As investors in Canadian oil and gas producer trusts and dividend-paying corporations, it’s critical that we don’t buy into all the bull. Rather, the key is to stay focused on two main points.

First, despite the price crash of the past 12 months, the underpinnings of the long-term energy bull market are still very much alive and well. Mainly, global demand is set to rise exponentially in coming years, as the developing world raises its standard of living. And the industry’s current base of production doesn’t come close to meeting it.

Second, despite a dramatic recovery from their lows of early March, the best Canadian producers are still extremely cheap. Not only do they trade at huge discounts to the value of their reserves in the ground, but they’re battle tested against the worst possible conditions. Their debt, never really very high, is at its lowest level in years. And despite record volatility in the prices of their principal products, they’re having few if any problems accessing credit.

Dividends have been cut back sharply in tandem with falling energy prices over the past year. But yields are still in double-digits and are now protected by extremely conservative assumptions for realized selling prices, which in turn are backed by systematic hedging.

Costs are falling, spurred by penny-pinching management but also by the long-awaited drop in production costs due to extremely slack conditions in the energy services business. And even 2011 taxation concerns are receding, as more trusts iron out their plans and most confirm intentions to remain dividend payers after taxation kicks in, at least to the extent the prevailing level of energy prices allows.

The smallest producers in the Canadian Edge How They Rate universe–Enterra Energy Trust (TSX: ENT-U, NYSE: ENT) and True Energy Trust (TSX: TUI-U, OTC: TUIJF)–are still fighting for their lives. Burdened by heavy debt, both Enterra Energy Trust and True Energy Trust and should largely be avoided.

But the best of the biggest are not only hunkered down to survive what’s left of this recession. They’re well-positioned to cash in on the inevitable recovery of energy prices, as the global economy stabilizes and energy demand growth returns to the torrid pace it held up until last summer.

To be sure, there are still formidable near-term risks. Producing natural gas remains barely a profitable proposition at current prices and a serious drag on profits for many. High-debt companies leveraged to producing gas–such as converting trust Advantage Energy Income Fund (TSX: AVN-U, NYSE: AAV)–face serious threats to their ability to follow through on business plans.

Oil has been a considerably more profitable business this year. But its surge hasn’t been driven by indicators on the ground, such as actual demand growth and inventories. Rather, oil prices have been a high-beta speculation on how fast and hard the global economy will bounce back from the disaster of the past year.

It may be only a matter of time before oil is again trading at USD100 a barrel. But what’s sent it higher thus far is basically a sharp reversal of the negative sentiment on the global economy that drove Black Gold to its doom in the second half of 2008. And as the jagged volatility in this market demonstrates day in and day out, the trend could certainly reverse again, should the economic news turn gloomy or even if enough investors decide it’s time to take profits on what they deem to be a “bear market rally.”

Torrid rallies like the one we’ve seen for energy prices and Canadian producers since early March have a way of sucking in the skeptics and then running out of gas without warning. My fear is that many of those who sold out at the bottom a few months ago are now returning, thinking the coast is clear. Should things go awry, they’ll likely be the first to stampede out, and prices will fall that much faster.

I’d like nothing better if oil prices never revisit even the 50s again. But with the economy this weak–and natural gas prices this low–it’s hard to argue that the industry is in the pink of health. And as long as the energy market is trading on prospects rather than hard current business news, you’d better be prepared to hang in there if prices do take a near-term hit on a swing in sentiment.

As I’ve said throughout this bear market, I want to ride this one all the way up. And as long as my oil and gas trusts are hanging in there as businesses, I’m going to stick with them throughout the ups and downs.

All of the Aggressive Holdings have demonstrated their ability to weather even the worst storms, mainly the one we’re in now. All are strong buys and excellent ways to garner high cash flow as we wait on the next leg of this energy bull market to unfold.

Return of the Bull

Given that this is the worst global recession in 80 years, it’s no surprise that global energy demand has been walloped over the past year. Even the fast-growing economies of Asia reduced their intake for a time. Meanwhile, in the developed countries, use has plummeted, led by dramatically reduced demand from heavy industry.

This demand destruction has created the illusion that energy is no longer in short supply and that arguments like Peak Oil theory, so popular just a year ago, are a bunch of bull. In reality, however, the long term supply/demand situation just got dramatically worse, as the crash in prices basically stymied conservation, use of energy alternatives and new production.

