Maple Leaf Memo
By-the-By Election
Say what you will about the Canadian prime minister–and income trusts and their investors have many unkind words for him and his finance minister–but the guy is playing the game hard. And he’s playing it well.
The game is politics; the evidence of his skill is the way he’s levered three Quebec by-elections into a likely ratification of his coming throne speech.
Stephen Harper waited the full six months he was allowed to call by-elections in Quebec; once a parliamentary vacancy is created, Canadian law allows the sitting prime minister as few as 11 and as many as 180 days to call an election to fill it.
Harper and the Conservatives wanted a battle test in Quebec to create leadership problems for Stéphane Dion and the Liberals more than to change the composition of Parliament.
The aftermath–the Conservatives took a seat from the Bloc Quebecois in the heart of separatist territory, the Bloc held a bastion, and the New Democratic Party took its first-ever seat in the province–reveals a great strategic move, and the tactical victory makes plain that where once the Bloc and the Liberal were the only federal choices, the Conservatives have muscled in.
Harper bloodied the liberals by stoking new questions about Dion’s leadership; the quiet intellectual wasn’t helped by news reports quoting “one source close to Dion” who questioned whether one-time party leadership rival Michael Ignatieff’s supporters working the ground in Outremont were throwing the game–hoping to cripple Dion and pave the way for their guy to fill the void.
Losing a seat your party’s controlled for decades, slashing each other on the way down, hardening the visage of a loser. Dion is left with a couple unattractive options: He can stay the cautious course, make a weak move from a vulnerable position and back off his throne speech demands; or he can pounce.
Is the result in the Outremont riding in Quebec a comment on Dion’s leadership? Can he survive it? Adam Radwanski, a member of The Globe and Mail’s editorial board and a blogger, says by-elections aren’t particularly useful barometers:
Good Canadian income trusts, like good US corporations, have to sell themselves to investors at some point. And representatives for several major oil and gas producer trusts were on hand at the Washington, DC Money Show a week ago to do just that.
From my perspective, it was another opportunity to ask some key questions. And I was able to moderate a panel of representatives from four trusts: Canetic Resources (CNE.UN, NYSE: CNE), Enerplus Resources (ERF.UN, NYSE: ERF), Enterra Energy (ENT.UN, NYSE: ENT) and Provident Energy (PVE.UN, NYSE: PVX).
I had three key takeaways from the meeting. First, though they continue to fight for changes, trust managements are proceeding as though 2011 corporate taxation is a done deal. They concede they lost the argument within the current Conservative Party government. They’re also hopeful the opposition Liberal Party will win upcoming elections (no date set as yet) and follow through on its current promise to roll back taxation.
None, however, is basing its strategy on the idea that things will go back to where they were before Halloween 2006. Simply, there are too many ifs.
On the plus side, none expect to be paying anything close in taxes to the statutory rate of 31.5 percent, which kicks in with 2011. In fact, one trust’s representative went as far as to state his trust could wind up paying something closer to the 6.5 percent average paid by ordinary Canadian corporations, which has been my contention for some time.
All four trusts pointed out that they’d be making judicious use of tax pools, or noncash deductions and expenses related to exploration and development. As we’ve pointed out in Canadian Edge, tax pools have the potential to shelter several years of income for many trusts. The representatives did point out, however, that not all tax pools are created equal and advised investors to check out the breakdown before valuing a trust on that basis.
As for restructuring moves, the consensus is that everything’s still on the table. Each trust stated the intention of increasing its US production of oil and gas, from the standpoint of growth and diversification and tax avoidance—since US income will be exempt from 2011 taxation. As of yet, only Provident has actually put US assets into a limited partnership, though the others raised the possibility of doing so at a later date.
Trust managements emphasized that they were considering many options and would continue to do so up until 2011. They were also unanimous in affirming there was no advantage to leaving the trust structure at this time. All also affirmed their desire to continue to pay big dividends well after 2011, regardless of their form of organization then. And although conceding that some dividend adjustments were likely no matter how much tax avoidance proved possible, the line “12 percent is the new 9 percent” is encouraging that the ultimate amount will still be generous.
