An Unconventional Way to Play

Trinidad Drilling (TSX: TDG, OTC: TDGCF) wasted little time putting part of the USD54 million from its sale of a barge rig project in Indonesia to good purpose, inking a deal with two unnamed parties for the construction of seven more drilling rigs for use in Louisiana’s Haynesville Shale, an unconventional natural gas play that’s shaping up as one of the key such resources in the US.  

Trinidad announced in May that it had contracted with “two major North American oil and gas exploration and production companies” for nine drilling rigs. Both programs are backed by long-term, take-or-pay contracts, meaning Trinidad’s utilization rates for the rigs are guaranteed to be 100 percent for the duration of the respective contracts.

Trinidad’s capital needs made conversion from an income trust to a traditional corporate format the most tax-efficient road to growth, a path it chose in January. The company scaled back its distribution and switched to a quarterly, rather than monthly, payment. It’s used its newfound flexibility to rapidly expand its onshore drilling activity in the US, a goal executives pointed to during the conversion process; moving a greater share of its operations south reduces its vulnerability to Canada’s weather-driven seasonality, and unconventional gas drilling has taken off in the US with the exploitation of resources in Texas and the Rocky Mountain States.

Trinidad initially expanded into the Barnett Shale in Texas in 2005, taking advantage of rising demand for rigs capable of executing more challenging projects. Unconventional plays such as Barnett and Haynesville require greater technological sophistication and capital investment to extract natural gas, but they’re also characterized by low geologic risk.

The recent announcements represent a collective acknowledgment that Trinidad is capable of the engineered solutions, design innovations and technology improvements on fit-for-purpose land rigs that will facilitate economies of scale and repeatability to produce declining well costs.  

Unconventional natural gas makes up more than 40 percent of US production, and that share should continue to rise into the foreseeable future. And the Haynesville Shale could be among the largest North American shale plays, based on preliminary estimates. Chesapeake Energy (NYSE: CHK), the third-largest natural gas producer in the US, said it “could potentially have a larger impact on the company than any other play in which it has participated.” In March, Chesapeake announced plans to develop its 300,000 acres in the Haynesville Shale and expects to pick up another 200,000 acres in the future.

The “explosive upside” way to play unconventional resource opportunities is through the producers; our colleague Elliott Gue, editor of The Energy Strategist, offers comprehensive coverage of the companies exploiting Haynesville, as well as Texas’ Barnett and others. Click here for Elliott’s discussion, in The Energy Letter, of the critical shift that’s led to increased onshore drilling activity.

Trinidad, on the other hand, represents a less commodity-sensitive opportunity; now paying a 60 cents Canadian per share annualized dividend, it’s yielding about 4.5 percent. It’s a sustainable growth proposition comparable to the way we suggest gaining exposure to another unconventional play.

Canadian Oil Sands Trust (TSX: COS.UN, OTC: COSWF), the publicly traded vehicle for the Syncrude partnership, has enjoyed a tremendous run along with the per-barrel price of oil in 2008. The oil sands are now an established part of the energy equation, and production in Alberta is critical to meeting rising global demand.    

Pembina Pipeline Income Fund (TSX: PIF.UN, OTC: PMBIF) holds the exclusive franchise on transportation for the Syncrude venture, a partnership between major oil companies on both sides of the border and operated by ExxonMobil’s Canadian unit.

Pembina’s profits don’t depend on oil prices or even Syncrude’s overall output for a given quarter or year. Rather, they grow as Syncrude’s output does over time, as the venture requires additional pipeline and transport capacity. Fees are earned based on capacity purchases.

Its focus on long-term contracts, US expansion and deep drilling make Trinidad a similar opportunity, proven by its ability to survive its sector’s two-year stress test. Its corporate status puts it in solid position to capitalize on improving industry conditions, and its new deals suggest it’s executing.

Rare Company Indeed

The Bank of Canada (BoC) followed up last Tuesday’s interest-rate announcement with the release Thursday of its quarterly Monetary Policy Report. The report largely tracked the language of the statement accompanying its interest-rate statement.

