First, I’ll give you the bad news. Alberta Premier Ed Stelmach has spoken, and it’s official: Royalty levies are going up for most producers of oil and natural gas in Alberta.

Now the good news: The vast majority of Canadian income trusts are either marginally or wholly unaffected by the move. Moreover, several of the best and brightest—including ARC Energy Trust (AET.UN, AETUF), Enerplus Resources (ERF.UN, NYSE: ERF) and Penn West Energy Trust (PWT.UN, NYSE: PWE)—stand to see their royalty rates drop substantially, providing a substantial boost to their cash flow and net asset value.

The government’s response to the commissioned report released last month was only 19 pages, a fraction of the size of the report itself. Here are the essential details in brief.

As David Dittman and I projected during the past month in the weekly Maple Leaf Memo—as well as in the October issue of Canadian Edge—the boost in royalty rates fell well short of what the panel had initially proposed and proponents wanted. And the boost was somewhat more than what industry would have preferred as well.

In the words of one observer, Mr. Stelmach is trying to “thread the needle” here. On the one hand, he’s attempting to keep royalty rates low enough to attract capital and keep the boom going. On the other, he’s trying to appease a groundswell of what amounts to resource nationalism in Alberta.

In the days before the announcement, the rhetoric on this issue reached absurd levels. Some groups urged jacking up royalty rates as high as 90 percent on producers. Others seemed to view slowing Alberta’s growth as a worthy goal and supported raising royalty rates to very high levels for the sole purpose of slowing the oil patch to give citizens time to “catch up.”

Ironically, that kind of flat earth thinking was put into practice not too long ago in Alberta, with the New Economic Policy (NEP) put in place at the end of the last energy bull market. Combined with the drop in oil and natural gas prices, that shut down the Alberta energy patch. The consequences weren’t pretty for the provincial economy.

Stelmach’s move likely heads off anything of this nature, at least for the foreseeable future. Predictably, it’s drawn criticism from the heads of the leading opposition parties.

The provincial New Democratic Party (NDP) leader charged that the premier “caved into big oil” and that he “compromised yet again on a report that represented a compromise in the first place.” Liberal leader Kevin Taft called it “another example of Mr. Stelmach’s broken promise to lead a government that’s accountable to Albertans.”

Resource nationalism is a constant of any commodity bull market. And no doubt some will continue to claim royalties are too low in Alberta, just as they will in every producer nation. Navigating resource nationalism will be an increasing challenge to oil and gas producers globally.

There’s reason to hope, however, that Stelmach’s new policy will have staying power. That’s because the royalty schedule is adjusted for both the grade of reserves and oil and gas prices.

First of all, as is the case now, mature reserves or those with lower “well productivity” rates are assessed a far lower rate than rich reserves. This has been considered essential to assure mature fields continue to have the economics to be developed. Mr. Stelmach’s ruling actually reduces royalty rates on mature fields, even as it raises rates on richer wells.

Natural gas royalties will range from a low rate of 5 percent to a top rate of 50 percent, up from a current high level of 35 percent. The rate will be capped when gas prices hit CAD16.59 per gigajoule. Rates won’t begin rising until gas hits CAD7 per gigajoule, rather than the CAD6 per gigajoule recommended by the panel.

The government projects additional revenue of CAD470 million for the province in 2010, versus CAD740 million recommended in the panel’s report. However, royalties will only increase if natural gas prices rise considerably from here, in other words if there’s a recovery in the gas patch. Put another way, until there’s a recovery, there won’t be any additional burden on gas producers.

The top royalty rate on conventional oil will also rise from 35 percent to 50 percent, though with oil at close to $90 a barrel, producers are likely to see higher rates sooner. As for oil sands development, the 1 percent royalty assessed until projects are paid out will rise to more than 4 percent and could hit 9 percent if oil reaches $120 a barrel. Meanwhile, the 25 percent royalty rate for projects that are already paid out will rise to a cap of 40 percent, again if oil reaches $120 a barrel.

In all, only 13 of the panel’s 26 recommendations were taken. Among the more important rulings, there will be no new tax on oil sands production. Finally, the changes will be delayed 14 months—until 2009—rather than beginning next summer as the panel had recommended.

