Albertans have a reputation for new
investment opportunities
This article is published in the
2015 Investment Guide to Alberta's Energy Industry
It’s hard to forget the 2008 financial
crisis, when the economies of North America and Europe went into free-fall.
The world seemed to be teetering on the brink of a collapse like the one that
followed Black Tuesday—the day in 1929 when a stock market crash triggered
what became the Great Depression.
By contrast, the Great Recession that followed the 2008
event was a period in which, in Alberta, imaginative companies were able to
find opportunity.
Take the case of a partnership of four small private
companies. Starting in October 2008, during periods when the petroleum
industry as a whole was nervous about the future, the companies were among
the few bidders on parcels at many Crown land sales—the biweekly auctions at
which Alberta sells mineral rights to the highest bidders. (The informal
consortium reached an agreement by handshake.)
“For a collective payment of less than $1.4 million
[including initial rentals and fees], we acquired mineral rights of different
sizes, in a variety of geological horizons and in many parts of Alberta,”
says one of the partners, who, for competitive reasons, does not want to be
named. “Excluding lands in which others hold minor royalty interests, we
acquired more than 60,000 hectares of mineral rights.”
That was a small amount of the mineral rights sold at
auction, but he and his partners bought those lands at “a very small fraction
of the average cost of lands sold within that time frame.”
The four companies were already moderately successful;
their proprietors had been in business for 25 years or so each. But this
deal—agreed to during a period of great uncertainty—took each player to
another level. In the years following, they entered into deals where they
sold or farmed out these lands and the plays they developed to a variety of
other players, retaining residual interests when they cut the deals. By
drilling and installing production equipment, “larger entities” successfully
transformed that land into producing operations. The partners received
production royalties and cash payments, and they have since gone on to other
deals—sometimes together, sometimes solo. Of course, those partners were
operators, whose ultimate goal was to develop their own companies. Other
companies see asset sales in a different light.
Liquid assets For many years Calgary has been home
to the largest number of major head offices in Canada outside the Toronto
area, which has five times the population. Calgary is a corporate city, which
arranges finance and makes business decisions. It is a technical centre, with
an amazing array of scientific and technical
Albertans have a reputation for new investment
opportunities. It is a management city, and its seasoned executives
continually make high-stakes decisions.
A mix of characteristics have
set Calgary up for growth and increasing strategic importance in the energy
world. Within the 10 blocks that make up the business part of downtown is an
extraordinary concentration of expertise—among the largest concentrations of
geological talent in the world.
Other areas of expertise include management, legal and
accounting skills; energy finance and economics; technological development
and environmental innovation. These skills developed in an entrepreneurial
climate that takes a competitive delight in financing, exploring, developing
and overseeing production from the geologically complex Western Canadian
Sedimentary Basin.
A vibrant business environment makes Calgary one of the
most enviable cities in North America. In the past 10 to 15 years especially,
there has been significant growth in the financial sector.
Because of the success of the energy sector, not only do
most Canadian financial institutions and lenders have a presence in Calgary,
but the number of foreign financial institutions has increased steadily in
recent years. Since 2011, new members of Calgary’s financial community
include KKR & Co., Bank of China, Industrial and Commercial Bank of
China, Mizuho Bank and United Overseas Bank (UOB) of Singapore. In 2011,
Calgary was added to the list of cities eligible to be recognized in the
Global Financial Centres Index.
Economic growth in Alberta is on track to be the strongest
in the country in 2014, according to the Conference Board of Canada, and its
two largest cities are reaping the rewards.
Calgary’s real gross domestic product is forecast to reach
4 per cent in 2014. In Edmonton, the provincial capital, the economy is
forecast to grow by a nation-leading 4.9 per cent in due to continued
strength in the energy, construction and manufacturing, sectors. Edmonton is
home to the Alberta Investment Management Corporation, one of Canada’s
largest and most diversified institutional investment fund managers with an
investment portfolio of approximately $80 billion (and a desired partner by
many foreign institutional investors).
Alberta’s entrepreneurial spirit “What makes
Alberta special is its great investment environment,” says Malcolm Adams, a
senior vice-president at Annapolis Capital. “There’s a fantastic
entrepreneurial spirit in western Canada, and good royalty structures. In the
Western [Canadian] Sedimentary Basin, there are opportunities for all kinds
and sizes of companies.”
Annapolis, which invests exclusively in Canadian energy,
has a pragmatic approach to asset liquidity. “We don’t invest in service
companies or the midstream, where we don’t have a lot of expertise, or in the
capital intensive oilsands,” Adams says. “We do put investment money into
companies that are doing unconventional tight oil and shale gas…that kind of
thing. “The best investments you can find are companies capitalized in the
$50 million to $150 million range. As an investor we can help those companies
grow, and might have somewhere in the range of $150 [million] to $400 million
in value some years down the road.”
There is also a big market for the “de-risked assets” that
result. “To achieve an annual 20 per cent rate of return for our investors,
we take a bit more risk at the front end than those bigger organizations are
willing to take,” Adams says.
As the eight to 12 companies in a portfolio grow,
Annapolis sells interests to bigger entities. Of course, the market for
assets within Alberta “ebbs and flows,” according to Adams. “We had six
realizations last summer. It was maybe 18 months since our previous
realization.”
Waste to wealth In one investment area,
Alberta is unequalled in the world. That is its approach to greenhouse gases
(GHGs), the inevitable by-product of oil and gas production.
