Small becomes big as energy goes conventional

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Takeovers, joint ventures, and initial public offerings are the splashy deals that renovate Canada's energy sector. But in 2010, the largest change in the oil patch came as a result of a string of lower profile transactions that added up to an unmatched transformation.

Energy companies, led by the majors, ditched roughly 140,000 barrels per day of conventional oil and gas production last year, an all-time high for these old-school zones, according to Scotia Capital. It was a year in which many energy outfits decided they had two choices: They could sell, opting to pursue the more expensive but lucrative unconventional oil and gas fields, or they could play the role of industry contrarians, doubling down on conventional assets.

The rapid-fire selling - led by Talisman Energy Inc., Nexen Inc., Suncor Energy Inc., Exxon Mobil Corp., and ConocoPhillips - allowed those companies to be more focused and concentrate their Canadian spending on oil sands and shale natural gas projects. Those that snagged conventional assets - Husky Inc., Canadian Natural Resources Ltd., and a slew of smaller players, some backed by private equity firms - gained critical mass.

"That kind of dramatic remaking of portfolios is unprecedented," Adam Waterous, head of global investment banking at Scotia Capital, and head of Scotia Waterous, the bank's energy advisory division, said. "You're getting a bifurcation of the large caps and their strategies."

Though some of the announcements were monstrous - Talisman sold $1.9-billion worth of conventional assets in five deals in April - the oil patch's makeover was mostly done by stealth. Moreover, because much of the market considers conventional assets washed up, those deals captured little attention - even if the end result meant that sellers had extra cash to pour into flashy oil sands or shale gas projects.

"No one transaction was a major headline grabber, but cumulatively, it was a dramatic reshaping of the landscape in western Canada," Mr. Waterous said, noting his firm was involved in about two-thirds of the total asset sales. "The pace of the restructuring surprised the industry."

The trend continues. Apache Corp., for example, recently hired RBC Capital Markets to help sell some of its conventional natural gas assets in British Columbia, Alberta and Saskatchewan.

The asset sales were, in part, fuelled by stock prices. The market, buoyed by an improving economy and a sharp improvement in the price of crude, is generally paying a reasonable price for energy companies. That has made outright takeovers, where premiums are a must, difficult, said Kent Ferguson, a managing director in RBC's energy investment banking group. So the action turned to deals for smaller properties.

While asset sales changed the face of Canada's energy sector in 2010, two of the country's largest IPOs cannot be ignored. Both were oil sands deals, and the first, a $1.35-billion debut by Athabasca Oil Sands Corp. in April, had a notable effect on its follower, MEG Energy Corp., which pocketed $700-million in July.

Athabasca's deal initially looked like a hit, with GMP Securities drumming up more demand than Athabasca anticipated. The excitement quickly crashed, with the stock falling from the IPO price of $18 to about $10 in less than two months. It has since rallied to more than $16.

Athabasca's history weighed on its performance. In 2009, the company struck a joint venture deal with PetroChina Co. Ltd. on two of its oil sands efforts - the MacKay River and Dover projects. PetroChina paid $1.9-billion for a 60 per cent stake in each of these projects, but the contract came with a twist: PetroChina has the right to buy the remaining 40 per cent of the projects if it chooses to, within 30 days of their respective regulatory approvals.

Moreover, Athabasca has the right to force PetroChina to buy the Canadian company's stakes within 30 days of their regulatory approvals. If these options are exercised it would make PetroChina the first Chinese outfit to own 100 per cent of an oil sands project - a unique position given that it is widely argued China's three state-owned energy firms have been buying smaller stakes, rather than entire projects, to make it easier to obtain government approval for their investments.

Rich partners like PetroChina usually draw in retail and institutional investors, giving them confidence that the millions of dollars necessary to fund oil sands projects will be accessible. But when Athabasca began to trade, investors were unsure of what they were buying, given the unusual structure of the joint venture. Its two main projects and its wealthy partner could evaporate within years, rival bankers noted. On the flip side, even if its projects ended up in PetroChina's hands, Athabasca could end up sitting on a fresh pile of cash.

Harris Fricker, GMP Capital Corp.'s chief executive, said Athabasca was hurt as "hot money" from hedge funds headed for the doors when the stock did not get the immediate pop they expected. Investors who owned shares in Athabasca prior to the IPO are not to blame, Mr. Fricker said, addressing the argument that those investors cashed out on the open market immediately after it went public.

"All of the shareholders were subject to a lockup by the underwriters. Then there were some shareholders at GMP and on the Street in general - they were all subject to both the underwriters' lockup and their own internal policies on lock up," he said. "There was no selling by the insiders. In fact, the management insiders were buyers." The lockup lasted six months, he said, with some investment bankers subject to even longer freezes because of their own house rules.

In addition to fleeing short-term investors, Mr. Fricker noted oil prices were under pressure and the wobbly European bond market affected the deal.

While it is difficult to pinpoint precisely why Athabasca struggled, there is no doubt it affected MEG's fundraising drive. It came up shy of its $1-billion to $1.25-billion target, with BMO Capital Markets serving as the only Canadian book runner on the deal. However, while MEG had to lower its expectations, its new shareholders were shielded from the pain Athabasca's investors faced.

The pinch, however, does not mean the oil sands IPO market is closed for business. For example, Laracina Energy Ltd., a private company with experienced management, could turn to the public markets for cash soon.

"They are set up very well to access public markets when they choose that they want to," Shane Fildes, the head of BMO Capital Markets global energy team, said. "But that is a choice right now. They have access to private capital as well as public capital.

"In the situation with MEG, they raised multiple billions of dollars privately before they accessed the public markets."