During the long hot days of summer, everyone seeks a little froth, whether it's on the head of a cold beer, in waves crashing onto the rocky coast of Maine, or in cumulus clouds set against a deep blue mountain sky. But what we don't want is an oil and gas world that's become too frothy. I fear it has. Commodity prices are still high, yet U.S. and Canadian drilling-rig counts are up only slightly since last year and production of natural gas is flat. So in the constant hunt for more drilling inventory to feed gas production, E&P companies on both sides of the border are spending premium dollars to buy assets. Several recent deals, highlighted elsewhere in this issue, have made headlines because eager buyers are paying outsized prices per barrel of oil equivalent (BOE). In Calgary last month, about 300 investors attended the annual oil and gas investment symposium organized by the Canadian Association of Petroleum Producers (CAPP), to learn how E&P companies are planning to grow. Some 51 juniors presented this year, reflecting the resurgence of this category and the ease with which small companies in Calgary can go public. The Canadian oil patch is always changing. Of 52 companies that presented at the CAPP symposium in 1991, only three remain in business this year-Canadian Natural Resources, Paramount Resources and Pengrowth Energy Trust-the others having merged or been acquired. Most chief executives spoke of the challenge that Canadian and U.S. firms face to create a balance between profitability and reserve growth. Calgary's energy firms are buying assets in western Canada, but also venturing to the U.S., the North Sea and elsewhere. The deals range in size from EnCana's purchase of Denver's Tom Brown Inc. for US$2.7 billion, to Petro-Canada's US$640-million purchase of 29.9% of Buzzard oil field in the North Sea, to much smaller deals. The royalty trusts are making waves by buying large asset packages in western Canada, and now for the first time, in the U.S. (For more on this, see "Completions" in this issue.) They are paying the biggest premiums of all and observers wonder how long that can last. Will there continue to be enough meaningful packages of assets for sale? The trusts are starting to merge with one another as well. On June 16, Petrofund Energy Trust, which trades in Toronto and on Amex, closed on its C$540-million acquisition of Ultima Energy Trust, ranking it among the top five royalty trusts. Total production will increase 35% to about 36,000 BOE per day. Prior to this recent deal, and since it was founded in 1988, Petrofund had completed 45 acquisitions for C$1.1 billion. The trust has a market cap of about C$1.3 billion. Last year, Petrofund's cash flow rose 67% to C$187 million while production increased 10%. In first-quarter 2004, its pay-out ratio was 74%, meaning that much of its cash flow was returned to unit-holders with the remainder being used to drill development wells. Its reserve-life index is 11 years. "We think this is a mark of our sustainability," said chief executive Jeffery E. Errico. "Investors ask us how royalty trusts can continue to buy properties at these high prices, and what happens if commodity prices fall. But in 2003, in addition to buying assets, we participated in drilling 100 net wells and spent C$71.4 million on development. And, we have a large undeveloped land position that is key," he said. "Our focus is on low-risk opportunities that have an expected pay-out of two years or less. Finally, we hedge 50% of our production with swaps, collars and floors." Despite the assurances of this company and others, some skeptics lurked the halls at the CAPP conference. Some investors commented on the royalty trusts in negative terms. They are waiting for the house of cards to tumble as soon as interest rates rise or commodity prices fall, which would jeopardize the trusts' economic model. Two Canadian buysiders used the words "Ponzi scheme." In investing, there are a few common-sense precautions one can take to avoid getting burned. John Moon, managing director of Morgan Stanley Private Equity, spoke of them at the Private Capital for Energy forum in Houston in May, co-sponsored by Cosco Capital Management LLC and Oil and Gas Investor. "It is absolutely key to ask structured and thoughtful questions about trends and market dynamics," he said. "You have to have intellectual humility and know what you don't know. You have to have a certain skepticism and engage with leaders in the industry [who have perspectives you may not have]." "This can be a very humbling business," said Peter Kagan, managing director with Warburg Pincus LLC, speaking at the forum. The New York firm has invested close to $1 billion in energy, including funding E&P successes such as Newfield Exploration and Spinnaker Exploration before they went public, and recent start-ups such as Bill Barrett Corp., Kosmos Energy and MEG Energy. "Our most popular fund is the one we call the Retrospective Fund, and all our investors want to be in it." Sign me up.