Canadian Oil and Gas Royalty Trusts Pay Hefty Cash Distributions

If you are looking for high income, consider a Canadian royalty trust that sells oil and gas from its proven and probable reserves. The trust pays shareholders a large percentage of its free cash in the form of cash distributions (dividends). Typically, the yield is in excess of five percent.

One downside of a royalty trust is that eventually it will run out of oil and gas so before you buy one, check the reserve life of the trust's holdings. Look for a reserve life of at least ten years and the longer the better. Of course a trust can purchase new reserves but there is no guarantee of their life span.

A trust pays its distributions from free cash flow (net income plus depreciation minus capital spending). Compute the ratio of the distribution with the cash flow. A small percentage means the distribution can be maintained or increased. Beware of a large percentage of 90 percent or more.

The day-to-day price of a trust usually tracks the price of oil and natural gas. When oil and gas prices fall, the share prices of most trusts will fall. Unlike a bond that pays you full face value when it matures, the future price of a royalty trust is not guaranteed.

IMPORTANT NOTE: Before investing in these trusts, check with your tax advisor about the tax treatment of the cash distributions.