It’s official. Penn West Energy Trust (TSX: PWT-U, NYSE: PWE) will convert to a corporation on Jan. 1, 2010. The exchange will be on a one share-for-one unit basis and should be a non-taxable event for unitholders.

Penn West’s move includes a cut in its monthly dividend from the current CAD0.15 per unit to a new monthly rate of CAD0.09, effective with the Oct. 15 payment. That’s a 40 percent reduction, but it still leaves a yield of a little more than 6 percent based on Wednesday’s closing price.

It’s safe to say that at least some of this reduction was priced in beforehand. Up to now, management has been coy about its intentions. But Penn West CEO William Andrew had long made it clear when addressing investors that he intended to take the trust to a business model that focused on exploration and development, implying a sizeable dividend cut.

Uncertainty about the post-conversion dividend has caused Penn West units to lag other energy producers for some time, notably Enerplus Resources Fund (TSX: ERF-U, NYSE: ERF), which announced a no-cut conversion earlier this year. And despite high oil prices and strong drilling results, Penn West units have routinely traded from 60 to 70 cents per dollar of proven reserves for most of the past year.

The good news is this cut, though painful now, closes the chapter on this issue. In my view, the reduction is very likely right in the middle of where expectations were. On that basis, I expect to see some selling today and possibly Friday as the market sorts this out. But given the stock’s deep discount to the value of its assets–and the fact that the new yield will allow a generous 2011 capital budget of CAD1 billion to CD1.2  billion to develop that oil and gas–it shouldn’t be long before value hunters come in and the shares recover.

More important, the cut does nothing to dim the long-term return potential for Penn West. In fact, with 2011 uncertainty now behind the company, investors will be able to focus on what have been a series of coups by management in recent months, from the China Investment Corp partnership to develop the Peace River oil sands region and Mitsubishi’s investment in the company’s main shale gas plays to the burgeoning Cardium light oil play, where early wells have yielded compelling results.

Would I have preferred a no-cut conversion? Absolutely, but the important thing is the lower dividend rate will allow robust development of Penn West’s production base and raw land potential, which will raise the value of the company and its share price. Meanwhile, cash flow will cover the new payout by better than 3-to-1. That allows plenty of room for upside should oil prices (60 percent plus of expected 2011 output) move higher.

Ultimately, energy prices will set the return here, as they always have. This cut does reveal a strong conservative streak in Penn West management, which was no doubt motivated by a desire to use internally generated cash flow to cut debt and limit the need to raise equity capital. Those aims are likely to serve shareholders well going forward.