It’s a shaky time in Calgary. In this high-cost, low-certainty energy game, some oil and gas producers are still thriving. But many others are not.
Are people worried? You bet. But not Paul Colborne.
He is a guy who has weathered a cycle or two. About 35 years ago, Colborne, now 48, moved to Calgary from Ontario. He started his career as a lawyer but has since become known in this town for his knack for creating energy ventures.
In fact, few can lay claim to more experience in, or knowledge of, oilpatch independents. In 1993, Colborne and a small team founded Startech Energy Inc. and grew it to an intermediate oil and gas exploration and production company. As president and CEO, he led the company until 2001, when it was acquired by ARC Energy Trust for $485 million. Since then, he has led companies such as Crescent Point Energy Trust and StarPoint Energy Trust. Today, he is chairman of TriStar Oil & Gas Ltd. (TSX: TOG), sits on Crescent Point’s board, and with some friends runs a private energy company called Star Valley Oil & Gas Ltd.
He recently spoke with Canadian Business Calgary contributor Michelle Magnan about energy stock performance, why the Alberta energy industry is fragile, and how his hedging strategy sometimes garners laughs.
CB: The junior oil and gas companies have been taking a real beating, but the senior producers seem to be doing better than ever. Why is there such a difference in their stock performance?
Colborne: I’d say the main difference is people are scared. There’s a liquidity premium for the senior companies right now. The reversal of the trust taxation rules, the threatened and soon-to-be implemented costs of carbon taxing, and now, recently, the government saying they’re going to look at royalty rates—that’s like a triple whammy against our industry. That’s caused a fear in investors. A lot of them have either left the sector or they’ve gravitated to the large-cap companies. You’re seeing the senior companies like the Huskys and EnCanas at all-time highs or making new all-time highs, and the juniors are getting beat up to the tune of trading two to three times cash flow. It’s a weird situation.
I really believe it’s largely induced by our government, because those capital flows can go anywhere they want in the world. When you start talking about a 30% tax on income
trusts out of the blue and a complete reversal on your statement when you got elected, that puts fear in the investors. I mean, most of the trusts are off 30% or more.
And TriStar’s stock is in the same boat?
It’s down, but almost everyone’s down. It’s bizarre. We’re now trading at 3.5 times cash flow, where a normal multiple for a good cash junior would be 5.5 to 6 times cash flow, especially with oil prices doing that well. One other external variable that’s changed is that natural gas prices have dropped quite a bit, from the $9 or $10 range down to $5 or $6.
Bottom line is, fundamentals are good. The cost side of things has come down. I think the environment’s great—it’s just too bad that we caused a lot of the problems by our own actions. That’s a pretty sad statement where your government is making the environment tougher. It’s a pretty mature basin as it is, and the returns are OK, but you start adding in all these extras and it makes it pretty tough.
That should change. It’s my belief that this will all turn, and if fundamentals stay strong, I think you’re going to see the sector have a great second half this year.
We’ve heard that costs in the oilpatch have exploded, but you say they’re down somewhat. Why?
We’re starting to see costs down by somewhere around 10% over last year. It should be more. Oil and gas companies pulled back when crude dropped from US$78 to US$49. Capital programs are getting cut, and natural gas prices are falling off. Trusts have pulled back. They were about 35% to 40% of the marketplace. Large companies pulled back, waiting to see what the outcome of the trust rulings would be. Today the rig count is 38%. A year ago it was about 64%.
That’s why you’re seeing service companies hurt. When they hurt and they’re not busy, they get out, they’ll cut their costs. The truth is, we’ve seen costs down about 10%. Now they’re probably going to cut them further to stay competitive.
So what’s next?
It will be interesting to see what’s going to be next. With this reversal on the tax, what is going to be the next structure that works? It used to be that large oil and gas companies controlled the big market, then you had intermediate companies that were largely trusts, then you had explore companies and they would build themselves up and sell to the intermediates. It was a perfect mechanism.
Now, since there’s no way for a junior like a TriStar to sell and they can’t convert to a trust fund because of the tax status, what’s the end point for the juniors? They’re not going to just grow to Canadian Natural size—the basin is too mature and the growth rate would be too slow.
That’s why the juniors are trading so low. What is the new structure for this basin? Everyone’s kind of waiting for the actual laws to come out on the income trusts to see what we can really do or not do, and then I think you’re going to see people move. Provident Energy Trust is rumoured to be looking at moving to the United States. I know at TriStar, we’re trying to wait to see what’s going to happen to decide what to do.
So you’re saying that everyone’s just waiting for clarity in the new legislation to make a move?
