Looking for yield but scared of risk? Energy trusts offer some of the highest yields around. But can we trust them?

Judging by the S&P/TSX Capped Energy Trust Index (^GSPRTEN), these stocks have already logged major moves. This index of major Canadian energy trusts gained an impressive +17% last year, and that's on top of a +27% gain the year before. But the rally shows no signs of letting up, with the index surging another +10% already this year. By contrast, the S&P 500 has held relatively flat throughout 2005.

The good news is that despite the recent run up, it's still possible to find a few select energy trusts with attractive price tags and tempting dividend yields. The three trusts we feature today, for instance, sport price-to-earnings (P/E) multiples of less than 22, yet boast dividend yields of +8% to +10%. 

But are their dividends trustworthy? To answer that question, we first need to ask more questions.

What if energy prices fall?
Energy trusts -- unique entities set up to profit from oil, natural gas, coal, or other energy production -- are required by law to pass along the majority of their profits to investors via dividends. Although their share prices have soared in the past two years, their dividend yields have stayed high because earnings have kept pace with surging energy prices.

If energy prices fall, then earnings among energy trusts could suffer. In addition, dividend yields could come down from today's lofty levels. In April 2003, for instance, the Fording Canadian Coal Trust (FDG) -- now trading at a rich P/E of 34 -- was forced to cut its dividend payment by -18% when coal prices plummeted.

The good news for investors, however, is that energy prices are widely expected to stay at their current highs for the foreseeable future. The federal government's Energy Information Administration (EIA) expects oil prices to hover around the $45 per barrel mark this year and stay well above $40 per barrel through 2006.

The agency also warned there's a very real possibility that prices might stay consistently above the mid-$40 range based on a delicate balance of supply and demand. For instance, the agency recently raised its forecast to an average $46.70 a barrel for the first few months of this year, up from the previous forecast of $43. Meanwhile, OPEC also raised its oil demand growth forecast for 2005 by +5%, partly because Chinese oil demand is now expected to be stronger than originally forecast.

The outlook for natural gas prices is even more bullish. The EIA expects natural gas prices to average around $6.50 per million cubic feet this year. That's higher than last year's average of $6.33 and far above the 2003 average of $5.82. The government's estimates are based on a projected +3% increase in demand over last year, yet only a +1.6% increase in domestic production.

In any case, the other good news is that even if energy prices decline, the stocks we profile below should still perform extremely well. This is because these stocks are less sensitive than most to oil and gas price swings. They are efficient producers with strong margins that shouldn't be hard pressed by a drop in prices.

What's the difference between Canadian and U.S. energy trusts?
There's a BIG difference between Canadian and U.S. energy trusts. The primary difference is that U.S. trusts can't buy new properties. When a company's reserves run low, its earnings will fall and it will be forced to cut its dividend payments.

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For instance, energy trust Dominion Resources Black Warrior (DOM) warned shareholders in a recent annual report that its reserves are "expected to decline substantially" from 5.4 Bcf in 2003 to 3.6 Bcf in 2006. "As a result," the company said, "cash distributions will decrease materially over time."

Shareholders in Canadian energy trusts can be less concerned about reserve life. In Canada, energy trusts are not much different from other companies. These trusts can raise money by issuing shares or borrowing money. As a result, they can use this money to buy new reserves or develop existing properties.

Two of the three energy trusts we profile in greater depth below are Canadian, and both have recently purchased new long-life reserves. We also selected a U.S. energy trust, but only after checking that its reserves are set to last at least another ten years.

While many Canadian energy trusts can make excellent income investments, some investors may be leery of stocks that don't trade on U.S. exchanges. After all, foreign companies are harder to track, their financial performance is given in a foreign currency, and their operations are affected by factors that may not be reported in the U.S. news. However, the good news is that five Canadian trusts are inter-listed -- meaning they trade both in Canada and in the U.S.

Listed below are five Canadian energy trusts that trade on one of the major U.S. stock exchanges:

Important Note: To view the remainder of this article, in which Carla Pasternak provides a listing of several dozen other energy trusts that trade only in the U.S. or in Canada, as well as an in-depth profile of each of her three favorite picks from this sector, you'll need to subscribe to our premium High-Yield Investing newsletter. After you subscribe you'll receive immediate access to the remainder of this article, as well as our semimonthly High-Yield Investing newsletter and a host of additional premium content. Please visit one of the following links to continue...

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