Sweet Dividends from Sour Crude

03/17/2010 12:01 pm EST

Focus: GLOBAL

Gordon Pape

Editor and Publisher, The Income Investor and the Internet Wealth Builder

The Baytex Energy Trust has found a better and cheaper way to work the oil sands, writes Gordon Pape in The Income Investor.

Baytex Energy Trust (NYSE: BTE, Toronto: BTE.UN) [produces mostly] "heavy oil," which will comprise about 63% of the trust's projected 2010 output of 43,500 barrels of oil equivalent per day (boe/d). Heavy oil constitutes about 65% of the trust's reserves. 

A large part of this is located in the Seal area of the Peace River Oil Sands in northern Alberta. However, unlike most oil sands producers, Baytex does not mine bitumen. Rather, it pumps heavy oil directly from underground pools using horizontal drilling, without using such cost-intensive methods as steam injection. This makes Baytex a highly cost-efficient producer with an average estimated expense this year of C$9.57 a barrel.

The trust also has extensive holdings in Saskatchewan (about 47% of total reserves), as well as two small operations in British Columbia and some properties in Montana, North Dakota, and Wyoming. Baytex is headquartered in Calgary. 

Baytex qualifies as one of our "survivor trusts". At the recent Orlando World Money Show, chief financial officer Derek Aylesworth said during a presentation that the heavy oil trust will maintain its distribution of 18 Canadian cents a month (C$2.16 a year) "for the foreseeable future" after it converts to a corporation later this year. He said he expects the trust's effective tax rate after conversion will be in the 10% to 12% range, which will "have no effect on distributions".

To qualify as a survivor trust, we require a clear statement of management's intentions in the run-up to the implementation of Canada's new trust tax in 2011. Most trusts have indicated they will convert to corporations prior to that, and in many cases the conversion will coincide with a significant distribution cut. (This has already happened in several cases.) "Survivor trusts" are expected to maintain payouts at or near current levels, assuming business conditions do not seriously deteriorate.

We also look at the sustainability of the business, and Baytex passes that test as well. Mr. Aylesworth said that the trust spent 49% of its 2009 cash flow on exploration and development and for that investment it was able to replace 100% of last year's production. The trust's proved plus probable reserves increased each year from 2004 to 2008.
 
All energy trusts are at the mercy of international oil price movements. Baytex has another concern, which is that heavy oil is less desirable than light, sweet crude and therefore sells at a discounted price. However, the price gap has been closing.

Baytex offers a combination of good cash flow and capital gains potential. Enterprise value is about C$3.8 billion. (Shares closed at C$34.79 in Toronto Tuesday, for a yield of 6.2%—Editor.)

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