Despite a 74% drop in net income in the fourth quarter, Calgary-based PanCanadian Energy Corp. said it had the strongest annual financial results in its history because of higher natural gas prices earlier in the year, increased gas production and favorable price hedges. Due to lagging gas prices — neighbor and proposed merger partner — Alberta Energy Co. (AEC) experienced a drop in earnings during 4Q 2001, falling 83% from the fourth quarter of 2000 to C$80 million (C$0.46 per share diluted).

PanCanadian also saw a big dip in the fourth quarter, reporting net income of C$91 million (C$0.35 per common share), compared with C$344 million (C$1.35 per common share) for the same period in 2000. Likewise, cash flow in the fourth quarter was down sharply to C$386 million (C$1.51 per common share) from C$784 million (C$3.09 per common share) in the last quarter of 2000. The company said that higher natural gas production and favorable natural gas and crude oil hedges only partially offset weaker market prices for natural gas and crude oil, and lower crude oil production. Commodity and currency hedges contributed C$149 million before tax in the quarter.

PanCanadian and AEC announced on Jan. 27 that the two companies intended to merge, creating the largest independent natural gas producer in North America (see NGI, Feb. 4). The new EnCana Corp. would have the largest proved reserve base in the world (7.8 Tcf of gas and 1.3 billion bbl of oil), equalling 2.6 billion Boe. In North America alone, the companies forecast 2.7 Bcf/d of production for 2002. The combined company would bring to the table more than C$2 billion in combined North American midstream and marketing assets, including energy services, gas storage, natural gas liquids extraction, pipelines and power generation. PanCanadian said the merger will lead to C$250 million in annual operating and administrative cost synergies and C$250 million in improved capital allocation. The transaction is expected to close in early April 2002.

“The year 2002 promises another giant step forward for PanCanadian through its proposed merger of equals with Alberta Energy Co. to create EnCana Corp….” said Grandin. “The merger, if approved by shareholders, would create a company with a more diverse and complementary portfolio of assets, operating and capital cost synergies, greater liquidity, and the size to compete on the global stage. As we undertake larger capital projects and the energy business becomes more international in nature, we believe that scale will be an important determinant of corporate competitiveness and success. The increased scope, scale and reach of EnCana will contribute to its performance and ability to deliver enhanced shareholder value.”

The full year and fourth quarter 2001 results of PanCanadian and AEC have some analysts optimistic about the pending merger, while others aren’t so sure. UBS Warburg said assuming the transaction proceeds, it believes the combined company will receive a significant positive re-rating for the following reasons:

“If approved, the combination of these two companies will create a new entity with an approximate EV of $28 billion — bigger even than Anardarko Petroleum, the largest US Independent, and about 2.5 times the EV of the next largest Canadian E&P company,” UBS Warburg said.

However, analysts with Lehman Brothers said that weak production results from PanCanadian and AEC during the fourth quarter could spell trouble for the combined super-producer.

“The fourth quarter oil and natural gas volume shortfall of 5% by PanCanadian and 11% by Alberta Energy supports our thesis that the proposed EnCana could disappoint on what is now a 7%-12% total volume growth target this year (up from 4%-9% due to lower than expected ’01 results), especially given that its ’02 capex budget is C$0.8-C$1.1B greater than our cash flow estimate on a January pro-forma basis,” Lehman Brothers said in an Equity Research report.

The group said the fourth quarter production miss also makes the previously stated 2002-2005 production growth target of 50%-55% for EnCana seem “even more aggressive.”

In the quarter, PanCanadian’s gas production averaged 1,077 MMcf/d, up about 4%. Production of crude oil and natural gas liquids was 9% lower, averaging 113,900 b/d, reflecting the disposition of 5,300 b/d from Pelican Lake. Realized prices, including hedging, for natural gas declined 41% to C$4.07/Mcf and crude oil decreased 16% to C$23.81/bbl.

The company reported a 26% increase in net income for the year to C$1.3 billion (C$5.09 per common share). PanCanadian President Michael A. Grandin said the company’s natural gas production grew by 11% to 1.053 Bcf/d (with realized prices up 33% to C$6.20/Mcf) in the Western Basin, and the company significantly advanced pre-development work for the Deep Panuke natural gas discovery offshore the East Coast of Canada. PanCanadian also completed delineation of the Llano field and greatly expanded its land inventory in the Gulf of Mexico, he said.

The increase in PanCanadian’s natural gas production in 2001 mainly reflected higher production from natural gas properties acquired as part of the Montana Power acquisition in the fourth quarter of 2000 and a successful drilling program. The exit rate in 2001 for natural gas production was 1,127 MMcf/d. Its marketing volumes increased 24% to 4,643 thousand MMBtu/d (approximately 71% natural gas) and marketing margins grew 40% to C$176 million.

Year-end debt to debt plus equity was 36%, the 12-month trailing net debt to cash flow was 57%, and the year-end cash balance was nearly C$1 billion. PanCanadian’s financial position remained strong even after a special dividend of C$4.60 per share (C$1,180 million) was paid to all shareholders in September 2001 as part of the Canadian Pacific Limited reorganization.

AEC was also affected by slumping gas prices, but still managed to record its second best financial results ever. For the year, AEC’s cash flow from operations fell 10% from its best in 2000 to C$2.02 billion (C$12.57 per share diluted). The company also reported that its net income was down 11% to C$824 million (C$4.98 per share diluted). Net revenues in 2001 were C$6.3 billion, up 14% from 2000.

In the fourth quarter of 2001, AEC’s cash flow from operations was down 76% from the same period in 2000 to C$219 million (C$1.38 per share diluted). AEC’s Quarterly net revenues were $1.2 billion.

AEC achieved record daily sales averaging 356,000 Boe, up 20% from 2000. Each of the three growth platforms, Canada, the U.S. Rockies and Ecuador, set new records, according to the company. AEC continued as Canada’s largest gas producer, recording daily sales averaging 1,323 MMcf/d, a 24% increase over 2000. AEC’s current daily gas production is on target at approximately 1.5 Bcf. Despite AEC’s record sales, the company was affected by North American natural gas prices as they eroded throughout 2001, averaging C$5.29/Mcf, down 3% from 2000.

“The past two years were mirror opposites, with prices rising steadily throughout 2000 and falling throughout 2001. In 2000, we were able to capitalize on higher prices at the end of the year, boosting daily gas sales from our storage,” said Gwyn Morgan, AEC’s CEO. “However, as prices continued to deteriorate in late 2001, we chose to temper sales volumes and retain gas in storage in anticipation of improving gas prices in the second half of 2002.”

Looking forward into 2002, PanCanadian said its activities will continue to be directed toward delivering strong near-term natural gas production growth from the Western Basin and developing offshore and international projects for medium- and longer-term value creation. The company said it expects to grow its North American natural gas production by 10% in 2002, while overall corporate production growth on a Boe basis is anticipated to be approximately 4%. Consolidated proven reserves are expected to increase by more than 10% in 2002, based on the company’s recent successes offshore and internationally.

PanCanadian’s board of directors approved a C$1.7 billion capital investment program for 2002, which will be funded largely from cash flow generated from operations. Reflecting PanCanadian’s plans to continue to grow natural gas production, approximately C$1.1 billion, or 70%, of the company’s exploration and production capital investment will be targeted toward natural gas.

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