"Trusty" Energy Plays

06/30/2006 12:00 am EST

Focus:

Gordon Pape

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

"High oil prices are here to stay," says Gordon Pape, editor of The Internet Wealth Report. "There will be ups and downs, but the days of $12 a barrel oil seen in 1998, are gone forever." Here’s his outlook and some favorite energy plays.

"Although a recession might push the price as low as the US$45 range, it’s hard to imagine it going beyond that. And while big profits have been made in energy-related securities in recent years, there is more to come. However, as we have seen, the entire sector is going through a stage of high volatility with huge swings up and down. So if you’re going to invest in oil at this stage, be prepared to ride out the dips.

"The best strategy is to decide on what companies you want to own and gradually build positions on pull-backs. One way to cushion the impact of price drops is to focus on energy-based income trusts, which provide monthly cash flow that will take some of the sting out of market volatility. Trusts with low payout ratios (the percentage of distributable cash that is actually paid to investors) are especially desirable. A low payout ratio reduces the chance that a trust will be forced to reduce its distributions if oil or natural gas prices weaken.

"Peyto Energy Trust (CA:PEY.UN Toronto) is an example. Peyto’s first-quarter results showed a payout ratio of only 44%. As a result, there has been no suggestion that the trust might cut its monthly distribution of 14c a unit despite weak natural gas prices. Peyto closed on Friday at $23.56 and it is a Buy at this level. (US investors can purchase units over-the-counter through the Pink Sheets where they trade under the symbol PEYUF.)

"The other energy trust on our recommended list is ARC Energy Trust (CA:AET.UN Toronto), which also trades in the US on the pink sheets with the symbol AETUF. The trust released first-quarter results in May and they were very good. Cash flow per unit came in at 94c, which was a 25.3% increase from the same period in 2005. Distributions were 60c per unit for a payout ratio of 63%, well within our comfort zone for energy trusts although slightly higher than a year ago.

"ARC also reported a 16.6% increase in production over the previous year to 64,600 barrels of oil equivalent per day (boe/d). On a per unit basis the improvement was 10%. The trust attributed the increase to output from acquisitions such as Redwater and NPCU, made in late 2005, and results from an active drilling program. A total of 27 new wells came on stream.

"Operating costs increased to $7.80 per boe in the first quarter compared to $6.10 per boe in 2005. The trust said the increase was primarily attributable to the addition of higher cost properties at Redwater and NPCU and overall industry operating cost increases. ARC is currently paying out 20c per unit monthly ($2.40 a year) for a yield of 9.2% based on the current price. Buy."

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