow of 1.15 times based on the December 31, 2008 financials (24% and 0.73 times for PC and 35% and 1.77 times for Suncor on a stand-alone basis). However, there are uncertainties and integration risks associated with the transaction in addition to the combined management’s approach regarding the potential use of balance sheet leverage to fund New Suncor’s substantial growth projects previously planned, which could somewhat offset the benefits of the combination and have rating implications for the merged entity. DBRS’s review will focus on the following:

(1) Financial and operational focus of the merged entity, including its capital structure, financing policies/prioritization (especially for growth projects), credit metric targets and capital spending profiles.

(2) Management structure and board composition.

(3) Liquidity arrangements commensurate with capital growth requirements before transaction closing.

(4) Hedging policies and arrangements to mitigate price volatility and to secure cash flows (currently none for PC and about 60% coverage on Suncor’s 2009 expected volumes).

(5) Resolution of legal structure, tax, contractual and regulatory issues.

Both Suncor and PC are currently rated A (low) and R-1 (low), with Negative trends (see separate press releases). DBRS expects to address the issues identified when the Negative trends were placed on PC on November 18, 2008, as a component of its review.

In the case of PC, the trend change reflected DBRS’s expectations that PC and its partners would proceed with at least the mining portion of the first phase of the Fort Hills oil sands project (60% owned and operated by PC) in some form, despite the September 2008 announcement of a 50% increase in its preliminary estimated costs. Further review of the Negative trend was to consider changes to PC’s business plan and capital spending requirements in response to the delay in the investment decision and further clarity on issues regarding the final investment decision on Fort Hills.

Key implications of the proposed merger include: (1) Combined proved reserves (after royalties) of approximately 3.3 billion barrels of oil equivalent (boe), including oil sands, and combined production (after royalties) of approximately 615,000 boe per day (boe/d) with refining capacity of 433,000 b/d as of December 31, 2008. These measures would rank New Suncor among the largest integrated oil and gas producers in North America. Production would be weighted 78% toward crude oil (87%/72% for Suncor/PC, respectively) with an estimated reserve life of nearly 16 years (26.5/8.3 years for Suncor/PC). (2) The combined entity would have greater financial resources to support substantial growth opportunities (including Suncor’s Voyageur and PC’s Fort Hills projects, both on hold), and be more broadly diversified than either of the companies on a stand-alone basis. PC would benefit from Suncor’s significant resource base and oil sands expertise, while conversely, Suncor’s concentration risk in Canadian oil sands would be greatly mitigated by PC’s international scope and strong downstream operations. (3) New Suncor would also likely benefit from operational and capital allocation synergies, going forward.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The PC Financial Partnership rating is based on the guarantee of Petro-Canada.

The applicable methodology is Rating Oil & Gas Companies, which can be found on our website under Methodologies.

This is a Corporate rating.