Income trust boom not sustainable, analyst warns

(April 14, 2005) Income trusts have enjoyed a lengthy winning streak, but there are dark clouds on the horizon, particularly in the oil and gas sector, cautions Clément Gignac, chief economist at National Bank Financial.

Over the past three years, trusts have averaged annual returns of 25%, with energy trusts faring even better, at 31%. However in March, trusts lost 3.5%, Gignac notes. “I believe that the breathtaking yields of recent years will be difficult to repeat.”

The stars have been aligned for energy trusts, he adds, thanks to historically low interest rates and record high crude oil prices.

“Those highly favourable conditions are unlikely to persist,” the analyst says. “All income trusts are now vulnerable to a pick-up in interest rates. We believe that long-term rates will rise by between 50 and 75 basis points in 2005. This would hurt income trusts because their distributions will be subject to increasingly unfavourable comparisons with rising interest payments paid by bond issuers.”

High oil prices have made is easy for energy trusts to raise their distribution rates, Gignac says. But he believes that economic growth will ultimately return to its historic average of 3.5%, reducing demand for oil. “If our scenario of $35 a barrel oil and a Canadian dollar that trades at about 80 cents US comes to pass, we can’t exclude the possibility that some oil trusts will be forced to cut distributions.”

In addition, there are indications that the energy trust sector is overcrowded and that consolidation may be on the way. On Wednesday, StarPoint Energy Trust and APF Energy Trust announced that they were joining forces, with executives at both trusts predicting that the deal could be the start of a trend.

Still, others remain bullish on trusts, noting that any rise in interest rates will be modest and that despite recent volatility, crude oil prices will inevitably remain high, due to stronger-than expected demand, especially in China.

“Accelerating global demand concurrent with accelerating global depletion points to much higher energy prices over the next five years,” said CIBC World Markets economist Jeff Rubin in a recent report. Rubin predicts oil prices will reach $100 a barrel by 2010.

But Gignac says investors should be cautious. “We recommend an underweight position in oil and gas trusts, and continue to favour income trusts whose distributions are stable, less influenced by economic cycles and not tied to black gold.”

Filed by Doug Watt, Advisor.ca, doug.watt@advisor.rogers.com