Monday, January 11, 2010

Stale dogma at work in this Deborah Yedlin column

This article by Deborah Yedlin in yesterday’s Calgary Herald, entitled “Ottawa's 2006 panic leaves lasting impact” comes close to telling the truth about the income trust fiasco, but not quite. It should not have to take three years for this story to be told properly by Canada’s media. The worst part of this account by Deborah Yedlin is the use of stale dogmatic messaging that advances a subliminal message that is false, for example:

The use of the term “tax advantaged” to describe income trusts: this implies that income trusts cause tax leakage which is a patent falsehood, Deborah Yedlin should have been able to figure that out over the past three years, since it only took me one phone call to a Bay Street contact on November 1, 2006. Deborah worked on Bay Street. Does she not have any contacts. No telephone perhaps?

Then Deborah sets the piece up by saying “The arguments haven’t changed”. I wonder why? Did it ever occur to Deborah that the arguments never changed, because YOU and the rest of the Canadian news media have failed to introduce new information into the debate, like the fact that tax leakage is completely false? Why write an article that completely ignores the 900 Gorilla in the room. Flaherty lied about tax leakage, It’s that simple. Introduce that little gem into the debate and then see whether “the arguments haven’t changed”.

Having branded income trusts (falsely) as being “tax advantaged”, Deborah then goes on to contradict herself by acknowledging that corporations are “The elimination of a tax-advantaged option means more money will be spent to create the tax pools, with distributions or dividends decreasing as a result.” That sure sounds “tax advantaged” to me, which goes about 95% of the way to acknowledging that income trusts do not cause tax leakage, since corporations have endless means to lower there taxes. Witness BCE who pay NO TAXES as a corporation.

The greatest disappointment I have in this article derives from the fact that Deborah Yedlin did work on Bat Street, So why is she saying the following “In one corner are those who maintain the conversion to the tax-advantaged model created an uneven playing field because the trusts were rewarded with higher unit prices and a lower cost of capital”? Saying this, implies that the “tax advantaged” part is the source of the “higher unit price” part. WRONG. The higher valuation accorded to income trusts arises from the fact that investors assign a higher value to a company that has adopted a payout discipline of the trust model that obligates it to pay out 95% of its excess cash flow to the owners every month. Plus the trust model imposes the discipline on the managers of trusts that they can only make acquisitions that are accretive (ie additive) to the trusts monthly distributions. For this, investors will pay a premium, that manifests itself into a lower cost of capital (a good thing!). This premium has nothing to do with any tax advantage, since no tax advantage per se, exists.

This article therefore contributes nothing to the debate about income trusts apart from reinforces views that have persisted since the outset, Views that are based on innuendo, falsehoods and spin doctoring of false concepts. Through in a lack of understanding of why investors pat premiums for income trust and you have an article entitled: “Ottawa’s 2006 panic leaves lasting impact”.

I did like the “panic” part however, since this income trust fiasco of a policy was true negligence on Flaherty’s part, borne from ignorance and panic. He probably was more used to chases ambulances than understanding simple concepts like the income trust matter. Yes “simple”, only made complicated to understand by those in the press with an agenda to dissemble the truth.

Ottawa's 2006 panic leaves lasting impact
By Deborah Yedlin,
Calgary Herald
January 9, 2010

Herald columnist Deborah Yedlin
The sting of the abrupt change in the rules governing royalty and income trusts announced on Halloween night 2006 lingers in Canada's oilpatch, as does the divergence of opinion within the sector as to the merits of the structure itself.

The arguments haven't changed.

In one corner are those who maintain the conversion to the tax-advantaged model created an uneven playing field because the trusts were rewarded with higher unit prices and a lower cost of capital. The result, say the detractors, was that asset values rose precipitously, shutting out the conventional players from the acquisition market.

In the other corner is the view that for certain types of oil and natural gas assets -- those that are in the twilight years of productive life or that do not require massive injections of capital -- it make sense to be structured as trusts. The company manages the assets on behalf of the unitholders, with the dollars remaining after expenses distributed to the unitholders.