No matter how bad things may be for the world economy, it isn’t always going to be in the sorry shape it is now. It’s highly debatable how long it will take for growth to revive, given the recent extreme shock to the system. And many may question whether or not government efforts to pump up growth will wind up helping or hindering the ultimate recovery.

What’s not debatable, however, is every slump in human history let alone American history has been followed by a recovery. And this recession is looking progressively more and more like those of the 1970s–which was followed by rapid inflation–than the Great Depression of the ’30s, which was followed by years of despondency.

It may take some months. But conditions will eventually stabilize and the global economy will return to growth. And when that happens, demand for energy will also recover, with the rebound greatest in the developing world as standards of living rise.

Even in the developed world, energy demand is only down because of the recession and is certain to rebound when the economy stabilizes. The dramatic drop in gasoline prices since last summer coupled with tight credit have eliminated the desire and wherewithal for the kind of permanent adoption of new technology to reduce energy consumption, such as the massive switch to small cars was to the ’70s. And no amount of government intervention in Detroit will make a dime’s worth of difference until those conditions reverse decisively.

As for supply, it wasn’t adequate for the task last summer, after several years of record capital spending on new development. And it surely isn’t now, after nearly 12 months of unprecedented supply destruction, i.e. the cancellation of literally hundreds of projects around the world to increase production. Canada’s oil sands alone have seen a steep cutback in spending. So has the development of much-ballyhooed shale gas in the US.

The end of the ’70s bull market for energy was dramatically hastened by the mass adoption of nuclear power in the US, which replaced the roughly 20 percent of electricity generated by burning oil. In contrast, hype aside, all of the growth of spending on wind, solar, geothermal and other renewables in recent years has yet to produce even 2 percent of US electricity.

Moreover, the energy renewables are chiefly replacing is coal, and the process actually requires greater use of another fossil fuel, natural gas. That’s because utilities must have backup capacity to meet demand if the wind isn’t blowing.

The discovery and development of conventional oil and gas resources in the North Sea broke the monopoly power of OPEC in the ’70s and was thus one of the most important factors ending that energy bull market. In contrast, all the discoveries this time around have been unconventional sources of energy, such as shale gas, Canadian oil sands and undersea reserves off the coast of Brazil.

All require much higher prices than conventional energy to be competitive and are clearly not economic today. As a result, they do little to lessen dependence on the still much cheaper oil being produced in hostile nations in the Middle East and elsewhere.

Most alarming is the cautious sentiment in the industry regarding new production that’s grown out of the energy price crash. Some data indicate the pace of drilling rigs going off line may be slowing in some areas of the world. But the number in service is still falling.

One reason is that, while oil has rallied to nearly USD70 a barrel, natural gas still can’t hold over USD4 per million British thermal units (MMBtu). As a result, producers are still thinking about how they can cut costs to save cash, rather than how to ramp up new output for profit.

Last month I moderated a panel of executives from three large Canadian producer trusts with sizeable US shareholder bases: Enerplus Resources Fund (TSX: ERF-U, NYSE: ERF), Pengrowth Energy Trust (TSX: PGF-U, NYSE: PGH) and Penn West Energy Trust (TSX: PWT-U, NYSE: PWE). One of my questions was at what level of energy prices would they ramp up drilling and distributions again. Their unanimous response was that prices would have to stabilize at a much higher level to stir them from otherwise very defensive postures.

As an investor, that’s quite comforting in one sense. It means these trusts have built in very conservative assumptions to budgeting, hence their current level of distributions. All three also remain focused on holding down debt and keeping costs under control as the best way to outlast the crisis. That should help their chances of surviving a low-price environment and staying on track to participate in a recovery.

It also means, however, that in the future the people running these trusts are going to be even more skeptical than usual when it comes to reacting to increases in energy prices.

Even during last year’s price spike–before anyone had any inkling of how far prices could fall in its aftermath–trusts were far more interested in using their cash windfalls to enhance their long-term sustainability by cutting debt and expanding reserves than in increasing output meaningfully.

