|
Royalty trusts suck capital from Canadian exploration, development Trust ‘frenzy’ may have cost drilling contractors C$2 billion, says chief executive officer of Precision Drilling, but some observers expect wave will eventually break up Gary Park PNA Canadian Correspondent
The parade of mid- and small-sized E&P companies converting themselves into royalty trusts, to an eager response from investors, has produced a grim downside in the drilling sector.
Hank Swartout, chief executive officer of Precision Drilling Corp., said Nov. 5 that the “trust frenzy” has slashed annual spending on oil and natural gas exploration and development by C$1.2 billion to C$2 billion a year, cash that would otherwise have been spent on drilling that is now going directly to trust unit holders.
Reinforcing Swartout’s concerns, the Canadian Association of Petroleum Producers has estimated that 89.7 percent of cash flow from the Canadian industry was reinvested in 2001, down from highs of 146 percent in 1998 and 122.7 percent in 1997.
Roger Soucy, president of the Petroleum Services Association of Canada, told a panel Oct. 30 his sector estimates the trusts will take about C$1 billion out of circulation this year.
Trust squeeze mature assets
The trusts are created to squeeze the last drop out of mature assets and, by keeping overhead to a minimum, they distribute 90 percent or more of their cash flows to investors, some of whom have been reveling this year in returns as high as 20 percent.
The trend has been further compounded in recent months with trusts swooping on start-up junior E&P firms. As a result the sector’s market capitalization is now close to C$10 billion while trusts make up about 20 percent of the top 35 publicly-traded oil and gas producers in Canada.
Swartout delivered his warning just a day after Vermilion Resources Ltd., which grew in nine years from a C$200,000 initial investment to a market capitalization of C$600 million, rolled 94 percent of its producing assets into a trust, ending a week of speculation that saw its share value soar 44 percent amid rumors that the trust move was imminent.
As a result, Vermilion will channel 13,800 barrels per day of oil and natural gas liquids and 63 million cubic feet per day of gas into its new trust, while creating Exploreco with 1,500 barrels of oil equivalent per day from Vermilion’s northern Alberta properties and 275,000 of undeveloped land to start out as an exploration-focused unit.
Some believe frenzy will end But not all industry leaders expect the “trust frenzy” will continue indefinitely.
Daniel Allan, chief executive officer of CanScot Resources Ltd., a junior E&P outfit, argues that at some point the trusts will “have their day ... someone is going to have to find oil and gas.”
Al Hamilton, an analyst with First Associates Investment, said the trust phenomenon could taper off once interest rates start rising and commodity prices slide.
In the meantime, Jim Welykochy, with Jennings Capital Inc. of Calgary, said there is an upside, with the trusts attracting investors who might otherwise bypass the oil and gas sector.
| 