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Ottawa’s new foreign takeover rules will likely trigger negative reaction from investors towards oil sands firmsAndy Wong/The Associated Press

Ottawa's decision to block future oil sands takeovers by state-owned firms will roil Canadian stock markets Monday, with shares in smaller oil sands producers taking the biggest fall, market watchers say.

The move by Ottawa thins out the pool of potential buyers – particularly the state-owned enterprises whose investments in Canada have been growing at the fastest pace in recent years, and which have paid hefty takeover premiums. The new rules dispel any lingering hope of a takeover premium fuelled by acquisitions by state-owned enterprises.

"In the short term I'm sure there will be negative reaction" that will likely drag down the shares of oil sands-focused Athabasca Oil Corp., Meg Energy Corp., Connacher Oil and Gas Ltd. and Southern Pacific Resource Corp., said BMO Capital Markets analyst Randy Ollenberger.

He expected the shares to trade down by 3 per cent to 5 per cent Monday compared to peers in the oil and gas sector.

"These are the four that investors would think to some degree have potential to be taken over" by SOEs, Mr. Ollenberger said. Rule changes announced Friday by Prime Minister Stephen Harper – as he approved takeovers under the old rules of Nexen Inc. and Progress Energy Resources Corp. by a Chinese and a Malaysian SOE, respectively – "don't make it impossible, just tougher."

But it's far from clear that the effect of Friday's decision will be strictly negative. The new rules will be "negative for smaller firms because it will be harder for them to find capital and harder for them to sell themselves," – but could also be positive for larger firms in reducing their competition for assets, said David Simon, chief executive of New York hedge fund Twin Capital Management Inc.

And Rob Lauzon, a managing director at Middlefield Capital Corp., said he expects Canadian energy stocks to hold steady, in part because investors dumped perceived takeover targets in October when Ottawa initially rejected the Progress deal. One stock he expected to do well is Calfrac Well Services Ltd, which does much of the hydraulic fracturing drilling work for Progress now, and will likely benefit from more work once Petronas takes over.

The policy change could also benefit larger firms in the oil patch such as Suncor Energy Inc., Cenovus Energy Inc.and Canadian Natural Resources Ltd. by keeping rising costs in check. "You'll see less pressure on capital costs with not as many state-owned enterprises trying to push projects along as fast in what is already an overheated environment" and bidding up costs, said a senior Canadian energy investment banker who spoke on condition of anonymity. "For these companies in the long run, it's positive."

Todd Hirsch, a senior economist with ATB Financial, added: "It could turn out that this is just kind of a nice, moderate that you don't see the overheated labour market and costs sky rocketing because everyone is trying to plow their project through at the same time."

Meanwhile, observers now expect several western Canadian energy firms, including Talisman Energy Inc., Encana Corp. and Athabasca to proceed with joint venture deals, possibly with state-owned enterprises, after the government said it welcomed such deals so long as control doesn't pass to foreign states. The three companies have been pursuing joint ventures, but are believed to have been waiting for Ottawa's new guidelines on foreign investments before proceeding.

But the rule changes also left some worried that foreign investors as a whole – not just SOEs – would cool on Canada's resource companies. "I certainly think valuations should come down after this," Laura Lau, senior vice-president and portfolio manager at Brompton Funds in Toronto, said. "Any foreign company that wants to come to Canada is going to have to rethink everything. It does chill the investment atmosphere, there is no doubt about that."

It also leaves many wary of the government's future policy moves. If SOEs embark on a brisk pace of joint venture deals here – as the government is now encouraging – that could spark a clampdown as well, warned Mr. Ollenberger. "You can't assume you can just do an endless number of joint ventures."

Meanwhile, George Toriola, an analyst with UBS Securities in Calgary, said the natural gas sector, which is also hungry for capital investment from foreign sources, "will probably be the next place the government starts scrutinizing."