Another key takeaway from the panel concerned energy prices, specifically that of natural gas. Trusts are most concerned about the volatile, depressed state of the gas market, which makes rational planning and production decisions exceedingly difficult.
The general expectation is that the price of gas will recover in the next year, if for no other reason than falling output causing the current inventory glut to contract. All four trusts continue to hedge their output aggressively to lock in cash flow and ride out the volatility.
Interesting enough, Provident’s natural gas liquids division is actually a natural hedge against falling gas prices. Simply, gas itself is the primary input and the natural gas liquids (NGLs) are sold at oil-like prices.
As a result, profit margins have widened dramatically as oil has gone from seven to eight times gas prices to 13 to 14 times. Eventually, if gas prices recover, the NGL business will be less profitable. At that point, however, the company’s natural gas production operation will return to strong profitability.
The third and most important takeaway from the panel was it reaffirmed the growing differentiation within the Canadian oil and gas producer trust sector itself. It was clear that Enerplus and Provident–as well as Canetic–are moving aggressively to deal with both economic and political challenges facing their industry. Battered Enterra, on the other hand, faces some severe challenges to its survival.
In my view, all oil and gas trusts are cheap now. Expectations for the sector are very low, and the fear level is high. As a result, it’s possible even the smallest and weakest in the group will be bailed out by a takeover, a recovery in natural gas prices and/or a favorable change in trust taxation.
It’s also possible, however, that the sector’s weakest players will continue their current death spiral. The takeover premiums for the likes of Thunder Energy have been meager. And in any case, the strong are also candidates for takeovers—though at strong premiums—and they’ll also benefit greatly from a recovery in gas or a change in prospective 2011 taxation.
In short, despite the low prices, there’s still no reason to buy or hold the weakest oil and gas trusts. Rather, stick with the strong, both for weathering the current crisis and to profit from the inevitable recovery.
The Roundup
Oil & Gas
Enterra Energy Trust (ENT.UN, NYSE: ENT) suspended its distribution for at least six months in order to repay debt. The cut will begin with the payment due Oct. 15 and was one of several measures, including an asset sale announced last week, taken to “improve financial flexibility.”
Enterra’s gross profit per barrel of oil equivalent produced fell 22 percent during the second quarter from a year earlier to CD17.08 a barrel. The company had CD190 million in bank debt at the end of that period.
Enterra is also enduring a series of executive departures; Kim Booth, the trust’s COO for US operations, is leaving at the beginning of November, and Enterra’s CFO resigned earlier this month. Sell Enterra Energy Trust.
Pengrowth Energy Trust (PGF.UN, NYSE: PGH) is cutting its distribution by 10 percent as of October as continued low natural gas prices have taken their toll. The company will pay unitholders 22.5 cents Canadian per trust unit in October, down from 25 cents Canadian in previous months.
Pengrowth’s board of directors reduced the payout to provide additional capital for the trust’s active development program. Hold Pengrowth Energy Trust.
Provident Energy Trust’s (PVE.UN, NYSE: PVX) US arm is paying USD1.44 billion for natural gas properties, including wells concentrated in a geological area of Michigan known as the Antrim shale. Provident-controlled BreitBurn Energy Partners (NSDQ: BBEP) has agreed to pay USD750 million cash and 21.35 million of its units to buy assets in Kentucky, Indiana and Michigan from Quicksilver Resources (NYSE: KWK).
Daily gross production is 95 million cubic feet of gas, the equivalent of about 15,830 barrels of oil a day. The deal makes BreitBurn the largest gas producer in Michigan and a leader in Antrim shale, a region in the north-central part of the state, which was a hot drilling area in the 1990s and is now more mature.
BreitBurn is selling USD450 million of new units and issuing 16.7 million of them to a group of institutional investors. Provident isn’t participating in the equity offering, meaning its stake in BreitBurn will fall to 23 percent from about 51 percent, but it will still control the entity through its ownership of BreitBurn’s general partner.
US partnerships such as BreitBurn avoid taxes by paying out their earnings to investors. Provident unitholders will benefit through the projected increase in cash flow from BreitBurn’s distributions. Provident Energy Trust is a buy up to USD14.
