Don’t Buy a Canadian Trust Until You Read This

Many investors would be surprised to learn from which country the United States imports the greatest amount of oil.

It’s not Saudi Arabia. It’s not Russia. And while Venezuela is high on the list, it’s not that nation either. The answer is Canada.

In all, the United States imports about two million barrels per day from its neighbor.

Much of that oil comes from Canadian trusts, many of which are based right here in my home city of Calgary, Alberta.

The trust model makes sense for Canadian energy producers with mature reserves that generate predictable cash flow. The oil and natural gas reserves offer up plenty of cash to pay investors. Meanwhile, trust rules mean that the business has to pass along the bulk of cash flow to investors. The result is high yields that attract shareholders and boost the share price.

But in a few months, Canadian trusts will no longer exist in their current form. Fearing the loss of billions of dollars in tax revenue, the Canadian government announced on October 31, 2006 that trusts would lose their tax-favored status starting on January 1, 2011. The proposal was known in Calgary as the “Halloween Massacre,” and the Canadian “Oil Patch” lobbied hard to beat it down, but was unsuccessful.

Fearing the end of double-digit yields and tax-advantaged income, investors dumped their units in droves. Trusts lost more than -30% of their value in the weeks following Prime Minister Steven Harper’s initial proposal.

What’s Next for Canadian Income Trusts?
The uncertainty of what will happen next has continued to weigh on trusts. Most will convert over to ordinary corporations, but which ones? Which will get taken over? Which will cut their payouts to conserve cash and focus on production growth? Which will keep paying dividends at the same rate?

Now the clouds are starting to clear. According to Canadian investment dealer RBC Dominion, as of late in the first quarter, 72 income trusts had been acquired at an average premium of +14% above their trading price. Another 40 had converted to dividend-paying corporations.

And a survey by investor relations firm BarnesMcInerney and others showed that 84% of the 165 Canadian income trust CEOs polled expect to cut cash distributions when they convert trusts into traditional corporations. But all is not doom and gloom. Yes, some are cutting payments, but others are saying they will maintain the current rate if they have the cash flow.

To provide the greatest benefit to investors, I’ve taken a look at what’s ahead for three of the most popular Canadian trusts. Keep in mind that the situation is still fluid. While this information is accurate as of August, you’ll still want to double-check with the company’s investor relations department just to make sure. I’ve included the contact information for each entity below.

Penn West (NYSE: PWE)
Penn West is a top producer of crude oil and gas in western Canada. The company produced about 175,000 barrels per day in 2009, with 60% coming from oil and 40% coming from gas.

The outlook for distributions from Penn West does not look promising, given that in years past the trust was heavily focused just on payments. The trust has said that it will convert to a corporation around January 1, 2011, and put more emphasis on growth. At that time, it’s likely that payments will be cut. “As a corporation, Penn West will focus on total shareholder return. This will consist of both growth and income from dividends,” CEO William Andrews said in a recent earnings report.

Leanne Murphy, an investor relations representative at the company, elaborated on Penn West’s new growth/income business model. “Management has said that they would like to see a total return for investors [per year] in the +8% to +10% range. At this time, we are most likely looking at a growth portion in the +3% to +4% range and an income portion in the +5% to +6% range,” she said. She added that more information will be forthcoming as the company moves closer to the conversion date.

Penn West can be reached at 888-770-2633 or by emailing

Enerplus (NYSE: ERF)
Established in 1986, Enerplus is one of Canada’s oldest and largest independent oil and gas producers. In 2009, the company produced nearly 90,000 barrels of oil equivalent (BOE) each day, with 59% coming from natural gas.

The company has already begun investing in early-stage resource plays as it moves toward converting into a growth and income corporation, which will take place around January 1, 2011.

Enerplus has stressed its commitment to distributing “a significant portion” of cash flow to shareholders after converting to a corporation. Tax pools, basically credits that protect future earnings from being taxed, of about $3 billion provide “shelter from cash taxes in Canada for three to five years beyond 2010,” management said in a May press release. Distributions will vary with cash flow, management added, but payments won’t need to be adjusted as a result of converting to a tax-paying corporation.

Garth Doll, an investor relations representative at Enerplus, said that if cash flow remains the same, the current dividend will remain the same. But the growth aspect of the company will require cash, so future cash flow increases will largely go to reinvestment, not distribution increases. “In total, the company is looking for a +10 to +15% total return to investors,” he said in an interview, “but no yield target has been given.”

For questions, you can contact Enerplus at 403-869-1950 or

Provident (NYSE: PVX)
Provident is a Calgary-based Canadian trust that is now a pure-play midstream business, specializing in natural gas liquids. Provident recently spun off its upstream business and merged it with Midnight Oil Explorations in a deal worth C$460 million. In 2009, the midstream business contributed about 60% of the trust’s funds from operations.

Provident has stated in a news release that the deal will “enable Provident Midstream to continue as a pure play, cash-distributing natural gas liquids (NGL) infrastructure and services business.” The company also said that it will maintain its current distribution through 2010. Provident has some $1.4 billion of tax pools available, which “will provide shelter for a portion of taxable income beyond 2011.”

Heidi Vandeveen, an investor relations representative at Provident, told us that the company intends to be a cash-distributing corporation but added that these plans are not definite. “The distribution policy is under review as our board looks at the plan to convert to a corporation,” she said. “We hope to have more information available to unitholders in the fall regarding this.”

You can reach Provident at 403-231-6710 or

Action to Take –> There’s no doubt the new tax laws will have a big impact on trusts, but right now it still appears there will be solid yields in the sector. I’m keeping a close watch on these three trusts — as well as many others — and will continue to keep High-Yield International subscribers apprised of further developments.