Editor’s note: This is the first in a five-part series of in depth stories from a conversation with E. Craig Lothian, CEO of Regina-based Keystone Royalty Group. On March 31, Topaz Energy announced it would be acquiring Keystone as part of an all-stock deal. These stories go beyond the deal, into what has made Keystone tick, the spawning of seven exploration companies, and how current politics are affecting the industry.   

REGINA – There’s patient capital, and then there’s patient capital. After 20 years invested in Keystone Royalty Corp., the 62 investors, many of whom have been with it from the beginning, will now have an opportunity to cash out.

And along the way, the company has spawned not one, not two, but seven exploration companies, in addition to returning dividends to their investors.

After 20 years in operation in its current form, Keystone Royalty Corp. of Regina is being acquired by Calgary-based Topaz Energy Corp in an $85 million all-stock deal. The deal, payable through the issuance of 4,187,193 Topaz shares, was announced March 31, and is expected to close April 29, 2022.

As Keystone was privately-held and Topaz is publicly traded (TSX:TPZ), this deal will provide liquidity for the 62 shareholders in Keystone.

E. Craig Lothian

E. Craig Lothian is president and CEO of Keystone, and its largest shareholder. He told Pipeline Online on April 5 he intends on holding onto most, or all, of his TPZ shares. “We have 62 shareholders, many of whom have been shareholders since 2002. Some of those were looking for liquidity, even though they have received a massive return on their original investment.”

Lothian spoke to Pipeline Online by phone from Scottsdale, Az.

Lothian explained that in 2002 he and an uncle, Jack B. Irwin of Calgary, put together a deal to purchase Keystone Petroleums Ltd. from US owners based in Pennsylvania, for $5.9 million. It was named for the “Keystone State.”

Since then, the company has paid out $83.4 MM in dividends.

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In a letter to shareholders dated March 31, Lothian wrote, “Topaz is a relatively new company, having completed an IPO in October 2020, and is a company formed as a result of a spin-out of royalty and energy infrastructure assets by Tourmaline Oil Corp. (a TSX-listed company formed in July of 2008). Despite having a short history, Topaz has an impressive record to date, both in terms of value creation (with a current market cap of approximately $3 billion) and in returning capital to its shareholders (with a current annual dividend yield of approximately 5 per cent). We believe that the Keystone assets, and in particular our significant inventory of fee simple mineral lands and royalties, are a perfect complement to the existing royalty and energy infrastructure assets of Topaz.”

In February, Keystone retained National Bank Financial as strategic advisors for the purpose of soliciting offers for the company.

The press release notes the Keystone Royalty Acquisition “adds a large and diversified Western Canadian royalty portfolio consisting of over 480,000 gross acres of royalty lands which includes (i) current royalty production of approximately 450 boepd (83 per cent liquids); (ii) over 310,000 gross acres of fee mineral title lands; and (iii) complementary seismic assets.

“The Keystone Royalty Assets, primarily located in Southeast Saskatchewan, provide low base decline, oil-focused production and include royalty interest ownership in a number of unitized production areas, including the Weyburn Unit, in which Topaz owns an existing 5 per cent royalty interest.

Map of Keystone Royalty Group Assets, from the company’s web page.

“Keystone Royalty has federal tax pools of over $25.0 million, positive working capital and no debt. Pro forma, Topaz will have over $1.8 billion of consolidated federal tax pools, approximately $500.0 million of which are non-capital losses. Topaz’s tax profile enhances its shareholder return proposition and provides the Company additional flexibility to expand its future dividends. Topaz expects to generate approximately $17.0 million of annualized royalty revenue in 2022 from the Keystone Royalty Assets, based on current strip pricing.”

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Keystone Royalty acquisition attributes include:

  • Average fee mineral title royalty rate of approximately 18 per cent;
  • Drilling activity over the past three months includes 10 gross wells which are expected to provide near term production growth;
  • 70 per cent of the acreage is undeveloped; across which Topaz has identified a significant number of future unbooked drilling locations;
  • Resilient historical drilling activity through low commodity price cycles; development and future drilling is expected to be economic at crude oil pricing as low as US$40/bbl WTI; and
  • In 2021, over 60 per cent of the royalty revenue was generated from six high quality Canadian public E&P companies including Canadian Natural Resources, Crescent Point Energy, Enerplus, Saturn Oil & Gas, Vermillion Energy and Whitecap Resources.

In a release, Topaz said president and CEO Marty Staples said, “The Keystone Royalty acquisition contributes predominantly fee mineral title royalty interests which provide Topaz with incremental exposure to higher WCSB drilling activity; complements the high-quality gross overriding royalty portfolio Topaz has established through its strategic partnerships; and the transaction structure enables Topaz to retain its significant Excess FCF for further M&A growth in 2022.”

He added, “In addition to FCF per share accretion, the Keystone Royalty acquisition provides future option value through increased leasing opportunities; technological advancements in drilling techniques; and potential exposure to future enhanced oil recovery projects and exploitation of other minerals such as potash, helium and lithium, in each case at no additional cost to Topaz.”

The release added that approximately 56 per cent of the shares of Keystone are beneficially owned or controlled by Lothian. He noted in the release, “We believe that the integration of Keystone by a well-capitalized, growth-oriented public royalty entity provides our shareholders with an incredible opportunity to realize additional long-term value, both from the former Keystone assets and from the significant royalty and infrastructure assets of Topaz.” National Bank Financial Inc. acted as the financial advisor to Keystone for the transaction.

Keystone had considered selling three years ago

Lothian said, “We actually looked at a potential corporate sale of Keystone in the summer of 2019. And we retained investment bankers, moved through the process, got bids. But of course, by the fall of 2019, things were falling off pretty hard. Even though it was pre-COVID, oil prices were slipping. There was such a dearth of M&A activity, because none of the acquirers had been able to do or had done any capital raises of any significance for probably two or three years, since there was any real money coming into the sector.

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“So we just found that the bids were below market or below what we are prepared to take and we aborted then. We revisited it in probably in about November, last year.”

There comes a stage in a business where it’s time to cash out, he explained. “Something that comes up, I think, in every private company that’s been around as long as we have that isn’t just a sole proprietorship, or pure family entity. (There’s) always some pressure to create liquidity for their shareholders, and certainly we were no exception. We had shareholders from time to time that would reach out and ask or suggest that it sure be nice if they can sell their shares. And we tried to accommodate those, and did, moreso over the last probably five to 10 years. We actually were actively trying to create a market for shareholders, and we did a number of fairly significant share buybacks. We tried to pair potential purchasers with willing sellers. Those were small, incremental liquidity windows.”

With the average age of the shareholder base around 60-63, he said there was some concern with where the world, and Canada’s federal government, were moving with regards to oil and gas.

“We had a number of people that were probably a little bit nervous about the federal government with they were doing their whole green initiative,” Lothian said.

After discussions with shareholders, Lothian said he gets the sense most won’t be selling their Topaz shares, except perhaps to cover a tax bill. “For the most part, I think, I think they’re pretty confident in the shorter term outlook,” he said.

 

NEXT, to be posted on April 21:

Keystone Royalty, Part 2: Lothian: “There’s no willingness to step in front of the woke green train that the Liberals have created”

 

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