How trusts will survive

Experts count on acquisitions rather than drill bit to fuel sector; expect energy trusts to tighten screws on cash flow distributions to unit holders

Gary Park

Petroleum News Calgary Correspondent

Canada’s energy trusts will grow through deal-making rather than the drill bit, those involved in the trust sector told a Conference Board of Canada seminar at the end of May.

Although the market capitalization of the trusts now stands at C$26 billion, a 13-fold increase from 1998, the trust firms account for only 11 percent of production from the Western Canada Sedimentary basin, meaning there is ample room for expansion, said Bruce McDonald, an analyst at Canaccord Capital.

He said the trusts, aided by their low capital costs, can outperform the conventional E&P companies through both acquisition and exploration during a period of sustained high commodity prices.

Keith McPhail, chief executive officer of Bonavista Energy Trust, said one of the biggest headaches facing the trusts has been a sharp per-unit decline in production and reserves.

But he is confident the trusts are now taking measures to more efficiently replace those losses as they realize that the cash flow paid out to unit holders needs to be trimmed.

To reinforce that trend, trusts must also hire strong technical teams and provide them with undeveloped land and strategic, timely acquisitions.

Those who can achieve those ends “with the least amount of capital” will emerge on top, McPhail said.

On a broad front, he is certain trusts that combine a technical focus, low costs and reasonable payouts will survive, even if some are forced into consolidation.

Buying assets will remain key

Proven finding, development and acquisition costs for 23 junior E&P companies averaged about C$18 per barrel of oil equivalent in 2003, while for trusts they averaged C$18.50 per boe, Serin said.

However, he cautioned that finding, development and acquisition costs are an ineffective measure of value creation because they don’t reflect differences in asset quality.

The changing complexion of the trust world was commented on by Leslie Lundquist, a portfolio manager at Bissett Investment Management, who noted some of the shifts taking place.

She said Bonavista has moved to relatively low payout ratios, Vermilion Energy Trust has extended its reach to France and the Netherlands, Provident Energy Trust has acquired major midstream assets and Enerplus Resources Fund has embarked on a joint venture in coalbed methane with MGV Energy through the trust’s takeover of Ice Energy.

In addition, Enerplus along with Acclaim Energy Trust were two of the three buyers of conventional assets unloaded by Chevron Canada Resources, with Enerplus forking over C$466.3 million to gain 11,500 boe per day of production and Acclaim paid C$433.7 million for 17,000 boe per day.

Lundquist said while there is no certainty that these new strategies will succeed, they are evidence that trusts are flexible.

She said the trusts serve a valuable role in producing reserves in a cost-effective manner, waste less capital on marginal projects and put their emphasis on results, not promises.

For those reasons, exploration and production of the Western Canada basin will be more disciplined and the distribution of capital between exploration and production will become more efficient.

Mark McMurray, an acquisition specialist at Kobayashi Partners, said that as trusts enter their “mid-life crisis” they must become more involved in portfolio management and ensure that they buy only high-quality junior E&P companies to replace reserves and increase output.

He said the competition will intensify for companies that have producing properties and a string of moderate-risk investment opportunities.