In 2003, Denver-based Forest Oil Corp. was primarily an offshore producer and frontier explorer, with assets in the Gulf of Mexico, and its activities had previously been in as many as 15 countries.

But during the next two years, the Mile High City operator shifted gears, becoming more of an onshore North American acquire-and-exploit producer. During this period, it acquired more than $1.3 billion worth of properties-primarily in onshore East Texas, the Permian Basin and in Alberta.

"We wanted to build this company on a portfolio basis-in places close to home that we understood best-such that we would never leave this company hanging on any one play," explains H. Craig Clark, Forest president and chief executive officer.

In July 2004, this strategy prompted the $330-million acquisition of Dallas-based Wiser Oil, whose assets were mainly onshore the Gulf Coast and in Canada, and subsequently, the purchase of 120 billion cubic feet equivalent (Bcfe) of proved reserves in the Texas Panhandle's Buffalo Wallow Field at a cost of $1.96 per thousand cubic feet equivalent.

Forest's reserves by early 2005 had risen to around 1.5 trillion cubic feet equivalent (Tcfe), up from 1.3 Tcfe in 2003. Shortly thereafter, the company decided to take a fork in the road with respect to its 306 Bcfe of Gulf of Mexico shelf reserves.

"We had already begun seeing organic growth in our onshore asset base, and felt the best way to unlock the company's intrinsic value for our shareholders-and make it better understood by the market-was to separate the two asset bases and focus primarily on the North American onshore," Clark says.

With its favorable net operating loss (NOL) tax position-$506 million NOL carry forwards and $198 million of tax pools in Canada-the idea of holding a garage sale to auction its Gulf shelf assets didn't make much sense to Forest. Why? It would have triggered a large taxable gain that would have eroded the producer's NOL position.

Enter Forest executive vice president and chief financial officer David H. Keyte. His divestiture solution: a Reverse Morris Trust that would spin off the Gulf assets, avoid a tax liability that would have amounted to $250- to $300 million, and give Forest shareholders a $1-billion dividend in the form of tax-deferred shares in another publicly traded operator-this one focused on both the deep and shallow Gulf.



How the trust worked

Beginning in April 2005, Forest entered discussions about the multi-faceted structure with Mariner Energy Inc., then a privately held Houston-based producer focused mainly on the deepwater Gulf. At the time, Mariner was in the process of completing the private sale of shares to institutional investors through a 144A transaction that obliged Mariner to make those shares publicly tradable through a subsequent "going public" transaction.

The way the Reserve Morris Trust structure worked: Forest first spun off its Gulf assets into an entity called Forest Energy Resources Inc. (FERI). Mariner then merged Mariner Energy Resources Inc. (MERI), which held all its Gulf assets, with FERI in a tax-free trust transaction.

Next-and all these events were completed simultaneously on March 2, 2006-Mariner went public on the NYSE, the combined offshore assets of FERI and MERI were merged into Mariner Energy, and Forest shareholders received 0.8 Mariner share per one Forest share held on a tax-deferred basis.

"The reason we as a company didn't have to pay tax on the offshore assets we divested is because Forest Oil didn't take any money-our shareholders did in the form of Mariner stock," explains Keyte. "In short, $1 billion of a $3-billion company went back to our shareholders in the form of a special dividend. On top of this, our shareholders got exposure to what is now a bigger offshore Gulf-focused company with a portfolio of both deepwater and shelf assets."

Obviously this transaction, wherein the principal advisors to Forest were Citigroup and Credit Suisse, had the immediate effect of shrinking the company's asset base. At closing, reserves dipped from about 1.5- to 1.2 Tcfe while daily production declined from 495 million equivalent to 267 million.

However, at about that time, Forest acquired East Texas assets, primarily in the Cotton Valley trend, for $255 million, adding proved reserves of 110 Bcfe, net daily production of 13 million cubic feet equivalent and 300 identified drilling locations.

"When you couple this acquisition with the organic growth we were achieving at Buffalo Wallow in the Texas Pandhandle and the Wild River play in Alberta, we were able by year-end 2006 to largely replace the reserves and production sold in the Mariner transaction," says Clark.

"More importantly, we began to achieve clarity in our valuation as an onshore acquire-and-exploit producer, and our stock began reflecting the higher cash-flow multiples typically associated with an onshore focus."



Another spin-off

In yet another creative transaction, again designed to further position the company for future growth in its core onshore areas, Forest spun off its Alaskan assets into a subsidiary, Forest Alaska Operating LLC, in November.

"We then went to the rapidly developing institutional term-loan market-which is interested in buying high-yield paper-and monetized the cash-flow stream of those assets while retaining the equity upside in them," explains Keyte. "Effectively, we were able to take $350 million out of our Alaskan asset base and put that capital to work in Forest's mainstream business."