Gas/Propane
Wellco Energy Services Trust (WLL.UN, WLLUF) slashed its distribution by 50 percent; the trust will pay a distribution of 3.5 cents Canadian per unit on Oct. 15 to unitholders of record on Sept. 28. The ex-distribution date is Sept. 26.
Prolonged weakness in western Canada’s drilling market has caught up to Wellco. The trust made the cut to bring its payout ratio within its target range and to allow flexibility to execute strategic plans.
Wellco’s utilization rates in many of its product lines are languishing along with current drilling activity, but Wellco anticipates that its accommodation and catering business will have a good winter because much of it is committed to customers operating in the Alberta oil sands. Wellco Energy Services Trust remains a buy up to USD6.
Business Trusts
Newalta Income Fund (NAL.UN, NALUF) is acquiring Nova Pb, Canada’s largest battery recycling facility, for about CD55 million. The lead recycling facility has two long-body rotary kilns and can process up to 200,000 metric tons of used batteries. It can also produce up to 100,000 metric tons of recycled lead per year. Buy Newalta Income Fund up to USD25.
Say what you will about the Canadian prime minister–and income trusts and their investors have many unkind words for him and his finance minister–but the guy is playing the game hard. And he’s playing it well.
The game is politics; the evidence of his skill is the way he’s levered three Quebec by-elections into a likely ratification of his coming throne speech.
Stephen Harper waited the full six months he was allowed to call by-elections in Quebec; once a parliamentary vacancy is created, Canadian law allows the sitting prime minister as few as 11 and as many as 180 days to call an election to fill it.
Harper and the Conservatives wanted a battle test in Quebec to create leadership problems for Stéphane Dion and the Liberals more than to change the composition of Parliament.
The aftermath–the Conservatives took a seat from the Bloc Quebecois in the heart of separatist territory, the Bloc held a bastion, and the New Democratic Party took its first-ever seat in the province–reveals a great strategic move, and the tactical victory makes plain that where once the Bloc and the Liberal were the only federal choices, the Conservatives have muscled in.
Harper bloodied the liberals by stoking new questions about Dion’s leadership; the quiet intellectual wasn’t helped by news reports quoting “one source close to Dion” who questioned whether one-time party leadership rival Michael Ignatieff’s supporters working the ground in Outremont were throwing the game–hoping to cripple Dion and pave the way for their guy to fill the void.
Losing a seat your party’s controlled for decades, slashing each other on the way down, hardening the visage of a loser. Dion is left with a couple unattractive options: He can stay the cautious course, make a weak move from a vulnerable position and back off his throne speech demands; or he can pounce.
Is the result in the Outremont riding in Quebec a comment on Dion’s leadership? Can he survive it? Adam Radwanski, a member of The Globe and Mail’s editorial board and a blogger, says by-elections aren’t particularly useful barometers:
Yes, losing Outremont would be highly embarrassing for Stephane Dion. (More on that tomorrow, if it happens.) Yes, taking a Quebec seat would be a major triumph for Jack Layton. (More on that too, tomorrow, if it happens.) But let’s all settle down a little here.Toronto Star columnist Chantal Hebert had this to say:
By-elections are useful practice runs for political organizers, and as such they give a pretty decent indication of whether parties have their acts together on the ground. But they’re not especially useful as litmus tests, since they’re fought on completely different grounds from general elections.
Since there’s no national campaign, local candidates count more. Because voter turnout is usually low, and many of those who do come out have to be dragged by the ear to the polling station, local organization counts more as well. And because voters are under no illusion that they’re choosing a national government, they’re much more likely to register protests votes or to vote strategically to send some kind of message.
The campaign has confirmed Harper’s growth potential in Quebec; it continues to fall well short of a one-way ticket to a majority.Trust Perspectives
The Conservatives are still only cherry-picking seats in Quebec. Their hopes today in Roberval-Lac-Saint-Jean rest largely on the notoriety of their local candidate, Roberval Mayor Denis Lebel, rather than on a return on their many overtures to the province. A Conservative win in Roberval-Lac-Saint-Jean would still leave the party shut out of urban Quebec. And, overall, the by-elections have highlighted the ongoing absence of a strong Conservative organization in the province.
