Canadian Energy Trusts Look Cheap

Posted 12 Dec 2008

The deflationary credit contraction has significantly strengthened over the past year and most analysts are beginning to accept the condition.  Holders of capital are seeking safety and liquidity for their capital.  Many have been selling most of their assets.  Particularly oversold appears to be the Canadian royalty trusts particularly in the oil and gas sector.

The implications of Peak Oil Theory are staggering.  Oil is extremely important for the United States economy and the need to access cheap and reliable imported oil is even more vital.  Foreign dependence makes domestic consumption of about 21 million bbl/day compared to about 7.5 million bbl/day particularly disturbing.

 Due to fixed costs in infrastructure these ratios are unlikely to decline.  There are many ways to play the oil and natural gas sector ranging from the oil majors like (XOM, COP, CVX, BP, TOT, etc.) to refineries like (TSO, VLO, etc.) to VLCCs like (FRO) and canadian oil and natural gas royalty trusts like (HTE, PVX, PGH, ERF, etc.)

Gold is a currency.  Commodities are produced because they add value to society.  Oil is the lifeblood of the modern worldwide economy and is integral in all aspects from food to aerospace.  The value gold adds to society is in performing mental value calculations.  The historic gold to oil ratio is incredibly consistent.

 Currently oil appears to be extremely cheap when priced in gold.  Additionally, almost everyone agrees the Federal Reserve Note rally is fundamentally unsound as it is tremendously encumbered.

As the deflationary vortex has strengthened the price of Canadian oil and gas royalty trusts have plummeted.  For example, over the past year HTE has fallen from about US$20 to US$8 or the price of a silver coin.

 It appears that market may be pricing in systemic collapse complete with breakdowns in food distribution accompanied with riots.  Assuming that is not the case the current prices have resulted in many outstanding bargains in my opinion.

Harvest Energy Trust (HTE) was founded in 2002 and headquartered in Calgary, Canada.  Harvest engages in exploration, development and maintenance of petroleum and natural gas properties along with a gasoline refinery.  Harvest currently has 154.5 million shares outstanding as of December 31, 2007 it had a net total proved plus probable reserves of approximately 192,297 million barrels of oil equivalent.  

Harvest pays a monthly distribution of C$.30 and has a payout ratio of 66% of cash flows.  This is extremely low for them historically.  To some extent the cash flows are protected and hedged through an extensive program with the intent to provide stability to the monthly distribution.

The North Atlantic refinery appears to have been an albatross around the income statement.  The Canadian dollar has significantly weakened against the Federal Reserve Note Dollar.  Oil and natural gas prices have significantly fallen over the last several months.  Proposed Canadian tax laws have been clarified and enacted.  Harvest is extremely well positioned with over $3B in 'tax pools' to draw upon to shield income.

The Canadian oil and natural gas royalty trusts were originally designed and intended as retirement vehicles.  The goal of Harvest management is to create long-term shareholder value.  Harvest currently has more than one barrel of oil per share with a payout ratio significantly below 100%.  Oil is and will remain a large component of the worldwide economy.  The oil price appears extremely cheap when priced in gold.

 The Federal Reserve Note Dollar's fundamentals are abysmal and according to GATA's contentions it is extremely overvalued relative to gold.  Therefore, it appears that the discounted future cash flows from Harvest when priced in gold are beginning to look like an attractive place to allocate capital for a few years.  For example, should the Federal Reserve Note Dollar collapse then tangible assets are owned so one's capital is preserved.

These are some key ratios for determining value calculation. Worst case scenario oil prices continue to fall and the Federal Note Dollar continues to strengthen which will weaken Harvest's extremely attractive yield from the current approximately 30% (depends on your tax situation).  

Long term put options can easily be purchased to preserve capital investment. The cash flow makes it more stable than the VLCCs and refineries and the North American production makes it safer than the oil majors.

For these reasons Harvest appears to be fairly cheap and a good opportunity.

Disclosure:  Long physical gold and long HTE.  No other positions in corporations mentioned.

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