A Matter of Trust:
The Rise and Fall of Energy Trusts - Part 2

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

continued from page 1

 At their peak, just before the Government's announcement, assets owned by energy trusts produced over one million barrels of petroleum per day in Western Canada.  This represented more than 20% of total Western Canadian production.   Trusts employed thousands of Canadians, and directly paid substantial royalties and taxes, plus indirectly generated personal tax on unitholder distributions.  It was thought that energy trusts represented an economically vibrant sector that was important to government revenue and the overall economy.

 However, the October 31, 2006 Government announcement said that Energy Trusts would now be subject to an additional tax of 31.5% at the corporate level.  Any new trusts would be taxed immediately, while existing trusts would be taxed as of 2011, provided they did not exceed "normal growth".  The phased in period was largely overlooked by the public and the media and the energy trust sector saw a $20 billion decline in four days. 

 Upon reflection, the announcement generated some further interesting points.  One concerned the apparent objective of the government to collect more tax.  Some pointed out that large corporations employ tax experts who can often find ways of minimizing taxes.  [For example, the trust might acquire an asset with offsetting tax losses.]  Individual unitholders, however, are often individuals who are not adept at mining the tax act for shelters.  By shifting the burden of tax paying to corporations, the Government seemed to set up a scenario where tax returns would be less than previously.

 Another argument the Government used was that income trusts had come to represent significant leakage of taxable income to foreign nationals.  This was probably a valid point as it is difficult to recover tax from such individuals. However, energy trusts, especially at their current devalued levels, are prime targets for takeover by foreign controlled corporations.  Once this happens, the energy trusts, with their enormous capital assets, are even more problematic taxpayers to the Canadian Government.

 The Government announcement resulted in drastically lower equity valuation of trusts; reduced ability for some trusts to access the capital markets; increased concern by companies about the reliability of Government policy; and a reduced confidence in capital spending in Western Canada by both trusts and non-trusts. Significant restructuring within the energy industry can be expected.  Larger corporations are likely to be the best survivors.  Smaller, and recent start-up trusts, will likely not survive.  As discussed above, the percentage of foreign ownership will likely increase.  Overall the result for Canada appears significantly negative.

 A consortium of stakeholders is still attempting to educate Government officials on the negative implications of their Halloween scare.  Only the most optimistic believe the Government can be convinced to take off their threatening tax collector mask and replace it with a face that would be more beneficial for Canada in its pursuit of energy sustainability.