Revisit your energy trusts

If you own any shares in oil and gas trusts, you may want to take a fresh look at them.

It’s true that on the surface, everything looks rosy. Oil and natural gas prices remain high, with no obvious reason for a pull-back in sight. In fact, with the North American economy finally starting to generate some momentum, winter closing in, and the prospects for a significant increase in Iraqi oil exports any time soon looking grim, we could see continued price strengthening in the coming months.

But the rapid rise of the loonie is causing headaches for Canadian energy trusts and corporations by eroding their bottom lines. Since gas and oil are priced in U.S. currency, every upward tick in our dollar means that they are earning less for each barrel of oil equivalent they produce.

In the case of energy-based income trusts, that translates into a reduction in unitholder distributions. For example, Freehold Royalty Trust (TSX:  FRU.UN) stated in its second quarter report that every 1¢ increase in the value of the loonie translates into a reduction of 3¢ in payments. Pengrowth Energy Trust says the effect on its distributions is about the same.&l;/>

With the Canadian dollar up more than 13¢ against the greenback this year, that implies a 39¢ reduction in payouts. To put that in perspective, Freehold’s regular monthly distribution is currently set at 10¢ per unit. Had the loonie remained around US63¢, Freehold’s directors might have been in a position to increase that by 30 per cent or more.

The strong loonie creates other problems as well. Reduced income and high production costs squeeze the margins of oil sands producers, such as Canadian Oil Sands Trust (TSX:COS.UN) . There has been speculation recently that currency exchange rates will have a greater impact on new oil sands investment than the Kyoto Protocol. As well, the in-ground assets of energy corporations and trusts will be devalued to reflect the decline of the U.S. dollar. That could affect future borrowing.

Some energy trusts face yet another problem. Many of them are not actively involved in the exploration and development of new properties. That means they must replenish depleting assets by acquisition, or see their reserves eventually run dry. Pengrowth (TSX:PGF.UN)  is an example of this kind of trust; it has relied on a series of ever-larger and more expensive deals to build its oil and gas reserves. So far, these have worked out well but some industry observers wonder how much longer the trust will be able to acquire properties at prices that are accretive to unitholders.

Among the trusts that actively carry out their own exploration and development, Peyto Energy Trust (TSX:PEY.UN) stands out. Investors have twigged to that and have been aggressively bidding up the price recently. Since Sept. 15, the stock has risen 20 per cent. 

All of this suggests that investors should take a fresh look at their energy holdings, especially in the income trust sector, and decide whether they want to retain their positions or take some profits.

However, if the shares are in a non-registered portfolio don’t lose sight of the tax consequences when making a decision. If you’ve owned them for some time and received large tax-deferred distributions, your adjusted cost base (ACB) for tax purposes could be very low at this point. Your ACB (not your original purchase price) will be deducted from the net proceeds from a sale to determine your capital gain for tax purposes. Unless you have some losses to offset your gain, you could end up with an unexpectedly high tax bill.