Canadian oil and gas royalty trusts continue to pop with energy and popularity. They grow faster than ordinary stocks or mutual funds. They regularly access the Toronto market for more capital. They buy many of the junior oil companies in Calgary. They hedge oil and gas prices. They are listing on U.S. exchanges. At press time, a traditional junior E&P company, Peyto Exploration & Development, converted to a trust structure with a market cap of C$769 million. Once Crescent Point Energy does so later this year, there will be 23 publicly held oil and gas trusts listed on the Toronto Stock Exchange. Some of these trusts are not to be trifled with. Enerplus Resources Fund, Pengrowth and ARC Energy Trust have multibillion-dollar market caps. Many of these trusts have plenty of fire-power to make acquisitions, their main avenue for growth in proved reserves. For example, Canadian Oil Sands Trust recently acquired all of EnCana Corp.'s interests in the Syncrude oil-sands project north of Fort McMurray, Alberta, for more than C$1.4 billion. ARC recently acquired privately held Star Oil & Gas Ltd. for C$632 million. Some of these trusts have displayed rapid growth. Since Harvest Energy Trust went public in December 2002, its production has grown to 10,600 barrels of oil equivalent per day, while returning 40% to unitholders. Every month it distributes 20 cents per unit. Proof that these trusts are more popular with Canadian investors is the fact that they have historically outperformed the S&P/TSX (Toronto Stock Exchange) Index. Canadian analysts expect that trend to continue. What's driving the performance? High commodity prices and strong investor demand for the yield the trust units provide. It hasn't hurt that several of the trusts have increased their distributions. Advantage Energy Income Fund hiked its distribution twice in recent months, along with making an acquisition. This trust was born in May 2001 when its predecessor, Search Energy Corp., converted from a traditionally structured E&P company. Advantage led the sector in 2002 with a total return of 81%, says FirstEnergy Capital Corp. analyst Patrick Bryden, who has an Outperform on the units. He says the average cash yield for the energy trusts he follows is 19%. Publicly held trusts from all industries, including oil and gas, have dominated Canadian market activity. So much so that The Globe and Mail (Toronto) ran a six-part series on their pros and cons in June, the same week of the investment conference held by the Canadian Association of Petroleum Producers (CAPP). That Calgary gathering, which saw 85 companies, including trusts, present their stories to 270 investors, was co-sponsored by 20 investments banks. "In a mutual fund world that has precious little to celebrate, these [trusts] boast 20%-plus returns...the masses are paying tribute by throwing millions at them," the newspaper reported. M&A driven The royalty trusts do not generate prospects and drill exploration wells. Rather, they acquire and exploit producing properties, although some observers think they are acting more like E&P companies than they have previously. Some trusts are retaining 20%, 30% or more of cash flow to grow, rather than distributing all of it to unit-holders. As such, they compete with the junior E&P companies, but tend to pay a higher price per barrel of oil equivalent for production. Often, they just buy the junior oil company, giving the latter a convenient exit. The trusts have decreased the size of the acquisition they are willing to make, notes FirstEnergy analyst Jill Angevine in a report.Good acquisition candidates are scarce. "Generally the E&Ps can afford to pay more for the exploration upside and the trusts can pay more for long-life producing reserves," she says. Indeed, it is that long-life, stable cash flow that generates the distributions investors so crave. The deals keep coming. APF Energy Trust paid C$92 million cash for a 17% stake in the Swan Hills Unit No. 1. And Ultima Energy Trust agreed to buy Trioco Resources for C$71 million. The latter's production, about 2,000 barrels of oil equivalent (BOE) per day, is a kind of magic threshold. At the recent CAPP conference, Dallas-based hedge fund investor Peter Vig called 2,000 BOE per day "the starter kit" for Canadian E&P companies and trusts. U.S. investor interest The amount of attention paid these trusts from "the Americans" is gaining ground. Canadian Oil Sands Trust, Enerplus, NCE Petrofund, Pengrowth Energy Trust, PrimeWest Energy Trust and Provident Energy Trust trade on either the New York or American stock exchanges. When Canadian Oil Sands Trust needed to finance its acquisition from EnCana, it did so in part through a private equity placement of US$325 million with U.S.-based Capital Research & Management Co. Enerplus last year placed private debt in the amount of US$175 million with 11 U.S. institutions. But by Canadian tax law, foreign investors may own no more than 49% of any Canadian trust's units, Now a few are approaching that limit. But it is not clear what a trust can do to monitor who owns its units on any given day, much less what management could do to prevent a U.S. investor from buying in. Most oil company executives would say that's a nice problem to have. -Leslie Haines