Another reason mentioned on why the federal government should have done a better job thinking through its decision has to do with tax revenues.

The impending changes are unlikely to see an increase in tax revenue because the distributions will turn into dividends, which are taxed at lower rates.

More important, perhaps, is the well-known fact that energy companies have never been big payers of cash taxes -- with the exception of 2008, when oil prices reached record highs. When an energy company spends money on exploration and development activities, it creates what are known as tax pools, which shelter future income from being taxed. The elimination of a tax-advantaged option means more money will be spent to create the tax pools, with distributions or dividends decreasing as a result.

With the clock now ticking down to Jan. 1, 2011, when the new rules come into effect, companies that are still structured as income trusts are faced primarily with three options. The first is to take themselves out of the publicly traded domain by going private -- where the rule changes don't apply. The question here, as with the option to convert back to a conventional structure, is whether either move would trigger change-in-control clauses that would result in some handsome payouts to management. This might not be so palatable, if one recalls the backlash when all but one of the trusts decided to internalize their management contracts that also resulted in some significant payouts. The final possibility is merging with another company -- a decision that would definitely trigger the change-in-control clause, but might prove the easiest route.

The betting is that the merger activity will likely start after the 2009 reserve reports are published -- with the smaller trusts being among the first to consolidate or be snapped up by bigger trusts or conventional players. What will be interesting to watch is how the ex-trusts are valued relative to companies that have been conventional exploration and production entities all along. Instead of being carved out into a segment of their own, they will find themselves benchmarked against a larger group of companies where differentiating themselves will undoubtedly be more challenging.

One way for them to do this, of course, is by continuing to pay out distributions as dividends. And while there is still the double taxation conundrum for dividends that flow into registered plans, being able to establish themselves as high dividend paying energy companies is certainly one way to stand apart in a sector that is traditionally viewed as being stingy on the dividend front.

They also enter a new world of exploration and development -- one in which technology has opened a wider array of opportunities -- and many industry watchers are waiting to see how they adapt. While some have pursued the twin tracks of asset exploitation alongside an element of exploration and development, others have stayed strictly with the exploitation model -- and it's these companies that will be most closely watched.

As the sun unfortunately sets on the structure, on which many individuals with fixed incomes relied for additional cash flow, the legacy of the trusts will likely be that the practice of distributions illustrated it was possible for energy companies to pay out cash to investors -- and moreover, that this practice demanded a different level of capital discipline.

Still, no matter what happens in the ensuing months, there is no denying that the energy sector continues to feel betrayed by one of its own, namely Prime Minister Stephen Harper, as $30 billion in value disappeared overnight. The chapter on this almost magical investment vehicle where investors benefited from healthy distributions in a low interest rate environment and appreciation in the unit values is all but closed.

It didn't have to be this way. There was, and still is, room for certain types of companies to be structured as income trusts. The problem was that too many wanted to convert to the structure for the wrong reasons. And on this, the government was spooked. The result was an ill-thought-out reaction that had a profound and lasting impact on corporate Canada as well as investors on both sides of the border.


Anonymous said...


I thought you said that Yedlin lived in Calgary?

I guess good journalists don’t mix with oil & gas folks. The article is very simplistic and shallow, like she recently thought of these issues. However the article gave me an idea. It is clear that CBC is trying to block attention of the questions in “Your Question Period”, however if real journalists became aware of the questions all hell could break loose. You have great media contacts so why don’t put them onto the CBC questions so we can get so awareness of the Tory Income Trust betrayal. -- Sean

CAITI said...

Good line Sean!!!...good journalism doesn’t mix with oil and gas. This piece by Deborah Yedlin is an exercise in droning and dumbing-down. What a farce, you’d think understanding tax leakage was the equivalent task of splitting the atom or discovery DNA. Total Neanderthals.

Brent Fullard