This time around, any additional cash flow they gain from higher energy prices will almost certainly be used first and foremost to trim debt, possibly dramatically. Priority two will again be to expand long-term reserve bases and then return some to long-suffering shareholders, most likely as share buybacks and possibly as special cash distributions.

Only if management is fully convinced that higher prices are here to stay will they really ramp up output. And that’s likely to take a prolonged period of much higher oil and natural gas prices than what we have now. This cautious sentiment is reflected across the industry. The upshot is when the global economy does revive and demand picks up, few are going to really believe better times are at hand. That means supply increases are going to lag demand growth, quite possibly for years.

As my colleague Elliott Gue pointed out at a recent conference sponsored by my publisher KCI Communications in Washington, DC, it generally takes a year to get a producing project back up to speed after it’s been shut or to bring a new project on stream once a “go” decision has been made. That lag is likely to be a lot longer this time around, as producers’ skepticism restricts them to revving up only their highest percentage projects until they get comfortable about energy prices.

For proof of how producers’ emotions can keep supply off the market, all you really have to do is look at the last decade of oil price history, starting with the bottom for oil of less than USD10 a barrel in the late ’90s. Every time oil hit a new price threshold, it had to prove itself capable of holding it, from USD20 to USD30 to USD40 to USD50 and so on all the way up to USD150 in mid-2008. Some of the largest players like ExxonMobil (NYSE: XOM)–which accumulated a cash hoard of USD30 billion this decade by refusing to ramp up investment–never relented in their bearishness until prices finally broke down this year.

The upshot: Given the carnage and pain of the past year, energy producers will be even more reluctant to ramp up output this time around. That will continue to keep supply off the market even after demand has noticeably revived in the developing world and very likely after it’s fired up again in the US as well.

Real recovery may not happen this year or even in 2010. But oil and gas prices are eventually going to take out last summer’s highs. In fact, it’s going to take the same factors that ended the ’70s energy bull market, the same factors that have ended every commodity bull market in human history, to restore the balance of market power to energy consumers, where it was during the ’90s.

Those factors are: real demand destruction from permanent conservation; a switch of meaningful energy production capacity from fossil fuels on the par with the move to nuclear power in the ’70s; and a genuine discovery of fossil fuel supplies that’s cost competitive with current conventional sources.

None of those developments are even possible at today’s low energy prices. Moreover, all have been rolled back dramatically by the last year’s catastrophic drop in energy prices. They will eventually end this bull market, as they have all others. But that’s only going to be possible after oil and gas make at least one more extremely profitable run for the roses.

Loaded for Bear, Ready for Bull

There are, of course, many ways to ride a recovery in energy prices over the next several years. Canadian producer trusts are attractive for several key reasons.

For one thing, they’re extremely cheap. Check out the table “Still at a Discount,” which compares the 29 Canadian energy producers tracked in How They Rate on several counts.

One of these is price to net asset value (NAV), which currently averages just 78 percent. In other words, buying the producers on our list gets you a dollar’s worth of assets in the ground for just 78 cents, and that’s based on energy prices that prevailed Dec. 31, 2008.

In Canada, producers submit their reserve bases to an annual review by independent auditors, chiefly Sproule Associates. Properties are analyzed on several counts, with reserves rated on a scale from “proven producing”–the highest potential for development–to “probable,” which are assessed as having a 60 percent chance or better of coming to market.

Reserves higher on the scale are assigned a greater value than those lower down. A dollar value is assigned to the total reserves, based on expected cash flows from their development, and discounted under certain scenarios. Different values are also assigned for differing types of energy, for example natural gas, heavy oil, light/medium oil and natural gas liquids. Those values, in turn, are expressed as dollars per barrel of oil equivalent. Inflation, exchange rates and other costs are also factored in and discounted.

Finally, overall NAV is calculated by adding up the value of all the various grades and types of energy reserves, subtracting out debt attached to them and then dividing by the number of trust units or company shares outstanding. The result is the ratio shown in column two of the table.

Since reserve analyses are conducted only once a year, values are by necessity based on energy prices prevailing when the analysis is completed. They’re typically benchmarked to prevailing assumptions for December 31, in this case 2008. Excluded from the calculation is the value of any other businesses run by the company or trust, such as the midstream assets operated by Provident Energy Trust (TSX: PVE-U, NYSE: PVX). So is the value of undeveloped land that may be found to contain abundant reserves.

