A Matter of Trust:
The Rise and Fall of Energy Trusts - Part 1

Article by Franklin Foster, Ph.D.
[note: this article made possible by support and funding from the Petroleum Society of CIM, Lloydminster Section]

On October 31, 2006, the Government of Canada, fully in the Halloween spirit, issued an announcement that scared a lot of investors in energy trusts.  As illustrated in the graph below, market capitalization dropped by more than $20 billion [figures on left axis are billions of dollars].  What happened? Why? and So What?

Graph courtesy of Harvest Operations Corp. 

 Energy Trusts were simply one segment of Income Trusts, an investment vehicle that appeared in a small way back in the 1980's.  An Income Trust pays a percentage of cash flow to unitholders as a distribution.  These payouts are taxed in the hands of the unitholders rather than at the corporate level.  In the early days, distributions were as much as 100% (or even more) of cash flow.  However, in recent years, the distribution was commonly around 60% with the remainder being reinvested in the asset base of the Trust, commonly by acquiring more assets (which in turn could generate more cash flow and thus increase the distribution to the unitholders).

As Trusts acquired more assets, they evolved from being small niche investment opportunities, toward being larger players in the petroleum industry.  Trusts were an attractive investment vehicle and companies moved toward them to raise capital to fuel growth and development.  This phenomenon is clearly represented in the graph below.  The numbers on the left represent thousands of barrels of production per day, while the numbers on the right represent the percentage of western Canadian production accounted for by Energy Trusts.

Graph courtesy of Harvest Operations Corp.