Energy Trust Losses Could Affect Canadian Oil Exploration

CALGARY, Nov 3, 2006 (Dow Jones Newswires from the Canadian Press)

Exploration money for Canada's oilpatch could be the main casualty as energy trusts spiraled downward Thursday, piling up more than $17 billion in losses since the Harper government announced plans to tax income trusts, Canadian Press reported.

"There's been a big 'for sale' sign put on a lot of these enterprises," said John Brussa, a tax lawyer with Burnet Duckworth & Palmer who helped create income trusts in 1984, the Canadian Press article. "It looks like the market prices are diving below intrinsic value."

But most potential buyers could be wary of what they would be getting, which will make acquisitions few and far between in the short run.

"I'd say it has to put a damper on things because the access to capital markets right now with trusts is gone," said William Lacey of FirstEnergy Capital. "At least for the next six months until there's greater clarity as to the operating future of trusts and how they're going to re-tool themselves."

While the energy industry tries to sort out the ramifications of the income trust decision announced late Tuesday, one business expert believes trusts will be forced to become more like the initial production companies they were designed to complement, Canadian Press reported.

"It's going to harder for larger companies to take their mature properties and sell those to energy trusts, then take the cash for that and go do exploration," said Bill Schulz, who teaches strategic management at Calgary's Haskayne School of Business.

"And their people mix doesn't match up with what the new strategy is going to be," he said. "They've got four years to figure it out, but in Calgary these days, (hiring) a geologist or a geophysicist is pretty hard to do."

Meanwhile, brokerage Canaccord Adams called the trust tax proposal a "knee jerk reaction" and said it would have significant negative unintended consequences, in a report that included phone numbers and email addresses for all MPs, Canadian Press reported.

"If the tax proposal is enacted as presented, we believe that Canada will lose control of its energy sector and investment activity will decline in conventional oil and gas production," the capital markets unit of investment firm Canaccord Capital said in a report Thursday, Canadian Press reported.

"This tax proposal puts a 'for sale' sign on Canadian energy resources by removing a competitive cost of capital advantage - a wave of foreign takeovers is likely to emerge. As a result, Canadian energy decisions will eventually be made outside of our borders."

Canaccord suggested the government has effectively increased the cost of capital for the Canadian oil and gas sector.

"Investors should be concerned that this proposed tax policy will reshape the energy industry and slow the growth of conventional oil and gas development," the firm said.

Schulz said that while the trust taxing plan won't inflict a body blow to the oilpatch on the scale of the National Energy Program of the early 1980s, it will impact sustainability in what has always been a boom and bust industry, Canadian Press reported.

"The people in Ottawa (who) looked at trusts were looking percent payout on distributable cash, but they forgot about capital expenditures," said Schulz in the Canadian Press article.

In the last week, three major energy companies have announced billions of dollars in cuts to their exploration spending because of high costs in the oilpatch and lower natural gas prices. Adding questions about the future of the energy trusts won't help, Canadian Press said in its article.

Income trusts began in 1984 when Brussa and investment banker Marcel Tremblay set up a structure to sell aging oil wells to retail investors. While the trusts took a while to catch on and eventually spread to include all parts of the economy, they became a vital cog in the oilpatch food chain.

Calgary-based oil and gas trusts now claim six of top 10 funds on the Toronto Stock Exchange and all dropped in value Thursday. One of the top trusts, Penn West Energy Trust fell $2.37 to $33.75, while Pengrowth Energy Trust declined 66 cents to $18.61. Canadian Oil Sands Trust, the biggest owner of the Syncrude oilsands project, dropped 24 cents to $27.17, Canadian Press reported.

When created, the trusts allowed large multinational oil companies to take mature assets that were no longer growing in production and let other interests focus on the less risky venture of squeezing the most oil or gas out of the ground, Canadian Press reported.

"They're not sexy assets but with a lot of TLC you can make quite good returns on them," said Brussa.

In recent months, the image of trusts has been one of a veritable cash cow for business. But some say it's not that simple, noting that most energy trusts face a production decline of 10%-12% a year, Canadian Press reported.

"The cow has to go back and renew itself," said Schulz. "It's not a never-ending stream of cash that comes out."

Energy trusts must continually acquire new assets ensure enough revenue for future years for future distributions. The amount of those distributions, paid out regularly to unit holders, is likely to decline with the new rules.

"Trusts are going to have to look very hard at distributions versus sustainability versus capital expenditures," said Schultz in the Canadian Press report.

Copyright (c) 2006 Dow Jones & Company, Inc.

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