As those familiar with my articles know, I forecast the value and future distributions of various oil and gas trusts. This article presents a comparison of 13 trusts, given forecasts of their future performances.
Underpinning my analysis are models that I’ve developed to forecast the future performance of oil and gas trusts. Each model estimates the future distributions of a trust based upon tailored forecasts for each element of that trust’s income statement, including production volumes, sales prices, production and capital costs, administrative fees, and financing charges.
Based on the output of a model, I compute various estimates for the value of a trust. Three value metrics tend to dominate my decision-making. The first is the net present value (NPV) of future distributions, which I compute at one or more discount rates. The second is the adjusted NPV-10, based on assumed production volumes and costs from a trust’s published reserve report. The third is near-term forward yield, which is determined by dividing forecast future distributions into the current market price.
Each model is based on public information and my own unprofessional judgement. Where possible, I favor transparency, so if you would like to know a trust-specific assumption, just ask.
Assumed Oil and Gas Prices
No one assumption affects the value of a trust more than oil and gas prices. So, before jumping into the valuations, let’s quickly review recent prices. For oil, West Texas Intermediate (WTI) recently traded at ~$60/bbl, within its six-month range of $50-63/bbl. NYMEX oil futures show a slow decline to ~$54/bbl. For gas, Henry Hub (HH) recently traded at ~$2.30/mcf. That’s at the bottom of its six-month range, which peaked around $4.00/mcf. NYMEX gas futures show a decline in 2019 and then a gradual return to ~$3/mcf, with seasonal variation.
Fig. 1: Oil and gas prices used by the model and implied oil price premium. Source: NYMEX and author's analysis.
For most trusts, I view the recent price curves for oil and gas as bearish signals.
July 2019 Valuations
The table below presents a comparison of 13 trusts, based on a variety of different metrics.
Fig. 2: Trusts ranked by IRR. Source: Yahoo Finance, SEC filings, and author's analysis. Columns with an "M" are derived from the model's forecast; those with a "T" from the trust reserve reports.
Predominantly Gas Trusts
- Top of the pack is Sandridge Mississippian Trust II (SDR), which was a terrible investment at $0.95 but appears to be a long opportunity under $0.82. The "sandito bandito" experienced a massive selloff in early June, when large-scale holders exited in anticipation of an upcoming delisting. If you don’t mind holding through this tumult, I’d expect prices to stabilize in the range of $0.75-0.95 - with the 19% forward yield attracting unassuming retail investors. The key risk is that my rationale for the selloff is bogus and there is a nasty surprise ahead.
- The model says San Juan Basin Royalty Trust (SJT) is a buy under $3.35. SJT is down substantially from its traditional price range of $6-8, but distributions are down as well... and there are lots of reasons to be skeptical of the future; SJT’s proprietor has announced a massive CapEx program, gas prices are comparatively low, and the spread between HH prices and SJT's sales price is historically high. When the model puts these three together, it says SJT may not pay again until mid-2020! The risk to a long position is that the distribution never recovers, sending SJT permanently lower. Short candidate.
- Sandridge Mississippian Trust I (SDT) is just SDR, part une. The model suggests that SDT’s production declines make it less appealing than SDR, but the differences are within historical variance. I expect a reversion to the mean and a similar return to a price range of $0.75-0.95. Same opportunity and key risk as SDR.
- ECA Marcellus Trust I (ECT) appears to be a buy under $1.42, well under the $1.72 is recently traded at. At current prices, there is a great trailing yield, but the forward yield is a disappointing 8.9%. Would you be willing to hold this capital-destroying asset for an 8% yield? Didn't think so. Short candidate.
- Hugoton Royalty Trust (OTCQX:HGTXU) is a grumpy old gas trust that is hanging on... barely. It hasn’t paid in months, has a massive debt overhang, and is about to enter a potentially crippling litigation. Oh, and the proprietor, XTO Energy, is ripping off unit holders to the tune of $1 million a month for “admin”. That said, would the big buyer who bid this up to $0.52 please message me? I’m always interested in hearing different perspectives.
