Oil patch eyes uptick in business receivership

Canada's oil and gas industry is closely watching the trend in receiverships, as companies especially smaller ones struggle with low oil and gas prices and reluctant investors.

"There are a fair number of them out there, and there are a fair number of them pending" Alan Tambosso, president of Calgary-based Sayer Energy Advisors told CBC News. Sayer advises clients on oil and gas mergers and acquisitions.

Exactnumbers are difficult to compile. While firms that trade on the public markets must disclose the information by law, there's no way to know how many companies backed by private investors have failed,short of rummaging through court records.

The banks are known to have pushedfive or sixfirms into forced liquidation so far thisyear, about the same number of all of 2011 and last year, and twice the number for all of 2010.

'We think there are more companies that are on the edge financially' Oil patch adviser Alan Tambosso

But it's well short ofthecouple of dozen that sought protection from creditors or were pushed into receivershipin 2009.

"We think there are more companies that are on the edge financially," said Tambosso, "but as far as the trend goes, its not any worse than some of the bad years weve had recently."

The firms that have failed so far this year had debtlevels that ranged from$2 million to$25 million.

"Its obviously a bit of a disturbing trend," says Doug Porter, deputy chief economist at BMO Nesbitt Burns. "I wouldnt say its shocking, though, given the confluence of factors weve had in recent years."

With oil prices above $93 US and the Dow making new, all-time highs, it might not make sense to some people that the Canadian industry is facing its challenges.

But natural gas prices have been low for years, as technology has opened up formations that couldnt be exploited before, flooding North American markets with supply.

Investors harder to find

Oil prices have been constrainedas pipeline bottlenecks in the U.S. produce a glut at a major pricing point on the continental transportation system at Cushing, Oklahoma, and prevent Canadian firms from getting world prices.

"Pipeline capacity is beginning to hurt the sector, I think thats weighing," said Porter.

And the recent rise in major U.S. stock market indices may not be showing it, but manyfirms in the higher risk oil and gas sector are finding it hard to line up investors.

"In the market were in today, with the equity markets being effectively closed, theres not a lot of capital available," says Tambosso.

Part of the problem was therelative ease getting into the oil and gas business just a few years ago.

Just put together a management team, getfinancing from the public markets or private investors along withbank debt and getlease rights to some potential production properties. Unlike mining, manufacturing or even farming, which take much longer before producing a return, in oil and gas, it was possible to start paying back investors in a year.

But then equity markets wentsoft, and companies, unable to sell more shares at a decent price, ran up debt as interest rates hovered at historic lows, debt that ballooned as commodity prices stayed stubbornly low.

Tambossodoesnt blame the lenders for the failures so far this year.

Often, he says,the problem is that managements view of what an undeveloped oil or gas property that it has put up for sale is really worth departs from the market reality.

Management, which a sees the potential development value, holds out for an impossibly high offer and the only possible result is receivership.

"If the company goes into receivership, the emotional attachment to the asset and the upside is off the table," says Tambosso, allowing the bank to have properties auctioned off and recover what its owed, which may often amount to the market price of the assets anyway.

"The banks arent in the business of putting people out of business," he said. "Theyre not interested in lending (companies) money and then puttingthem into receivership. (Those are)their customers."

He believes the banks have beenpatient, but four years of low natural pricesalthough both gas and oil prices seem to have made some recovery recently have cut into cash flow falls at the same time asproperties produce less oil and gas.

"After two or three years of prolonged low natural gas prices, the banks have reached the point where they realize with some companies that if they dont do something soon, then they may be at risk of not recovering their investment."

Asset sales surpassed $14B in 2012

So companies are selling off assets or looking for outright buyers, and doing it quietly, to avoid pushing prices down as much as possible.

"Many companies, particularly publicly-traded entities, will be quietly shopping for purchasers or for merger candidates," Tambosso said in a commentary released Jan. 30.

The value of asset sales in the Canadian oil patch surpassed $14 billion last year, the second highest level in 10 years, and Tambosso expects to see that continue this year as firms try to find funds to invest in exploration and developing new production.

But capital spending is still at its lowest level in years, reflecting a drop off in cash flow and earnings.

In February, Statistics Canada reported theoil and gas extraction sectors watched their profits plummet by 22.7 per cent in the fourth quarter of 2012, the sixth consecutive period of decrease.

And as the hundreds of exploration and production companies in the industry struggle, so to the service companies they contract with to drill their wells for them and to provide other services.

Typical of that, last week Calgary-based Total Energy Services blamed a slowdown in activity for a 55 per cent drop in fourth-quarter net income to $10.5 million and a fall of 19 per cent in revenue, to $78.4 million from the same period a year earlier.

As the industry's growth remains muted, that will have trickle-down effects in the overall economy,in trade and in income tax revenue for Ottawa androyalty payments, especially in Alberta.

"I think theres no two ways about it, that the energy sector and oil production in particular had been the main driver for the relative outperformance of the Canadian economy, not just over the past few years, but Id say for the past decade," Porter says.

"I would say its still the workhorse for trade, though. Last year, we had our second largest trade surplus on record in the energy trade sector alone, and thats really one of the few points of strength that were seeing for overall Canadian trade at this point."