QUICK LOOK REPORT #33: Oil & Gas Trusts in Canada
by Dr. Stephen Rinehart
November 5, 2006

Background:

This Quick Look Report is a brief commentary on the current fire sale prices of Oil and Gas Trusts in Canada resulting from the Canadian Minister of Finance’s latest Tax Proposal and collapse of income trust prices (many over 20%+ drops in one day). A number of the Oil and Gas Trusts in Canada were starting to recover from major downtrends in recent months with the weakness in oil and natural gas prices before the announcement. The timing of Canada’s Tax Proposal coincides roughly with one of the major XOI lows in November (see Chart 1 which was originally published in Quick Look Report #27 as Chart 2) and another low (which maybe higher than Nov low) in April 2007. After April 2007, it is expected a major uptrend will resume in the XOI Index (probably along with continuing political turmoil).

Remarks: 

1. For a trader or hedge fund, the current investment opportunity to obtain a nice price appreciation (over next six to twelve months) in O&G Trusts while collecting a solid divvy (for years) has not been better since last November when the Canadian Government did the same thing but this time count on a showdown for the billions in damages done to the income trusts. If the current Tax Proposal passes (in some form with 42% tax on US investors starting in 2011), one can still collect 10%+ dividends for the next four years (and over 15% in some cases) and resulting NAV appreciation from rising oil and natural gas prices. It could be a long winter this year (and for years to come) and we are dealing with depleting resources. Unclear as to why Ottawa did not call a special session to stop the corporate business such as BCE from converting to an income trusts.

2. The long-term consequences of the Canadian Tax Proposal are not really in the proposed tax structures (tax increases are going to happen anyway and if politicians did not look for a way to raise taxes they might not have anything to do in the future) but in the fact that Canada has a placed large percentage of its oil and gas assets on the market (and for all time) at fire-sale prices and the sharks are circling. The large income trusts with low debt will pay you a dividend over the next four years in any event and be positioned to takeover the smaller trusts. We may not see these prices again for the major oil and gas trusts. Ottawa does not appear to understand the O&G income trust models with large Capex (they operate nothing like a business trust) and what is needed in cash flows to develop/produce marginal wells. If these wells start shutting down, natural gas (and oil) prices in the US will show marked coming increases in the next twenty-four months. The US is not some sideline player in this drama as we depend heavily on Canada’s natural gas imports (every day).

3. I bought Arc Energy (very solid major Canadian O&G Trust) for under $21.00 on Friday. This Trust provides a significant possible coming total return in future years while paying over a 10% yield if you get in now. Look at a small purchase of Arc Energy (or other large O&G Trusts on sale such as Enerplus, Penn West or Peyto) for the grandkids as they have large land-holdings, low debt and low payout ratios and send a nice letter to the Canada thanking them for the early Christmas present as we could pick-up $5+ a share increase in next 12 to 18 months (back to business as usual). Other solid buys are Penn West, Enerplus and Vermilion but you may wish to do your diligence now. You can invest smaller amounts initially or whatever you are comfortable with in investing and collect monthly dividend for the next decade to come.

4. Several other Canadian (trust income) major index (mutual funds) are also at fire-sale prices such as Enervest (not a qualified dividend but may now buy up a lot of these trusts and increase its NAV) and Avenir Diversified Trust (looking more like a REIT). You can probably recover a 15% - 20% increase in NAV in these puppies in next 12 to 24 months while collecting a nice dividend (if it takes that long) and in the case of Enervest get paid a 14% divvy for holding 120+ different income trusts (solid dividend). I just bought some additional Avenir and I own Enervest. These are buy and holds and don’t give them back anytime in near future. You may not see this type of opportunity again unless Ottawa decides to hold this turkey shoot again next November.

5. The O&G Trust CFOs must be in shock at this giveaway since it threatens the financial life of smaller trusts with high debt and the Big Dogs are waiting on the sidelines to get into the game. If Ottawa really wants to do something constructive for investors, consider passing a law that requires all Oil & Gas Income Trusts to trade at NAV (determined quarterly) and take the volatility away from Bay Street but that would not be any fun anymore. Let’s continue to call them “Income Trusts” and trade them with the volatility of Internet stocks. Of course, maybe Google is worth more than all the oil and gas in Canada – but for how long!?

6. The Canadian Tax Proposal still has to pass Parliament and four years is an eternity in politics. In The US elections, The Democrats can win the House and have a good chance at winning the Senate (talk about gridlock which may be a good thing right now). The next two years in the US may seem like a lifetime for some politicians.

© 2006 Dr. Stephen Rinehart
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Dr. Stephen Rinehart
Lynn Haven, FL USA
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DISCLAIMER: The author is not a registered stockbroker nor a registered advisor and does not give investment advice. His comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity, index or any other financial instrument at any time. While he believes his statements to be true, they always depend on the reliability of his own credible sources. Of course, the author recommends that you consult with a qualified investment advisor, one licensed by appropriate regulatory agencies in your legal jurisdiction, before making any investment decisions, and barring that, we encourage you confirm the facts on your own before making important investment commitments.