ERF -- another Bakken Play

Background: I don't own any shares in Enerplus Resources (ERF), a Canadian royalty trust ("Canroy") but I have traded ERF in the past couple of years for the dividend. When I last sold whatever ERF holdings I had, I moved on and sort of just forgot about ERF. Enerplus is a royalty trust and I remembered, but forgot the details, that Canada was changing their tax laws regarding royalty trusts. The announcement spooked investors, and I just sort of forgot all about it when I last sold ERF.

Tonight, while updating my "investment links" at the top of my web page, I thought again of ERF (I guess, sort of like thinking of an old girl friend -- or boy friend for the women you might be reading this) -- and wondered whatever happened to ERF.

So, I took a look. And, lo and behold, there's a July 9, 2010, commentary on Seeking Alpha.com about ERF.

Conversion: Yes, ERF will convert from a royalty trust to a dividend-paying corporation at the end of the year, but the company expects to maintain its current payout, but now as a dividend instead of a distribution. The company has enough cash reserve and operating cash flow to maintain that payout to at least sometime between 2013 and 2015 (that seems like quite a long period of uncertainty -- 2013 to 2015 -- but whatever).

I could be wrong, but I believe the precipitous drop in share price in late 2008/early 2009 was a combination of the decline in the market overall, as well as the change in Canadian tax law regarding trusts. Since then, the share price has remained in a trading range between $20 and $25 with a monthly distribution that equated to a 9 percent payout. 

Obviously the transformation from a royalty trust to a corporation has been priced into the share price and, all things being equal, one would not expect a significant share price change going into 2011.

The Bakken Connection: It was interesting to note that the Seeking Alpha commentary said that ERF's holdings in North Dakota appear not to be priced into its current share price. The author says that ERF holds 180,000 acres of tight oil land in Saskatchewan and North Dakota, according to their July, 2010, corporate presentation. (I believe "tight" refers to the geology of the Bakken formations, but I could be wrong.) For comparison, Whiting has 87,000 net acres in the Sanish and Parshall oil fields in North Dakota. Continental Resources has 775,000 net acres in the Bakken (North Dakota and Montana). Most (all?) of ERF's North Dakota Bakken acreage is inside the Fort Berthold Indian Reservation.

Unintended Consequences: If the tax benefits to dividends go away at the end of the year for US taxpayers, it is ironic that ERF would be converting to a dividend-paying corporation at this moment. Of course they did so as a response to Canada's new (punitive) tax policy on royalty trust. This just goes to show that a) you can't outfox taxing authorities; and, b) what makes sense one year, may not make sense the next year due to unforeseen policies. (By the way, that's one reason the job market and the stock market are, respectively, in the doldrums and volatile: corporations are hesitant to add new employees or expand when they don't know what Congress is going to do next, especially with an anti-business administration in power.)

Weyerhaeuser (WY) is doing just the opposite in this country: at the end of the year WY will be converting from a dividend-paying corporation to a real estate investment trust (REIT). This is something their investors had been requesting for quite some time, but I think the timing had to do with expected tax changes going into 2011 in our own country.

With taxes going up on dividends, for some folks distributions from trusts make more financial sense.

Risks: It looks like ERF is about 50/50 oil/natural gas. Natural gas has been a laggard in price appreciation compared to oil. The good news is that ERF has entered into the Marcellus in a big way; it is very productive. The bad news is that ERF has entered into the Marcellus in a big way; threat of EPA or state moratorium on drilling. Offsetting that, of course, is the fact that ERF has significant holdings in western Canada. At the moment, Canada seems to have a more favorable business climate than the US.

The break-even point for Marcellus natural gas is about $3.85; natural gas is priced at about $4.50 right now. To me that is not a huge spread compared to oil which has a finding/production cost of under $20/bbl for most companies (it seems) and price of oil is consistently above $40/bbl for Bakken after taking out transportation discounts, etc. Again, my strong point is not financials, and I may be completely wrong on this. 

Bottom line: For me personally, there seems to be plenty of places to invest for the dividend that doesn't involve the transformation of a company, unless of course, the SeekingAlpha author is correct and ERF has some significant growth opportunities. I like the fact that ERF is moving into the Bakken, and I like the fact that ERF is positioned in Canada, which seems a bit more stable than America right now with regard to energy policy. I am concerned about the Marcellus shale story and risk of continued or new moratoriums.

But I hope I remember to watch it closely. If I remember, I will keep provide updates. The Yahoo!Financial ERF message boards are not particularly enlightening; I always appreciate feedback.

Be that as it may, I've added it to my "investment links" at the top of the page to remind me to check in on ERF once in awhile.

Trivia: Thinking back on ERF reminded me of Harvest Energy Trust. Harvest, another Canadian oil trust (another "Canroy"), paid distributions as high as 16 percent but was bought out by the Korean National Oil Corporation in 2009.