Provident Energy (PVX): A 'Canadian Edge'

Roger Conrad offers a specialized newsletter for sophisticated income investors; his Canadian Edge, focuses on high yielding investments north of the border.

Bucking the market trend, he notes that the nine Canadian oil and gas producers in his portfolio have returned nearly 50% in the first half of 2008. Here, he looks at Provident Energy Trust (NYSE: PVX).

"The 24% year-to-date return from Provident Energy Trust actually more out of step with the torrid gains in other oil and gas sector trusts. The question: Are there real reasons to expect these trusts’ first half 2008 underperformance to continue or even get worse?

"If so, we don’t want to keep owning them. If not, there’s every reason to expect they’ll outperform in the second half. Fortunately, I think the latter is the case for both.

"Provident’s underperformance basically appears because of investors’ perplexity about the sale of its interest in BreitBurn LP, which represented the bulk of its US assets.

"Many investors (myself included) had wrongly assumed BreitBurn was part of a move to head south and avoid prospective 2011 taxation. As it turned out, management cited restricted ability to raise capital as a reason for selling.

"For the better part of this decade, Provident has ranked among the more aggressive trusts, acquiring fee-generating 'midstream' assets and oil and gas production properties in the US and Canada.

"Selling its general partner and limited partner interests in BreitBurn will net the trust $345 million (Canadian) to reduce the $1.2 billion debt load. And the nature of the sale—essentially back to BreitBurn itself—eliminated the risk of selling on the open market.

"The question is does this transaction make Provident Energy Trust more valuable or less? That will only be answered over time, but there are already strong indications shareholders will benefit.

"Focusing on Canada will simplify management’s job, while funds freed up by debt reduction will speed expansion of the properties acquired over the past few years. It will also dramatically reduce currency risk from further US dollar weakness, which had been growing.

"Moving headquarters south is no longer a viable escape strategy for 2011, and concentrating in Canada leaves the trust more exposed to prospective taxation.

"It may also, however, make Provident a more attractive takeover target, given its now very long reserve life, the natural hedge of the midstream operations and stronger balance sheet.

"There’s always the risk management has lost its touch. But the trust’s realized oil and gas first quarter selling prices -- $75 per barrel and $7.82 per million British thermal units, respectively—are set to rise for some time to come as older hedges are replaced with higher-priced ones.

"That means little risk betting with them, particularly with shares selling for a sector low at one time annual sales. Provident Energy Trust is still a buy."