Canadian Energy Trusts Seen as Risky by S&P
Canadian energy income funds, which have gained favor with investors with successful exploitation of oil and gas properties in mature basins -- many in the Western Canadian Sedimentary Basin -- received an overall low rating in a new report by Standard & Poor's Ratings Service (S&P) this week.
Of most concern to S&P are the swings in commodity prices and future high capital costs, which it said will threaten future distribution payments. Also, the ratings agency noted that the Canadian energy sector faces risks from the rapid depletion of resources, and trying to maintain production levels at mature basins will only be more expensive over time, putting even more pressure on the funds.
"Because of the commodity price volatility and the capital intensive nature of the business, in our assessment they are inherently more volatile than a great number of the other funds," said S&P analyst Michelle Dathorne. "We felt it was important to comment on that given the oil and gas subsector represents such a large component of the Canadian income fund universe."
The report focused on income funds in the exploration and production business, and it concluded that cash distribution payouts are at risk from the typical volatility in the oil and gas industry. "Moreover, the oil and gas income funds have had a history of fairly high payout ratios, which further exacerbates the risks associated with their distribution sustainability," the study found. High commodity prices in the past two years boosted the energy funds and helped them to meet spending, financing and distribution payment needs but "a fund's ability to meet these spending requirements would be severely strained in a less robust environment."
For instance, said S&P, if crude oil prices were between $18-$20/bbl and natural gas prices fell back to $2.50-$2.75/Mcf, the fund investors might see the "marginally positive break-even profile realized by these funds in 2002 and 2003...quickly become negative."
In a separate report in December, Lehman Brothers' analysts noted that some of the recent announcements by producers such as Murphy Oil and ChevronTexaco to sell western Canadian properties is "at least partially the result of the Canadian Royalty Trust sector's continued willingness to pay premium valuations" (see Daily GPI, Dec. 17, 2003).
Canada now has 32 energy income funds, with a combined market capitalization of C$28 billion ($22 billion) and combined, they had the largest portion of the total income trust market at the end of 2003. In all, the funds accounted for 34% of the overall C$83 billion market, S&P said.
S&P separated the funds into its two riskiest active categories, with stability ratings of SR-5 and SR-6 for some of the best known funds, including Enerplus Resource Fund, Pengrowth Energy Trust, ARC Energy Trust and PrimeWest Energy Trust. Only Canadian Oil Sands Trust received a better rating at SR-4 ranking with a positive outlook. The lowest S&P level is SR-7, which is reserved for companies that suspend distributions.
"What that says is there is a large degree of volatility inherent in the expected cash flows and very little sustainability of the distribution streams," Dathorne said.