New federal income trust rules that have stung investors will benefit pipeline operators, says the president and CEO of the Canadian Energy Pipeline Association (CEPA).

David MacInnis says Ottawa's new regulations, to be introduced in 2011 for existing trusts and immediately for new ones, will encourage pipeline operators to invest in new oil and gas transmission lines and the research and development of new technologies.

"We believe that it was the right policy decision," says MacInnis. "We believe that the government had to take this step."

But Gordon Kerr, co-chair of the newly created Coalition of Canadian Energy Trusts, says the changes will deter the development of smaller resource plays, jeopardize supply in the declining Western Canadian Sedimentary Basin, reduce foreign investment in Canada and hurt pensioners who rely on monthly distributions to boost their retirement incomes.

The coalition is calling for a clarification of the rules and more collaboration with Ottawa.

"For existing trusts, it would look like you have about four years before the impact, but the real key here is there has already been a very significant impact as a consequence of the announcement on these proposals - on investors right across Canada," he says. "We think an impact like that deserves a consultative dialogue."

Unlike companies, income trusts do not currently pay corporate income tax on revenue that flows through to investors. To reduce taxable income, the trusts pay monthly distributions, on which trust unitholders pay personal tax.

Calgary-based CEPA represents Canada's pipeline operators, who are based mostly in Alberta but operate globally. MacInnis's view contradicts the position of many other oil and gas industry insiders, who have largely condemned the Oct. 31 move announced by Finance Minister Jim Flaherty. The announcement resulted in stock losses of more than $36 billion in the two days that followed.

Flaherty has apologized for the market chaos, but said he won't make any exceptions for energy trusts or those in other sectors. Citing more than $70 billion in trust conversions this year, he announced plans to start taxing existing trusts after BCE Inc. and Telus Corp. said they intended to convert into huge trusts. According to some reports, EnCana Corp., Canada's largest independent oil and gas producer, was also getting ready to put many of its assets into a new trust.

The revised rules come as pipeline companies are looking to fund billions of dollars worth of new projects, including the proposed Mackenzie Valley and Alaska Highway lines and oilsands-related infrastructure. Meanwhile, producers are seeking funds for oilsands projects and new unconventional oil and gas plays.

Many oilsands projects are slated to come onstream around the same time the new rules would take effect.

MacInnis says exploration and production companies (E&Ps) have been the hardest hit by the revisions. Pipeline and service-company operators will also be affected, because they rely on a healthy E&P sector, but E&Ps will be able to find solutions to the revised regulations, he adds.

He says pipeline firms that were thinking of converting into trusts will be able to put money that they would have used on monthly distributions into other projects in order to gain tax deductions that now flow through to trust investors.

A trust essentially acts as a parent of a traditional E&P firm, service company or pipeline operator. Several large pipeline companies, including Enbridge and Pembina, have converted some or all of their assets into trusts.

MacInnis suggests pipeline operators have faced a disadvantage because their profits are regulated by the National Energy Board, which sets oil and gas transmission rates across Canada.

"(A trust structure) hasn't been as attractive to pipeline companies," he says. "When you get a regulated rate of return, there's not as much of an incentive to change a pipeline company into a trust whereas, with the E&P sector for example, an E&P company will enjoy significant benefits by converting from a company into a trust, because it will see a 20-per-cent increase in its stock valuation as a result."

Kerr says while he doesn't object to a levelling of the playing field, "there are a lot of things that exist in corporate structures that the general public don't see relative to how, for example, debt is employed within organizations."

But Bob Michaleski, president and CEO of Calgary-based Pembina Pipeline Income Fund, says the most significant impact will be an increase in Pembina's cost of capital - in the form of both debt and equity.

Depending on what new rules Ottawa actually does implement, it may make sense for Pembina to switch to a traditional corporation.

"If we were to revert to a corporate form - in other words, to convert out of the trust form to corporate form - I think we can neutralize some of that disadvantage," says Michaleski.

He says the revised rules may also hamper pipeline operators' ability to finance future oilsands-related projects. Pembina will start construction this month on a $300-million pipeline for Canadian Natural Resources Ltd.'s mammoth Horizon oilsands project.

The coalition's Kerr contends the revised rules will harm the "symbiotic relationship" between trusts and junior exploration and production companies.

"By and large, we've been able to access some of the more mature properties in the (Western Canadian Sedimentary) Basin and realize value out of those lower-margin properties because we have a low cost-of-capital (business) that allows us to access them," says Kerr.

He says trusts have drilled on mature properties that major producers sold off because profits were too small.

Kerr, CEO of Calgary-based Enerplus Resources Fund, says trusts also provide an exit strategy for junior E&P companies that reach certain production and growth levels, sell to energy funds and then reform as new juniors.

"We are creating spinoff activity obviously (for service and pipeline firms)," says Kerr. "We are drilling a lot of wells, we are moving oil and gas to market. If there's less (oil and gas) to move, it's negative to them over the long haul - just in terms of fundamental business."

Chris Bolton, an analyst in the Calgary office of BMO Capital Markets, agrees the new rules will make acquisitions more difficult for energy trusts. As a result, oil and gas operators may develop more projects internally rather than make acquisitions.

Trusts have enabled companies to sell off mature assets and invest the proceeds in the oilsands, overseas countries, coalbed methane, compressed natural gas and other unconventional energy sources, he adds.

"Particularly on the oil and gas side, for a lot of smaller companies, their exit strategy was to sell to a trust at some point and some of these guys were able to do that quite successfully numerous times," says Bolton. "From my perspective, (Ottawa's action) hoops their exit strategy."

He says it's a possibility that pipeline operators will invest in more capital projects in order to write off taxable income, but it's still too early to tell what will happen.

CEPA's MacInnis predicts the new rules will spell the return of intermediate, or mid-sized, oil and gas firms. During the last six years, they disappeared following large mergers and acquisitions and conversions of smaller E&P operations into trusts.

(Monte Stewart can be reached at monte@businessedge.ca)