Underground Economy

Canada, unusual among developed countries in the importance of natural resources and raw materials, now ranks with the world’s top five producers of 14 mineral commodities and leads in the production of uranium and potash, the scarcest of the three main raw materials of fertilizer. (Nitrogen and phosphate are the other two).

Its unique natural bounty could help it survive a US downturn. Between 2002 and 2006, the US share of Canadian exports fell from a peak of 84 percent to 79 percent. During the first seven months of 2007, this share declined to 76 percent.

In the five years since it gained entry to the World Trade Organization, during the same period Canada-to-US trade has shrunk, China’s imports have grown substantially. It’s forecast to import nearly a trillion dollars worth of stuff in 2007, tripling the USD300 billion of 2002. China’s demand for natural resources has driven this rapid growth and has boosted prices for Canada’s exports of oil, gas, metals, minerals and farm products.

Canada’s exports to China rose from CAD4 billion to nearly CAD8 billion between 2002 and 2006. And there’s no sign that trend will end soon: The most recent data for 2007 indicate a 43 percent year-to-date increase from the same period in 2006, a rate of growth faster than any other G-7 country.

As long as Chinese demand keeps commodity prices high, the Canadian economy and the loonie will stay aloft, and the Great White North will ride out a US slowdown.

Potash, better than any other resource, illustrates Canada’s good fortune. The country’s potash reserves, at around 75 billion tons, are among the most extensive and the richest in the world. In 2001, the country accounted for about a third of global potash output. The worldwide leader’s share has grown to more than 40 percent on rising demand from China and growth in biofuels production.

Canadian potash shipments to China spiked in 2005 but softened in 2006 because of protracted contract negotiations between Canpotex, a marketing and distribution company wholly owned by the Saskatchewan potash producers, and the Chinese government. China chiseled a USD25-per-ton increase this year and paid about USD100 to USD150 per ton less than other countries for its 2007 potash.  

But fertilizer prices in Asia spiked considerably in October, according to Scotiabank Economics; plantation owners in Malaysia and Indonesia accepted another USD30 hike, and JPMorgan analyst David Silver recently reported in a research note that Russia-based Silvinit made a USD450-per-metric-ton spot sale to a Southeast Asian customer, a USD50 jump in the first quarter 2008 price.

Increasing demand for potash in China is largely a result of the agricultural industry in the country, which uses 54 percent of China’s total land area. Intense farming robs the soil of nutrients, and a good fertilizer is needed to keep crops growing.

China negotiates its price at the beginning of each year and pays that price through the year. This time around, it can do its best Michael Corleone  for a while, but it needs potash and will put a signature on a new contract at a much higher price, perhaps as much as USD80 per ton higher.

China is likely to deal with Russian suppliers before sitting down with Canpotex, which represents Potash Corp, Mosaic Co and Agrium. But the Chinese will pay more in 2008, closer to other contract amounts and spot prices.

According to a May 2006 report on biofuel development by the International Fertilizer Association, in the 30 years between 1975 and 2005, global biofuel output rose from zero to 30 million tons–a drop in the bucket compared to consumption in 2005 of 1.5 billion tons of oil for transportation. But the biofuel growth rate is accelerating, and production is expected to exceed 80 million tons by 2015.

The biofuel drive is generating new levels of industrial demand for potash. As farmers become biofuel miners, the demand for organic fertilizer has driven up the price for potash, which is required in increasing concentrations to sustain crop yields on the shrinking supply of arable land. Three crops used to produce biofuels require large amounts of potash to boost yields: sugar cane in Brazil, palm oil in Asia and corn production in the US.

In 2006, in Brazil the price of potash jumped 55 percent to USD280 per ton. In Malaysia, the largest producer of palm oil, the potash price climbed by 50 percent to USD300.

Population growth and increasing per-capita income–prime characteristics of developing countries–are driving global demand. Demand, now growing at between 3 and 5 percent annually, is widely anticipated to grow faster than producers’ ability to add and expand capacity. Taking the more conservative estimate, for every succeeding year, there will be demand for up to an additional 2 million tons of potash, equivalent in volume to the startup of a new mine.

But it’s difficult to get a new mine established and up to capacity; despite a series of expansion announcements, the industry will still be challenged to keep pace with demand.

