Oil prices are soaring to new heights. But Canadian oil and gas producer trusts continue to be range-bound. In fact, most have slipped a notch the past few days.

As I’ve pointed out, the primary reason trusts are still weak is still-slumping natural gas prices. Most trusts rely on gas sales for at least half of their cash flows, and gas prices have been weaker than oil prices have been stronger. Also, the benefit of higher oil prices has been somewhat muted by the drop in the US dollar versus the Canadian currency because oil is priced in US dollars.

My view remains that gas prices will eventually recover. For one thing, the fuel is historically cheap relative to oil. In fact, oil’s current level of 13 to 14 times gas prices is about twice the historic ratio of seven to eight times. That kind of price differential has always triggered switching between the two fuels.

For another, gas production continues to decline in North America, and the drop will only accelerate with Chesapeake Energy’s decision this month to cut overall output by up to 6 percent. Even if the weather (and demand for gas) doesn’t return to normal, lower supply will bring prices up. And given our growing reliance on liquid natural gas imports—which follow world prices—there’s the growing possibility of a global price shock.

Until gas does recover, however, Canadian producer trusts won’t break out to the upside. Meanwhile, we’ll continue to see distribution cuts in the weaker trusts, for which lower gas prices are having a particularly horrific impact.

The demise of Enterra Energy Trust (ENT.UN, NYSE: ENT) this week is a powerful cautionary tale. The trust this week suspended its distribution for six months, in order to make good on credit agreements. The shares, which had been falling for some time, have now slipped well under USD2, and remain in what appears to be a death spiral. Sell if you haven’t already.

The good news is stronger producer trusts such as ARC Energy Trust (AET.UN, AETUF), Enerplus Resources (ERF.UN, NYSE: ERF), Penn West Energy Trust (PWE.UN, NYSE: PWE), Peyto Energy Trust (PEY.UN, PEYUF), Provident Energy Trust (PVE.UN, NYSE: PVX) and Vermilion Energy Trust (VET.UN, VETMF) remain well positioned to maintain distributions. Unlike the weak, they have the heft, strong reserves and financial power to maintain their output through the difficult times in the natural gas market.

They’ve weathered gas’ plunge since late 2005 to date and show every sign of doing so until prices eventually recover. Moreover, it looks like they may finally catch a break from Canadian authorities on the tax front.

Royalty Relief?

As we’ve pointed out in Canadian Edge’s companion, weekly Maple Leaf Memo, we’re not counting on a defeat of the Conservative Party to bail out our trusts. In fact, the only trusts we want to own are those with the business strength to keep paying big dividends well after 2011 and which are making plans to maximize their opportunities under the prospective new rules.

Our favorite trusts’ prices now fully reflect 2011 taxation. So any change will be on the plus side. But we’re not counting on it, and neither should you.

Good trusts, however, may be on the verge of greater royalty relief in Alberta. Royalties paid to the government are currently a fairly large slice of income. Any reduction would increase distributable cash flow directly.

On Sept. 18, the Alberta Royalty Review issued a long-awaited report with recommended changes for royalties in the province’s energy sector. Entitled “Our Fair Share,” the report’s headline item was a recommendation for a markedly higher royalty on oil sands production.

This report generated immediate selling Sept. 19 for oil sands companies. By the end of the day, though, affected companies were trading well off their lows.

One reason is the proposed increases wouldn’t kick in until a given reserve reached a certain level of production. It wouldn’t apply to new projects, which would still enjoy the same low royalty rate of 1 percent.

Many conventional oil and gas trusts pulled back on the news in sympathy. Ironically, the report also included a recommendation to lower royalty rates on “less productive fields,” which are the core of trusts’ production. That would tend to make these more profitable.

At this point, there are more questions than answers on this issue. For one thing, it’s up to the provincial government to adopt as much or as little of this report as it wants to, and there’s no clear direction for it to take either politically or on policy.

Albertans would stand to benefit from higher royalties, but most work for the energy industry in some capacity. Anything seen to be killing the golden goose will be seen as threatening jobs.

From investors’ standpoint, raising taxes is bad news. And Alberta’s attempt to grab more oil sands revenue—though not in the same ballpark with moves made by other countries such as Russia and Venezuela—is a negative.

As someone who’s followed regulation on both sides of the border for many years, my own feeling is the final product will be considerably more benign for industry than the report’s full recommendations. Energy is just too important for Alberta, and the risk for politicians is too great to move too radically. That likelihood may be why selling ended so quickly, with even Suncor and Canadian Oil Sands Trust (COS.UN, COSWF)—the most-affected entities—sharply paring the initial losses.

It’s also highly speculative about whether royalties will be cut for “less productive fields” owned by oil and gas trusts. That’s the direction other provinces have taken in recent months.

The bottom line is even in a worst case—where all the recommendations are adopted—good income trusts will be affected very little. Simply, this isn’t an event worth reacting to, at least for the strongest trusts.

It’s true that Enerplus Resources and Penn West Energy are both in the process of developing big oil sands reserves. But these projects are only in their early development stages; it’s going to be years before they’re liable for anything close to the proposed higher royalty rate. And if there’s a cut in royalties on mature fields, they and every other Alberta-based oil and gas producer will benefit immensely.

As I’ve said before, if the turbulence in energy producer trusts isn’t something you want to live with, you’re far better off in the Conservative Portfolio selections. These aren’t directly impacted by changes in oil and gas prices or Alberta royalties. All are backed by strong businesses, have conservative finances and are positioned to keep paying big distributions well beyond 2011.

If you can take the volatility and live with the uncertainty, the name of the game is patience. A recovery in natural gas prices is the key to a move higher.

The only guarantee you can make about government is it will raise taxes. But this plan as written isn’t going to come anywhere close to sinking good trusts. In fact, it could well make them very attractive as takeovers to the rest of the Canadian energy production industry, which has a lot more to lose here. Stick with them.

If you’re interested in reading the report, use the following link: http://www.albertaroyaltyreview.ca/panel/final_report.pdf.