Wednesday, October 31, 2007

“Halloween massacre‘‘ still horror story for oilpatch one year later

TORONTO _ Major oil patch players say Finance Minister Jim Flaherty‘s “Halloween massacre‘‘ has turned into a full-blown horror story a year later, with oil and gas income trusts more prone to foreign takeovers and less able to access capital.

“We‘re not just a bunch of spoiled brats concerned because a toy has been taken away. This is something that is an enormous mistake,‘‘ said John Dielwart chief utive of Arc Energy Trust.

Dielwart, whose company was among the first to adopt the popular investment model, has been one of the most vocal opponents to Flaherty‘s plan to impose a 31.5 per cent tax hike on income trusts by 2011.

Dielwart said Flaherty made a big mistake in interfering in capital markets, which helped a $100-billion energy trust sector.

“It wasn‘t a gimmick, it wasn‘t based on artificial tax advantages. It was based on a very solid business model,‘‘ he said. “This was, if not the optimal model, it was pretty darn close.‘‘

Eilat warns that Canada‘s oil and gas sector _ owned and operated and run by Canadians _ will get back into foreign control “and I don‘t think anybody wants that.‘‘

One key example is PrimeWest Energy Trust, which Abu Dhabi-based state-owned energy firm TAQA is proposing to take over for $5-billion.

“We‘re going to see a lot more of them fall into foreign hands,‘‘ said Ross Freeman, a partner in Calgary‘s Borden Ladner Gervais LLP, but he adds that most of the activity won‘t happen until the four-year grace period comes to an end.

“The vast majority of the royalty trusts are still out there. They‘ve hung in there. They‘re trying to take advantage of the remaining grand fathering period. But they‘re under increasing pressure to do something and certainly there‘s a lot of pressure from overseas,‘‘ Freeman said.

He says the biggest losers from the income trust decision have been junior producers.

“Killing income trusts was a very, very severe blow, not just to the income trusts themselves, but to the whole junior sector, and that‘s where the impact, I think, was grossly underestimated by a lot of people,‘‘ he said.

With the weakening of that structure, juniors are getting less investment and fewer are being “gobbled up‘‘ by other trusts.

“The amount of financing the juniors were able to be doing just crashed. They just couldn‘t get investors any more,‘‘ Freeman said.

The majors, on the other hand, are doing ok, he said.

“They were never in the model of distributing their cash flow. They were not a yield investment. Even the very largest ones pay only very modest dividends. So clearly they‘ve been the winners of all of this.‘‘

They majors have also done well in the face of the income trust decision because it‘s brought their operating costs down, Freeman said. The cost of drilling has plummeted by more than 50 per cent over the past year, leading to the creation of far fewer wells.

“From an oil and gas company‘s perspective, that‘s a positive, it‘s cheaper to drill. Not so good if you‘re a drilling contractor,‘‘ he said.

Les Stelmach, an analyst with Bisset Income Fund agrees larger players may not have so much to lose in the short term.

“They‘re large, they have diversified asset portfolios, so they‘re less sensitive to changes in commodity prices or changes to royalty rates. They‘re certainly a viable business 2011. For smaller trusts, they, too can be very viable,‘‘ Freeman said.

He says smaller energy companies can also remain viable if they carve out the right course.

“The crux of the matter is they can‘t pay as much for property so they‘re less likely to be as acquisition focused as they were in the past,‘‘ he said, adding producers that have carved out specific niches will do better than ones that rely solely on acquisitions.

As the chief of one of the so-called “majors,‘‘ Dielwart said he disagrees that the bigger companies aren‘t taking as much of a hit. He said his company saw a 25 per cent decrease in capital from pre-Oct. 31, 2006 levels.

He also takes issue with the argument that values have somewhat recovered since the initial blow. Arc Energy units are trading about $7 below what they were a year ago, which Dielwart blames on the income trust decision.

“One one who suggests that values have recovered are just not doing their homework,‘‘ he said.

Meanwhile, ripples are being felt south of the border, too.

A Chicago couple, saying Flaherty‘s move has cost Americans and Canadians billions of dollars in lost investments, is using a provision of NAFTA to challenge the Conservative government‘s move.

“The Halloween 2006 income trust decision by the Government of Canada has had a massive financial impact on thousands of investors in Canada and the U.S. and we believe that it breached Canada‘s NAFTA obligations,‘‘ Marvin Gottlieb said in a statement Tuesday on behalf of himself and his wife.

“Because of this decision, more than $30 billion has been lost by individual investors in Canada and more than $5 billion has been lost by energy trust investors, including Elaine and me, in the United States.‘‘

Source: Oilweek Magazine - Canadas Oil and Gas Authority