Will Alberta Hearing Impact Investor Faith?

Abstract: The Alberta Securities Commission's hearing into the 1999 collapse of Blue Range Resource Corp. is worth following since echoes of the firm's collapse continue to linger in the Canadian energy industry.

Analysis: The prosecution raised the specter of Enron-like accounting practices; the defendants dismissed the allegation as a gross distortion.

While the two sides have vastly different views, no one can doubt echoes of Blue Range Resource Corp.’s collapse continue to linger in the Canadian energy industry.

Normally, the bankruptcy of a relatively obscure junior producer would not merit much attention. But in the wake of Enron’s high-profile failure last year, the Alberta Securities Commission’s hearing into the early 1999 crash of Blue Range should attract a lot of attention.

The case started this week in front of the ASC, a provincial regulatory agency which oversees capital markets in Alberta. The hearing is scheduled to last months; more than 50 witness will testify and about 175 thick binders of evidence will be examined.

Besides the impact on the reputations of the various executives, the tortuous saga deserves more than a yawn for several reasons.

A hostile takeover in late 1998 resulted in Big Bear Exploration Ltd. taking over Blue Range, a much larger firm, for about C$300 million.

Big Bear was headed by Jeffrey Tonken, then seen as oilpatch wunderkind for rapidly building up his former company, heavy oil specialist Stampeder Exploration Ltd. in the mid-1990s. Tonken went to Big Bear after Stampeder was sold in 1997 to Gulf Canada Resources Ltd. for approximately C$1 billion.

Big Bear relied on public documents to launch its bid for Blue Range, which had faltered in the stock market in 1998 after missing production and financial results.

Shortly after taking control in December 1998, the new management cut Blue Range’s production and reserve estimates while boosting its reported debt.

But the deal continued to go as sour as a well only containing hydrogen sulfide. Big Bear put Blue Range into court protection in March 1999 to shelter the assets from creditors.

Canadian Natural Resources Ltd. ended up buying Blue Range for C$235 million, meaning a haircut for creditors owed C$275 million. Big Bear wrote off the whole mess for C$152 million, and the financial disaster contributed to Big Bear merging with Avid Oil & Gas Ltd. in early 2000.

The discrepancies between Blue Range’s publicly available figures and what was found upon taking over caused Big Bear to complain to the ASC in February 1999.

For example, Blue Range reported its gas production using raw figures. It did not tell shareholders and others that it was using an unconventional measurement practice that obscured shrinkage of around eight percent.

The provincial regulator alleges Gordon Ironside, chief executive of Blue Range, and CFO Robert Ruff deliberately misled Big Bear officials, investors and even its own auditors. The two men are accused of improperly reporting output and failing to disclose the firm’s true financial picture, including a liquidity crisis.

The Blue Range debacle happened around the same time that two other high-flying juniors, called Probe Exploration and Merit Energy, also imploded. The failures, all basically caused by accounting problems and management control, caused investors to avoid small Canadian producers like they carried the deadly ebola virus.

The resulting indifferent equity markets helped push consolidation in the sector during 2000 and 2001. The contraction in cash flow trading multiples made juniors more attractive to U.S. buyers as well as Canadian income trusts.

Following on the heels of Enron and other accounting scandals, the ASC needs to demonstrate to skittish investors that it can police the market and ensure fairness for all players. Investors must have confidence that they can trust public information filed by energy companies.

If the allegations are proven true, the ASC should mete out severe penalties, such as heavy fines and long trading suspensions, on Ironside and Ruff. Any mixed or muted message from the ASC will chill investors. A cold shoulder is the last thing Canadian juniors need, since they often spend more than internally generated cash flow in their early years when growing rapidly.

The hearing certainly won’t decide the fate of all junior producers, but it will play a role in keeping the taps open for equity financings. Small companies are playing a bigger role in the search for new discoveries, a direct result of reduced drilling by the growing income trust sector which doesn’t drill many exploration wells. This means the ability of juniors to raise capital is important to the long-term health of the Canadian oil and gas industry.

Even if the ASC is not successful with its case, some lasting good has come from Blue Range’s collapse. The affair prompted industry and governments to work together to toughen standards for estimating and reporting proven and probable reserves. The new rules kick in for fiscal years that end following Dec. 31, 2003.

Better late than never.