Penn West Energy Trust: Canadian Oil Play

The winters are frigid in Alberta's oil patch, but at least you don't have to grapple with flaky Latin American dictators or despotic Persian Gulf sheikhs. That's one reason Kurt Wulff, a crack independent energy analyst, likes Penn West Energy Trust, a big Canadian oil trust (market value: $10 billion) that listed on the New York Stock Exchange in June under the symbol PWE.

But the main reason Wulff has a buy on Penn West is the stock's lush yield -- 9.5% -- and the company's ability to maintain or increase its dividend by pumping more oil. The stock closed Friday at $39, or nine times the $4.11 per share that Wulff expects Penn West to earn over the next 12 months. Dividends are "qualified" for American investors, meaning the maximum federal income tax rate on them is 15% (the Canadian government withholds 15% of dividends, which Americans can reclaim on their U.S. income taxes).

Canadian oil and gas trusts have greater operational and investment flexibility than the more passively managed American royalty trusts. Wulff notes that Penn West is paying out only 50% to 60% of its cash flow to shareholders. It plows the rest of the capital back into oil exploration and expansion of capacity, which supports the cash distribution.

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Wulff counts three sources of potential new oil production for Penn West. First is its extensive holdings of exploratory lands across western Canada. The trust farms out those holdings to drillers and takes a cut of output as royalties. Next is Pembina field of Alberta, Canada's largest conventional oil field. Pembina is mature and depleted from years of primary recovery, but Penn West is applying tertiary recovery technology -- injecting carbon dioxide, a greenhouse gas -- to make the oil flow. Finally, Penn West owns a large amount of land in the Peace River area, one of three main oil sands regions in Alberta. Wulff says that Shell recently paid a rich price for Peace River acreage of a similar size.

One key, of course, is the high price of crude, which makes oil sands and other capital-intensive energy projects in Canada viable. Wulff thinks oil prices are heading higher -- a lot higher. He projects that crude will fetch $150 a barrel by 2010. If he's right, that's bearish for the world economy, but it's bullish for Penn West.