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Wednesday, September 12, 2007

Will Canadian Trusts Convert to US Master Limited Partnerships?

The following is an excerpt from a UBS report issued in June 2007.

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MLPs expected to be a catalyst for the sector. We believe that sometime this year, a Canadian trust will announce its intention to convert to an MLP, which should trigger a positive re-rating of valuations.

In our view, the government will be forced to respond in one of three ways, each of which should be good for investors. First, if the government does nothing, most trusts will be forced to convert to the MLP model in order to remain competitive, which should be positive for valuation.

Second, if the government chooses to invoke the GAAR, the structure may be rejected, although we are unsure on what grounds this might be possible. However, it would further highlight the valuation disparity between the two sectors and, we believe, should contribute to further convergence in valuations.

Finally, the government could choose to alter its proposed “Tax Fairness Plan”, in order to encourage Canadian trusts to remain in Canada. We believe that the government would be reluctant to lose a $60+ billion sector with more than 1.0 million boe/d of production—roughly 25% of total Canadian production. As such, we would place greater emphasis on the latter two options, although the issue is really one of politics.

Will the government back down? The jury is still out on this issue (and we have no special insight), but in our view the first conversion announcement will force the government to respond. This should further focus the market’s attention on this alternative structure and the disparity in relative valuations, which should be good for investors.

In our view, the most likely candidates to announce conversion could be Harvest Energy Trust, Pengrowth Energy Trust, or Provident Energy Trust (not under coverage, which already owns a majority stake in the Breitburn Energy Partners MLP in the United States).

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