The BoC said “available evidence” indicates the Canadian economy has bounced back from a first quarter dip and grew at an annualized rate of 0.8 percent in the second quarter. And it says the economy will recover further, growing at a rate of 1.3 percent in the current quarter, 1.8 percent in the fourth and 2.8 percent in the first half of 2009.

During a press conference following release of the report, BoC Gov. Mark Carney pointed out a critical distinction we’ve emphasized many times: Unlike most industrialized countries, Canada benefits from rising oil and natural gas prices, and this effect isn’t confined to Alberta and other producing provinces.

“There are a variety of industries that feed into the energy industry, including manufacturing industries in Ontario and other areas of Central Canada; there are wealth effects in portfolios; there are wage effects for secondary and tertiary industries spread across the country,” he said.

This money adds strength to other sectors, including construction and services in Central Canada, he added: “And that puts us, in the industrialized countries, in very rare company.”

Speaking Engagements

“The coldest winter I ever spent was a summer in San Francisco,” a saying that’s almost a San Francisco cliche, turns out to be an invention of unknown origin, the coolest thing Mark Twain never said.

The natural setting is, however, among the most exciting in the US. Venture west for the San Francisco Money Show Aug. 7-10, 2008, and conduct your own field study.

Neil George, Elliott Gue and I will discuss infrastructure, partnerships, utilities, resources and energy, and tell you what to buy and what to sell in 2008.

Click here or call 800-970-4355 and refer to priority code 011362 to attend as our guest.

I also have a special invitation for readers to join me and my colleagues Elliott Gue, Gregg Early and Neil George aboard an exciting 11-day investment cruise Dec. 1-12 through the Caribbean and Panama Canal.

This will be a unique opportunity to step away from your daily routines, relax in one of the most beautiful parts of the world and share analysts’ knowledge and passion for the markets. During the sail, you’ll not only explore the cerulean splendor of the Caribbean, but you’ll also delve deep into current markets in search of the most profitable opportunities for your portfolios. You’ll also have the rare chance to sail through one of the world’s engineering marvels, the Panama Canal.

It’s always a special treat to meet and talk with subscribers in person, and we couldn’t have picked a better setting than aboard the six-star Crystal Serenity. This is sure to be an especially memorable experience. We hope you’ll join us.

For more information, please call 877-238-1270.

The Roundup

Here are second quarter earnings reporting dates for CE Portfolio recommendations.

