Corporate performances of Canadian oil and gas firms in 2005 were sterling, reports Calgary-based investment banker FirstEnergy Capital Corp. Producers benefited from high commodity prices for production of reserves that had been added in past years at lower costs, and earnings shot skyward.

As a caveat, costs also rose, and companies were not able to gain a significant increase in capital efficiency. So, finding, development and acquisition (FD&A) costs bumped upward, though not to the same lofty heights as earnings.

Large oils. Large caps and integrated oils posted enviable results. For companies in this group, FD&A costs rose to US$11.12 per net barrel of oil equivalent (BOE) in 2005, versus US$10.14 per net BOE in 2004, a 9.7% increase.

Cash flows per BOE jumped to US$25.33 per net BOE, a 39% increase from 2004 figures.

Future development capital is becoming evermore crucial as companies pursue large resource plays, where reserves are known long before development is complete. One metric that calculates the efficiency of cash-flow reinvestment is recycle ratio, or the annual cash flow per produced BOE divided by FD&A costs.

The large-cap recycle ratio broke 2.0 for the first time since 2000. If future development capital costs were included-the money needed to turn undeveloped reserves into developed reserves-FD&A costs topped out at US$16.20 per barrel last year, and the large-cap recycle ratio dropped to a still healthy 1.56.

During the past three years, Apache Corp., EnCana Corp., Talisman Energy Inc. and EOG Resources Inc. have posted the best FD&A ratios in the large-cap group. The same four companies, not surprisingly, had the top recycle ratios for the period.

This year, FirstEnergy expects the integrateds and large caps will enjoy another successful year, albeit not as robust as 2005. That's due mainly to a drop in natural gas prices. The investment firm predicts the group will see FD&A costs (including future capital) of US$18.23 per net BOE, a 12.5% rise from 2005. And, cash flow per BOE will be US$25.99.

Midcaps. The midcap group consisted of those firms with year-end market caps between US$500 million and US$2.5 billion. Midcaps posted FD&A costs (plus future capital) of US$11.81 per BOE and a three-year recycle average of 1.93, even stronger results than the largest firms. Noteworthy performances were handed in by Rider Resources Ltd. and Crew Energy Inc., companies that had recycle ratios above 2.5 for the past three years.

However, midcaps suffer from short reserve-to-production lives, at an average of 6.1 years. "The difficulty for midcaps has always been growth," FirstEnergy's analysts report. Just to maintain size, a typical midcap company has to annually acquire reserves of some 16 million BOE and production of 7,200 BOE per day. And, growth beyond maintenance is expensive.

Midcap firms are caught between the expectations for a growth stock and a size more appropriate to an income investment, and they endure both high decline rates and FD&A costs. Indeed, midcap companies often become trusts: eight of 13 companies in FirstEnergy's midcap group in 2003 are now trusts.

Trusts. Trusts were also evaluated on performance. Their 2005 average FD&A costs were US$15.28 per BOE. If future development costs were lumped in, the total rose to US$17.43 per BOE. The recycle ratio was an average of 1.59, including future capital costs.

The five trusts-out of 21 total-that managed to post above-average recycle ratios for the past two years were Peyto Energy, Bonavista Energy, Bonterra Energy Income, Daylight Energy and Vermilion Energy.

"This underscores the difficulty of the business," notes FirstEnergy.

Small caps. Small-cap firms, those with capitalization below US$500 million, averaged FD&A costs of US$11.71 in 2005, and cash flow per BOE of US$24.32. This year, the group is expected to experience a jump in FD&A costs to US$13.25, and a slight rise in cash flow per BOE to US$24.55. (Future capital added in increased the FD&A costs to US$13.68 and US$16.29 per net BOE, respectively.) The low gas prices of summer 2006 have caused some small producers to pare programs, although economics remain robust and positive.

Small caps were extremely successful in raising money in 2005. Companies in this group rounded up an amazing US$2.2 billion for their capex programs last year, some US$1.4 billion in equity and US$762 million in cash flow.

The massive amounts raised and spent by these firms yielded substantial added reserves. In 2002, small-cap firms layered on just 41.4 million BOE of proved reserves, mainly in Western Canada. In 2005, small companies contributed 187 million BOE.

Overall, the outlook for the future is sunny, even against the backdrop of swelling FD&A costs and not-so-swelling cash netbacks per BOE. In FirstEnergy's opinion, much of the upside in Canadian companies remains to be captured because recycle ratios will continue to hold at favorable levels. The firm predicts a 30% rise in the S&P/TSE Oil & Gas Index for both this year and next.