As a result, NAV tends to be an exceedingly conservative measure of a trust’s value. That’s also true of this year’s calculations, though oil’s steep rise and natural gas’ continued drop have altered the investment calculus somewhat from where it stood at the end of December. Mainly, oil has risen from roughly USD44.60 a barrel to the upper 60s, while natural gas has tumbled from around USD5.62 per MMBtu to less than USD4 today.

Looking at the table, only three trusts and one corporation trade above their NAV as stated in reserve tallies. And they are the exceptions that prove the rule.

One, for example, is Provident, which is arguably grossly undervalued as it also owns and operates a midstream natural gas liquids business that provided two-thirds of first quarter cash flow. Another is Canadian Oil Sands Trust (TSX: COS-U, OTC: COSWF), which though not reflected in its annual NAV calculation, has almost certainly enjoyed an enormous increase in the value of its reserves, due to the doubling of oil prices since mid-February. As a result, it would almost surely trade at a steep discount were its NAV to be calculated now.

The third is Trilogy Energy Trust (TSX: TET-U, OTC: TETFF), which has been at an elevated level for several months due to takeover speculation. Finally, giant corporation Talisman Energy (TSX: TLM, NYSE: TLM) holds assets all over the world that are almost invariably undervalued in such analyses. Its price of just 1.44 times book value is exceptionally low in any case.

As for the rest of the universe, discounts go as low as True Energy Trust’s 19 percent, or in other words a market value less than a fifth the NAV of its reserves. It’s important, however, to note NAVs in the context of column three, which indicates the percentage of production coming from liquids–i.e. much higher priced oil and natural gas liquids–as opposed to far lower priced natural gas.

Those heavy on gas, for example Paramount Energy Trust (TSX: PMT-U, OTC: PMGYF), are still cheap relative to NAV. They’re just not as cheap as they appear, at least based on current energy prices. Mainly, as a 100 percent gas producer, Paramount probably sells for something more like 70 to 75 percent of NAV, rather than the 55 percent shown in the table.

That being said, we’re still looking at a very cheap looking group of producers. As recently as mid-2006, several of the trusts sold for as much as two times NAV. Just getting back to a valuation equal to NAV would mark an extraordinary gain for most of these companies and trusts. And gains would of course be multiplied by increases in energy prices.

As column four indicates, the vast majority of companies and trusts on this list pay a lower dividend that they did 12 months ago. That’s yet another illustration of how energy producers’ cash flows, distributions and share prices always track energy prices.

In the past I’ve presented a long-term graph comparing Enerplus Resources Fund’s share price with that of oil. Occasionally, the two lines have diverged somewhat, owing in large part to the fact that Enerplus derives roughly half of its energy production from natural gas which has been known to go its own way at times. There was also a divergence around the time Canadian Finance Minister Jim Flaherty announced the 2011 trust tax.

Over the long haul, the oldest income trust in North America has always tracked energy prices. When oil and gas have been on the ascendancy, it’s performed very well, as rising cash flows have spurred higher distributions. That was in fact the case last summer, when the trust raised its monthly distribution briefly to CAD0.47 a unit.

Conversely, when energy has collapsed as it has since last summer, Enerplus has generally performed poorly. The main reason: dividend cuts as declining energy prices have hit cash flow hard. And the same is true for every other trust.

In a sense, energy producer trusts aren’t really income investments at all. Rather, they’re best thought of as ways to garner big cash flows while betting on higher energy prices. The good news: There’s rarely been a better time to do just that.

The table again has more reasons why. Column five shows the payout ratio for each trust, mainly the current distribution rate as a percentage of first quarter distributable cash flow. Lower numbers indicate a lower percentage of cash flow had to be used for distributions. Therefore, more was used to keep debt low and continue development projects and there’s a bigger cushion to guard against a further drop in energy prices.

The current average payout ratio of just 51 percent is conservative by any measure, though there are a couple of trusts paying out noticeably more, such as Pengrowth (82 percent) and Canadian Oil Sands (150 percent). The first quarter is normally a period of higher production for most trusts than the second quarter, owing to the breakup of Arctic ice. So those ratios are likely to rise a bit in the second quarter, as output, and hence cash flow, are lower.