The rules were basically a press release. They don’t cover everything. The government did not do their homework. They just flung it out there. It makes it very difficult to run a business.
The next structure will have to take into account that it is a maturing basin, and the rate of return is so fragile. You’re actually starting to see valuation come back to the trusts now. It’s rallied back. They’ve put out some really good quarters.
If the investor doesn’t see the rate of return there, they’ll just go to the States. While all the Canadian juniors and trusts have dropped, U.S. MLPs [master limited partnerships] have gone from 7% or 8% yield to about a 5% yield, or risen to about a 10-times-cash-flow-per-share multiple. So the capital just leaves and goes across the border. We have to be competitive in our investing environment.
What do you think needs to happen in Canada for the oil and gas industry to remain competitive?
I think a lot of things we had were going well. Now we need US$50 per barrel plus. That’s important. Another reason things are soft is gas prices have come off quite a bit. Probably $6 or $7 gas as a floor [price] is what we need to stay competitive. We need a regulatory tax environment that is conducive to business. The one thing that was working in this basin for both the seniors and the juniors was the trusts. To just come out of the blue and slap a 30% tax—I think it’s political suicide for them. I can’t believe they did that.
So who’s going to be able to weather the current situation?
The normal situation in an uncertain time like this is, you’re starting to see the haves and the have-nots. The big guys and the quality juniors will survive; the quality trusts will survive. You’re seeing consolidation. And the weak go away—they get dispersed, they get sold, consolidated into other companies. There are tons of deals being talked about. There are 40 to 45 trusts, and you might see 12 or 14 really good ones survive. The weak won’t. And the same with juniors.
OK, so here is the play. You see a nice asset out there and you have to pay 4.5 to 5 times cash flow to get it. If your stock is trading at 2.5 or 3 times cash flow, there’s no gain for your shareholders. So at a time of low valuation, the have companies will keep their valuation better than the other guys. Everybody’s down, but the top guys are still trading 3.5 to 5 times cash flow. The poorer guys who don’t deliver on numbers, don’t have the greatest assets and don’t have a levered balance sheet, they could trade down to 2.5 times cash flow—then how do you buy something for 4.5 value and add value? You don’t.
You become uncompetitive pretty fast if you can’t entice investors into your stock and trade at five, six times cash flow. It’s pretty tough to play.
What are your thoughts on where commodity prices are going?
I’m a very risk-averse person. I always get laughed at or lauded—one or the other. If the long-term price of oil for 100 years was US$19 a barrel, why at US$50, US$60, US$70 would you not be hedging and taking that risk out of it?
Our business is inherently risky—you have drilling risk, dry holes, commodity prices, exchange rate risk, interest rate risk, risk of getting and retaining good people, risk of finding and buying good assets, risk of the market valuations. If you’re offered a chance to lock in two or three times, almost four times the 100-year average of crude, why wouldn’t you?
So the companies I’ve been involved with, we mostly try to hedge 50%–60% of our daily oil production every chance we get, because I don’t know the [future] prices of oil and gas. And they’re so variable. Oil was US$78 a barrel, dropped as low as US$49, and then rebounded to US$74 and change. Who knew? Now you’ve got guys like [CIBC World Markets chief economist] Jeff Rubin and others saying it’s going to go to US$80 and maybe to US$100. I couldn’t have envisioned that. I believe oil will be sustainable above US$55 a barrel, maybe US$60.
So what’s your outlook for the oil and gas industry?
I believe this basin is great. We always view ourselves as maturing, but I think there’s lots of room for growth yet in our industry. Like we talked about earlier, it is a fragile basin. You can’t make it uncompetitive with your taxation or regulatory rules. I think people see the numbers of an Exxon or some of the bigger companies and say, “This is outrageous.” Some of those big guys, that’s true.
But there are lots of little guys that are losing money at US$55 WTI [West Texas Intermediate crude] and $7 gas. The way costs have risen—you add all those things together and it can be a very fragile basin.
I personally think that it’s a great time to be buying oilier stock right now. With gas, I don’t know for sure. If oil rallies to US$80 or US$90, some of those oily stocks will be good value, but a lot of those guys are pretty bruised right now. Everybody can run when the commodity prices are running and the valuations are high.
It’s a tougher environment than a year ago. And once the vacuum of uncertainty is lifted, then capital will flow in and valuations will go up.
