Canadian Energy Trusts
A Introduction to Canadian Energy Trust Funds

Also see
Canadian Energy Trusts
Canadian Energy Trust List
Canadian Income Trusts
Canadian Royalty Trusts
Canadian Oil Trusts

In a Canadian energy trust, the underlying asset is acquired by the operating company, typically using a combination of third party debt and funds received from the Canadian energy trust (through equity offerings and/or its own third party debt), in exchange for the grant of royalties, debt and shares. Net operating cash flow, generated from the sale of crude oil, natural gas and NGLs produced and other services provided, is passed on to the Canadian energy trust as distributable cash flow through a combination of payments under the royalties, interest and principal on the debt and dividends or capital repayment under the shares.

Distributable cash flow is available to unit holders, net of operating expenses, general and administrative expenses, capital expenditures, debt service and management fees. As Canadian energy trusts tend to have little or no taxable income at the corporate level, distributions paid from the trust structure tend to be higher than dividends received from comparable common equities.

Canadian energy trusts do not have high retained earnings, as a substantial majority of operating cash flow is paid to unit holders. Therefore, a credit facility is established in order to fund, among other things, future acquisitions and development programs. To pay down debt, equity offerings are made periodically, having regard to the debt position from time to time and prevailing market conditions.

Typically, the assets that are suitable for Canadian energy trusts are mature, low exploration-risk properties and toll-based energy infrastructure with predictable operational profiles and minimal or low capital expenditure requirements. In the case of oil and gas properties, drilling tends to be in-fill or other relatively low-risk projects, generally resulting in higher drilling success rates than those experienced by conventional exploration and production companies.

Different from U.S.-based royalty trusts (which are legally precluded from making acquisitions financed by new debt and/or equity and, therefore, cannot as readily replace depleted reserves), Canadian energy trusts have managed, during certain extended periods, to actually increase per trust unit production, discounted cash flow value and distributions, in addition to maintaining reasonable monthly or quarterly distributions on the trust units. The ability to acquire assets and finance them with new equity, combined with a tax-efficient structure, leads to a financial vehicle that is radically different from its U.S. counterpart.

Whereas the substantial component of U.S. royalty trust assets are actually overriding royalty interests, the vast majority of Canadian energy trust assets are operated and non-operated working interests. In this sense, Canadian energy trusts are more similar to conventional oil and gas production companies (albeit with no higher-risk exploration activities) than U.S. royalty trusts, which in many instances can be more accurately characterized as financially structured derivative instruments to oil and gas assets.

Canadian energy trusts appear to offer a somewhat higher yield than their U.S. counterparts, which may, in part, reflect the overriding royalty nature of the U.S. royalty trusts’ cash flows (and, therefore, lower operating leverage and capital requirements). The U.S. royalty trusts typically have no debt, reflecting the blow-down character of their assets and operations and the absence of acquisition activity. Meanwhile, Canadian energy trusts do carry some debt, reflecting previous acquisition activity and development capital, which are typically funded, in whole or in part, with debt.

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