These payout ratios do, however, represent fairly safe levels for most, particularly in the context of the contents of column six, “Realized Selling Prices” for oil and gas in the first quarter. The larger number shown on the left-hand side of the column indicates the average price at which a company sold its light oil, expressed in dollars per barrel. The smaller number shown on the right hand side is the average price of natural gas sold, shown in Canadian dollars per million British thermal units.

The US dollar equivalent can basically be found by multiplying the Canadian dollar value by about 0.8, reflecting the approximate mid-point value of the Canadian dollar during the first quarter of 80 US cents. My point, however, isn’t to invite some kind of complex mathematical exercise. Rather, it’s to illustrate that realized selling prices for oil in the first quarter for most trusts is well below the current price and what has prevailed the second quarter. Natural gas, in contrast, is trading somewhat below the realized selling prices of most producers for the first quarter, depending on how you calculate the Canadian dollar exchange rate.

With that in mind, three conclusions can be drawn. First, producers most heavily weighted toward natural gas will probably see a drop in second quarter cash flow from first quarter levels, unless gas prices stage a massive recovery this month. Notably, producers hedge entirely on the forward curve, where prices are higher than spot prices, so this isn’t a 1-for-1 relationship.

Second, producers most heavily weighted toward oil output are likely to see an increase in cash flows, barring a steep correction in June for Black Gold. And finally, producers that balance their output are likely to see stable cash flow, as greater profits from oil offset lower returns on gas.

The larger point overall is that distributions for the vast majority of trusts appear to be in line, and even conservative, with the current level of energy prices. That suggests the abrupt reduction in sector distribution cuts we’ve seen the past two months is likely to stick.

Again, that’s barring another steep drop in energy prices, which is impossible to rule out in the current weak economic environment, at least for oil. But along with the discounts to NAV, well-backed distributions do provide a solid underpinning for current prices, even if this recession lasts longer and energy prices swoon again. And perhaps more important, it augurs sizeable dividend increases when energy prices do rise again, which, as history shows, are a strong driver of share prices as well.

Even approaching 2011 taxation is rapidly receding as an issue. None of the executives on the panel I hosted last month expected the trust tax to be overturned beforehand, and certainly none were betting on such as favorable outcome. But they all affirmed their intention to pay sizeable distributions after taxation kicks in. More important, they also affirmed that the level of energy prices would be far more important to determining what their payout levels would be than the prospective new tax rate.

That’s an attitude I expect to see more of as 2011 approaches and trusts begin to make their moves to convert to corporations. Moreover, the market has now rendered an unmistakable verdict that it vastly favors producers that make the jump to corporations while leaving their distributions intact to those that cut in the name of “growth.”

For example, Crescent Point Energy Trust (TSX: CPG-U, OTC: CPGCF) last month announced it would convert to a corporation while retaining its monthly distribution at its current rate of CAD0.23 a month. Its shares have continued to rise and are now up more than 42 percent for the year.

Meanwhile, Advantage Energy–which earlier this year completely eliminated its distribution when it announced its conversion–is still well underwater for 2009, despite a powerful rally in producer shares and the Canadian dollar.

That’s the kind of divergence that turns heads in corporate boardrooms. And it’s good news for preserving value in Canadian producer trusts, as well as their attraction for income investors.

I’m certainly no mind reader, and how trusts handle the 2011 tax is entirely at management’s discretion. But this kind of action is a powerful incentive for converting trusts to maintain distributions, provided their businesses are strong enough to carry the load.

My Favorite Producers

Currently 20 of the 29 producers tracked in How They Rate are buys. That’s based on an analysis of their assets, financial and operating strength, and distributions, relative to current prices. The only exceptions are the high-debt weaklings and trusts that appear to have run up past fair value.

My favorites by far are the eight that I currently recommend as Aggressive Holdings. I still consider my core five to be ARC Energy Trust (TSX: AET-U, AETUF), Enerplus Resources Fund, Peyto Energy Trust (TSX: PEY-U, OTC: PEYUF), Penn West Energy Trust and Vermilion Energy Trust (TSX: VET-U, OTC: VETMF).

