Analysis:An intense corporate takeover battle in Canada's energy industry has finally ended after months of increasing rancor and competing offers.
While the battle for coal miner Fording Inc. is over, the underlying fundamentals of natural gas supply and demand that drove some bidders will continue to influence strategies for years to come.
In a complex deal unveiled early this week, Fording came up with a C$1.8 billion solution to settle the debate about its future. A new income trust will be created that involves both the hostile bidders that put the company in play and white knights found to defend Fording.
A bit of background is needed to understand why the fight over a coal producer is connected to the gas industry.
Spun off in the fall of 2001 by the breakup of historic conglomerate Canadian Pacific, Fording is Canada's biggest producer of metallurgical coal (used in making steel and sometimes referred to as "met coal"). It is also the country's second largest producer of thermal coal.
The company was put in play last October with a hostile bid worth C$1.5 billion from Sherritt International Corp. and the Ontario Teachers' Pension Plan (OTPP), one of Canada's largest pension funds.
The partnership wasn't a complete surprise as Sherritt and OTPP worked together in early 2001 to take over a coal income trust, called Luscar. They proposed combining the assets of Luscar and Fording into one income fund.
After first considering a trust composed solely of Fording's properties, company executives found white knights in Teck Cominco and Westshore Terminals, two Vancouver-based companies, to come up with an even bigger proposed income trust.
The two sides traded barbs and ever-richer offers until this week's proposal, the seventh and final one since Sherritt and OTPP have withdrawn their bid.
The various sides agreed to form the Fording Canadian Coal Trust. It will contain the metallurgical coal assets of Fording, Teck Cominco, and Sherritt's Luscar, making it the number two producer of coking coal behind Australia's BHP Billiton.
A part of the deal—one that forms the link to the gas industry—is Fording's agreement to sell its thermal coal assets to Sherritt and OTPP for C$225 million.
These assets were always a key consideration for Sherritt and OTPP. If they had been successful in their quest, the bidders planned to throw Fording's met coal properties into an income fund and retain ownership of the thermal coal assets.
This may look like a small detail, but it wasn't, considering the history of Sherritt. Famous in the U.S. mostly for sanctions imposed by Washington against executives because of its interests in Cuba, Sherritt is led by Canadian financier Ian Delaney.
Nicknamed the "Smiling Barracuda," Delaney has become very wealthy by spotting hidden value well ahead of most other people. Delaney and his partners are making a long-term bet on the value of thermal coal because of declining gas production in North America while electricity demand is rising.
As surely as starlets swarm Cannes' annual film festival, government data will eventually show gas production in 2002 dropped on both sides of the border. (A recent report by Merrill Lynch, for instance, said third-quarter gas production fell six percent in the U.S. and 2.7 percent in Canada).
Will higher prices, which jumped C$2 per thousand cubic feet in the fourth quarter of 2002 compared with a year earlier, correct the problem? It's unlikely because most basins in Canada and the U.S. are maturing, leaving producers hard-pressed just to offset annual declines.
Last week's release by the Energy Information Administration (EIA—part of the U.S. Department of Energy or DOE) of its annual energy outlook certainly did not reflect recent experience in the gas industry. If anything, the thick document probably reinforced the views of contrarians like Delaney.
The EIA forecasts domestic U.S. gas supply climbing to 26.8 trillion cubic feet (tcf) by 2025, up from 19.5 tcf in 2001. Imports of Canadian gas are projected to rise to 5.31 tcf annually over the period, up from 3.6 tcf in 2001. These figures translate into annual production gains of 1.3 percent in the U.S. and 1.6 percent in Canada.
Those assumptions seem almost as shaky as a skyscraper not built to code in California. The Canadian National Energy Board, for example, forecasts Canadian gas supplies will decline over the next couple of years.
The EIA's number-crunchers obviously believe 2002 will be a blip and higher prices will unlock additional domestic reserves and encourage the building of Arctic pipelines.
If the data gathering arm of the DOE is wrong on gas supply, then its prediction of falling coal prices over the next two decades also goes into the garbage.
Even with its prediction of increased gas supply, the EIA expects coal sales to meet electricity demand will jump to 1.35 billion tons in 2025 from 957 million tons in 2001.
"Between 2005 and 2025, rising natural gas costs, increasing demand for electricity and retirements of existing fossil-fired steam capacity are projected to result in increasing demand for coal-fired baseload capacity," the report said.
Some people argue environmental pressures, which will only increase in the future, limit prospects for the dirtiest of all fossil fuels when it comes to greenhouse gas emissions. Faced with the choice of blackouts versus extending a license for a coal plant that puts in scrubbers, it's pretty easy to guess which way most regulators and politicians will vote.
In addition, coal producers are working on cleaner technologies to reduce their environmental footprint. Several Canadian companies, including Sherritt's Luscar, are cooperating on a C$1 billion project to enable coal to burn as cleanly as natural gas. The Canadian Clean Power Coalition expects to build a commercially viable demonstration plant by 2007 and retrofit an existing generation facility by 2012.
The Canadian project is a long way from reality, but it helps explain why Sherritt and OTPP were so interested in Fording's thermal coal. Delaney didn't get rich overnight, but time has shown he's been right a lot more times than he's been wrong.
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