It was the early ’90s, and four mavericks were staging an investment banking coup. For months, Brett Wilson, Jim Davidson, Rick Grafton and Murray Edwards would meet at Calgary’s Petroleum Club, sneaking in and out separately and at different times so that their meetings wouldn’t be noticed. The friends, who knew one another either from university days (Wilson and Edwards both attended the University of Saskatchewan) or through their finance dealings in Calgary’s tight business community, had an idea. “The four of us started dreaming up what a full-service specialty boutique in energy would look like,” recalls Wilson, the firm’s chairman, while sitting in his luxurious Calgary home and drinking a morning tea. “It took us about nine months to plan what the firm would look like.”
The day they launched FirstEnergy Capital Corp. in mid-September 1993, the men took an ad out in the Calgary Herald that read, “We’re not here to test the water, we’re here to make waves.” Westerners love a maverick spirit—FirstEnergy was trading the first day. Now, it is a well-known and respected boutique investment bank. Under its belt: 736 financings with more than $50 billion of capital raised, and more than 190 merger-and-acquisition assignments representing in excess of $84 billion in transaction value. “They’ve developed a depth of expertise and relationships,” says John Brussa, a longtime friend of the four for at least 20 years and a senior partner at law firm Burnet, Duckworth & Palmer LLP. “They’re very deeply embedded in the Calgary business community, and they’re known as being smart, very ethical and community-oriented.”
FirstEnergy’s solid reputation is evident in its plush office on the 11th floor of a downtown Calgary highrise, where details of completed deals hang in manly steel frames on meeting-room walls. The office is the third since the company’s inception, and it’s modern and beautiful. A wall of water trickles behind the main desk, glass walls separate bright meeting rooms, and three fully stocked kitchens provide for the firm’s 90 or so employees. The digs are downright spectacular, especially considering the firm’s beginnings.
Starting up a week earlier than the partners had expected—because about half of the 20 or so employees they were recruiting from other firms were getting antsy to make the switch—they started out with rented church basement tables and chairs, no phones, and no computers. “The first week was one hell of a scramble,” says Wilson. “We didn’t have a stock quote system, either. We put one of our staff over in Murray Edwards’ office, and she had a cellphone in her ear and we had a cellphone in our office, which was the quote phone. You just moved it around if you needed a quote and wanted to do any trading.”
So what is it that the firm actually does? “Our core business is financing oil and gas companies,” says Wilson. “Within that, we provide research, we trade the stocks, provide advisory services, M&A ideas—a full range of all the things that can be done.” It’s more team-oriented than most would assume. “No one has an office here,” says Davidson, FirstEnergy’s CEO, as he sits in a glass-walled meeting room. “That was done on purpose from the beginning. It was designed to create a sense of equality and heightened communication.” They’re serious about the teamwork stuff. The men didn’t even have official titles until about 2000, when they thought shifting roles and an expanding firm required them.
At the helm with Davidson is John Chambers, a 40-year-old with an MBA from McGill University, who came to FirstEnergy in 1998. He assumed the role of president in July 2006, when Wilson transitioned into executive chairman. (Grafton is vice-chairman at Canaccord Capital Corp., having left his managing director role at FE in 1999. Edwards is a shareholder and remains vice-chairman of the board at Canadian Natural Resources Ltd., the energy powerhouse he built from scratch.) “We take our business very seriously but ourselves not so much, which is a key aspect of the people who work at FirstEnergy,” says Chambers. “You’ve got to be able to have some fun and laugh at yourself.”
They’re also serious about the fun stuff. FirstEnergy and the men who lead it have made names for themselves not just for the high-profile investment bank they run, but also for the splashy parties they throw. The parties are often a mix of corporate, personal and charitable endeavours, as they entertain clients and friends in the name of raising money for one of about 300 causes they’ve supported over the years.
Mention names such as Wilson and Davidson, and anyone hooked into Calgary’s business scene mentions the word “legends.” Perhaps most recognized is Wilson, whose face adorned the cover of the December 2006 issue of local lifestyle magazine Avenue with the headline “Person of the Year.” Wilson is known for extensive personal commitment to charity (think: building homes for the underprivileged in Mexico) and hosting lavish parties in his backyard (think: performances by über-producer David Foster and American Idol’s Clay Aiken). “Brett is full of energy,” says Brussa. “He’s almost a life force.”
He’s also known for throwing birthday parties at concert halls. This June, Wilson and Davidson, along with 11 other friends who have all or will turn 50 this year, threw themselves one hell of a birthday bash. In true legend style, they booked the 2,500-seat Southern Alberta Jubilee Auditorium and booked Randy Bachman and Burton Cummings. Admittance, by invitation only, was free—well, in a sense. “The words in the invite were ‘Meaningful charity cheques will be expected,’” says Wilson. “We offended people. We know we did.” Wilson says some of his partners told friends and family not to worry—that the request wasn’t all that serious. “I said, ‘Bullshit! That is dead serious.’” If people were offended, they got over it. In a single night, the event raised almost $3 million in the name of prostate cancer research and awareness.
