Commodity prices, interest rates and the value of the Canadian dollar could all be factors in the future direction for Canada’s energy trusts.
But those unknowns aside, there is a growing consensus that trusts can no longer simply buy assets to sustain production at their current combined level of about 750,000 barrels of oil equivalent per day, they must also explore.
For those who resist that pressure, consolidation may be their only option.
The most dramatic change in the management of trusts has been the swing from acquisitions to exploration.
Through the 1990s, as the trust sector was embarking on its growth phase, unit holders grew accustomed to receiving 95 to 100 percent of a trust’s cash flow.
Those payouts have now dipped below an average 70 percent, although some trusts are clinging to the traditional cash distribution ratio.
In a recent report, trust specialists Brian Ector and Grant Hofer of Scotia Capital said sustainability for trusts “means mitigating declines on a reserves-per-unit and production-per-unit basis.
“Sustainability means a shift toward lower payout ratios to fund capital development programs and ultimately being less reliant on the equity market.”
Finally, they warned: “Sustainability means being well positioned to withstand a downturn in commodity prices.”
Colborne: trusts headed for consolidation round
Paul Colborne, president and chief executive officer of StarPoint Energy, believes that regardless of how much money is put into exploration and the direction of commodity prices, the 35 trusts established over the last decade are headed for a significant round of consolidation.
It will be survival of the strongest, he told a Conference Board of Canada exploration management forum in Calgary earlier this month.
Trusts with higher cost structures, steeper reserve decline rates, over-leveraged balance sheets and inadequate hedging programs are doomed, he suggested.
Colborne has been through all phases of the trust evolution, selling a conventional E&P company to a trust for C$500 million and being involved in the creation of junior exploration companies (known as explorecos) that have been spun-off from larger takeover/acquisition deals.
He has created an estimated C$1.1 billion for investors in his junior companies over the past decade, lending weight to his claim that “we deliver on our goals.”
Theal: survival may hinge on lower distribution
Chris Theal, head of institutional research at Tristone Capital, told the Conference Board forum that survival for trusts may hinge on them distributing only 50 to 60 percent of their cash flow to unit holders, down from the 80 percent that is common today.
He also noted that junior E&P companies now typically last less than two years, with 34 of the 50 juniors that entered 2004 now swallowed up in various deals.
The most conservative category of trust reserves is described as PDP — proved, developed producing — which demand a high level of confidence that they actually exist in the quantities estimated.
Of the 20 trusts tracked by Scotia Capital, the average PDP reserve life index is 5.7 years, led by Enerplus Resources Fund at 7.7 years and ARC Energy Trust at 7.5 years.
Ector and Hofer say their analysis shows that “reserves per unit have declined sharply over the past few years,” with their group of 20 trusts posting an average annual decline of 17 percent from 2001 through 2003.
Production per unit declined an average 11 percent a year, the analysts reported.
They said the challenge for trust management is to “mitigate these declines in order to generate incremental value for unit holders.”
