The Oil Drum: Canada | Income Trusts and the Canadian Energy Sector

52 comments on Income Trusts and the Canadian Energy Sector

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Sunlight on November 21, 2006 - 5:00pm

Last time I checked, the value of ALL financial assets is, the present discounted value of EXPECTED future cash flows. You don't buy stock for past earnings, but for future earnings. The fomula is: PV = cf1/(1+r1) + cf2/(1+r2) +...+ cfn/(1 +rn)

where PV = present value
cf1 = cash flow received in period 1
r1 = risk free interest rate (ie Tbill rate for example) in period 1

In case anyone thinks this is a just a theoreretical exercise, let me tell you what happened to a prominent Canadian energy trust when word of the retroactive taxation hit the wires. The Enerplus Resources Trust closed at $54.30 per share on October 31, the last pre-announcement day. Two days later on November 2 it closed at $39. Similarly the PennWest Energy Trust closed at $37.52 pre announcement and $29.80 on November 2. Slashing expected future returns slashes current value.

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Sunlight on November 21, 2006 - 5:27pm

While my point about slashing future value equals slashing current value still stands, I need to correct the formula quoted above.

PV = cf1/(1+r1) + cf2/(1+r2)*2 +...+ cfn/(1+rn)*n

where the double asterisks denote "raised to the power of." Thus the divisor of the second term to the right of the equal sign should read, (1+ r2), squared.

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JustZisGuy on November 22, 2006 - 12:01am

Slashing expected future returns slashes current value.

Yes, so? The same thing happens when the trust itself announces a cut in distributions. Is such an announcement "retroactive"? Of course not - it affects distributions in the future. The proposal to start taxing distributions in four years is also something that takes effect in the future.

Why is this concept so difficult to understand?

When you invest you accept a number of risks. I have been affected by the proposed changes to the tune of ... oh probably more money than anyone else who is whinging about it here. Yes, it's a bitch, but you can't say you weren't warned:

From Enerplus' March 7 2006 prospectus, page 2:

The actual amount distributed will depend on numerous factors including: the financial performance of the subsidiaries of the Fund, debt obligations,
commodity prices, production levels, working capital requirements, future capital requirements, applicable law and other factors beyond the control of the Fund.

(I added bold face to highlight critical words)

Or how about their 2005 annual report, page 86:

Government royalties, income tax laws, environmental laws and regulatory requirements can have a significant financial and operational impact on Enerplus. [..]
[..] In the January 2006 election, the Canadian Liberal government was replaced by a Conservative government. Both parties are on record as stating that they do not intend to change the tax treatment of trusts. Nevertheless, there is always a risk that the Canadian government may reconsider its position and propose changes to the tax regime that could negatively impact the Fund.

(I added bold face to highlight critical words)

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