Canadian Income Trusts at Risk - Association Head

Dow Jones Newswires

CALGARY, Dec 01, 2006 (Dow Jones Newswires)

Canada's energy trust sector has been left "in limbo", with firms not sure if they are allowed to make acquisitions under the country's plans to make trusts pay corporate tax, according to a income trust spokesman.

The uncertainty for energy trusts also means that some firms have already become ripe acquisition targets, said George Kesteven, president of the Canadian Association of Income Funds.

"There's already private equity funds in Calgary, flush with cash, shopping for some of these companies," he told Dow Jones Newswires in an interview.

An income trust is a Canadian investment vehicle that has little taxable income at the corporate level and pays out most of its income to unit holders in monthly distributions. Nearly 60% of Canada's income trust sector is comprised of energy trusts, which typically shy away from expensive exploration activities and focus their resources on squeezing every last drop of oil and gas out of mature properties. Trusts produce around 20% of Canada's daily crude output.

Last month, the Canadian government said new income trusts will be taxed starting in 2007, while existing trusts will be taxed starting in 2011. The decision slashed about C$35 billion of market value from the energy trust sector, cutting some firms' share prices by as much as 20%.

The government has also said it will allow "normal growth" for the trusts until 2011, but it may stop "undue expansion", and hasn't yet defined those terms. Consequently, both trusts - and the capital markets they attain their funding from - are uncertain as to whether they can still make large acquisitions, creating "uncertainty and chaos" within the industry, Kesteven said.

"We need immediate clarity around these issues," he said.

No Trust Left

That clarity may not arrive as quickly as the trusts would like. While the government has said it expects to release more details in mid-December, the complexity of the issues involved means an arrival time of January is more likely, Kesteven said.

The uncertainty could create buying opportunities. As well as private equity firms looking to snap up trust assets through using debt financing, Canadian pension firms are also likely to target funds with infrastructure holdings, he added.

"Private equity funds can come in and offer a premium on the current market price for trusts, and that price may start to look good," he said.

Kesteven added that it's "too early to tell" if Canadian oil and gas production would drop as a result of the income trust situation, saying that operations would likely continue as normal in the short term. However, if there is a large consolidation of trust assets, marginal fields would be more liable for shutdown, likely resulting in a decline in output, he said.

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