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Canada’s trusts, juniors in a bind Pending final legislation on their tax status, Canada’s income trusts struggling to attract investment; fallout impacting smaller firms Gary Park For Petroleum News
Income trusts are stuck in a holding pattern in Canada, with a spillover to the junior sector.
Pending final legislation on their tax status, trusts are both struggling to attract investment and attempting to stay flexible to react to whatever the Canadian government imposes, said Enterra Energy Trust Chief Executive Officer Keith Conrad. As a result, the “farm system” of junior E&P companies is partly frozen — unable to convert to trust ranks or be acquired by trusts.
In its latest quarterly survey, Bryan Mills Iradesso, a communications company, found that share values of 85 junior firms — generally seen as those producing less than 15,000 barrels of oil equivalent per day — have tumbled by 12 percent this year.
That follows a 32 percent decline in 2006 when the juniors took a pounding from the fall in natural gas prices.
These and other elements are taking a toll on upstream activity, contributing to the quietest drilling spring in many years and expectations of more to come in the summer, with hopes now pinned on a recovery in the fall as gas supplies start to tighten.
Conrad said Enterra is waiting for details of the tax changes before deciding whether to rejoin the conventional corporations.
“Until such time as we know what the rules are, it’s pretty hard to take that next step,” he said, reflecting the mood across the trust spectrum.
The uncertainty along with the slump in gas prices, higher production costs and rising administrative and interest costs pushed Enterra into the red, posting a first quarter loss of C$62.8 million, forcing it to cut its monthly cash payouts to unit holders in half.
Trust financing now takes longer Menal Patel, an oil and gas analyst with National Bank Financial, said that since Canada’s Finance Minister Jim Flaherty made his bombshell announcement on the future of trusts last October, trusts find that financing deals they once arranged in 30 minutes can now take four weeks.
He said the time needed to raise capital is likely to become a key factor for trusts in deciding whether they should return to the corporate world, especially for those trusts that find they are simply unable to raise the equity for acquisitions.
In addition, Patel noted that the corporate tax rate is lower in Alberta than the expected new trust tax rate. “So why stay a trust?” he asked.
Despite the uncertain outlook, some trust leaders intend to stay the course until 2011, when the new tax rules take effect.
At that time, they will weigh several options, such as converting back to a corporation or adopting the U.S.-style master limited partnership, said Gordon Kerr, chief executive officer of Enerplus Resources Fund.
Bill Andrew, chief executive officer of Penn West Energy Trust, said his trust’s tax pools allow it to continue unchanged until 2014.
Michael Culbert, chief executive officer of Progress Energy Trust, said there is enough value for Progress unit holders to stick with the current structure until the 11th-hour “when we will look at all sorts of different structures that might make sense.”
Notwithstanding some recovery in gas prices, junior E&Ps producing less than 5,000 barrels of oil equivalent per day are having a tough time attracting enough attention to raise money for exploration.
Andrew Boland, an analyst with investment bank Peters & Co., said many of the small companies are “completely out of favor” because of the strong Canadian dollar, rising upstream costs and low levels of growth.
He expects the end result will be a flurry of mergers and acquisitions this summer.
The only slight positive to emerge from under the pile of negatives is that the drilling downturn has helped drag down rig costs by as much as C$4,000 per day, but that break is expected to be short-lived once activity rebounds.
Finding the cash a challenge Duncan Robertson, a principal with market consultants SBM, told an investment symposium June 19 that borrowing or selling shares to raise cash is difficulty given the shaky outlook for gas prices over the next six months.
Although many smaller companies are living in hopes of a rebound in the upcoming heating season, nothing is certain and they could in fact be faced with further price softening this summer “based on the fundamentals,” he said.
Hot weather and hurricanes could affect prices, but there is also the risk of record storage inventories by September, Robertson said.
For now, he said there is evidence of “little guys chewing up their balance sheets by taking on a lot of debt,” adding that because drilling costs haven’t fallen as much as gas prices over recent months “margins are getting squeezed.”
Even so, industry veterans are reaching for the panic button.
Cinch Energy President George Ongyerth conceded “it can get scary at times, (but) our focus has never varied. We’re focused on growth through exploration.”
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