Stelmach adopted the panel’s recommendation not to grandfather existing projects. However, he also pledged to rely on negotiations—rather than edicts—to reach a new royalty deal with Suncor and Syncrude, which currently have agreements that run through 2015. These companies’ projects currently produce nearly 40 percent of Alberta’s bitumen. Failure to reach an accord would take a serious dent out of projected additional royalty revenue.

Suncor’s CEO has already staked out a position that oil sands development economics could be affected by the decision. Nonetheless, it appears he will negotiate, as will other major players.

How Trusts Are Affected

Thus far, the reaction in the market to Stelmach’s announcement has been decidedly muted. Even Suncor (NYSE: SU) and Canadian Oil Sands (COS.UN, COSWF)—which owns roughly a third of the Syncrude project—have been spared big declines. Other trusts have mostly been flat.

Over the next several days, it’s still possible we’ll see some selling, including in the trusts. On the balance, however, the trusts have come out winners. That includes those involved in the oil sands, such as Enerplus and Penn West.

The biggest factor is the drop in royalty rates on mature or less productive wells, which are trusts’ bread and butter. Not only will this increase cash flows, it also signals the province is sympathetic to the plight of trusts in the wake of the national government’s plan to tax them as corporations beginning in 2011.

Barring a still very possible change in that policy, the end game for oil and gas producer trusts will be to become high dividend-paying intermediates. Lower royalty rates in Alberta will make that transition easier, though trust managements are unlikely to move in that direction precipitously.

Based on the new rules of the game, Harvest Energy Trust (HTE.UN, NYSE: HTE) stands to see the biggest decline in royalty rates. Harvest Energy Trust is currently being challenged by weakness in its refinery business, which is why I’ve rated it a hold.

More exciting in my view is the projected decline in royalty rates for ARC Energy, Enerplus and Penn West. These should translate into substantial cash flow gains when the lower rates take effect in 2009.

As for other buy-rated producer trusts, no change is expected for royalty rates paid by Vermilion Energy Trust (VET.UN, VETMF) or Progress Energy Trust (PGX.UN, PGXFF). A small drop in royalty rates is expected for Canetic Resources (CNE.UN, NYSE: CNE).

Falling royalty rates will also increase the net asset value of trusts. ARC Energy, Enerplus and Penn West stand to gain substantial value. So do Canetic, Crescent Point (CPG.UN, CPGCF) and Focus Energy Trust (FET.UN, FETUF).

Besides Canadian Oil Sands—which will be hit by greater oil sands levies—the only trust that appears to have a significant additional liability is Baytex Energy Trust (BTE.UN, NYSE: BTE). That’s another reason why investors are better off in other trusts, though I continue to rank Baytex Energy Trust a hold for now.

There’s another way oil and gas producer trusts could benefit from the higher royalty scheme. Next to oil sands-focused companies and trusts, the other group to be hit hard from the change in royalty rates is the junior producers.

In the past, this has been the group trusts have drawn from to make acquisitions to increase assets. High royalty rates on juniors could open up more opportunities for purchases to extend reserve life and expand production on the cheap. Both are critical for trusts to gain the scale needed to become high dividend-paying intermediates in the post-2011 world.

No matter how they come out on the royalty front, the ability to sustain business in an environment of volatile costs and energy prices remains the key to oil and gas producer trusts’ success. Those that can sustain will surge. Those that can’t will sink.

In the unfortunate latter camp, Fairborne Energy (FEL.UN, FELNF) has now capitulated, launching a proposal to convert to a corporation and gut its distribution. Management of the small, gas-focused trust has decided it no longer has what it takes to survive as a trust.

Other weaklings may be forced to follow suit in coming months, unless they’re able to find a suitable merger partner. Ironically, as a converted junior, Fairborne may wind up paying higher royalty rates than it would have as a trust. That’s another reason to sell Fairborne Energy if you still own it.

For the core of sustainable trusts in the Canadian Edge Aggressive Portfolio, however, this royalty decision is another reason why they should hold their own for a long time to come. There’s no cheaper group in the energy patch anywhere in the world.

Note: We’ll be reporting their earnings—as well as those of every other trust in the Canadian Edge universe—in the next few weeks in Maple Leaf Memo. Your next issue of CE will be e-mailed to you Nov. 9.