In spite of that, Harper is in much better shape than his main federalist opponent. Even before the votes are counted, the campaign has shown that, at least in Quebec, Liberal Leader Stéphane Dion is not election-ready. More than ever, his party is on the defensive and his leadership is not lifting its fortunes.
That’s ominous news for the Liberals and, in a roundabout way, for the Bloc, for whom a split in the federalist vote is immensely better than a one-on-one battle against the Conservatives.
As for Harper, who might relish the chance to take on a wounded Liberal leader in a snap general election, he will have to balance that temptation in the weeks to come against the quasi-certain knowledge that he will only get one shot at campaigning for a majority against Dion.
As of tomorrow, the future of the minority Parliament may rest with Dion’s survival instincts. He is headed back to Parliament next month with the greatest need for more time.
Good Canadian income trusts, like good US corporations, have to sell themselves to investors at some point. And representatives for several major oil and gas producer trusts were on hand at the Washington, DC Money Show a week ago to do just that.
From my perspective, it was another opportunity to ask some key questions. And I was able to moderate a panel of representatives from four trusts: Canetic Resources (CNE.UN, NYSE: CNE), Enerplus Resources (ERF.UN, NYSE: ERF), Enterra Energy (ENT.UN, NYSE: ENT) and Provident Energy (PVE.UN, NYSE: PVX).
I had three key takeaways from the meeting. First, though they continue to fight for changes, trust managements are proceeding as though 2011 corporate taxation is a done deal. They concede they lost the argument within the current Conservative Party government. They’re also hopeful the opposition Liberal Party will win upcoming elections (no date set as yet) and follow through on its current promise to roll back taxation.
None, however, is basing its strategy on the idea that things will go back to where they were before Halloween 2006. Simply, there are too many ifs.
On the plus side, none expect to be paying anything close in taxes to the statutory rate of 31.5 percent, which kicks in with 2011. In fact, one trust’s representative went as far as to state his trust could wind up paying something closer to the 6.5 percent average paid by ordinary Canadian corporations, which has been my contention for some time.
All four trusts pointed out that they’d be making judicious use of tax pools, or noncash deductions and expenses related to exploration and development. As we’ve pointed out in Canadian Edge, tax pools have the potential to shelter several years of income for many trusts. The representatives did point out, however, that not all tax pools are created equal and advised investors to check out the breakdown before valuing a trust on that basis.
As for restructuring moves, the consensus is that everything’s still on the table. Each trust stated the intention of increasing its US production of oil and gas, from the standpoint of growth and diversification and tax avoidance—since US income will be exempt from 2011 taxation. As of yet, only Provident has actually put US assets into a limited partnership, though the others raised the possibility of doing so at a later date.
Trust managements emphasized that they were considering many options and would continue to do so up until 2011. They were also unanimous in affirming there was no advantage to leaving the trust structure at this time. All also affirmed their desire to continue to pay big dividends well after 2011, regardless of their form of organization then. And although conceding that some dividend adjustments were likely no matter how much tax avoidance proved possible, the line “12 percent is the new 9 percent” is encouraging that the ultimate amount will still be generous.
Another key takeaway from the panel concerned energy prices, specifically that of natural gas. Trusts are most concerned about the volatile, depressed state of the gas market, which makes rational planning and production decisions exceedingly difficult.
The general expectation is that the price of gas will recover in the next year, if for no other reason than falling output causing the current inventory glut to contract. All four trusts continue to hedge their output aggressively to lock in cash flow and ride out the volatility.
Interesting enough, Provident’s natural gas liquids division is actually a natural hedge against falling gas prices. Simply, gas itself is the primary input and the natural gas liquids (NGLs) are sold at oil-like prices.
As a result, profit margins have widened dramatically as oil has gone from seven to eight times gas prices to 13 to 14 times. Eventually, if gas prices recover, the NGL business will be less profitable. At that point, however, the company’s natural gas production operation will return to strong profitability.
The third and most important takeaway from the panel was it reaffirmed the growing differentiation within the Canadian oil and gas producer trust sector itself. It was clear that Enerplus and Provident–as well as Canetic–are moving aggressively to deal with both economic and political challenges facing their industry. Battered Enterra, on the other hand, faces some severe challenges to its survival.
