The Canadian asset marketplace today is like a buffet for 1,000, but 2,000 have arrived: tons of food but still not enough to satiate everyone. While the dollar volumes of Canadian E&P acquisitions and mergers that made for tasty headlines a few years ago have flamed out, prices for proved reserves are among the most tantalizing ever-to sellers. Yet, buying is brisk, largely by hungry oil producers. Calgary-based investment-banking firm Sayer Securities Ltd. reports first-half 2003 deals fell to C$5 billion in enterprise value from C$21 billion in first-half 2002. "The lack of mega-deals-those with a value of more than C$1 billion-available for purchase was the main reason for the decrease, followed by less interest on the part of foreign buyers," says Frank J.D. Sayer, principal. Houston-based transaction advisory firm Randall & Dewey Inc. counts 71 deals for Canadian assets during the first half, totaling US$2.7 billion and having an implied reserve value of US$7.96 per BOE, up from an already strong US$7.03 in the first quarter. Prices paid were stronger than for U.S. assets, where the average implied reserve value in the first half was US$6.98. "Interestingly, this marks the second year in a row that the implied reserve value of Canadian transactions is higher than comparable U.S. transaction numbers, reflecting the impact of royalty trusts on acquisition economics," Randall & Dewey reports. Some Canadian oils are feasting; some are famished. At one table, the royalty trusts are hoping to gobble up low-cost assets that throw off calorie-free cash and would like to go back for seconds and thirds. At another table, the junior oils are looking for assets sauced with extra upside. The large Canadian independents are eyeing dishes in both buffet lines, as well as looking across the fence, where non-Canadian producers are dining on Asian, Gulf of Mexico, North Sea and other overseas fare. Meanwhile, U.S. producers work quietly on their first servings, which were super-sized acquisitions, and are sometimes offering to share. The buyers The highly acquisitive royalty trusts are remaining focused on Canadian reserves and production while unit-holders continue to expect strong distributions. Trusts pay unit-holders from pre-tax revenues. Revenues from production abroad would be diluted by taxes due those countries. Unless they have to seek production replacement abroad, they're staying home. "The problem with crossing over to most international arenas is the impact of tax leakage," says Paul Beique, director of investor relations for Calgary-based Vermilion Energy Trust. The trust knows from experience; it already has production abroad-about 25% of its output comes from France, and it has a 72% interest in Aventura Energy Inc., which produces from onshore Trinidad-and it wants to expand its international presence. Most trusts are reportedly still finding the size and kind of assets they need in Canada, predominately through the acquisition of junior oils and the few remaining intermediate oil companies-Star Oil & Gas was one, but was bought by a trust this spring-and by acquiring assets from major oil companies. "I don't say that, going forward, it's going to be as easy," says Beique. "Eventually the trusts are going to have to see if it's worth their while to move overseas or to the U.S." Traditional Canadian producers, such as the large independents like Nexen, Husky, EnCana and Canadian Natural, are able to look abroad without changing their earnings profile significantly. Roger Tang, president and chief executive officer of privately held junior producer Action Energy Inc., Calgary, finds his bids for long-life proved developed producing assets often compete with bids by energy trusts-and lose. "The cost of capital is cheaper for them than a normal E&P company like ours, so it has made it harder for us to compete for a lot of the assets we like to buy," he says. Action Energy seeks long-life, shallow-gas assets, primarily in southwest Saskatchewan. Meanwhile, when Action doesn't meet royalty trusts in the data-room, it meets with other juniors, especially the many that have been started in the last year or two. "You can stay away from competing with the trusts if you're looking at marginal assets, but then you compete with these new juniors." In the past year, the company has looked at many C$100-million-type properties and didn't win any of them. In response, the company has been focusing on its grassroots business-exploration and exploitation. "Instead of buying more reserves, we're creating them," Tang says. The company has a 100-well exploitation program under way on 200 sections of land it recently acquired in southwest Saskatchewan. Calgary-based Grid Resources Ltd. is among these new Canadian junior oils. It was formed in 2001 by former Stellarton Energy and Addison Energy management. Properties it seeks are primarily gas-producing, in Alberta and priced at under C$10 million. The company is finding more assets to buy this year than last, says George Marquardt, president and chief executive officer. "We've spent about 25% of our capital budget on acquisitions this year, compared with less than 5% last year." Prices have been consistently high, "but last year they were consistently high and not available." He doesn't expect prices to decline anytime soon or much, but he is expecting more property offerings. "If they don't get the price they want, they'll just take them off the market," Marquardt says. Rising prices Demand for Canadian assets still outstrips supply, says Ross Kobayashi, president, Kobayashi & Associates Ltd., a Calgary-based divestment advisory firm. Some offerings are by the trusts, such as parts of purchases that didn't pass their investment tests. "What they're selling is small compared with what they're buying." Trusts' purchases that go back onto the market are, for example, ones that produce limited cash flow. "If it is a low-maintenance overriding royalty interest, they'll likely hang onto it. It adds another $1 to funds available for distribution to unit-holders." Numerous companies will sell assets in the fourth quarter, says George Gosbee, president and chief executive officer of Calgary-based investment-banking and asset-divestment firm Tristone Capital Inc. "We have high commodity prices, plus the trusts and the juniors still have a lot of access to capital, so it should be a strong quarter." Kobayashi says the most attractive prices are being paid for gas reserves and production. Among oily asset deals, prices for light oil have increased more than for heavy oil. In general, however, all proved reserves are fetching more on the market. Sayer calculates the median acquisition price for reserves in first-half 2003 was C$8.94 per BOE, up from the C$7.60 during first-half 2002. "With commodity prices remaining relatively high... and acquisition prices following suit, it would stand that more companies that made major purchases in the past will review their assets with the intention of selling. We may well see more activity in the second half of 2003," he says. The popularity of buying reserves and production-by all types of Canadian producers-is propped in part by higher average finding and development costs, Kobayashi adds. Pool sizes are smaller, and costs are being made higher by the increasing remoteness of exploration targets. The combination means spreading greater expenses out over fewer reserves. "So we're not seeing as much exploration." The forecast What would change the landscape is lower commodity prices. For now, junior oils and royalty trusts continue to have relatively strong access to capital. Higher interest rates and reduced access to equity capital would greatly alter acquisitions' potential rates of return. U.S. buyers have virtually disappeared from the Canadian asset-acquisition stage. Instead, they have become net sellers. At press time, Marathon Oil accepted a US$588-million offer for its Canadian business from Husky Energy. Gosbee expects more U.S. asset sales through the year. Sayer says royalty trusts have taken up the net-buyer space U.S. companies had filled a few years ago. The trusts made C$2.6 billion in purchases in first-half 2003, representing 56% of total deal volume. When trusts venture outside of Canada, they will likely look south of the border first for acquisitions that meet their economic criteria, says Beique at Vermilion. "They'll look to the U.S. first because there is a healthy turnover in oil and gas assets." During the past five years, 75% of worldwide mergers and acquisitions occurred in North America, and almost 45% in the U.S., he says. "It is a liquid market. In the rest of the world, that's not so much the case." One place traditional oil companies are not likely to compete with a Canadian trust for assets is the U.K. North Sea. One reason is that the U.K. tax regime is geared to attract large new exploration and development investment. "We believe the North Sea doesn't work for a trust." These are opportune times in Calgary. "The dynamics in this town have never been better," Gosbee says. "The time is ripe for the junior companies." The larger traditional E&P companies are focusing on large exploration plays, and the energy trusts are focusing on exploitation. "So this creates a lot of opportunity for juniors. It's a great time to be starting an E&P company."