NORVAL SCOTT

00:00 EST Tuesday, December 16, 2008

CALGARY -- Not so long ago - in July, in fact - life in Canada's junior oil and gas sector seemed pretty sweet.

Oil prices were at $147 (U.S.) a barrel, meaning cash flows were at record levels, while gas prices were also high. Even better, buyers desperate for reserves were prepared to pay silly money for companies with strong growth prospects, as shown by Royal Dutch Shell's astonishing $5.2-billion (Canadian) purchase of Duvernay Oil Corp., a Calgary-based junior that only produced 23,500 barrels of oil equivalent a day.

But then the bubble burst. Spectacularly.

As the global financial crisis blew up, claiming blue-chip bank after bank, financiers were sent into a tailspin and funding for risky players like junior oil and gas companies dried up. Hedge funds, panicked by the chaos, liquidated what positions they could, sending stock valuations plunging. And oil prices collapsed to $40 (U.S.) a barrel in just six months.

That's created a world of pain for Calgary's juniors, whose attraction to investors is largely based on their potential to grow rapidly.

Now, however, most companies can't raise cash from banks or investment houses. They also can't make much money themselves because of lower commodity prices and Alberta's new royalty scheme, which will increase the amount firms must pay on existing production from Jan. 1.

In short, most juniors don't have the cash to grow. So instead of exploring, they're tightening their belts, developing the fields they've already found, and hoping they can make it through the storm intact.

The impact has been swift and dramatic. The average share price of junior companies fell 67 per cent from July through November as investors cashed out. Meanwhile, per-share production of oil and gas in the third quarter, compared with the second quarter, was flat across the sector.

"Things are horrible right now, and companies will have some real challenges, especially in the first half of 2009," said Peter Knapp, president of Bryan Mills Iradesso, a Calgary firm that compiles a quarterly in-depth look at the sector and is The Globe and Mail's partner in the annual Canada's Hottest Juniors report. "The entire [sector] is being pummelled all the time, but even if oil had stayed above $100 a barrel, the market would still be down a substantial amount," he said. "The hedge funds need cash and they've been actively selling off their positions."

With lines of credit tougher to secure, and most companies either unwilling to issue shares at current prices or unable to find a market for underwriting at all, juniors have little option but to slash their 2009 budgets and spend within cash flow.

Most firms will reduce their spending by between 25 and 50 per cent, producing a significant decline in exploration activity, said Gary Leach, president of the Small Explorers and Producers Association of Canada. Juniors drill some 40 per cent of all of Alberta's wells, and about 60 per cent of the exploration drilling that tries to locate new pools of oil and gas. "Juniors are expected to deliver growth and if they can't do it through the drill bit, the alternative is through mergers and acquisitions. Those with cash in the bank will be looking at what opportunities are out there."

As companies go to the wall, those with good assets will be snapped up by larger firms with relatively strong balance sheets. For weaker juniors, the likely path forward is mergers with other firms through share swaps, as they seek safety in scale. The result will be a consolidation of the sector.

There are still some bold players interested in the sector for the long term, not least because - given the huge drop in valuations - this is probably about the time to invest. But those with money are being picky; they want great assets, strong management teams and, most of all, balance sheets with enough room to ride out the downturn. "The number one asset in this market is cash," said Jason Brooks, president of Calgary-based private equity fund Invico Capital Corp. "Forget about reserves or any intangibles; it's cash. If you have that, you're in a good position, and if you don't, this market will [undervalue] you."

But amid the crippling negativity that's taken hold of the sector there's still some light at the end of the tunnel.

Even though gas natural prices have fallen, they haven't slid as far as oil, only dropping by about 40 per cent. Consequently, gas-weighted names appear to have been oversold and are poised for a rebound once the market stabilizes.

Also, while Alberta comes to terms with its new royalty regime, the red-hot unconventional oil and gas plays in northeastern B.C. and Saskatchewan continue to hold massive potential.

So while there's still a huge uncertainty hanging over the sector, it's also possible that the market is reasonably close to bottoming out - providing a huge buying opportunity, if investors can find the right names. "It's a great sector to be in," said James Moon, president of Toronto-based investment dealer All Group Financial Services. "There's going to be guys that fail, but if you're wise enough now to find the company with the property that's going to make it, with cash flows that are reasonable at these prices ... then you can pick up [stock] at phenomenal valuations."

Globe and Mail

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So now we're wiser eh? The big fish are going to eat the little fish.

H'm mm, great example of that today when Vale-RIO-N zeroed in on TL-T for a profit of over two dollars per share.

I couldn't think of a better Christmas present for Buckshot if the same thing happened to BVG-X.

To accumulate one has to speculate.

KISS theory! Keep it simple! Nothing fancy!

Good Luck to all.