Eagle Energy Trust: A Dream Come True For Income Invstors?

The latest release from Eagle Energy trust is the kind income investors get all excited about. Eagle is currently yielding 12% at current prices but unlike the ex-trust dividend paying energy corporations it is 100% weighted to oil, with no debt and is expecting to achieve its 50% payout ratio target for the next 3 years.

Operationally, Eagle grew its oil production 8 fold since it acquired the field and recently settled around 2,250 bopd remaining on track for 2011’s exit guidance at 2,400 bopd. The company aims to grow production by 10% in 2012 which requires capital expenditures of $14M. However, at 2,600 bopd the company will cash flow $40M for 2012 at $88 WTI oil. In case you did not notice, WTI oil is currently above $100 a barrel. The strong oil prices will certainly support this scenario and provide hedging opportunities to smooth oil price volatility.

When it comes to the sustainability ratio, allow me to give myself a small pat on the back as my 2012 scenario that I discussed in my last post 2 weeks ago was confirmed in the latest news release. I calculated a 57% payout ratio with WTI oil at $90 and the company reported a POR (payout ratio) of 55% at $88 WTI oil. The best part of the news release is the following:

“Eagle’s strategy for the Salt Flat field is to attain a sustainability ratio below 100% for the years 2012 to 2014″

There are currently 60% of unit holders participating in the DRIP program which means they are buying shares with their monthly distributions and getting a 5% discount on the price. This high level of participation is a vote of confidence these investors are putting in Eagle Energy Trust and I consider this another star on the CEO’s wall. This confidence is certainly deserved as the young company became a licensed operator in the state of Texas and took over operations at the Salt Flat Field in a relatively short period of time.

Eagle Energy EGL-UN.TO 1.84 [+0.02] heralds a new era for energy income trusts, it’s a structure where the company pays corporate taxes in the US while Canadian investors pay a personal income tax on the distributions they receive. The model and the company sound too good to be true and this is where we have to remember the risks of which 3 stand out:

  1. Sitting on top of the list is Europe of course with its 2 year old DDD (Debt and Deficit Disorder) which if left untreated might suddenly trigger a meltdown and bring oil prices crashing.
  2. The second risk would be of operational nature i.e. the usual risks associated with an oil and gas company.
  3. Finally, the biggest risk of all is of legislative nature, could the government of Canada block the benefits of the new trust model? In my opinion, highly unlikely based on the following:

• Foreign income is coming into Canada vs. Canadian produced energy income going untaxed.
• The government won’t bother interfering because so far it is only a niche limited to a few small oil and gas companies vs. every man and his grandma wanting to convert to a trust structure prior to 2006.

I put my money where my mouth is and following my last post I increased my position to 1,500 shares in my HELOC account bringing my average price down to $8.62. The CEO, Richard Clark, is a man of good breeding who did a great job since he launched the trust. The strategy is simple: acquire mostly producing assets with undeveloped upside in the US, develop them, rinse and repeat. The end result is increasing free cash flow and a growing distribution. In order for the sustainability ratio to rise above 100%, WTI oil would have to fall below $75 for an extended period of time. While this is always a possibility, unless there’s a new killer green technology out there, in my opinion a collapse in oil prices would be a quick and short lived event given the current tight supply/demand fundamentals.

What’s your opinion on Eagle Energy Trust?

 *The usual disclaimer applies, this is not an invitation to buy or sell shares in EGL.UN, please do your own due diligence. The last operational update can be read here.