What a difference a year makes. Last year at this time, oilpatch deal lawyers were busy positioning themselves as trust lawyers. That’s because income-trust conversions, acquisitions, flips and mergers were the bread and butter of both blue-blooded law firms and upstart entrepreneurial shops.

“It was a joyous time for all concerned,” says James Pasieka, a corporate partner with the Calgary office of Heenan Blaikie LLP. Indeed, for many Calgary lawyers, 2006 was a banner year, building on an equally profitable 2005. “We had a robust [mergers and acquisitions]marketplace in Calgary, driven by the oil and gas trusts that could do accretive acquisitions,” Mr. Pasieka notes.

Trusts still cast a long shadow as the oilpatch approaches the Oct. 31 anniversary of what Calgary lawyers call “The nightmare on Halloween” — the day that Finance Minister Jim Flaherty announced the federal government was curtailing the income-trust game. Nowhere is the trust shadow longer and darker than over the exit options open to junior oil and gas exploration companies.

Prior to the government’s announcement, a junior had one clear and preferred exit: sell to an income trust.

“The trusts provided a natural exit for the oil and gas juniors,” says Mr. Pasieka. The strategy was simple. Acquire a few assets, drill a few wells, scribble some decent production numbers on a piece of paper, and lo and behold, an income trust would snap you up at a tasty premium.

It was easy for juniors to find financing to build their production and make them more attractive to income trusts. “All kinds of capital was in the sector, chasing the new story and the latest producers that were to be taken out shortly by the income trusts,” says Mr. Pasieka. “A year ago we knew what the exit strategy would be. It was a rare time when all the planets were aligned.”

Now things have changed and junior oil and gas companies have had to switch course. “They are no longer trying to build production fast to make their numbers look good so they can sell to a trust quickly,” says Pat Burgess, of Calgary’s Thackray Burgess LLP. “Their built-in strategy is gone, so they have to have some longevity now and be real exploration companies.”

However, the income-trust exit isn’t completely dead. “There is still the odd trust picking up juniors,” says Jay Reid, a corporate partner with Calgary’s Burnet, Duckworth&Palmer LLP( BDP).

Mr. Reid’s tax partner, John Brussa, was one of the masterminds responsible for the oil and gas income-trust structure. That meant BDP led the legal pack in income-trust conversions and mergers. The firm represented more than half of the market’s oil and gas trusts, and had a seat at the main table for all of the sector’s key trust mergers.

Today, BDP lawyers and investment banks serving the junior sector, are catching their breath.

“We’re still busy and there is still lots to do when you show up to work in the morning,” says Mr. Reid. “But for four or five years, we were totally maxed out. Now, we are at a more workable pace.”

One of the focuses is finding workable exit strategies for the junior oil and gas companies that need one. “We’ve got a class of juniors who are really on the ropes right now,” says Mr. Reid. “On the equity side, they are having a hard time finding financing; on the debt side, their bank lines are pretty close to the end and their exit strategy is to do either a public sale or a private process, where they engage a dealer or two to shop the company around and hope someone is interested.

It’s having a negative impact on valuations. “Right now there is a bargain-bin scenario for such companies,” says Mr. Reid. “You don’t want to exit in this market right now. You won’t get full value.”

Not all the juniors are in that position, he notes. “There is a second group of companies, with good balance sheets and perhaps some drilling success,” says Mr. Reid. “They’re cutting back on capital expenditures and being patient, waiting for the cycle to come back so they can look for an exit through an acquisition by a larger company.”

For those with cash, now is a good time to buy and grow. “If the juniors have strong management teams and they are capable, they are busy acquiring both production and drilling prospects,” says Mr. Burgess. Of course, getting the cash to do the acquisitions is more tricky. The sector is less “sexy,” notes Mr. Burgess, and the markets are “skittish.”

Nonetheless, lawyers expect to see M&A activity among juniors heat up.

“We’re into the part of the cycle where there are companies in trouble that have to do something,” Mr. Reid says. “The trust structure was a valuable solution for the industry in Alberta,” he says. “The basin here is not a basin that has a lot of exploration windfall opportunities anymore. The trusts really filled that void. Theirs was a very specific niche in the market, and they were there to deal with production of ageing assets and to produce it economically. Now, who is going to fill that void?”

The answer, briefly, seemed to be private equity. While private equity has been active picking up troubled business trusts, the impact on the Alberta energy trust market has been underwhelming. The big deal of note was the $3.5-billion going-private transaction announced in June involving CCS Income Trust, an oilfield and industrial waste handler.

“There has been tire kicking, and lots of doors getting knocked on,” says Mr. Reid. But the flow of anticipated deals hasn’t happened.

There are a number of reasons why private equity is balking. Valuations might not yet be low enough, or it might be the lack of an obvious exit strategy that are keeping private-equity players away.

Maybe private equity just doesn’t have the stomach for it. As the federal government’s backpedalling on income trusts shows, investing in this sector is as risky as it gets. As Mr. Pasieka puts it, “The oil and gas market is as volatile as Calgary weather.”

Still, despite the lack of private-equity interest and financing challenges, Calgary lawyers remain optimistic that the good times will continue, aided by high oil prices.

“The phone is ringing,” says Mr. Reid. “Clients are starting to call us and indicate they are looking at various opportunities. It will be a busy fall.”

Credit: Financial Post

(Copyright National Post 2007)