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Alberta vs. the oil companies — will investors win or lose?

This advisory sorts out the escalating battle over energy royalties in Alberta — and looks for a winner in a Bay Street financial battle.

Who would’ve thought it? Surely the best friend Canadian oil companies have in the political arena is the government of Alberta. And yet here they are at daggers drawn.

Royalties, of course, are the sticking point. Just yesterday, another energy trust added its voice to the growing controversy. Crescent Point Energy Trust (TSX-CPG.UN) threatened not to spend a cent in Alberta next year if royalties are jacked up.

To make sense of this ongoing controversy, we turn to one of Canada’s leading advisories on income investment, the Money Reporter. Later, we will also turn to the advisory’s special supplement, the Income Trust Guide, to chronicle yet another battle, this one among Bay Street financial giants.

But let’s take it one fight at a time. Royalties first.

Target: the oil sands

Most of Canada’s energy companies do a lot of business in Alberta, of course, and Calgary’s skyline bristles with their head offices. The question is, do Alberta residents receive a fair share of the royalties the oil companies pay to the provincial government as the price of doing business? If not, do royalties need to be raised?

Indeed, there is even a question as to whether the royalties already owing have been properly collected, according to a report issued earlier this week by the province’s auditor general.

That declaration comes on the heels of the recommendations of a six-person panel convened by the Alberta government which, on September 18, came down on the side of the general public. “Albertans do not receive their fair share from energy development and they have not, in fact, been receiving their fair share for some time,” said the chair of the panel, Mr. Bill Hunter.

The panel recommended that the province’s royalty intake be increased by 20 per cent from its current level of $10 billion a year. That means collecting another $2 billion a year.

“And the oil sands seem to be the panel’s main target,” says the Money Reporter. “The panel recommends that the government not increase more than half of conventional oil and gas royalties, given that this sector of the industry is on the decline. At the same time, it is advocating a new tax specifically on oil sands production.”

Coming less than a year after the income trust tax, this proposition must be particularly galling to the people at the energy trusts. It’s one thing for Ottawa to go gunning for them, but Edmonton as well? And it’s not like they’re getting fingered by the NDP. These are their best friends, the Conservatives.

Not all trusts are heavily involved in the oil sands, of course, but either way they are looking at a higher bill. As are the conventional oil and gas companies. Let’s see how the current royalties add up.

Should be good

Alberta-based companies pay some 20 to 25 per cent of their revenues in royalties. The conventional oil and gas companies pay this royalty on a sliding scale based on price and productivity. If oil prices rise, or if production is higher than expected, up go the royalty payments.

Oil sands companies pay 1 per cent of revenues until construction costs are recovered. After that, they pay 25 per cent of revenue minus costs. In short, provision has been made (up to now) for the exceptional expenses required to exploit the oil sands.

When you add in federal and provincial income taxes, the government is getting roughly 50 per cent of the revenue.

That’s where we stand today. While the oil sands companies try to come to grips with the idea of raised royalties, other companies speak out. Several natural gas giants are nervous about the impact of higher royalties on risky wells in the Rockies. More than one firm has issued dark statements about economic repercussions and potential job losses.

So what will happen? Here’s what the Money Reporter has to say.

“Will Alberta implement the panel’s recommendation as is, and potentially drive away business? We believe the structure may be rejigged, but not as much as the panel recommends. That should be good for energy stock and trust prices, because right now they’re assuming the worst.”

So should investors look for a surge in energy stocks once this issue is resolved? This advisory implies as much, and it is highly likely that energy firms that are good investments today will continue to be so no matter how the royalties fall. And at any rate, the price of oil seems to keep going up. Or does it?

How much does oil cost, anyway?

According to the Money Reporter, we should take oil prices with a grain of salt these days. Or rather, with a stack of greenbacks. Here’s why.

Oil is priced in U.S. dollars. “And so naturally, when the U.S. dollar drops in value, anything priced in U.S. dollars goes up. And so oil may not be up in price at all. It’s maybe more that the U.S. dollar is down.”

Thus, in a week when the Canadian dollar was up 2.99 per cent and the price of oil was up 3.19, the gains that oil made were more apparent than real.

“So when we analyze oil and gas stocks,” concludes the advisory, “we have to be sure not to get too excited about how new higher oil prices will help producers’ bottom lines, without taking currencies into account as well.”

The strong dollar is a mixed blessing, to be sure. But let’s conclude by leaving the oil field and see where the loonies are landing on Bay Street.

Big money for wealth management

“Personal banking, corporate loans and other traditional bank lines of business aren’t where the profits are, domestically or internationally.” So says the Income Trust Guide published by the Money Reporter. Wealth management is the big money maker in the financial world these days.

Of the big five banks, the Bank of Nova Scotia (TSX-BNS) has the smallest presence in wealth management. It set out to rectify that gap by purchasing Dundee Wealth Inc. (TSX-DW). In mid-September, Scotiabank struck a deal with Dundee’s parent company to buy an 18 per cent stake in Dundee Wealth at $12.76 a share. It would also have the right to increase its stake by 20 per cent. And, for an additional $206 million, it could buy the one-year-old Dundee bank, which had gotten off to a flying start in life before stumbling over some asset backed commercial paper (ABCP) of dubious value.

The deal looked great on paper. Then along came CI Financial Income Fund (TSX-CIX.UN). It steamrollered over the Scotiabank deal with an offer for all of Dundee, at a 59 per cent premium to the big bank’s offer. CI offered $20.25 a share, which would allow a tax-free rollover.

This deal would vault CI’s assets from $100 billion to $162 billion and give it a fully formed bank in lieu of the one it was planning to start from scratch. But it’s all contingent on Scotiabank’s deal not going through.

The Income Trust Guide believes CI-Dundee is a much better fit than Scotia-Dundee. Dundee’s 600 brokers and 1,200 fund salespeople are less liable to leave if their new boss is CI rather than a bank.

It’s not clear yet who will win this battle, but it has convinced the advisory of one thing. It has “seen enough from CI Financial, from its recent acquisitions, plans to take on the Big Five and open a bank, and this latest move, to take it off a hold recommendation and put it back on our buy list.”

It’s one of the Income Trust Guide’s three “Best Buys” for October. Another, is Canadian Oil Sands Trust (TSX-COS.UN). In light of the royalty dispute, the advisory has re-assessed its short-term assessments for most energy trusts, but not this giant. The third buy is Series S-I Income Fund (SRC.UN), for those who like the income from income trusts and want a diversified portfolio of them.

We’ve left a few unresolved issues on the table, from oil royalties to the Dundee deal. What is clear is that investors with the patience to see things through will almost certainly be the winners.

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