Exclusive: Cenovus in exclusive talks with Teachers' fund on land assets

By John Tilak, Euan Rocha and Scott Haggett

TORONTO/CALGARY (Reuters) - Cenovus Energy Inc (Toronto:CVE.TO - News) is in exclusive talks to sell Canadian oil and gas royalty lands to the Ontario Teachers' Pension Plan in a deal that could fetch C$2.5 billion to C$3 billion ($2.45 billion), according to four sources familiar with the matter.

The sources, who asked not to be named as they have not been cleared to discuss the matter publicly, said the discussions between Calgary-based Cenovus and Ontario Teachers, one of Canada's top pension fund managers and investors, are at an advanced stage.

Royalty lands are privately held oil and gas properties that are not subject to the royalties that producers pay to governments on publicly owned lands. Instead of paying royalties to governments, producers pay a mineral tax, while the royalties go to the property owners.

Two industry sources said that Teachers may look to partner with another player, given the size of the deal. In March, the fund manager said it was actively scouting for energy assets as it looks to trim positions in oil and gas derivatives and invest instead directly in producing assets.

Cenovus and Teachers declined to comment.

Shares of Cenovus rose 4.4 percent to touch a six-week high of C$21.57 following the news, and ended the day up 4 percent at C$21.51.

Cenovus's move to sell its 2 million acres of royalty lands, mainly in southern Alberta, has been closely followed by investors and comes about a year after Encana Corp (Toronto:ECA.TO - News) raised over C$4 billion by spinning out similar properties in PrairieSky Royalty Ltd (Toronto:PSK.TO - News), which was one of the biggest spinouts in Canadian corporate history.

Other parties that have shown interest in the Cenovus asset include PrairieSky, Freehold Royalties Ltd (Toronto:FRU.TO - News) and Franco-Nevada Corp (Toronto:FNV.TO - News), as well as other pension funds such as the Canada Pension Plan Investment Board (CPPIB), the sources said.

Franco-Nevada, Freehold and CPPIB declined to comment. PrairieSky could not immediately be reached for comment.

If no deal is reached with Teachers, Cenovus could still approach PrairieSky or weigh an initial public offering, one of the sources said.

A second source said PrairieSky made a cash and share offer that fell short. He added the asset was too big for Freehold to acquire on its own.

Cenovus, Canada's second-largest independent oil producer, has been evaluating options for the royalty lands. It said earlier this year it had hired TD Securities to explore a sale or initial public offering.

Most of the Cenovus properties date back to 19th-century grants by the Canadian government to railway companies building lines in Western Canada. They later proved rich in oil and gas.

In 2014, output from third-party producers on the Cenovus lands was approximately 7,600 barrels of oil equivalent per day.

For investors, the royalty streams from the properties can offer exposure to oil and gas production free from the costs of finding and developing reserves, though payouts are contingent on the price of oil and gas.

The returns on these assets are expected to be sluggish in the near term, due to weak oil and gas prices, but they may fit well within a pension fund's long-term strategy, one of the sources said.

Teachers created a natural resource group in 2013 to buy into real assets. In March, the natural resources group bought a working interest in Weyburn Unit, a Saskatchewan-based oil asset, for C$153.4 million, marking its first energy deal.

CPPIB has also expressed an interest in oil and gas assets.

The new investment focus on physical energy assets comes as pension funds are more often running into bidding wars for the infrastructure and real estate assets they have long coveted for their steady cash flows. Competition for such assets has intensified as sovereign wealth funds and long-life private equity funds now also vie for them.

(Reporting by John Tilak and Euan Rocha in Toronto and Scott Haggett in Calgary; Editing by Jeffrey Benkoe; and Peter Galloway)