DBRS Confirms Canadian Oil Sands Trust at STA-4 (high)

DBRS has confirmed the stability rating of Canadian Oil Sands Trust (COS or the Trust) at STA-4 (high).

This removes the rating from Under Review – Developing, where it was placed on November 1, 2006, following the federal government’s proposed taxation on income trusts beginning in 2011. The rating confirmation reflects the Trust’s improved financial and operating profile following its completion of the Stage 3 Expansion (Stage 3), and its intention to focus on steadily growing its business while keeping its credit metrics close to current levels. While the Trust has indicated that it may convert to a corporate structure post-2011 due to favourable tax rates (versus the proposed 31.5% for trusts), DBRS believes this should not have a material impact on its stability rating. There are also substantial taxation considerations (including $2 billion tax pools) that could reduce the Fund’s taxes payable in future years.

In response to the proposed tax change, the Trust has increased its net debt target to $1.6 billion from $1.2 billion to expedite fuller payout of free cash flow and to preserve the tax pools. The current pools of approximately $2.1 billion are expected to shelter cash taxes for an estimated one or two years beyond 2011.

The June budget, which contained legislative provisions to tax income trusts, resulted in COS taking a $701 million charge to future tax expense, resulting in the Trust’s first net loss of $133 million for the first half of 2007. However, this had no effect on cash flow. DBRS has adjusted net income before the extraordinary items (principally the tax charge) to $499 million.

COS’ rating is higher than the conventional oil and gas income trusts (conventional trusts) rated by DBRS at the “STA-5 and lower” range and reflects the following factors:

(1) The Trust’s 36.74% working interest in Syncrude’s (additional 1.25% acquired in January 2007) long life reserves of 27 years based on proven reserves are well defined with no exploration risk. Due to its superior asset base, per unit reserves have remained stable, compared to the declining reserves for the conventional trusts.

(2) Similarly, per unit production performance has remained strong and is expected to grow substantially as a result of the completion of Stage 3 in 2006. Further internal expansion opportunities exist compared to its peers’ dependence on purchased assets to maintain production.

(3) The Trust’s relatively conservative payout ratio based on operating cash flow (45% in 2006 and 59% in H1 2007) and low maintenance capex provide a measure of stability in the event of softening oil prices, relative to the 70% to 75% average payout and high maintenance capex for its peer group.

(4) Strong sponsors/partners in Syncrude, including executives seconded from Imperial Oil / ExxonMobil under a new four-year management-services agreement, provide project management experience and operational expertise.

(5) With its 100% crude oil focus (albeit of high quality, light sweet crude), the Trust’s cash flow is highly sensitive to the price of oil, as there are no hedges planned for 2007 and beyond (although the high capital spending years are now behind with the completion of Stage 3). In addition, operations are concentrated in one area in Alberta, which adds to operational risk.

Going forward, DBRS expects the onset of Stage 3, with its 40% higher production capacity, should improve cash flow and efficiency with further de-leveraging expected over time. Also, DBRS expects COS to move towards a fuller payout of free cash flow, while maintaining credit metrics within the current rating category.

Note:
All figures are in Canadian dollars unless otherwise noted.