Much as our “great deliberative body,” the US Senate, often falls down trying to measure up to its idealized self-image, Canada’s Senate came ever-so-close to throwing off tradition and, many would say, propriety, in threatening a federal budget ratified by the elected representatives of the Commons.

But the Liberals and Tories apparently put together a backroom deal to ease passage of the federal budget (the “quid”) along with eight other bills, including private member’s bill that requires the government to implement the Kyoto protocol (the “quo”). Another bill passed will establish fixed election dates. The next federal election, unless a no-confidence vote brings down the Conservative minority, will be in October 2009.

Sen. George Baker, a Liberal representing Newfoundland and Labrador, opposed the budget on the government’s alleged breach of the Atlantic Accords signed between the former Liberal government and the provinces of Nova Scotia and Newfoundland. The budget introduces a new equalization formula that the Atlantic Provinces can’t enter into in addition to the Atlantic Accords. The accords, signed in 2005, guaranteed Newfoundland and Nova Scotia 100 percent of their offshore natural resource revenues, which are included in the new equalization formula.

Sen. Baker’s budget amendment was said to have brought the Senate close to a constitutional crisis. The Senate doesn’t have the standing to amend a government money bill, which would send the legislation back to the House of Commons. Approval of both Houses is necessary to pass legislation, but the Senate rarely rejects bills passed by the directly elected Commons. And the government is responsible solely to the House of Commons; the prime minister and cabinet stay in office only as long as he or she retains the support of the lower house.

The Senate doesn’t exercise any such control. Legislation can normally be introduced in either house, the majority of government bills originate in the House of Commons. Under the constitution, money bills must always originate in the lower house.

The Budget Implementation Bill passed by a 45-21 vote after proposed amendments were rejected.

The budget divided Conservatives in Nova Scotia as well as Newfoundland and Labrador. Tory governments in both provinces opposed the spending plan, which forces them to surrender offshore oil and gas rights in return for richer equalization.

Saskatchewan has already said it would sue the federal government for breaking its campaign promise to exclude natural resource revenues from the equalization formula, and Newfoundland and Nova Scotia may well follow.

The Kyoto bill could also form the foundation of some interesting litigation. The Tories have argued that the bill is unconstitutional because it forces government spending, although the Speaker of the House of Commons has said it doesn’t. Experts from Canada’s Justice Dept have warned the Kyoto bill could open the door for individuals to sue the federal government if it ignores the legislation.

The private member’s bill was drafted to force the government to release a plan to reduce greenhouse gas pollution, as required under Kyoto, within 60 days of the law coming into effect, and to issue new regulations for industries within six months.

Environment Minister John Baird has maintained that the government plans to stick with its own plan to fight climate change and air pollution. Although Canada is required to meet its Kyoto target of reducing greenhouse gas pollution by 6 percent below 1990 levels between 2008 and 2012, the government’s new plan pledges to meet that target after 2020.

Fair Thee Well

The Tax Fairness Plan, Finance Minister Jim Flaherty’s levy on income trust distributions at the entity level, now has the force of law. The new tax–devised without consultation, announced without warning–threw Canada’s financial markets into upheaval and harmed plenty of US-based investors as well, though prices of most trusts have since recovered sharply. The law could still be softened by a new Liberal-led government, though we’re proceeding strategically as if it won’t be.    

Some income and royalty trusts that have strong earnings growth potential have stated they see no need to alter their organizational structure to account for the pending tax. Enerplus Resources (ERF.UN, NYSE: ERF) and Advantage Energy Income Fund (AVN.UN, NYSE: AAV), among others, have significant tax pools that will defray any potential tax on distributions well beyond 2011.

Following the enactment of Bill C-52, the budget implementation legislation, Enerplus released a statement renewing its commitment to yield-based model. We had reported on a conversation we had with senior members of Enerplus’ management and investor relations teams where the trust’s intent was made clear, but here it is in Enerplus’ own words:

We intend to continue our yield-oriented distribution model given our belief that investor demographics, the demand for yield product and our asset base will continue to support such a model with a premium valuation;

We intend to continue our existing focus on lower risk energy production, long life and low decline assets, and large scalable resource plays as we believe this approach is consistent with a successful oil and gas business and a yield-oriented model;

We intend to continue our disciplined acquisition strategy as the normal growth parameters outlined in the legislation and the strength of our balance sheet support active involvement in the M&A market in the U.S., Canada, and potentially internationally;

We see significant value in the four-year tax exemption period and would be hesitant to make major changes to our structure during this period without compelling reasons to do otherwise that we do not currently foresee; and

We estimate that as of December 2006, we had tax pools of approximately $1.9 billion.

