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Providing coverage of Alaska and northern Canada's oil and gas industry
May 2007

Vol. 12, No. 20 Week of May 20, 2007

Trust deals point to consolidation

Merger ends a 6-month trust-on-trust drought; analyst counting on more share-swap transactions, pending release of tax-change regs

Gary Park

For Petroleum News

Held back for the past six months pending the release of new federal tax rules, the dam is starting to break for Canadian income trusts, setting off a possible flood of mergers and acquisitions.

Although the Canadian government has yet to spell out the details of its plans to start taxing trusts like normal corporations in 2011, some in the trust sector have apparently decided they can no longer wait.

Ending a six-month lull since the government broke its promise to leave trusts alone, two trust-related deals surfaced in quick order this month — one sees the merger of PrimeWest Energy Trust and Shiningbank Energy Income Fund to create a new entity with a market value of about C$2.5 billion and the other saw Provident Energy Trust acquire Capitol Energy Resources for C$457 million cash and assume debt of C$41 million.

The PrimeWest-Shiningbank deal involves a stock-swap valued at about C$1.25 billion to create Canada’s fifth largest producing trust, with output of 66,000 barrels of oil equivalent per day, 70 percent of it natural gas.

However, the two trusts expect to unload some of their non-core properties, with the combined operation (which will carry the PrimeWest name) exiting 2007 at 59,000 boe per day.

The assets include proved and probable reserves of 280 million boe and 1.1 million net undeveloped acres in British Columbia, Alberta and the Williston Basin of North Dakota, Montana and Wyoming.

Tims: wave of consolidations imminent

The transaction may reinforce the prediction of Michael Tims, chairman of Calgary-based investment dealer Peters & Co., that with many trusts trading at 20 percent below their value when the government decided to remove trusts form their tax shelter, a wave of consolidations is imminent.

He told a Conference Board of Canada seminar May 7 that despite the trust sector’s weakness, the failure by trusts since the tax announcement to embark on takeovers resulted from lingering concerns over the pending tax-change rules and a feeling that, regardless of their ample cash, conventional producers are unwilling to consider buying back assets they previously sold to trusts.

Even so, Tims is betting the number of Canadian trusts will decline, more through share swaps (matching the PrimeWest-Shiningbank transaction) than cash deals.

John Brussa, an attorney with the Calgary firms of Burnet, Duckworth & Palmer, suggested to the seminar that trusts may start putting their assets into privately held trusts which would in turn be held by publicly owned trusts.

He said that U.S.-based master limited partnerships may also start moving into the Canadian oil and gas industry.

Brussa said a U.S. limited partnership listed on U.S. and Canadian exchanges could acquire and operate Canadian oil and gas assets in combination with a Canadian private trust.

McDonald: many willing players

Bruce McDonald, an analyst with Canaccord Adams, said there are many willing players in the M&A market now that trusts — in a fallout from the change of government policy — are experiencing difficulty raising capital to fund acquisitions of their own.

He told the Financial Post some of the large-cap trusts may be ready to throw in the towel by using economies of scale to get together with another trust in the same league.

But FirstEnergy Capital analyst William Lacey questioned the value of merging just to produce a stronger balance sheet and improve the chances of raising debt or equity.

He argued that just being bigger creates its own problems, noting that a trust producing 20,000 bpd has to replace 4,000 bpd of production annually to sustain output, while one pumping 60,000 bpd has to find 12,000 bpd.

Lacey praised the leadership of PrimeWest for shifting the focus from acquisitions to internal development.

However, PrimeWest Chief Executive Officer Don Garner said that under the federal tax transition rules the enlarged PrimeWest has a C$4.8 billion ceiling on future deals, leaving “a lot of room for growth.”

For now, he said the merged entity will offer more financial flexibility, lower debt levels and an expanded development portfolio, while moving PrimeWest towards a business model where future development capital spending and distributions are expected to be financed with funds flowing from operations and still allowing the payout to unit holders of 60-75 percent of cash flow.

Whatever conditions the government imposes, the initial anger among trusts and pledge to spend C$10 million on a public lobbying campaign has gone quiet.

Unit holders urged to voice objections

Typical of the new mood, Andrew Wiswell, chief executive officer of NAL Oil & Gas Trust, urged his unit holders to continue voicing their objections to government, while conceding the government is unlikely to change its mind.

He did not “dispute the fact that (the government) had to change the world so that not everybody was going to be an energy trust next week. … What I do (say) is that it was ill thought out based on faulty logic and there was a better way.”

Trust leaders hammered home those points in a dinner meeting with Finance Minister Jim Flaherty.

In the meantime, he said trusts are exploring their full range of options, including simply remaining a trust, or securing private equity or converting to an Alberta-based corporation.

“But we don’t have (the federal tax) rules and we don’t even have final understanding in legislation as to what’s going to happen,” Wiswell told NAL’s annual meeting.

While most trusts seem bogged down, others are pursuing fresh opportunities, such as Vermillion Energy Trust, which announced that a wholly owned subsidiary has exercised a pre-emptive right to acquire an interest held by Wandoo Petroleum in Western Australia’s Wandoo field to gain a 100 percent operated interest.

The US$125.4 million transaction will boost Vermillion’s production from the field by 3,000 boe per day and add proved plus probable reserves of 10.1 million barrels of oil.

Vermillion has set the pace for trusts branching outside their domestic base. As well as Australia, it is France’s largest oil producer and has gas production in the Netherlands.






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