Conservative Portfolio

Algonquin Power Income Fund (TSX: APF.UN, OTC: AGQNF) Aug. 14

AltaGas Income Trust (TSX: ALA.UN, OTC: ATGFF) Aug. 8

Artis REIT (TSX: AX.UN, OTC: ARESF) Aug. 13

Atlantic Power Corp (TSX: ATP.UN, OTC: ATPWF) Aug. 13

Bell Aliant Regional Communications Income Fund (TSX: BA.UN, OTC: BLIAF) Aug. 5

Canadian Apartment Properties REIT (TSX: CAR.UN, OTC: CDPYF) Aug. 13

Energy Savings Income Fund (TSX: SIF.UN, OTC: ESIUF) Aug. 8

GMP Capital Trust (TSX: GMP.UN, OTC: GMCPF) Aug. 7

Keyera Facilities (TSX: KEY.UN, OTC: KEYUF) Aug. 8

Macquarie Power & Infrastructure Income Fund (TSX: MPT.UN, OTC: MCQPF) Aug. 8

Northern Property REIT (TSX: NPR.UN, OTC: NPRUF) Aug. 7

Pembina Pipeline Income Fund (TSX: PIF.UN, OTC: PMBIF) Aug. 1

RioCan REIT (TSX: REI.UN, OTC: ROICF) July 28

TransForce (TSX: TFI, OTC: TFIFF) Aug. 8

Yellow Pages Income Fund (TSX: YLO.UN, OTC: YLWPF) Aug. 8

Aggressive Portfolio

Advantage Energy Income Fund (NYSE: AAV, TSX: AVN.UN) Aug. 14

Ag Growth Income Fund (TSX: AFN.UN, OTC: AGGRF) Aug. 8

ARC Energy Trust (TSX: AET.UN, OTC: AETUF) Aug. 1

Arctic Glacier Income Fund (TSX: AG.UN, OTC: AGUNF) Aug. 14

Boralex Power Income Fund (TSX: BPT.UN, OTC: BLXJF) Aug. 4

Daylight Resources Trust (TSX: DAY.UN, OTC: DAYYF) Aug. 7

Enerplus Resources (NYSE: ERF, TSX: ERF.UN) Aug. 1

Newalta Income Fund (TSX: NAL.UN, OTC: NALUF) Aug. 8

Paramount Energy Trust (TSX: PMT.UN, OTC: PMGYF) Aug. 8

Penn West Energy Trust (NYSE: PWE, TSX: PWT.UN) Aug. 7

Peyto Energy Trust (TSX: PEY.UN, OTC: PEYUF) Aug. 28

Provident Energy Trust (NYSE: PVX, TSX: PVE.UN) Aug. 8

Trinidad Drilling (TSX: TDG, OTC: TDGCF) Aug. 7

Vermilion Energy Trust (TSX: VET.UN, OTC: VETMF) Aug. 7

Oil and Gas

Daylight Resources Trust (TSX: DAY.UN, OTC: DAYYF) declined to raise its offer for Cadence Energy (TSX: CDS, OTC: CDSFF), clearing the way for Barrick Gold (NYSE: ABX, TSX: ABX) to snap up an asset it hopes will reduce its exposure to rising energy costs at its operations around the world. Cadence will pay Daylight a CAD9 million breakup fee in accordance with the earlier agreement between the companies.

Matching Barrick’s CAD410 million bid for Cadence would have strained Daylight’s cash position and diluted existing investors. Daylight still has ample development opportunities, despite the short-term setback of not being able to consolidate ownership of the Sturgeon Lake South Leduc oil field in northwestern Alberta. It’s likely to focus on its Peace River Arch and West Central Alberta assets. Daylight Resources Trust is a buy up to USD12.  

Business Trusts

Somerset Entertainment Income Fund (TSX: SOM.UN, OTC: SOEIF) has agreed to a buyout by Fluid Music Canada (TSX: FMN) for CAD4 per unit. Based on the number of units outstanding, the total purchase price would be approximately CAD71.25 million. The proposed offer price would be payable in cash and/or common shares of Fluid.

Holders of Somerset units may elect to receive all or part of their consideration in cash or Fluid common shares or a combination of both. Somerset has agreed to negotiate exclusively with Fluid until Sept. 10, 2008. Hold Somerset Entertainment Income Fund.

Financial Services

Bank of Nova Scotia (NYSE: BNS, TSX: BNS) last week agreed to pay CAD442 million for E*Trade Financial Corp’s Canadian unit. Scotiabank will gain control of E*Trade’s CAD4.7 billion in Canadian assets and 125,000 active accounts.

Chris Hodgson, Scotiabank’s head of domestic banking, said the acquisition will add 2 cents Canadian to Scotiabank’s earnings per share by 2011, an estimate that doesn’t include new revenue that may come from selling bank products and services to E*Trade customers. Bank of Nova Scotia is a buy up to USD58.

Food & Hospitality

Priszm Income Fund (TSX: QSR.UN, OTC: PSZMF), which runs 465 KFC, Taco Bell and Pizza Hut outlets in Canada, announced a 50 percent distribution cut Monday. The company plans to use the cash freed up by the cut to buy back units and invest in high-growth areas.

Priszm’s board approved a 5-cents-Canadian-per-unit distribution for July, down from 10 cents Canadian per unit in June. Priszm earned a second quarter (ended June 15) net profit of CAD2.8 million (18 cents Canadian per unit), rebounding from a CAD1.9 million (12 cents Canadian per unit) loss during the same period of 2007. Hold Priszm Income Fund.