Sayer: 'Stiffer competition' could force RITs to search outside Canada for growth

By OGJ editors

HOUSTON, May 1 -- "Stiffer competition among oil and gas royalty income trusts (RITs) for Canadian oil and gas assets could force RITs to search internationally for acquisitions and growth opportunities," according to Frank J.D. Sayer of Calgary-based Sayer Securities Ltd.

In the last 3 years, the number of trusts in Canada has risen 77% and over the same time period acquisition prices also have increased—by 32%—which has caused "some RITs to search out every opportunity for assets that are more easily available and lower priced," Sayer said.

The acquisition of public oil and gas companies by RITs has been one of the major drivers behind the growth of trusts, Sayer noted. "For the 3-year period 2000-02, RITs purchased $7.9 billion in Canadian oil and gas assets and companies, of which 50% were public 'midtier' oil and gas companies" with a market capitalization ranging from $100 million to $1 billion, he said, adding that in the last year, four of these intermediate-sized firms were acquired by RITs.

Frequency decline
The frequency of these transactions, however, is declining, Sayer observed. "In addition to the four that were purchased, another three of the midtier companies reorganized themselves into trust structures in 2002." Another three companies this year revealed their intentions to convert into RITs, Sayer said. These include Bonavista Petroleum Ltd. and Peyto Exploration & Development Corp., both based in Calgary.

The purchases of these midtier companies—as well as the reorganizations—has led to only 18 remaining, Sayer said, adding that this number might continue to decrease amid press rumors that some companies, such as Calgary-based independents Baytex Energy Ltd. and Compton Petroleum Corp., also plan to convert into RITs. "This dwindling supply of acquisition targets will make it difficult for trusts to maintain their asset base," Sayer noted.

"As the number of RITs increases, the amount of acquisitions they need to do just to maintain flat production is increasing," Sayer reported. Conventional RITs are currently collectively producing roughly 480,000 boe/d, he said.

With a total enterprise value of about $18 billion as a group, RITs will have to replace about $3.6 billion/year in assets just to "maintain their current size," Sayer calculated. "As of the end of the first quarter of 2003, there was an estimated $2.6 billion in oil and gas assets and companies publicly available for sale in Canada. However, not all of these assets are the type that RITs prefer, long-life reserves with a predictable production profile," he added.

"Escalating oil and gas prices in 2002-03, the high demand by RITs for oil and gas properties, and the lack of supply of assets and companies for sale has led to soaring acquisition prices in the Canadian (mergers and acquisitions) market," Sayer said.

Lowering costs
"One way RITs can lower their cost of reserve additions and grow without going international," Sayer suggested, "is to aggressively develop the assets they currently possess." This would include the drilling of low-risk development opportunities and the farming out of undeveloped land for a portion of any production developed, he said. "Canadian trusts," however, "have not historically received most of their new production from these sources," Sayer noted.

He added, "If drilling it up doesn't offset the decline or provide growth, and the amount of assets for sale in Canada doesn't increase, RITs would have to be like all the other large Canadian companies that went multinational for growth, such as EnCana Corp., Nexen Inc., and Talisman Energy Inc.," all based in Calgary. "In the case of trusts, they would tend to go to countries which are politically stable and where country risk is minimal. Countries or regions such as the US, Australia, and Western Europe could be ideal areas," Sayer said.

"The US could be a unique area to focus on because five trusts currently have their units trading on American stock exchanges, and American investors may find an RIT more appealing if it has assets in their country," Sayer explained.