Steady income

Ontario Teachers looks to mitigate low rates with $3.3B deal with Cenovus.

• Like many large institutional investors looking to offset the impact of chronically low interest rates on longterm liabilities, the Ontario Teachers’ Pension Plan set its sights on opportunities on the oilpatch when oil prices slumped.

That interest culminated in a $3.3-billion deal Tuesday in which Teachers will pick up the broad portfolio of oil and gas royalties held in the Heritage Royalty LP (HRP) subsidiary of Calgary-based Cenovus Energy Inc.

The deal has many of the characteristics Teachers and other large pension funds seek out to manage their long-term liabilities, such as providing recurring revenues over many years.

Royalty owners contract with oil and gas operators and are paid based on production. In 2014, HRP had revenues of about $320 million based on average production of 14,800 barrels of oil equivalent per day.

The acquisition also offers Teachers a hedge against unexpected inflation because royalty property cash flows are correlated to the price of oil and natural gas, which is itself highly correlated with inflation.

The pensions on the liability side of Teachers’ operations are indexed to inflation, so such protection is key.

With the purchase, Teachers picks up one of the largest packages of fee title acreage in Canada, consisting of about 4.8 million acres in Alberta, Saskatchewan and Manitoba. HRP owns the mineral rights to these properties and leases the land to operators who develop the lands and pay royalties on gross revenues from production.

The Canadian pension fund also picks up gross overriding royalties on half a million acres at two of Cenovus’s largescale, lifelong oil projects.

A report sent to clients of National Bank Financial said Teachers paid a “premium price” for the assets. But Ziad Hindo, senior vice-president of tactical asset allocation and natural resources at the pension giant, said the acquisition was made at an “opportunistic” time in the oil cycle.

Teachers intends to shift to more direct and diversified energy-sector holdings and has already looked at “various” opportunities,” he said.

At the end of last year, oil and gas assets accounted for one per cent of Teachers’ natural resources portfolio. Agriculture was another tiny slice of the pie that was dominated by commodities and timberland.

Arriving at this week’s deal involved testing a range of oilprice scenarios to ensure the pension fund could generate adequate returns, relative to risk, over a number of years.

“It’s exactly the commodityprice exposure that we’re seeking,” Hindo said.

Pension funds are increasingly pushing into new invest-

It’s exactly the commodity-price exposure that we’re seeking

ment arenas as they adjust to the “low for long” interest rates environment, according to industry expert Keith Ambachtsheer.

Generating the returns necessary to fund long-term obligations in the decades to come “will require doing new things,” he says.

Teachers, which had $154.5 billion in net assets at the end of last year, is not the only large institutional investors looking for opportunistic purchases in Alberta’s oilpatch. In May, Brookfield Asset Management Inc. chief executive Bruce Flatt said BAM was looking to beef up its holdings is the sector, which “is under more stress than it has been in a long time.”