Slightly more aggressive are smaller gas weighted trusts Daylight Resources Trust (TSX: DAY-U, OTC: DAYYF) and Paramount Energy Trust, as well as midstream/upstream play Provident Energy Trust.

The five core plays offer lower yields than some producers tracked in How They Rate. But they offer by far the best combination of balanced production, conservative finances, healthy reserves, low costs and seasoned management. And that’s the best formula for weathering the rest of this recession and riding the energy price recovery to come, as well as scoring high and secure distributions.

The two aggressive gas plays give us a solid bet on what’s still in my view the highest potential fossil fuel. That’s both for use in North America and for its export potential, once liquefied natural gas (LNG) infrastructure can be turned around to export rather than merely import, as is the case today.

Provident, meanwhile, is an asset-rich special situation that stands to profit richly this year from the yawning gap between natural gas and oil prices.

If you own other trusts and companies listed in How They Rate, rest assured that a “buy” means a “buy” and that a “hold means a “hold.” My Portfolio picks aren’t the only selections that measure up on my criteria. And note that there’s considerably more information available on all producer trusts in the Oil & Gas Reserve Life Table, including reserve life, debt, dividend history and various data on operating and finding costs. The Portfolio picks, however, are my favorites because they measure up the best to my criteria, and that’s what I’m going to focus on here.

Last month I reviewed earnings for Daylight and Penn West, which were both early reporters. Here’s the lowdown on the numbers from the remaining six Portfolio producers, all of which made the grade in the first quarter with room to spare despite horrendous conditions in North American energy markets.

ARC Energy Trust, as I note in the Dividend Watch List, has been ratcheting back its distribution in recent months, pretty much in tandem with natural gas prices. That’s in part because gas is roughly half of the trust’s output. But it’s also because of ARC’s successful development of property in the Montney Shale area of British Columbia that management believes could transform its reserve base just as the initial energy pools at its founding did over a decade ago.

ARC’s first quarter saw both revenue and cash flow per unit slide sharply due to much lower realized selling prices for oil and natural gas output. Netback–a measure of profitability calculated by subtracting basically all costs from revenue–fell to CAD21.16 per barrel of oil equivalent from CAD44.81 a year earlier.

On the bright side, however, production remained steady, and the trust was able to continue executing its development program while keeping debt low. And that’s in effect what I’m looking for in continuing to hold producers in this battered market.

ARC shares have noticeably surged from their early March lows. But they’re only about half the all-time highs they reached last summer. My bet is they’ll get there again, though there will be a lot of ups and downs on the way. Buy ARC Energy Trust up to USD17 if you haven’t already.

Enerplus Resources has held its distribution constant since its last cut back in February. It has, however, found abundant savings from streamlining its reserve development program, putting the Kirby oil sands project on ice and placing greater emphasis on developing its Bakken properties. Even under a best-case, Kirby wasn’t going to produce until 2011. Meanwhile, the Bakken properties have greatly exceeded expectations and are providing immediate cash flow.

The company did record a 7 percent boost in output from last year’s levels but expects to gradually curtail that to rein in costs, at least until there’s some evidence of recovering energy prices. Given the steep decline in realized selling prices for oil and gas of recent months, the February distribution cut was necessary to enable cash flow to cover capital spending plus distributions, and thereby eliminate the need to take on more debt.

Management now expects a total coverage ratio of 100 percent or less for full year 2009 and debt-to-12-month trailing cash flow is just 0.6. As for the longer term, Enerplus has numerous opportunities to ramp up output when the time is right and conservative finances ensure it will have the means as well. And management has affirmed it intends to be a big-dividend-paying entity long after 2011 taxation. Buy Enerplus Resources Fund if you haven’t already up to USD25.

Paramount Energy Trust could well have been in dire straits as a 100 percent natural gas producer, given the continued plunge in the price of its only product. Management’s policy of aggressive hedging to ensure cash flows, however, continues to pay off richly, as have its recent acquisitions of fresh reserves and strategic dispositions of other assets.

Realized selling prices for natural gas fell only 11 percent in the first quarter year-over-year, less than half the drop in spot prices. And that gap has almost surely widened sharply in the current quarter. The result is a huge hedge-book profit that the trust has been able to monetize for instant cash to pay off debt and increasingly to buy back shares.

