While leaping into the top five Canadian natural-gas producers, Burlington Resources Inc. also raised questions about its ability to stay there when it laid out C$3.3 billion (US$2 billion) cash for its takeover of Canadian Hunter Exploration Ltd. (see Daily GPI, Oct. 10).

The new combination has annual average Canadian gas output exceeding 800 MMcf/d, making it the third-biggest in the field. Only Alberta Energy Co. and PanCanadian Energy are bigger in gas, with production nudging one Bcf/d each. Close rivals for third spot, with production on the rise into the 800 MMcf/d range, include Canadian Natural Resources Ltd., Talisman Energy Inc., Petro-Canada and the industry’s other new marriage, Devon Energy Corp. and Anderson Exploration Ltd.

When Burlington chairman Bobby Shackouls visited Calgary to explain the sale, the talk was all about acquiring big growth opportunities. Hunter has been a leader on the “explorationist” side of the Canadian gas industry since it was created in 1973 by two geologists with a penchant for prospecting, Jim Gray and John Masters. The president of Burlington Resources Canada Energy, Mark Ellis, told a news conference “this whole transaction is not founded on cost savings. This is founded on growth and growth opportunities” with “an extremely low-cost producer.”

The deal about doubled Burlington’s Canadian gas production, two years after it entered the country by taking over Poco Petroleums in a very different deal, valued at US$2.5 billion in share swaps and debt assumption. Shackouls described Hunter’s production and proven reserves as only the tip of an iceberg of quality expansion prospects: “You can’t buy a Mercedes for a Ford price.”

But the prospects alone did not impress the financial community or Burlington’s Canadian rivals. On Wall Street, Moody’s Investors Service promptly declared Houston-based Burlington’s credit rating to be “under review for possible downgrade” as a result of the deal to pay cash for the Calgary company. The private credit watchdog agency described the price paid by Burlington – US$9.90 per volume of proved oil and gas reserves equivalent to one barrel – as “a relatively elevated reserve acquisition price.” Moody’s acknowledged that the deal is not just about proved reserves, which are as good as future sales revenues in the bank.

Instead, the price in the Burlington-Hunter deal is “in line with recent rising reserve price trends as companies seek to acquire prospective natural gas plays in North America.” The acquisition includes 1.5 million acres of western Canadian drilling targets led by “significant undeveloped Deep Basin gas with characteristics similar to Burlington’s large mature San Juan Basin position in New Mexico,” Moody’s observed. “The reserves and exploration potential should enhance Burlington’s operating and reserve position in Canada and its overall production growth profile, which has been flat to declining in recent years.”

Moody’s review will ask the same questions that rippled through the Canadian financial and gas-producer communities. Will Burlington emerge in a position to take full advantage of the newly-acquired Canadian assets? Or will it have to divert money from growth opportunities to make loan payments? Moody’s pointed out the deal “will significantly increase Burlington’s financial leverage, with pro-forma debt to capitalization in the area of 55 per cent.” The rating review “will focus on the exploration potential and the production and cash flow impacts of the acquired reserves, as well as on Burlington’s capital allocation and asset sales strategies to reduce financial leverage in a reasonable time frame.” A similar review of the US$4.6-billion Devon-Anderson deal ended in the U.S. company’s credit rating being downgraded.

By contrast, the debt-to-capital figure was only 20% for the new combination of ChevronTexaco Corp. when it closed Oct. 10, Prudential Securities Inc. calculated. Moody’s promptly upgraded the ratings on the corporate paper involved in the transaction between the giants. It was valued at US$39 billion but was done with a swap of corporate equity – Texaco stockholders received Chevron shares rather than a cash payment with borrowed money.

The Burlington-Hunter deal set off a flurry of speculation that more international takeovers are ahead, causing jumps in prices of shares of other senior Canadian oil and gas producers such as Alberta Energy Co., PanCanadian Energy Inc. and Talisman Energy Inc. PanCanadian, freshly cut loose from former parent Canadian Pacific Ltd. by a share distribution, was the favorite candidate for most likely to be next in the takeover wave.

Among Canadian companies, one senior executive privately expressed the expectant mood in a nutshell. The corporate captain observed that U.S. gas producers appear to be so hungry for new reserves and sheer size that Canadian companies are in danger of losing their only defence against takeovers, strong share prices that make them too expensive to swallow up easily. The buyers do not seem to be worried about price.

Among the Canadians, the big transactions stand out as especially expensive in light of the 80% drop in gas prices to the range of US$2-$3 per Mcf from the record high of US$9.82 set in January. There is little conviction that markets will return to the highs any time soon.

In the financial community, oil and gas share specialist Peters & Co. agreed that the takeover deals for Anderson and Canadian Hunter were “at dramatic premiums to prevailing stock prices.” Devon and Burlington “require a return to strong natural gas prices within the next two years to justify the economic viability of the transactions.”

The Canadian takeover targets were valued as if gas prices will turn out to average US$4 per Mcf in future, the Peters investment house calculated. “The gas market will attempt to find an equilibrium price at which consumers are willing to pay and producers can afford to explore and develop. The futures market says this price is US$3, but the large independent American producers are saying it is US$4…the market will continue to grapple with this fundamental dichotomy in the pricing of natural gas.”

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