Perpetual Oil Trusts
Three trusts have income primarily from oil production and have no fixed termination date (so-called "perpetual" trusts).
- Permian Basin Royalty Trust (PBT) offers a paltry, sub-10% yield and a pitiful 2.8% long-term IRR. The model says buy under $3.53, but doesn't flag any near-term reasons why the market might change its opinion - so, holding this is merely a bet on long-term oil prices. But why bother when there are so many other better options?
- California-based Pacific Coast Oil Trust (ROYT) continues to chug along. However, declines in both oil prices and production have kept the lid on distributions and dampened optimism. The model suggests that the distribution is not sustainable at current levels, so without a fundamental change in the market or well performance, I'm looking for a retrenchment under $2. I’m long since $1.50, but reducing. Key risks to a long position are production volumes, decline spread to WTI, and operator shenanigans.
- BP Prudhoe Bay Royalty Trust (BPT) is the Alaska-based granddoggy of all trusts. It’s grossly overvalued, but everyone knows that, so there's no informational asymmetry. The key risk of a bet on this trust is that you are not nearly as smart or as clever as you think you are.
Terminal Oil Trusts
Five trusts are terminal oil trusts:
- VOC Energy Trust (VOC) is an oil play with multiple properties operated by VOC Brazos. Although, at current prices, the trust has a decent trailing yield, the likely effect of future production declines and a 2030 termination date make it not much better than a savings account. The model says it's only a buy under $3.71, but I've been known to take an occasional flyer/short when this swings on low volatility.
- Chesapeake Granite Wash Trust (CHKR) is another oil-focused play, though the story here is gas. CHKR’s disappointing oil production and steep discount to Henry Hub gas prices mean that low gas prices can result in negative sales prices. The model says go long under $0.63, but with its 2019 selloff, I suspect there's a bounce before the next distribution.
- SandRidge Permian Trust (PER) is an oil play focused on West Texas. PER also experienced a 30% selloff since April, but the 15% one-year forward yield suggests to me that somebody is going to chase this back up to $2. The key risk is that the selloff was a sign that bad news is coming.
- MV Oil Trust (MVO) is an MV Oil and Vess-operated trust with wells in Kansas and Colorado. Same story as VOC, PER, and CHKR - MVO is a terrible investment long term, but could bounce in the short term due to yield chasers. Anyone want to wager this dog hits $9? The key risk to a long position is that the yield chasers make a different losing bet.
- And then there is Whiting USA Trust II (OTC:WHZT). This former champion has crossed back - way back - into overbought territory. For safety purposes, the model assumes that the proprietor increases CapEx to the maximum allowed by contract; in which case, WHZT is worth $0.85. The best-case scenario at current oil/gas prices is that WHZT barely pays out what you put in. Plus, the trust is OTC and illiquid. I'll pass, my friend, but will always remember you fondly.
Lots of interesting plays coming into the Q2 distribution announcements:
- SDR and SDT selloffs may have been forced selling due to a likely delisting. If that’s the case, I expect further rebound in late July, with 40% upside.
- PER... another selloff story, but with less confidence. 10-20% upside with the next distribution announcement.
- The ROYT fan club keeps dreaming of $3, but distributions are heading back under two cents. I’m taking profits and hoping for a reentry at $1.80, for a 20% gain.
- The SJT forecast suggests it may not pay again until 2020. Options are an inexpensive way to short and offer 50-80% upside once folks realize that it won't be paying for a while.
- The always overbought oil suite (MVO, VOC, CHKR) is already on the upswing, but each could gain another 10%+ in coming weeks with good distributions (which the model seems to think are coming... meh, it's just math).
- BPT is always good for a volatility ride. I suspect folks will be willing to overpay at $17.
There is no free market for oil.
- T. Boone Pickens
Disclosure: I am/we are long BPT, CHKR, ROYT, PER, SDR, SDT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: And short SJT