The Saskatchewan producers will continue to benefit from rising Chinese demand and the biofuels boom. Exports so far in 2007 have already surpassed 2006 values and are on track to match the record set in 2005. And China’s imports rose 88 percent through August, according to Scotiabank.

Potash Corp, the biggest player, is spending USD1.8 billion to expand the capacity of its Rocanville facility in southeastern Saskatchewan by 2 million tons a year. The project will boost companywide production capacity to 15.7 million tons annually by 2012, a 15 percent rise from current levels.
 
Potash’s third-quarter output was about 25 percent higher than a year earlier, and its inventories were down more than 40 percent after falling 44 percent in the July-to-September period. 

And Agrium recently increased capacity at its Saskatchewan mine by 300,000 tons to 2.05 million tons and is now working on engineering studies for another 800,000-ton expansion. But the company will need up to a year to finalize plans and costs, with an eye to boosting production in 2010 at the earliest.

Making the Rounds

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The Roundup

Electric Power

Boralex Power Income Fund (TSX: BPT-U, OTC: BLXJF) announced that the Quebec Superior Court has issued an injunction ordering AbitibiBowater to continue supplying power from its Dolbeau, Quebec, facility to Boralex. The injunction will remain in effect until the conclusion of the arbitration process, which should begin soon and could last up to a year.

Boralex purchased the wood residue cogeneration facility in Dolbeau in 1999 from a predecessor of AbitibiBowater. The purchase included an agreement requiring AbitibiBowater to operate the facility.

AbitibiBowater notified Boralex in August that it planned to stop operating the facility in October. Boralex Power Income Fund is a buy up to USD8.

Gas/Propane

Energy Savings Income Fund (TSX: SIF-U, OTC: ESIUF) reported that the amount of a special distribution, announced in December will be 41 cents Canadian per unit. The special distribution will be paid 50 percent (20.5 cents Canadian) in cash and 50 percent (20.5 cents Canadian) in units of the fund based upon the closing market price for units of the fund on the Toronto Stock Exchange (TSX) on Dec. 31, 2007, or CAD16.70.

Nonresident unitholders will be subject to applicable Canadian withholding tax on the whole 41 cents Canadian special distribution. For taxable US residents who hold units, the amount of the unit portion of the distribution shouldn’t be included in income nor should it be included in the adjusted cost base of the units held for US income tax purposes.

Consult your legal, business and tax advisors about the tax implications of the special distribution. Energy Savings Income Fund is a buy up to USD18.

Eveready Income Fund (TSX: EIS-UN, OTC: EISFF) has received the OK from the TSX to make a normal course issuer bid that allows Eveready to purchase for cancellation up to 5.09 million units, about 10 percent of the public float. Eveready has made no purchases of its own units during the last 12 months, and the fund recently announced that it would no longer pay a monthly cash distribution.

Eveready opted for an in-kind distribution, meaning it would pay in units rather than cash, in order to “reinvest the fund’s cash in growing [its] business.” Looked at together, the two moves are contradictory.

But Eveready explained that it wanted the flexibility to buy units when the market didn’t properly reflect the underlying value of the business. Hold Eveready Income Fund.

Spectra Energy Income Fund (TSX: SP-U, OTC: SPFFF) announced a CAD41 million project to expand its West Doe facility in the Peace River Arch area of northeast British Columbia. The project will include a 30-million-cubic-feet-per-day expansion of sour gas processing capability, increasing overall capacity at the West Doe facility to 53.5 million cubic feet per day (MMcf/d).

It also includes a 50 percent ownership interest in a 58 kilometer gathering pipeline from the Sundown area of northeast British Columbia. The expansion will be financed from existing credit facilities and is supported by firm contracts with area producers.

The Sundown gathering pipeline is expected to start deliveries to the West Doe plant during the second quarter. Expansion of the plant is expected to begin in the third quarter.

The increased capacity is expected to be available in the first quarter of 2009. Buy Spectra Energy Income Fund up to USD11.

Wellco Energy Services Trust (TSX: WLL-U, OTC: WLLUF) has sold its production testing division, Lonkar Well Testing, for CAD6.5 million. Net proceeds from the transaction will be used to pay down long-term debt.

The sale is the last move in a review of Wellco’s product lines aimed at focusing its business on providing remote accommodations, including waste water treatment rentals and water and waste water treatment design and assembly. The deal doesn’t affect Wellco’s pending merger with Peak Energy Services Trust (TSX: PES.UN, OTC: PKGFF). Wellco Energy Services Trust and Peak Energy Services Trust are both sells.