We expect to maximize the preservation of and possibly build those pools in the next four years in order to maximize the tax shelter available post-2010.

It’s easy to forget about or play down the relative advantage accruing to well-run trusts based on the tax window. In an investing world where yield is king, the shares in businesses that emphasize paying their shareholders have tremendous upside potential. 
 
Many trusts have gone private, with the assistance of private-equity financing, or have been acquired by strategic industry players.

CCS Income Trust (CCR.UN, CCRUF) is the latest to announce a deal. The Calgary, Alberta-based oilfield waste management services outfit agreed to be bought by a management-led group for about CD3.5 billion. Unitholders will receive CD46 per trust unit; founder and CEO David Werklund will get CD45.50 for each unit he sells. The price represents a 21 percent premium on the closing value of CCS units the day before the announcement. The Werklund-led investor group includes CAI Capital Partners, Goldman Sachs Capital Partners, Kelso & Co, Vestar Capital Partners, British Columbia Investment Management Corp and OSS Capital Management LP. The deal is expected to close during the fourth quarter.   

Werklund downplayed the role of the pending tax as a motivating factor; this is as much a strategic move to enable the privateers to leverage CCS’s dominant Canadian position into a bigger US presence.

As part of its strategy to build the world’s leading logistics service for frozen food, Iceland-based Eimskip Holdings has ventured into Canada to snap up Versacold Income Fund (ICE.UN, VCLDF) and Atlas Cold Storage Income Trust. The two deals have made it the largest frozen foods handler in the world. Eimskip is now looking to expand into the US.

Others have merged within the same industry in order to bulk up and realize synergies. PrimeWest Energy Trust (PWI.UN, NYSE: PWI) agreed to acquire Shiningbank Energy Income Fund (SHN.UN, SBKEF) in a share exchange. The two trusts will operate as a single trust under the PrimeWest name. Both sets of managers and directors will still be involved.

PrimeWest and Shiningbank say combining will cut the cost of raising capital, boost liquidity for unitholders and lower oil and gas development costs. The new PrimeWest will have proven and probable reserves of about 280 million barrels of oil equivalent and would have produced about 66,000 barrels of oil equivalent a day during the first quarter. Based on those numbers, it would be the fifth-largest income trust.

The deal is as much about natural gas prices as it is about the new tax. Output for the combined trust will be weighted approximately 70 percent to natural gas and 30 percent to crude oil.

The merged company would extend PrimeWest’s current reserve life to 11.5 years from 9.8 years. About 4,000 barrels of oil equivalent per day produced from noncore properties will probably be sold after the deal closes. PrimeWest intends to boost its distribution 3.3 percent.
 
One avenue pursued by by virtually no one is to convert to a conventional corporate structure during or just after the four-year transition period. True Energy Trust (TUI.UN, TUIJF) tried to convert into a traditional corporation, but unitholders rejected the proposal.

And here’s an intriguing possibility, which is discussed further in this month’s Feature Article: Many oil and gas trusts have operations in the US, assets that would look pretty good wrapped in a publicly traded partnership package. Provident Energy Trust (PVE.UN, NYSE: PVX) is the only Canadian oil and gas company to have issued master limited partnership (MLP) units south of the border. Provident converted its US assets into MLP units in September 2006 as BreitBurn Energy Partners, prior to Ottawa’s announcement of the income trust changes.

Harvest Energy Trust (PVE.UN, NYSE: PVX) is more vocal about the prospect. Most Canadian energy trusts get their entire cash flow from oil and gas production, but 40 percent of Harvest’s cash flow comes from its US refinery.

Yet another possibility is to convert an existing trust to a new structure whereby investors would directly hold both an equity and a debt security in the underlying business rather than holding trust units. TimberWest Forest Corp (TWF.UN, TWTUF) and Atlantic Power Corp (ATP.UN, ATPWF) trade publicly as so-called stapled shares.

This structure could largely replicate the economic benefits of an income trust. However, it’s unclear whether the government would seek to apply the anti-avoidance rules announced as part of the proposals to eliminate the effectiveness of these structures.