PTR Petrochina Company Ltd

CALGARY, Alberta—Energy companies aren't the only ones reeling from the industry's bust.

Japanese auto maker Toyota Motor Corp.'s supply and trading arm, Toyota Tsusho Corp., made an ill-timed bet on Canadian natural gas, inking a $500 million deal with Canada's Encana Corp. in 2012 to develop gas-rich lands in southern Alberta. Two years after the market for such joint ventures collapsed, the deal has devolved into a court battle over who owns the underlying assets.

Deals pairing an outside investor with an energy producer became a popular way of financing new wells a few years ago. Several such agreements have been struck in the U.S. and Canada, many with foreign investors eager to tap into the unfolding shale boom.

With oil prices below $50 a barrel and natural gas hitting 17-year lows earlier this year, these revenue-sharing agreements haven't turned out to be the bonanza expected by many producers and investors.

The dispute between Toyota and its Canadian operating partner is another in a string of disappointing investments by Asian investors eager to establish a beachhead in North American energy by targeting assets in Western Canada.

Some operators, such as Whiting Petroleum Corp., still embrace this financing model, saying it allows them to continue drilling more wells at current prices than they could otherwise afford. But legal experts say their heyday has passed.

"Those went out of vogue with the collapse of oil and gas prices," said Michael Darden, head of the oil and gas practice at Latham & Watkins LLP in Houston. "We were doing them like crazy and a lot of the money was from foreign investors," he said.

The deals are a way for energy producers to boost output, even though they can reduce the return on their assets. Jim Volker, Whiting's chief executive, told analysts on a July 28 conference call that having an outside investor pay 65% of a well's cost in return for 50% of its earnings is a good deal with profits capped by prices below $60 a barrel.

The deals allow outside investors to invest directly in oil and gas wells without the burden of operating them, and corporations can use them to hedge against energy-price spikes that raise their fuel costs. If commodity prices rise, these participation agreements can pay off handsomely. But they come with a big downside risk—unprofitable wells can be shut down, permanently halting the profit-sharing and forcing the minority partner to forgo its investment.

Toyota Tsusho and Encana hailed their joint venture as a model marriage between Asian capital and North American energy production. Under the deal, Toyota was to invest 600 million Canadian dollars (US$462 million) in exchange for a 32.5% royalty interest in production from half a million acres of gas-rich lands in western Canada. For its part, Encana got funds to help cover the cost of 4,000 existing wells and some 1,500 future drilling locations.

Encana's joint venture with Toyota was the first of several similar deals it struck with outside partners in 2012. The Calgary-based company also received funds in return for a percentage of production royalties from Mitsubishi Corp. of Japan, U.S. steelmaker Nucor Corp. and Chinese state-controlled energy giant PetroChina, each for different assets in Canada and the U.S.

In late 2013, Nucor said it suspended the drilling program with Encana in Colorado's Piceance Basin, citing low natural-gas prices.

"We're not pursuing any joint ventures" now, Doug Suttles, Encana's chief executive, said in an interview.

Toyota Tsusho, in which Toyota Motor owns about a one-third stake directly and through another affiliate, has branched out in recent years from its core automotive-parts and vehicle-distribution business, but it is still a relative newcomer to the energy industry. Its energy holdings account for just a fraction of its overall profit and focus on coal-fired and wind-generated electric power, according to its annual report.

That shows its only other investments in natural-gas production beyond its Canadian business, known as Toyota Tsusho Wheatland Inc., are minority interests in some Australian offshore fields.

Most oil and gas operators only lease production rights and can sell off part of the resulting revenue stream to outside investors. What made the Toyota deal unique—and the subject of a lawsuit—is that Encana had full title to own mineral rights from "fee simple" Canadian government land grants dating to the 1880s.

Encana and Toyota Tsusho both declined to comment on the legal wrangling. But they have staked out opposing positions in public documents filed with the province of Alberta's superior court.

Toyota says its contract effectively makes it a co-owner of underlying mineral rights to more than 450,000 acres in southern Alberta and hundreds of wells drilled on those lands, and protects its investment despite well shutdowns due to low prices.

Encana contests that view, arguing in court filings that it never agreed to share ownership to the underlying mineral rights, only a portion of the royalties earned from them. It wants the case dismissed and the court in April referred most of the claims made against it to arbitration under international law.

The Tokyo-based company also contends Encana didn't have the right to unilaterally transfer those assets to a former subsidiary.

After its deal with Toyota Tsusho, Encana carved out its royalty unit into a new company called PrairieSky Royalty Ltd., which took over ownership of the disputed mineral rights. To raise cash, Encana split off that company in a 2014 initial public offering. Toyota Tsusho alleges Encana engaged in a conspiracy to deprive it of funds raised from the IPO and subsequent sale of a retained stake.

"The fee title transaction, which lay at the heart of the PrairieSky IPO and created value for both Encana and PrairieSky, was a material breach of the Toyota agreements," according to a statement of claim filed by Toyota Tsusho Wheatland with the Court of Queen's Bench of Alberta.

Representatives for PrairieSky didn't respond to a request for comment.

Write to Chester Dawson at chester.dawson@wsj.com

(END) Dow Jones Newswires

September 04, 2016 22:15 ET (02:15 GMT)

Petrochina (NYSE:PTR)
Historical Stock Chart
From Mar 2024 to Apr 2024

Petrochina (NYSE:PTR)
Historical Stock Chart
From Apr 2023 to Apr 2024