There’s a new horse race heating up the action in the oilpatch.

It’s a run for roses called the ‘Royalty Trust Derby.’ The horses have been called to the post. The punters are stampeding to the parimutuel windows to place their bets.

This event has replaced the long-running Takeover Derby as the feature race on the oilpatch card.

It wasn’t so long ago that the touts were handicapping takeover targets as junior and mid-sized oil and gas companies were being swallowed up by the big players in a flurry of activity.

Now the trick for investors is to pick the next company to reinvent itself as a royalty trust.

The last energy outfit to grace the winners circle was Vermilion Resources, with jockey Jeff Boyce bringing his thoroughbred across the finish line as a newly minted royalty trust. There is a catch, though.You need to place your bets early.

In the ’patch, where everyone drinks at the water cooler, word spreads like wildfire. Vermilion (VRM-TSX) shares were off to the races four trading days before the company made it official that it would restructure its assets into a trust and spin off some of its exploration interests into a separate company. When the trading frenzy began, Vermilion had to issue a release saying it was considering a restructuring and the cat was out of the bag.

In four days before it was official, five million shares traded as the stock soared 38 per cent. The buy-on-rumour, sell-on-news credo played true to form. The actual news resulted in only a minor pop.

There’s at least one man on the street calling for the fever pitch of royalty trust action to continue. Peter Linder, who used to cherry-pick takeovers as Research Capital’s energy analyst, is now breathlessly picking royalty trust candidates as senior energy strategist with DeltaOne Capital Partners.

You want names?

Linder, who relished the Vermilion ride – it’s one of the holdings in the DeltaOne Energy Fund he manages – reels off three hot prospects he believes are champing at the royalty bit.

“Thunder Energy, Baytex Energy and Compton Petroleum, in that order,” pipes Linder.

You want odds?

“I would say I’m more than 50-50 certain that two of those three will become royalty trusts based on their characteristics,” says Linder, who rates Thunder Energy (THY-TSX) and Baytex Energy (BTE-TSX) as two of his top three Edge picks (see Pro’s 3 Stars in this issue).

Income trusts have become all the rage in Canada as wisened bear market investors search for alternatives to traditional stocks and low-interest money markets.

Trusts are investments that pay attractive regular distributions to unitholders from cash flow.

Vermilion CEO Boyce says the new royalty trust anticipates a distribution of about $2 per trust unit in 2003 while returning about 85 per cent of its cash flow to unitholders.

Companies that fit the mould of a trust are quality and stable operations that have high sustainable cash flow and assets that maintain value.

The move towards royalty trusts by small to mid-sized companies has given the oilpatch a much-needed spark, with new money coming into the industry from investors who formerly shunned oil and gas because of the volatility of commodity prices.

The royalty trusts have also begun to command the attention of some of the oilpatch’s biggest players such as Hank Swartout. The CEO of Precision Drilling recently laid part of the blame for his company’s disappointing third-quarter results on “trust frenzy.”

Swartout said royalty trusts could cost as much as $2 billion annually in oil and gas exploration and development because most of the profits are funnelled to investors instead of being put to work. While some of those in the exploration game, such as Greg Noval, characterize royalty trusts as a fad, Linder doesn’t see this run for roses losing steam any time soon.

“The royalty trusts are so popular because they provide very strong distributions,” says Linder. “Some of them have annual distributions to unitholders of 15 to 20 per cent. As long as commodity prices remain relatively strong, they’re an excellent vehicle for more conservative investors. “

As the saying goes, all ships rise with a rising tide. I think PrimeWest Energy Trust (PWI.UN-TSX) is one that might be near the bottom of the barrel, but in the current oil-price, natural gas-price world, they all look quite attractive. The trusts offer good value, good exposure to the sector and limited risk.”

Although royalty trusts are promoted as conservative investments, they’re more volatile than most other income trusts due to commodity fluctuation.

The TSX Energy Trust Index is up about two per cent year to date, but has dropped about 10 per cent in the past eight months. Linder, who is bullish on natural gas prices for 2003, emphasizes a natural gas weighting in sizing up the companies suited to becoming trusts. “I think a gas weighting is important, the company should have a track record for buying companies at reasonable prices, a good management team and strong liquidity and size,” says Linder.

* CALL RIPLEY’S: Believe it or not, a study of TSX-listed Canadian companies showed companies with well-paid CEOs financially outperforming those with lower-paid CEOS.

The study, by Watson Wyatt WorldWide, was done between 1998 and 2001. One question: How the heck is this possible if the grossly overpaid former CEO of Nortel Networks, John Roth, was part of the study?

* SAGE WORDS: “If Alberta poker chips are involved at the poker table, we will be at the table.”

– Premier Peter Lougheed, speaking to the National Press Club in Ottawa in 1971 about Alberta’s determination to have a greater say on national energy policy.

HOT ALBERTA STOCK: Rosetta Exploration
RSA-TSX $1.24
Up 39 cents (+45.9%) on 139,600 shares (for week ending Nov. 8).
There are still some signs of life on the lacklustre junior exchange as exhibited by Rosetta. The Calgary-based natural gas explorer got a boost from shareholders in a week when it beefed up its cash position with the closing of a $6.35-million private placement. This stock has almost doubled in the past four weeks.

COLD ALBERTA STOCK: Ridgeway Petroleum
RGW-TSX Venture $1.80
Down 41 cents (-22.8%) on 201,700 shares (for week ending Nov. 8).
It goes to show you that investors don’t buy into many news releases anymore that don’t have any dollar signs. Ridgeway announced it had an agreement with a major U.S. pipeline company to pursue the commercial feasibility of Ridgeway’s CO2 and helium.
The Calgary company says it has the largest known accumulation of CO2 and helium but shareholders have shrugged it off, knocking the wind out of a stock that traded as high as $6 in the spring.