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Battered investors find comfort, reward in Canadian income trusts Trusts notch total returns of 9.7 percent for first 7 months of 2002, with 5 largest conventional producers yielding up to 18 percent; market cap now at C$9 billion Gary Park PNA Canadian Correspondent
In a year of evaporating fortunes and retirement hopes, Canadian investors have found at least one haven of hope — energy income trusts. Close to 20 publicly traded trust companies are producing almost 200,000 barrels per day of crude oil and natural gas liquids and 800 million cubic feet per day of natural gas, or 10 percent of Canada’s total crude/NGLs production and 5 percent of its gas. Their combined market capitalization is now estimated at C$9 billion, compared with C$665 million in 1995.
More importantly, in these days of stock market turmoil, they have easily outperformed more traditional investments.
The Scotia Capital Oil and Gas Royalty Trust index recorded 9.7 percent in total returns, including distributions to unit holders, over the first seven months of 2002, following a 40 percent annual return in 1999 and 2000.
Stack that up against declines of 15 percent on the Standard & Poor’s/Toronto Stock Exchange, 17.1 percent on the Dow Jones Industrial Average and 24.7 percent on the S&P 500.
Operate much like producers Having been around for about 15 years, the trusts operate much like conventional producers — buying and selling properties, producing oil and gas and selling their output.
But they diverge in significant ways from the traditional oil patch path, where growth is the major objective.
Instead of setting out to create value for investors by finding new reserves, trusts exist to deplete reserves and are often managed by external teams who look to maximize cash flow by crunching costs and limiting risks.
Verne Johnson, senior vice president at Enerplus Resources Corp., part of a group which manages over C$2 billion in assets, said that as the Western Canada Sedimentary Basin has matured to the point where major new fields are tougher to find there are assets that are better run by asset managers than those focused on growth through the drill bit.
He views trusts as a natural progression for investors who have grown weary of a high risk business “that undeniably destroys equity from time to time.”
For investors, there is great appeal in knowing that the trust’s cash flow comes to them as monthly or quarterly distributions.
Current sector leaders The current sector leaders are Enerplus Resources Fund with 51,500 barrels of oil equivalent per day, Canadian Oil Sands Trust 47,700 bpd (all of it from the Syncrude Canada Ltd. oil sands operation) and ARC Energy Trust at 42,800 boepd.
The five largest conventional producing trusts currently yield between 12 percent and 18 percent, according to Calgary-based Sayer Securities Ltd., while Scotia Capital has forecast average cash yields of 14.2 percent this year, based on moderate average prices of US$21 per barrel for oil and US$2.75 per thousand cubic feet for gas.
Brian Ector, an analyst with Scotia Capital Equity Research, told a strategic options conference in June that trusts are a new “investment class,” shouldering aside the intermediate E&Ps that were previously their most serious rival.
As they have gained in recognition, trusts have also grown in their ability to attract capital, as illustrated by the C$1.33 billion they raised in 2001, far outstripping the C$117 million by conventional E&Ps, and another C$520 million in the first half of 2002, a slight drop from last year’s C$630 million.
U.S. counterparts not the same thing Ector said there is a clear distinction between Canadian trusts, which are actively managed, and their U.S. counterparts, referred to as master limited partnerships, which he described as “blow-downs” of production from their oil and gas properties.
The latest addition to the income ranks occurred July 18 when Acclaim Energy Trust announced a C$384 million (US$250 million) deal to acquire the bulk of mature producing properties from Ketch Energy Ltd., leaving Ketch to spin off its exploration assets and form a small producer, starting at 1,700 boepd.
Acclaim President Jack Lee said the transaction will lift his company’s producing portfolio to 16,100 boepd from 10,700 boepd, making Acclaim the seventh-largest income trust in Canada.
In the process, Acclaim’s market capitalization will grow to more than C$400 million from C$155 million.
Calgary-based investment firm Peters & Co. has forecast for 2002 that the Canadian trust group will trade at 7.1 times cash flow against 3.8 times for intermediate producers and 4.1 times for juniors.
Also junior players Typical of the new breed of junior player in the Canadian oil patch is Storm Energy Corp., which grew in four years to 13,000 bpd from 1,500 bpd, but rather that pursue growth for its own sake and risk declining production it has opted to ask shareholders this month to approve a royalty trust spinoff producing about 8,500 boepd.
Storm President and Chief Executive Officer Matthew Brister said his company can get a higher valuation for its assets in an income trust, while starting over with an E&P company with 4,000 bpd of production, allowing management to target a doubling of output.
Wilf Gobert, an analyst with brokerage Peters & Co., told a Canadian Association of Petroleum Producers investment symposium in July that Storm is “avoiding what has become a burial ground for companies — trying to grow through the production threshold” of 15,000 to 20,000 barrels of oil equivalent per day.
The path to the ranks of income trusts starts with small and junior producers — a breeding ground analysts say is quickly re-emerging from the disposal of non-core assets by companies involved in the tidal wave of mergers and acquisitions that has swamped the Canadian oil patch.
Rob Jennings, president and chief executive officer of Jennings Capital, said that with 72 percent of the Canadian industry’s total market cap now consisting of companies smaller than C$100 million “there is competition for investor attention. The retail investor is basically looking at the royalty trust for income.”
Enticed by the prospects of enhancing shareholder value, other industry-related sectors are also joining the trend.
Parkland Industries Ltd., with annual operating revenues of about C$500 million from retailing and wholesaling transportation fuel and running a small Alberta refinery, transformed itself last month into an income fund.
In May, Canadian Crude Separators Inc. became the first Canadian service and supply company to reorganize as a trust. It was quickly followed by Wellco Inc. and Trinidad Drilling Ltd. , despite some concern among analysts that the sector does not have the predictable cash flow or stability associated with trusts.
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