One thing I’ve always been impressed with about Paramount is the extraordinary level of detail they provide with regard to projecting their payout ratio and debt coverage, based on various pricing scenarios. The current numbers project strong dividend coverage even at CAD3 natural gas. That’s certainly not reflected in Paramount’s current market valuations. But it is a good reason for those who want an aggressive gas bet to buy Paramount Energy Trust up to my target of USD5.

Peyto Energy Trust’s management decided some time ago that preserving and expanding its reserve base would be a better use of its time and money in a bad market for energy than simply ramping up production. As a result, output slipped another 6 percent in the first quarter versus year-earlier tallies as the trust focused on costs and increased its proven reserve life to 17 years, more than giant ExxonMobil itself.

Net debt was cut from year-end 2008 levels, as the trust accomplished this without issuing significant new capital. In its latest conference call Peyto management stated it can run its gas wells with natural gas at a market price of less than CAD2 per MMBtu. That’s basically half the operating costs of its typical rival, and it points to the trust’s tremendous staying power in an otherwise extremely volatile industry.

Looking ahead, the trust has numerous opportunities to ramp up its output from its huge base of lands and has been biding its time building up its geologic knowledge as well. And management affirmed once again in its first quarter 2009 conference call that it intends to be a dividend-paying entity, either as a converted corporation or even a trust in 2011 and beyond. Buy Peyto Energy Trust up to USD12.

Provident Energy Trust took down some 73 percent of its first quarter funds flow from operations from its midstream unit, assets that generate income based on the price spread between natural gas liquids (as tied to oil prices) and natural gas itself.

Income from these operations is far steadier than that from upstream oil and gas production operations, providing a firm floor for the trust’s finances and distribution, which it covered with a payout ratio of 65 percent.

Upstream operations produced 11 percent less energy year over year, as Provident focused on controlling costs and limited capital spending in line with falling energy prices. Meanwhile, management concentrated its capital spending mainly on new midstream assets, which should create further cash flow stability in coming quarters. Capital spending was recently increased by CAD27 million for 2009 for midstream, basically doubling the original planned outlay.

Net debt was a relatively low 1.6 times trailing 12-month cash flow, which again is steadier than that of pure producer trusts due to the midstream operations. If there is a reason Provident doesn’t yet rate in my “core” producer group, it’s the still-pending lawsuit from Quicksilver Resources (NYSE: KWK) stemming from the latter’s purchase of Provident’s interest in the BreitBurn Energy Partners (NSDQ: BBEP). The latter has since suspended distributions due to falling natural gas prices, and Quicksilver has cried foul on the purchase terms.

At this point there’s been little word on the case, and a settlement is certainly possible. But until there’s more clarity, Provident should be considered more speculative than the core five. Note that the suit is almost certainly a major reason why Provident continues to trade at a discount to other trusts. Provident Energy Trust is still a buy up to USD6 for those who can handle the legal risk.

Vermilion Energy Trust remains one of the three trusts that haven’t cut their distribution once over the past year. The reasons are all in its first quarter numbers.

Cash flow did fall, mainly due to lower realized selling prices for its energy in North America. But sharp gains in Australian production offset lower output elsewhere for a solid sequential output gain from fourth quarter 2008 levels.

And management once again kept the lid on operating costs and especially debt, which it could still zero out and then some once the pending sale of its 41 percent interest in energy developer Verenex (TSX: VNX, OTC: VRNXF) is completed. Net debt came in at just 0.9 times first quarter annualized cash flow, the best number in the industry. Long-term debt stood at just CAD168 million at the end of the first quarter, down from CAD500 million a year earlier.

As I’ve pointed out, one of Vermilion’s principal advantages is its location in European and Australian markets as well as North America. Gas prices especially remain sharply higher outside North America, and the trust has been able to realize sharply higher realized selling prices than its peers because of it.

Management is reported to be looking into a range of acquisition opportunities, which it could do before or after disposing of the Verenex stake. That would certainly put it in position to be more profitable than ever when energy prices do recover from their swoon. The shares have risen sharply this year and have successively broken above a series of buy targets.

As a result, I’m not inclined to raise the buy target again beyond its current level of USD28. But Vermilion Energy Trust is certainly a buy below that price and a worthy holding for even the most conservative portfolios.