M&A activity, and acquisition prices, have increased dramatically in the Canadian oil and gas industry between 2002 and first-quarter 2005. This activity is affecting credit quality, says ratings agency Standard & Poor’s.

The income trust sector did add some momentum to recent M&A volumes, S&P says, but the trusts account for about only one-third of the transactions completed in 2004. “Escalating finding and development costs and diminishing size of the reservoirs found are making it increasingly more economical to acquire reserves through acquisitions rather than develop them through the drill-bit,” it notes. “Strong hydrocarbon prices have kept acquisition economics robust.”

But, it warns, “even at their current high levels, the cyclical nature and inherent volatility of hydrocarbon prices will compromise the economic viability of recent transactions if crude oil and nature gas prices weaken.”

“Despite the risks inherent in the commodity price cycle, increasing global demand for crude oil and a tight regional supply and demand balance in North America do suggest near-to-medium term oil and gas prices will remain well above their historic midcycle ranges,” S&P adds. “Nevertheless, if companies look increasingly to acquisitions rather than the exploration of their existing acreage to bolster their reserve replacement statistics, these elevated acquisition prices being paid by many will dampen financial performance if hydrocarbon prices soften.”

And, it observes that already, “many of these high-price acquisitions have already put some strain on the acquiring companies’ credit profiles, which has been reflected in many of the recent rating actions Standard & Poor’s Ratings Services has taken”.