The era of the dominance of the Canadian energy trusts is drawing to a close just as a similar E&P regime in the U.S. gets under way. The Canadian government is ending tax breaks on trusts.

The news from north of the border has been bad for U.S. and other investors in the trusts-they've seen their unit values fall up to 20% since the new tax plan was announced November 1.

However, it may be a boon to the new U.S. upstream master limited partnerships (MLPs) that have gone public this year and those that are on the drawing board. Money that had chased the tax-free Canadian trusts' distributions may turn its attention now to these U.S. platforms instead.

Publicly traded U.S. E&P MLPs are Linn Energy, EV Energy Partners and BreitBurn Energy Partners. (For more details on the lattermost, see "The BreitBurn Model" in this issue.) In the drafting room are MLPs sponsored by Constellation Energy and Exco Resources.

Dan Pickering of Houston-based energy investment-banker Pickering Energy Partners Inc., says the proposed new tax law would change the effective tax rate U.S. investors see on their Canadian trust dividends from 15% to some 40%, and "a number of royalty trusts have significant U.S. ownership...

"Do investors looking for yield gravitate to MLP structured companies?"

George Gosbee, chairman, president and chief executive of Calgary-based energy investment-banking firm Tristone Capital Inc., says the new tax law will likely be adopted. He adds that it could have the effect of encouraging non-Canadian companies to rebuild E&P asset ownership in Canada. (For more on this, see "NewsWell" in this issue.)

Asset prices in Canada are expected to soften now as the trusts' access to lower-cost capital dissolves. This means U.S. producers can compete for assets in the region again.

It also means the Canadian juniors won't have the fat-pocketed trust buyers of their asset packages that they have been developing and flipping. Some juniors may leave the scene entirely, or keep their portfolios, expand, merge amongst themselves and begin forming larger, traditional E&P companies again. These larger producers will be good acquisition fodder for U.S. producers looking to return to the basin.

The upheaval may also result in the release of some drilling rigs, as the trusts reduce their capex plans, and the Canadian juniors are forced to reduce their own.

From this, U.S. producers may also benefit, in the way of newly propped-up natural gas prices. Canadian gas exports to the U.S. have been struggling to stay flat. Reduced capex in the region will certainly result in a decline. (For more on this, see "Canadian Gas Supply," Oil and Gas Investor, November 2006.)

"We haven't cut our rig forecasts for Canada in 2007...but we probably will," Pickering says. "...Some simple math: If we assume trusts are directly and indirectly responsible for 25% of Canadian activity, and we assume that they slow drilling by 33% to 50%, then Canadian activity probably gets 8% to 12% softer just on the paralysis associated with the changing tax structure."

Meanwhile, the news does reduce the market value of Canadian assets currently held by U.S. producers, such as Devon Energy Corp., Quicksilver Resources, Pogo Producing and Pioneer Natural Resources. Getting out of Canada just under the wire was Anadarko Petroleum Corp., which sold most of its Canadian assets last month to Canadian Natural Resources for US$16.18 per proved barrel of oil equivalent. It also swapped its Arctic frontier assets with Chevron Corp. for deepwater Gulf of Mexico interests. (For more on this, see "Company Briefs" in this issue.)

The trusts are expected to begin merging, dissolving and reforming into traditional E&P companies; some may relocate to the U.S. or to the Bahamas. Andrew Fairbanks, an analyst with Merrill Lynch, has tagged all the Canadian energy trusts he covers with Sell since the Canadian government's news.

Now in play, the trusts are up for grabs by traditional U.S. and Canadian producers. "Where does one hide? Nowhere," says Richard Roy, an analyst with Citigroup. "This is a very complex issue and we believe the entire sector will be down; no exceptions."

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