Alberta’s Specified Gas Emitters regulation identifies
companies that emit more than 100,000 metric tonnes of carbon dioxide
equivalent per year. Those companies are required to reduce their emissions
below baseline levels, through continuous improvement, buying offsets or
emission performance credits from other emitters, or by paying $15-per-tonne
emitted into the Climate Change and Emissions Management fund. “Or they can
do all of these things; it is up to them to decide how they want to pay the
bill,” says Kirk Andries, managing director of the Climate Change and
Emissions Management Corporation (CCEMC). Such a funding arrangement is
possible because the large emitters are responsible for 70 per cent of
Alberta’s emissions.
In turn, CCEMC runs global competitions to find and fund
ideas that have the potential to make real reductions in carbon emissions for
the benefit of all society. It doesn’t take long to recognize that as a
transformative investment idea.
“We have invested about $230 million in 90 projects, yet
their total value is about $1.6 billion,” Andries says. “Our money is leveraged;
on average, for every dollar we spend we get $5–$6 of return. Ours is risk
capital, and it is mostly put into projects that would not occur without our
funding. We support transformative technologies that can deliver meaningful
[GHG] reductions.”
“From the GHG perspective, the reduction potential from
all the projects we have funded is more than 20 million tonnes by the year
2020,” he adds—a number he says, is generated at the project level. “When the
technology itself is commercialized and then broadly deployed in Alberta and
anywhere else, we expect a much greater reduction.”
These numbers continue to grow with the issuing of
annual Grand Challenges and bi-annual expressions of interest for funding of
the next big GHG reduction idea. “Alberta isn’t the only jurisdiction with
this kind of technology fund, but we are the only technology fund supported
with these types of regulations,” Andries says.
Look at the long term In the fall of 2014,
global oil prices had just gone through what the business press frequently
called a “price collapse.” These price declines followed half a dozen years
in which international oil prices averaged nearly $100 per barrel. In real
terms, that is one of the longest periods of higher oil prices on record. Of
particular interest, Brent crude—an international standard, based on oil
production from Europe’s North Sea—was higher-priced than WTI, the most
important North American benchmark.
These prices made heavy oil and oilsands projects quite
profitable, but they also made tight oil production profitable and
competitive. Fracking projects were releasing natural gas and condensate in
large volumes, profitably, and the oilsands sector was providing the market
with more complex hydrocarbons—resources with uses for both fuel and
petrochemicals.
For the first time in many
decades, North America had excess production and was looking for ways to
export petroleum and its products on a large scale. However many factors led
to a rapid decline in oil prices beginning in October 2014. How significant
was that for continued project growth?
According to Ziff Energy’s Bill Gwozd, “What is really
important is the price over the next several decades. Construction on the
projects that we are working on won’t even start until 2019, say. They won’t
be going on production until 2023, and then they’ll produce for maybe 40
years. What you care about is the median price, maybe three decades forward.”
Of course, not everyone shares the same view: an executive from Cenovus, for
example, says lower prices have an impact on a company’s ability to invest.
According to executive vice-president Dan
Allan of the Canadian Society for Unconventional Resources, the resources in
the province are such that, although price declines will not seriously affect
long-term development, they can affect capital markets.
“Rates of return dictate the business,”
he points out. “If margins start to thin out, capital goes elsewhere. That is
reality in the financial sector. Certain projects being considered for
mezzanine financing, for example, are now going to be marginal or at least
less attractive.”
But then Allan’s infectious optimism—an
optimism that is evident throughout Alberta—kicks in. “I have been around
long enough to know that we always find a way,” he says. “We go somewhere
else with a different product. It might be light tight oil; it might be
liquids-rich gas. We go to the products that provide the highest rates of
return, while we let other assets sit idle for a while until circumstances
change. When it becomes difficult to attract capital on one side of the
equation, an opportunity opens up on the other side. That is how markets
correct themselves.”
As Allan observes, “it is the nature of
markets to change.” For example, at the beginning of 2013, it was
difficult for some companies to raise money. As the year progressed, however,
that changed. “The right assets with the right management teams got in favour
again because people were feeling more comfortable about the prospects for
success in some of these projects; capital started to flow back in. Capital
flows are robust, and that is a good thing.”
To cite one example, Ziff Energy—the company Gwozd works
for—does “two things for a living. We have an E&P [exploration and
production] services group, and we have a natural gas group. Our E&P
services group has national oil companies as clients, intermediate oil
companies, private companies, public companies, small producers, big producers,
onshore producers, offshore producers” in 70 countries around the world.
“The most important thing we do is to benchmark operating
costs. For example, when you are drilling an offshore well, you need
materials and unique services. You may need chemicals such as glycol. For
similar operations, the Gulf of Mexico versus Indonesia, for example, your
annual glycol costs may represent $1 million in one area and $10 million in
the other.” Because his firm has so many clients, its database enables it to
quickly benchmark minute operating costs. “We help our customers understand
that in some areas they are very efficient, while in others there is room for
improvement,” he says. “By benchmarking you get best practices, and you drive
your operating costs down.” That’s one part of Ziff’s business.
The other is its forecasting group, which uses
sophisticated tools to forecast energy prices to the year 2050.“We forecast
gas supply, gas demand, gas transportation, gas pricing, cost of gas. We
forecast the decline rate of new shale gas plays in the Marcellus in the year
2029. We are interested in at least a 30-year spectrum—say, the price of oil
from 2017 to 2047; 2032 is the midpoint. The same with LNG projects: the
relevant time period is 2020-50. That is how you build your economics.” He
returns to the question of price declines. “Today’s price has no relevance
for big, mammoth projects.”