Indeed, that capital will help fund the company's pending $1.5-billion cash-and-stock acquisition of Houston Exploration Co. The purchase will boost Forest's reserves from 1.5- to 2.1 Tcfe and add more than 2,800 drillsites to the operator's prospect inventory, principally in South and East Texas, along with other upstream opportunities in the Arkoma Basin and the Rockies.

"We used to drill about 50 net wells per year; in 2007, we'll probably drill 150 net wells while reducing capital spending by about $100 million, to $500 million-without including drilling on Houston Exploration properties," says Clark. "We're not going into plays that are only economic at $8 gas; rather, we like the ones that are economic at $2 to $4 gas."

Back to the Mariner transaction, it accomplished three key objectives, sums up Patrick J. Redmond, Forest director of investor relations. "It enabled both Forest and Mariner to focus exclusively on a class of assets they're very good at operating; Mariner, to go public and distribute its stock in a tax-advantaged manner to a base of 2,000 shareholders already in place and hence, draw more analyst coverage; and the shareholders of each company, the opportunity to participate in two separate asset classes."



Mariner's voyage

Mariner Energy was primarily a deepwater Gulf operator prior to consummation of the transaction with Forest. It had year-end 2005 proved reserves of 338 Bcfe and daily production north of 75 million cubic feet equivalent.

"After I joined Mariner more than five years ago, we began a process of trying to diversify the company by expanding on the Gulf shelf, as well as growing in the Spraberry trend in West Texas," says Scott Josey, the company's chief executive officer.

"So when Forest approached us about the merger of our two offshore asset bases-theirs being mainly shelf-focused-we felt it fit us like a glove while it gave Forest shareholders the opportunity to participate in the future growth of two distinctly focused asset classes.

"This rationale wasn't simply predicated on the fact that we understand the shelf and deepwater Gulf-and have the resources to develop both-but because we felt, as Forest did, there was still plenty of upside left in its Gulf assets."

That's not all. In the proposed transaction-which doubled Mariner's position in the Gulf to just under 1 million acres-Josey saw yet another silver lining. Mariner, intending to go public, had just completed a $440-million, 144A private placement of stock, increasing its shareholder base from two to 350.

Under the tax-free Reverse Morris Trust structure proposed by Forest, which wanted to shield its NOLs in this asset sale from a substantial taxable gain, Josey saw the opportunity to not only pick up a nice asset base-306 Bcfe of proved reserves-that had plenty of upside left, but also the chance to immediately acquire an additional base of 2,000 shareholders that Forest had spent 20 years developing.

"That base is the difference between becoming an NYSE-listed stock versus one that trades on Nasdaq," Josey says. "Such shareholder scale also means the opportunity for higher market visibility and greater analyst coverage." At press time, six analysts were covering the stock with a consensus rating of Buy.

At closing in March 2006, wherein Lehman Brothers was the advisor to Mariner, the company issued just under 51 million shares of its stock to Forest shareholders who then became 58% equity stakeholders in the enlarged offshore producer. Mariner shareholders, meanwhile, retained the balance of the company's 87 million shares then outstanding.

However, there was something else that Mariner, now a $1.6-billion-market-cap operator, got out of the transaction. In addition to doubling its asset base, the deal brought with it most of Forest's seasoned Gulf shelf personnel.



Deal dividends

When Mariner closed on the multi-faceted Reverse Morris Trust transaction, it knew it now had not just a critical mass of complementary offshore assets. It also had plenty of elbow room for fast-track exploration and development growth as it began moving ahead with its more than $600 million of capex spending for 2006-85% of that earmarked for the Gulf.

Case in point: within seven months of closing, Mariner announced a discovery on one of the Gulf assets it acquired from Forest. This was the High Island 116 find, with an estimated 40- to 60 Bcfe of proved plus probable reserves.

Adds Josey, "So far, we've identified some 40 prospects and leads on our acquired Gulf holdings-and these are just on 10% of the Forest assets that have been studied to date."

With about half of Mariner's Gulf assets now on the shelf, the company will be stepping up its drilling on Forest's properties in 2007.

"Last year, we drilled 26 offshore wells, four of them development," Josey says. "This year, we plan to drill 29, with more development wells in the mix, and to increase our capex spending to $658 million."

The figure excludes hurricane-related repairs of $19 million for which Mariner expects to begin receiving insurance reimbursement during the year.

Not overlooking its existing deepwater legacy holdings, the company also plans to develop two major offshore projects this year. One is the Bass Lite project in more than 6,500 feet of water. Mariner operates it with a 42% working interest and first production is expected in 2008. The project's gross unrisked reserve potential-proved, probable and possible-is more than 250 Bcfe.

The second deepwater project involves bringing on production from four wells drilled in 2006 at Anadarko Petroleum Corp.'s Northwest Nansen property, formerly a Kerr-McGee asset. These wells, in which Mariner has working interests ranging from 33% to 50%, will be connected through subsea tiebacks to the Nansen spar platform. The gross unrisked reserve potential in this project is 50- to 90 Bcfe.

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