Thursday, October 18, 2007

Energy Trust Takeover Keeps Canada's Conservatives in Tough Spot

Yet another round of his ongoing royalty trust blunder was played by Canadian Prime Minister Stephen Harper this week as he stated any protectionist legislation regarding royalty trust acquisitions by foreign buyers would be put off until next year.

Because last year's bombshell that Canada would change the way it treated royalty trusts was fraught with political risks, not only did the ruling Conservatives pull it off with surprising ease, they've dodged all the bullets since. This latest one, however-- the announced takeover of PrimeWest Energy Trust (PWI) by Abu Dhabi's national oil company-- may be a tougher bullet to dodge. Here's a quick summary of the big royalty trust political events of the last year, capping with the latest:

1) Late last year-on Halloween, fittingly-the minority Conservative government in Canada announced a plan to prohibit the creation of any new royalty trusts and to force all existing trusts to convert to normal corporations by 2011, a 180-degree reversal from every promise it made on the topic, both pre- and post-election.

  • The Political Risk: barely a year earlier, in late 2005, the then-ruling Liberal government simply floated the idea of changing the tax status of royalty trusts and voters revolted, particularly retirees who relied on the hefty dividends the royalty trusts paid. In fact, it became one of the key issues which toppled the tenuous ruling coalition and helped to sweep Conservatives into power for the first time in 15 years.
  • The Political Solution: when the time came for the Conservatives to go back on their word in late 2006, they didn't just float an idea-they had a plan. That strategy consisted of well-crafted baubles for senior citizens, tax breaks for the retirement set carefully planned to mute the uproar that would have been expected. The plan worked; while CARP (Canada's AARP) eventually came out against the proposal, its reaction was slow and half-hearted, due in part to its happiness with income splitting and other tax goodies they were given.

2) The next big challenge was the budget process in the Spring of 2007, during which the Conservatives needed to pass the "Tax Fairness Plan" that contained the royalty trust tax change they had proposed months before.

  • The Political Risk: because the budget process is by definition a confidence measure in Canada's parliamentary system, the government can fall and new national elections can result if an officially tabled budget doesn't pass. Being a minority ruling coalition (Conservatives have the most seats in parliament but not a majority of them), the Conservatives need the votes of at least one of the minority parties in order to pass its budget and avoid national elections.
  • The Political Solution: Conservatives bought the votes they needed from the Bloc Quebec, which received a huge package of tax transfers from other Canadian provinces in return for their support of the budget. Thus, the Halloween proposal became enacted law.

3) Finally, the announcement on September 24th that TAQA, the Abu Dhabi national energy company, would be acquiring PrimeWest Energy Trust posed yet another challenge for the Conservatives.

  • The Political Problem: shortly after the Conservatives announced their proposed change to the royalty trusts and the stocks got clobbered as a result, energy trust CEOs warned that they had been made sitting ducks for acquisition by foreign buyers. At the time, Finance Minister Flaherty brushed off the claims as self-serving propaganda on the part of the energy trust CEOs who opposed the tax change proposal, but TAQA's bid for PrimeWest-at a 30% premium-proved the trust CEOs correct. The Conservatives' tax law change had perhaps set the stage for the selling of Canada's vital natural resources to foreign buyers.
  • The Political Solution: this one clearly has the Conservatives in a quandary. At first, Prime Minister Harper reacted swiftly, using the Middle-Eastern origin of the buyer to float the idea of blocking the deal on national security grounds. However, this deal was TAQA's 3rd takeover of the year in Canada, and one of those purchases has already closed; if it wasn't a national security issue then, why would it be now? Since that wouldn't make sense, he then backed off and said such protectionist legislation would be coming soon, but that the TAQA deal would be reviewed based on existing laws, preserving its ability to complete the PrimeWest deal. Even this solution wasn't ideal however, as it would keep the topic of the TAQA deal in the news, reminding Canadians that the energy trusts were indeed trading at fire-sale prices as a direct result of the change in their tax status.

Ultimately, there has been no political solution to the PrimeWest takeover, and this week's announcement by Canada's Conservatives that no such national security takeover legislation would be crafted until next year shows clearly they don't quite know how to make this problem go away. They must be hoping the topic will die down, that they'll have time to quietly pass such legislation at some point in the future.

Will this work? Maybe, but the fact still remains that the TAQA takeover of PrimeWest signaled clearly that Canadian energy trust assets are very inexpensive. In reality, a foreign acquirer might actually step up any similar plans in hopes of getting a deal done now, before any new legislation that would block such foreign buyers is tabled next year.

Regardless, the royalty trust tax change was a huge mistake, and the lack of any clever political play in the aftermath of the PrimeWest takeover shows that Harper, Flaherty and their team will have an increasingly difficult time covering up that fact.

Note: click here to listen to my podcast interview with Roger Conrad about current energy trust valuations in general and the PrimeWest takeover, in particular.

Disclosure: Author has a long position in PWI

Source: Seeking Alpha