In 1996, it dawned on the managers at a Canadian oil and gas consultancy that their clients were doing well - perhaps too well. Their consultancy was named ARC Financial, after the advisory, research and capital raising expertise that made up the bread and butter of the revenue.
ARC Financial itself was doing fine, but much of the ultimate value ended up with the owners of the assets being advised on. A decision was made to convert to a royalty trust structure so that assets could be kept and developed in-house, and the name of the company changed to ARC Resources. When the opportunity arose to acquire 21 unwanted properties from Mobil Oil Canada, they pounced.
As a small-scale energy player with no track record of its own, ARC Resources raised only C$180m in its initial public offering and was unable to find any institutional investors to take part. Thirty years later and the company has risen to become one of Canada’s top energy producers, and now a new holding in RGI Global Income and Growth.
There is much more to ARC than meets the eye, and it has all the hallmarks of an energy company that is built to last. Financial strength, long management tenures and a low-cost and efficient resource base are three starting points we look for in this sector. ARC has made it through many downturns and remarkably produced a total shareholder return of just under 12% per annum over 30 years, better than Chevron, and even the S&P 500[1]. Even more impressively, most of the return was in the form of cash dividends, a rarity in an industry that tends to dilute shareholders and overinvest their money at the wrong time.
ARC does business in only one region of Western Canada, where unconventional drilling techniques like those used in the United States have transformed the economics of producing oil and gas. This has made ARC the Canadian leader in condensate, a mixture of the heaviest molecules in natural gas, and a critical product needed to dilute the heavy tar sand oil produced in the North of the country.
For many years, the oil and gas produced in Western Canada was sold at low local prices, a result of limited pipeline investment and difficult access to international markets. It was a sleepy backwater of energy markets. With the recent new government, alongside more mature fields south of the border, there is a sudden interest in the region. The first exports of LNG started last summer, and as of November there were 37 new data center projects in Alberta waiting to connect to the grid[2]. Using local gas can be a faster and cheaper option.
Better pricing will be a plus, but ARC’s mantra is to control its own destiny. That means wholly owned infrastructure, limited to no royalty agreements, and tight contractor relationships. It also means the ability to sustain dividends in low commodity price environments.
Ideally, we like buying companies like ARC when they fall out of favour. In this case, the first drilling results from a new development area missed initial expectations and communicated targets. When we looked into the details, we formed the view that this problem was both reflected in the price, and likely solvable in time.