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From Russia with indifference

Why the natural gas deal between China and Russia doesn't necessarily hurt the prospects of North American LNG exports to the region, and how to play the forthcoming PrairieSky IPO

When he was younger, Max Fawcett wanted to make a mint in the markets. Now as the managing editor of Alberta Venture he gets to write about them. Close enough, right? He can be reached at mfawcett@albertaventure.com

May 28, 2014

by Max Fawcett

Last week’s epic natural gas deal between Russia and China stirred some concerns in Alberta that our delay in getting LNG to market may ultimately mean that market isn’t there when we finally do. But in his latest energy chart, Arc Financial’s Peter Tertzakian suggests that there’s a much different – and favourable – dynamic at play for those with a vested interest in exporting natural gas. “The world today is consuming roughly 320 bcf/d of natural gas,” he writes. “Annual growth of the primary fuel is running at about 2.2 per cent, or just over 7 bcf/d – nearly two times the size of the ‘landmark’ deal each year. In China, the consumption of natural gas is running at more than 14 bcf/d. Several agencies and consultancies have go-forward projections, but most are underestimating what the world’s biggest consumer of energy will need a decade out. We think it will be at least 60 bcf/d.”

That’s good. The fact that the incremental cost of bringing new natural gas sources online will be substantially higher than the $9.91/mcf implied by the Russia-China tie up might be even better. “The marginal cost of coal substitution will get progressively more expensive on increasing volume demanded by emerging economies seeking a greater fraction of cleaner energy supply,” Tertzakian writes. “If three Canadian LNG projects get built over the next 10 years, Canada’s contribution to the world’s gas supply might be 4.0 bcf/d, the equivalent of a party balloon inside the Goodyear blimp. The issue for Canada is not worrying about the availability of market share, but about ensuring the capture of maximum value amidst the impatient competitive noise.”

Meanwhile, Encana’s much talked about IPO of its royalty interest in approximately 500,000 acres in southern Alberta continues to attract attention. The company, which will administer that acreage and collect fees from other companies who would do the actual work of drilling up and producing its reserves, is expected to distribute 85 per cent of its operating cash flow in the form of a dividend. The ongoing thirst for yield, both from institutional investors and retail buyers, has resulted in a premium valuation for PrairieSky, whose shares will be priced at $28. For Encana, which will retain a majority stake in the company, the 52 million shares of PrairieSky it’s putting on the market will raise almost $1.5 billion, and if the over-allotment option gets exercised – and it almost certainly will, given the heavy demand for shares – the finally tally could hit $1.67 billion. Either way, it will be the biggest Canadian IPO in more than a decade.

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But don’t bother trying to get in on the action. As BNN’s Jameson Berkow wrote on Monday, most of the shares on offer are already spoken for. Instead, according to Investors Group Financial Services’ Shafik Hirani, the best way to play it is by buying Encana shares. “ECA shares are widely available and since that company will remain PrairieSky’s single largest shareholder by a gigantic margin,” Berkow writes, “it is expected to reap substantial cash flow benefits in the medium and longer terms. ‘Encana is the real winner here,’ said Hirani.”

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