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Nickle's Daily Oil Bulletin -- 23 February 2004

Private Capital Looks For Opportunities
In High Market Cycle

By Shaun Polczer

One man's bull market is another's bear -- just ask Cameron Smith.

Smith, the head of COSCO Capital Management LLC, a New York-based oil and gas investment bank, is bringing his annual Private Capital for Energy forum to the Westin Inn on Thursday, Feb. 26, at a time when private capital financing in Canada is facing stiff competition from public markets eager to take advantage of strong commodity prices.

That poses a bit of a dilemma for private investors, whose "buy low, sell high" mantra is being put to the test after an extended stretch of oilpatch prosperity. For a business that prides itself on expecting the unexpected, the five-year bull run in oil and gas prices has caught many private investors flat-footed, Smith concedes.

"If it's not the peak, it's certainly a high plateau," he says. "That means alternate forms of financing are prevalent and cheap. Public markets are extraordinarily active, which makes for a challenging environment for private capital."

Undeterred, Smith says current market conditions test the creativity of private investors to look for opportunities. Rather than focus on acquisitions, private investors will typically use the high cycle to pursue drill bit strategies, back new management teams, "harvest" existing investments and reload their own coffers.

"You have to get out of the centre of the current and find the profitable eddies," he says. "In times like this, private capital says: 'terrific, what makes sense, now?'

"It can bring into play larger, lower margin, longer lead-time projects like heavy oil and coalbed methane, that have mixed appeal to public markets and were harder to justify at lower prices, but which lend themselves to the longer perspective and greater experience of private capital."

Smith recognizes that Canadian public markets are particularly efficient at raising smaller amounts of money, especially for micros and juniors, when compared to public markets in the U.S. But he is also quick to note that the rejuvenation of public markets in both countries is more a function of high commodity prices than any fastidious commitment to the local oil and gas industry.

"The retail market is following a commodity, not backing a team, and definitely not a strategy," he says. "People who flood in during good times, flow out during bad."

Where public markets are fixated on quarterly production targets, private capital is about investing in people and ideas, especially when commodity prices inevitably fall. In a high cycle, private investors are keen to find people they can work with once the next downturn arrives, and Smith says that’s when their "contrarian capital" becomes particularly valuable.

"Public capital tends to be like a cookie cutter," Smith explains. "If you don't fit the mould, you don’t make it to the oven, whereas private capital takes time to understand the merits and track record of a particular management team. The difference dictates how they respond to change."

With the rise of a new crop of publicly funded juniors, are private investors concerned about a shortage of seasoned management teams to back? "Never," Smith replies. "There will always be qualified entrepreneurs with exciting ideas seeking experienced investors."

Despite impressive growth in the Canadian based private capital industry over the past several years, the level of private capital in Canada is still "miniscule" in relation to what's available in the U.S. Smith predicts that 2004 "will tell the tale" on the immediate future of many of the new entrants in Canada, as they strive to attain critical investment returns in competion with the renewed tide of public capital.

"Performance is what will attract more institutional investors," to private capital funds he says. "But it will still take a significant shift in thinking from Canadian entrepreneurs to resist the siren-song of public capital and buy into the long term dollars these new Canadian funds have to offer."

Over the longer term, Smith says private capital funding for energy is likely to continue on an upward path on both sides of the border. "It's still a small portion of the monies spent by industry," he says. "In Canada, particularly for larger scale or longer term needs, the industry could accommodate significantly more private capital than it does today."

Since 2000, COSCO has helped energy companies raise private placements in excess of $500 million and participated in transactions worth an additional $550 million in Canada, Australia and the U.S. COSCO opened an office in Calgary in May 2003 and its biggest deal on this side of the border since then was Purcell Energy Ltd.'s $62-million takeover of Belair Energy Corporation, which closed in September.

The theme of this year's Calgary conference is "ultimate tools" and Smith says that's because "private capital provides the ultimate tools for constructing a sound financial foundation ... it's the difference between custom built and pre-fab."

The COSCO forum will hear from 15 capital providers representing more than $8 billion under management, representing the full gamut of financing styles, structures and investment interests. Smith reports his panelists spent over $1.8 billion in 94 separate deals in Canada and the U.S. last year, while harvesting an additional $1.5 billion through mergers, sales, and initial public offerings.

Smith joked that royalty trust conversion has emerged as a distinctly Canadian method of monetizing investments, particularly for companies in the 5,000 plus bbl of oil equivalent range. "Selling to a royalty trust, now that's a good exit strategy ... there's no equivalent in the States."

In addition, the forum will hear from five beneficiaries of private capital, who will share their experiences and insights, including the relative strengths and drawbacks with receiving private funds. Noted energy analyst Robert Gillon, senior vice-president and co-director of equity research with John S. Herold Inc., will deliver a keynote address on the "Nuts and Bolts of the Greater Energy Economy."

Delegates will gain the opportunity to network in roundtable discussions with individual capital providers in a one-on-one setting. Smith notes the conference is as much a chance for potential investors to meet potential new business partners as it is for entrepreneurs to bring forth new ideas and business plans.

"Somebody comes to this conference to understand his capital options and assess the merits of a capitalization strategy that's not all that prevalent in Canada. Smart entrepreneurs will learn if their business plans and capital needs are well suited to private capital and how best to seek it out."