In my view, all oil and gas trusts are cheap now. Expectations for the sector are very low, and the fear level is high. As a result, it’s possible even the smallest and weakest in the group will be bailed out by a takeover, a recovery in natural gas prices and/or a favorable change in trust taxation.
It’s also possible, however, that the sector’s weakest players will continue their current death spiral. The takeover premiums for the likes of Thunder Energy have been meager. And in any case, the strong are also candidates for takeovers—though at strong premiums—and they’ll also benefit greatly from a recovery in gas or a change in prospective 2011 taxation.
In short, despite the low prices, there’s still no reason to buy or hold the weakest oil and gas trusts. Rather, stick with the strong, both for weathering the current crisis and to profit from the inevitable recovery.
The Roundup
Oil & Gas
Enterra Energy Trust (ENT.UN, NYSE: ENT) suspended its distribution for at least six months in order to repay debt. The cut will begin with the payment due Oct. 15 and was one of several measures, including an asset sale announced last week, taken to “improve financial flexibility.”
Enterra’s gross profit per barrel of oil equivalent produced fell 22 percent during the second quarter from a year earlier to CD17.08 a barrel. The company had CD190 million in bank debt at the end of that period.
Enterra is also enduring a series of executive departures; Kim Booth, the trust’s COO for US operations, is leaving at the beginning of November, and Enterra’s CFO resigned earlier this month. Sell Enterra Energy Trust.
Pengrowth Energy Trust (PGF.UN, NYSE: PGH) is cutting its distribution by 10 percent as of October as continued low natural gas prices have taken their toll. The company will pay unitholders 22.5 cents Canadian per trust unit in October, down from 25 cents Canadian in previous months.
Pengrowth’s board of directors reduced the payout to provide additional capital for the trust’s active development program. Hold Pengrowth Energy Trust.
Provident Energy Trust’s (PVE.UN, NYSE: PVX) US arm is paying USD1.44 billion for natural gas properties, including wells concentrated in a geological area of Michigan known as the Antrim shale. Provident-controlled BreitBurn Energy Partners (NSDQ: BBEP) has agreed to pay USD750 million cash and 21.35 million of its units to buy assets in Kentucky, Indiana and Michigan from Quicksilver Resources (NYSE: KWK).
Daily gross production is 95 million cubic feet of gas, the equivalent of about 15,830 barrels of oil a day. The deal makes BreitBurn the largest gas producer in Michigan and a leader in Antrim shale, a region in the north-central part of the state, which was a hot drilling area in the 1990s and is now more mature.
BreitBurn is selling USD450 million of new units and issuing 16.7 million of them to a group of institutional investors. Provident isn’t participating in the equity offering, meaning its stake in BreitBurn will fall to 23 percent from about 51 percent, but it will still control the entity through its ownership of BreitBurn’s general partner.
US partnerships such as BreitBurn avoid taxes by paying out their earnings to investors. Provident unitholders will benefit through the projected increase in cash flow from BreitBurn’s distributions. Provident Energy Trust is a buy up to USD14.
Gas/Propane
Wellco Energy Services Trust (WLL.UN, WLLUF) slashed its distribution by 50 percent; the trust will pay a distribution of 3.5 cents Canadian per unit on Oct. 15 to unitholders of record on Sept. 28. The ex-distribution date is Sept. 26.
Prolonged weakness in western Canada’s drilling market has caught up to Wellco. The trust made the cut to bring its payout ratio within its target range and to allow flexibility to execute strategic plans.
Wellco’s utilization rates in many of its product lines are languishing along with current drilling activity, but Wellco anticipates that its accommodation and catering business will have a good winter because much of it is committed to customers operating in the Alberta oil sands. Wellco Energy Services Trust remains a buy up to USD6.
Business Trusts
Newalta Income Fund (NAL.UN, NALUF) is acquiring Nova Pb, Canada’s largest battery recycling facility, for about CD55 million. The lead recycling facility has two long-body rotary kilns and can process up to 200,000 metric tons of used batteries. It can also produce up to 100,000 metric tons of recycled lead per year. Buy Newalta Income Fund up to USD25.