Canada: Fistfuls of cash, and spending it badly

You can’t underestimate the value of good management. Put the right people in charge, and they’ll make a decent business a great one. And a lousy business? As often as not, they’ll salvage what they can.

Here’s the proof, in one word: PrimeWest, one of the country’s largest energy trusts, which yesterday sold for $5-billion to a state-controlled company from Abu Dhabi. Yes, the sheiks of the Middle East are coming after our oil and gas, and far from being a national disaster, it’s a blessing, if these are the prices they’re willing to pay. Dumb money can be a beautiful thing.
Why sell? The operative number here is two, as in two barrels of oil. That’s roughly what an investor owns today if he has a share of PrimeWest. The company has the equivalent of about 280 million barrels of reserves in the ground, divided by a little more than 140 million shares.

The trouble is that not so long ago, at the end of 2002, the ratio was closer to three barrels per share. Rare is the enterprise that can thrive when the value of what it owns is steadily declining. (Think of it this way: If you owned a hardware store, and your revenue per square foot dropped by 50 per cent, what would happen to profits?) But such is the inexorable math of energy trusts, which suck oil and gas out of the ground, pay most of the cash flow to investors, then issue shares to buy more reserves. Managing one of these companies is like running on a treadmill that steadily increases in speed.

All you can do is hope like hell that energy prices go up quickly enough to offset the massive dilution. That hasn’t been such a bad bet as oil has climbed above $80 a barrel (Canadian or U.S. – take your pick). PrimeWest, alas, is primarily a natural gas producer, the market for which is far less bullish at the moment. Gas prices, after peaking in late 2005, have plunged by almost 60 per cent in U.S. dollars (and the drop is even steeper in Canadian bucks).

The Globe and Mail (Canada)