Harvest Trust Energy (HTE) – Part 2 – Business Issues

Harvest Trust Energy classifies itself as an integrated energy company reflecting their presence in both the upstream and downstream businesses. This is a moot point though, as logistical issues prevent them from using the oil produced in their refinery. The refinery feedstock requirements range around 110,0000 bbls per day while production is only about half of that. Further, the feedstock requirement is medium sour crude oil while the production is spread-out over light, medium, heavy oil, and natural gases.

HTE acquired North Atlantic refinery for C$1.6B. Considering the refinery output to be around 115,000 bbls per day, the purchase price can be broken down to be around 14000 per flowing barrel. This price was on the high end for refineries at the time. The rest of the business is valued at about $3.6B.

Harvest has an extensive hedging strategy. It is structured such that there is only minimal or no cost in a low price environment, when Harvest would otherwise be less able to afford the cost of such an ‘insurance’. The following are the three types of hedging used:

• Crude Oil Hedges for Upstream,
• Refined Product Hedges for Downstream, and
• Currency Exchange Rate Hedges.

Currency hedging is essential to mitigate the operational risk of costs associated with the local currency (Canadian dollars) while the revenue is in US dollars. The complex nature of the remaining hedging types indicates more of a throwback to hedging strategies employed by the acquired companies rather than an optimized strategy allowing for the business risks. Specifically, a much simpler strategy should be worked out, which takes into account the fact that roughly half of the feedstock requirements for the refinery need not be hedged since production is in that range.

Harvest along with other Canadian royalty trusts is negatively affected by a Canadian tax law change that comes into effect in the 2011 timeframe for existing trusts. When the tax-exempt status on distributions expires, the trusts will pay taxes like other regular corporations. The probable scenario is for Harvest to act like a regular corporation where the lion share of its cash flow for capital expenditures will be used to fund future growth as opposed to distributions. The shareholder base will also undergo a similar shift from income-oriented investors to growth-oriented investors before that timeframe.

Provincial royalties also has an impact on Harvest. Specifically, Alberta recently unveiled plans for increased royalties in the 2010 timeframe and Harvest has a major portion of its upstream business in the area. The counter measure from the company was to reduce capital expenditures in the area. While this can help send a message to regulators, the company needs to prepare itself better for a high-tax scenario.

Related Posts:

1. Harvest Trust Energy (HTE) - Part 1 - Introduction.
2. Harvest Trust Energy (HTE) - Part 2 - Business Issues.
3. Harvest Trust Energy (HTE) - Part 3 - Outlook.