Wilf Gobert: After A Long Peace, Serious Political Risks Reappear
By Mike Byfield
Wilf Gobert ranks among the most experienced of energy analysts, steeped for three decades in oil and gas. Last May, when the 59-year-old Calgarian resigned as vice-chairman of Peters & Co. Limited, the upstream was still upbeat. Just months later, the oil and gas sector finds itself in strikingly different circumstances. Junior producers, according to Gobert, face much more daunting prospects. On the other hand, integrated majors with oilsands exposure may be entering a more favorable period.
"My dad always said the hardest job should be given to the laziest person because he'll figure out the easiest way to do it. That was me," says Gobert, who grew up on a farm in southern Ontario. Early on, he determined that working with numbers was easier than manhandling crops so he earned a mathematics degree from the University of Windsor. Mutual Life of Canada (now Clarica) recruited the math major as a systems analyst, a common practice when computing was still in its infancy.
Drawn to business, the young analyst took an MBA and began assessing Mutual's investments in energy and technology companies. Wood Gundy Limited, a national brokerage, hired him as a full-fledged oil and gas analyst in 1978. Petroleum was booming as never before, which prompted Rob Peters to create a boutique financial firm specializing in junior oil and gas equities. To establish a research arm for his fledgling outfit, he lured Gobert from Toronto to Calgary.
The late 1970s and early '80s were characterized by bitter and recurring strife between federal and provincial governments over rapidly rising petroleum revenues. In contrast, the surge in oil and gas activity over the past five years took place amid political peace - until now. The first of several public policy difficulties arose unexpectedly on October 31 when the federal government announced its intention to begin taxing income trusts in four years.
Gobert, who invests strictly on his own account now, thinks the stronger trusts remain plausible investments. "A lot depends on your outlook for commodity prices. Many trusts have been achieving annual returns of 15%, some even more. If oil and gas prices hold up reasonably well, it's possible to recover 60% of your investment in a good income trust before taxation comes into force," he points out. Furthermore, despite Prime Minister Stephen Harper's vow that his current plan is unalterable, the trust sector may yet win more favourable tax treatment after the next election.
Still, the veteran analyst advises caution. Until recently, oil and gas trusts could buy assets more easily than virtually anyone else. Investors consistently put a higher value on those reserves once they became the property of an untaxed operator. Following the federal decision to tax trusts, however, their equity units trade at values more comparable to conventional shares. That change leaves trust manager with far less capacity to maintain their production through purchasing additional reserves. Gobert expects to see the weaker trusts forced into consolidations, not necessarily on favourable terms.
Royalty trusts are also vulnerable to another new political development, again at the federal level. In recent weeks, the Harper government has been wooing green-minded voters in Quebec and Ontario. Details have yet to be released but that policy, aimed at putting a curb on global warming, could place a heavy burden on larger petroleum producers. Gobert is concerned that the Tories, given the public expectations raised by their own aggressive rhetoric, will find themselves bound to deliver policies with some bite.
The fate of the trusts envelopes most juniors as well. Until this fall, smaller producers had evolved a comfortable pattern of drilling up new reserves and then selling them to a royalty trust. "Between high commodity prices and buyers with cash in hand, a junior really didn't need to be exceptionally proficient to earn good returns for its investors over the past few years," Gobert says. Now that strategy has been hobbled by the federal decision to tax trusts.
Smaller investors should be especially wary of juniors, the former Peters analyst warns. The publicly-traded model of smaller company had already fallen out of favour for several reasons. Managers found that compliance with securities requirements ate up large dollops of their time and cash, while investors' desire to maintain steady profitability and hence consistently high share prices often impeded rational capital spending decisions.
An alternative ownership structure - privately held juniors - are mainly a high-risk game for the well-connected and rich. "Generally you can't get in for less than $100,000 or $150,000," Gobert explains. "The best returns are earned by individuals who invest when a new company is created, and those opportunities generally go to associates of the founders." In addition, money committed to a privately held junior normally remains locked in for several years. And if a small producer of this type gets into trouble, its equity holders typically have no way out.
Liquidity is one great strength of the integrated major producers. These companies also have the large reserves needed to ride out the commodity cycle - they're bound to still be in business when prices recover. Gobert notes that large oilsands reserves are particularly long-life properties, a powerful asset in a world where conventional discoveries are becoming more elusive.
No new refineries were built in North America during the 1980s and '90s, in part due to weak returns. As a result, the world's petroleum processing capacity has gradually become at least as tightly choked as its crude oil supply, and refining assets are now profitable. All in all, Gobert thinks oilsands and refineries should both perform relatively well for investors if government policies remain reasonable.
But political risks to the major integrateds and bitumen producers have materialized in the past few months. As massive emitters of carbon dioxide, federal restrictions on greenhouse gases could be a serious factor for them. So could higher provincial royalties. Ed Stelmach, in his recent campaign to win the Alberta Conservative leadership and become premier, promised to implement a royalty review, with oilsands operators a particular target.
Gobert recognizes that the energy sector still has reassuring strengths. The global demand versus supply outlook is promising. In Western Canada, the economically available resource base has expanded massively due to higher commodity prices and better technology. Corporate debt is often modest in the oil and gas sector, which gives managers far more ability to survive rough patches. And Canadian politicians of this generation have not yet made mistakes comparable to the National Energy Program in the early 1980s.
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