Canada enters new, undefined era; observers, analysts speculate on energy sector’s direction, trusts

Tristone Capital, an investment banker and global energy advisor, is talking about a “New World Order” in the Canadian energy sector.

Peter Knapp, president of junior investor relations firm Iradesso Communications, is predicting a “changing landscape.”

RBC Dominion Securities doubts publicly traded energy trusts will survive beyond 2010, leaving themselves vulnerable to a wave of takeovers in the next four years.

It’s all part of the attempt by observers and analysts to figure out where the industry is heading as trusts deal with the impending loss of their tax-free status in 2011.

But not all are ready to write off trusts.

Now that the Canadian government has issued guidelines that allow trusts to double in size between now and 2011 there are even some who think the rules leave the door open for trusts to grow by more than 100 percent.

Peter Slan, an investment banker at Scotia Capital, is one of those who believe the rules allow trusts to issue new equity (up to 40 percent of market capitalization in 2007) to pay off their debts without that equity counting as part of the limits to growth imposed by the government.

Slan told the Calgary Herald the “rules apply to growth through equity financings, but they don’t apply to growth through debt financings.”

Companies could eliminate debt, then reload

However, the Department of Finance has cautioned that the strategy can be deployed only once.

The downside, even if the tactic is legal, is that trusts would be replacing debt carrying an interest rate of 6 percent with new trust units that carry a 13 percent yield.

Whatever the merits of that debate, assuming there is a “New World Order” in the making, how might it unfold?

There could be an early reversal of roles after years of trusts paying premium prices to swallow the assets of junior E&P companies once they reached a production plateau of about 10,000 barrels of oil equivalent per day.

The trusts could, instead, now find themselves prey for juniors, who can once more aspire to intermediate ranks as the playing field is leveled.

Knapp said in mid-December that a decline in the market value of both trusts and junior companies, which he noted was under way even before the government’s trust taxation announcement, had created “some investment opportunities for those prepared to look beyond the short-term uncertainty.”

He said companies and trusts backed by strong management teams, good assets and less-levered balance sheets have better prospects of thriving regardless of the regulatory or commodity price environment.

Tristone Managing Director of Investment Banking Brad Hurtubise told the Globe and Mail he expects the transition market will regain momentum as opportunities to acquire smaller assets resumes.

The Tristone report said that juniors, whose equity is highly valued by investors, are best positioned to grow rapidly because “they are the likely acquirers,” said analyst Chris Theal.

There could also be fresh opportunities to buy assets being spun off by trusts that engage in sector mergers.

Companies with strong drilling prospects may be in demand

Two companies high on that list, according to UBS Securities Canada, are Duvernay Oil and Real Resources, each of which has more than 1,000 identified well sites.

Real Chief Executive Officer Lowell Jackson, whose company is building its output from 11,600 barrels of oil equivalent per day to 14,500 boe per day, is a firm advocate of growth through the drill bit, even when volumes hit 20,000 boe per day. Without that growth companies are doomed to stall, he believes.

For many juniors, growth is not an end in itself unless they can see an exit strategy.

Josef Schachter, president of Schachter Asset Management, has no doubt that companies climbing to production levels of 30,000-40,000 boe per day and having assets in several concentrated areas will be attractive prospects for many companies, including senior Canadian producers.

—Gary Park