The cause is close to Wilson, who was diagnosed with prostate cancer in 2001. “I’m lucky,” he says. “Other guys don’t know if they’re going to get it. I got it and dealt with it.” As he focused on getting back to good health, Wilson scaled back his duties as president and stepped into the chairman role. The latest transfer of responsibilities, to Chambers, marked a further step back. The transition has been smooth, with Wilson keeping a desk at the office and coming in a few days a week. “The firm as a whole is performing very well,” says Chambers. “I think all things considered, it’s going exceptionally well.”
“All things considered” include the weak price of natural gas, the government’s new stance on income trusts, and an explosion of costs in the energy sector. These days, the team at FirstEnergy is faced with a much tougher environment. “It’s challenging,” says Davidson. “There are periods of time when everyone is excited and energized. And then there are periods of time where it’s just difficult and it tends to slow down. We’re in one of those right now.”
That doesn’t mean FirstEnergy has nothing on the go. “Investment banking, as opposed to the energy industry, is busy as long as things are changing,” says Chambers. The trick, adds Davidson, is positioning your team to make sure it’s able to take advantage of the opportunities once the market really picks up again. And pick up, it will. Wilson, Chambers and Davidson believe there is better news for the energy industry coming soon. “I think we see gas prices ultimately rebounding, and this is a gas-prone basin, so I think profitability goes up as a result,” says Davidson. Chambers adds that high crude prices will continue to keep the focus on oilsands players. “The world’s perception of Canada has changed dramatically in the last two to three years with the recognition of the oilsands as a world-class resource,” he says. “This is driven by prolonged increased crude pricing. That will continue. And it will evolve, so there will start to be smaller players in the oilsands and service companies focused on the oilsands. That will continue to be a big driver of growth in the Canadian industry.”
For his part, Wilson is a firm believer the world is underestimating demand and overestimating supply. “We’re not replacing the amount we produce, and there’s still growth in demand,” he says. “Lower-class India and lower-class China are all starting to consume. We’ll see significantly higher growth rates in those economies, and given the size of the populations it’s going to overwhelm capacity.” Wilson believes that the economics of greener alternatives such as ethanol don’t make them viable in the near future, and that oil and gas will rule as kings for a long while. “You saw [CIBC World Markets economist Jeff] Rubin come out with the US$100 [crude] forecast,” he says. “Well, you know what, buddy? You’re two years too late, because we’ve been talking about that probability for a while. I agree with you, but the writing’s been on the wall for several years.”
With high crude prices, the guys at FirstEnergy anticipate an even stronger focus on Alberta’s oilsands, and a growing part of the firm’s strategy will be to help clients harness international opportunities. A key strategic component is a new deal with a European bank, which FirstEnergy is set to announce formally any day now. Paris-based Société Générale, one of thebiggest banks in the world, is buying a significant chunk of the firm in an expansion of an initial smaller deal forged in November 2005. “Société Générale is in 80 countries around the world and they have 1,500 people on the ground in London, so it’s a very powerful tool for us in terms of expanding our business on the international stage,” says Chambers. “[The oilsands] are very capital intensive, so the Soc Gen transaction really gives us a leg up. If you can’t attach yourself to someone with a large balance sheet and offer a lot of these companies both the debt and the equity side of the equation, it’s hard to be competitive.”
As the firm gears up to tackle international energy markets, Wilson is happy to turn his attention to local business. “I’m still cautiously optimistic about the business, but I’m not the roaring bull I was four or five years ago in terms of leveraging up to buy bigger and bigger positions,” he says. “So I’m diversifying into Western Canada, whether I’m buying farmlands in Saskatchewan or development properties in B.C. It’s still tied to what’s going on in the energy sector.” (In fact, on the early Friday morning he spoke to Canadian Business, Wilson was on his way to the Calgary airport en route to Saskatchewan to check out a 10,000-acre farm that’s for sale.)
Just as he’s explaining how he’ll stay involved with FirstEnergy in an advisory position but not in the firm’s day-to-day activities, the BlackBerry sitting on his dining room table buzzes. “Having said that, I can’t ignore it,” he says as he looks at the gadget. It’s a message from someone at FirstEnergy. “We did our largest equity financing ever this morning,” he explains. Overnight, Niko Resources Ltd., a Calgary company with international operations, completed a $500-million deal, of which FirstEnergy had a 20% chunk. That means significant cash for the firm, but Wilson looks unfazed. For him, maybe big deals aren’t really that big a deal anymore. But for the company he helped build, the day is off to a good start.