Business Trusts

CI Financial Income Fund’s (TSX: CIX-U, OTC: CIXUF) board, responding to pressure on the fund’s assets under management brought by recent equity market turmoil, has approved a 16 percent cut in its monthly distribution. CI will pay 16 cents Canadian per unit starting in March, down from 19 cents Canadian per unit in January and February.

The fund plans to pay CAD1.98 per unit for 2008, an average of 16.5 cents Canadian per unit, down 10 percent from 2007. CI Financial Income Fund remains a buy up to USD30.

Connors Bros Income Fund (TSX: CBF-U, OTC: CBICF) will pay a special distribution equivalent to 15.4 cents Canadian per unit on Jan. 30 to unitholders of record as of Dec. 31, 2007. The distribution will be paid as 0.02 units for every unit held, based on the average closing price for the 20 trading days prior to the record date.

The fund announced Dec. 18 that its board had approved this special distribution subject to a final review of the fund’s taxable income for the year ended Dec. 31. Connors Bros has yet to restore its regular distribution. Sell Connors Bros Income Fund.

Priszm Income Fund (TSX: QSR.UN, OTC: PSZMF) has restored its distribution to 10 cents Canadian per unit for the month of January 2008. It will be paid Feb. 15 to unitholders of record as of Jan. 31.

Priszm also reported that, as part of the plan to refocus and restructure its business, it’s closed 19 marginally performing stores. The closures are forecast to add about CAD500,000 to earning for 2008.

The fund also announced the creation of Priszm Venture Assets Group to drive the process of refranchising approximately 120 locations to new owners over the next 24 months; Priszm expects to generate between CAD20 million and CAD30 million in gross proceeds from the sale of these restaurants. Buy Priszm Income Fund up to USD7.

Tree Island Wire Income Fund (TSX: TIL.UN, OTC: TWIRF) should benefit from a ruling by the US Dept of Commerce regarding nails being dumped into the US by producers in China and the United Arab Emirates. Subsidiary Tree Island Industries, which produces collated and bulk nails, expected the favorable ruling.

Daniel McAtee, president and CEO of Tree Island Industries and a trustee of the fund, said, “We manufacture nails only in North America and we have available capacity to meet the anticipated additional demand that this ruling may create.” Tree Island Wire Income Fund is a sell.

Real Estate Trusts

Canadian Apartment Properties REIT (TSX: CAR-U, OTC: CDPYF) completed a previously announced sale of 10 noncore properties to TransGlobe Property Management Services containing 1,478 suites located in Niagara, the Greater Toronto Area and Montreal.

The sale is tied to the acquisition of eight apartment properties from TransGlobe announced Oct. 1, 2007, containing 748 suites located in British Columbia and Alberta. The total sales price was approximately $121.2 million.

CAP REIT has also sold two Quebec City apartment properties to a separate purchaser for approximately CAD6.4 million. The two transactions generated approximately CAD63.4 million.

The net proceeds will be used to reduce CAP REIT’s debt, fund unit repurchases and for other general purposes. Canadian Apartment Properties REIT is a buy up to USD20.

InnVest REIT (TSX: INN-U, OTC: IVRVF) has secured CAD350 million of mortgage financing hotels acquired as part of its Legacy Hotels REIT acquisition. The average interest rate on this financing is 5.6 percent per year with an average term of just under five years.

The proceeds will be used to repay the CAD215 million bridge loan financing and certain of the existing mortgages. The transaction is expected to close during the first quarter of 2008; upon closing, InnVest will have no debt maturities until 2010. Buy InnVest REIT up to USD13.

Natural Resources Trusts

Canfor Pulp Income Fund (TSX: CFX-U, OTC: CFPUF) is looking for alternative sources of chip supply to its mill, which was discontinued because of a fire in the chip screening and in-feed system. Canfor also reported that it will take about five weeks to get the mill back up and running.

Lost production is estimated at approximately 28,000 tons. To mitigate the impact on customers, the paper machine is currently using pulp supplied from Canfor’s Intercontinental and Northwood pulp mills.

The fund’s property damage and business interruption insurance coverage should limit financial losses. Canfor Pulp Income Fund is a buy up to USD13.