swanlinbar
6年前
BP Prudhoe Bay Royalty Trust: On Death Row
Jun. 12, 2019 10:28 AM ET|15 comments | About: BP Prudhoe Bay Royalty Trust (BPT)
Guy Whitehead
Guy Whitehead
Long/short equity, value
(138 followers)
Summary
At the current West Texas Intermediate crude price, BP Prudhoe Bay Royalty Trust (BPT) will stop payouts after January 2020.
As long as the WTI price stays under the 2020 “death line” of $55.05, WTI fluctuations have little effect on BPT’s intrinsic value.
Investors do not seem to recognize the serious risk to share price if WTI fails to rise.
The likely share value at dissolution is likely to be about zero.
It is a terrible long term investment for all and some investors may find it an attractive short.
BP Prudhoe Royalty Trust (BPT) is facing a severe crisis. Every year, the costs assigned to shareholders increase substantially by a formula. The recent severe decline in oil price means that payouts will be zero in 2020 at the current WTI oil price and two years later the Trust will dissolve.
In the fable of the boy who cried wolf, a boy kept shouting that a wolf was coming so that he could get attention. Eventually, the villagers ignored him; the wolf actually did come and ate the hapless lad. Over the years, whenever the price of oil drops some predict the imminent demise of the BPT trust. Each time a rally in oil prices has saved BPT from extinction (although the share price has dropped from $100 to $20 over the last few years.) Will BPT escape once again? Or not? I suspect not and am short BPT via long term put options.
The BPT Trust is structured so that costs are contracted at an increasing rate each year. This formula is in the Trust contract and has no relation to real costs of production. These costs of production and Alaskan taxes are subtracted from the average WTI for the quarter and the difference is paid out to share holders. If the costs are greater than the WTI price, no payment is made that quarter. After two years of no payments, the Trust dissolves. Any BPT investor should carefully review the BPT 10K.
The 10K is available at SEC Filings | Prudhoe Bay Royalty Trust Investor Center. Pages 6-9 discuss calculation of costs, pages 4-5 discuss conditions for termination of the Trust, and pages 15-31 give a comprehensive review of risks facing the Trust. Daily WTI prices are available at the Bloomberg site under "Markets". Historical WTI prices (useful for estimating the payout for the end of a quarter) can be found at investing.com. The costs for Trust are approximately:
2019 $49.30
2020 $55.05
2021 $60.93
2022 $66.92
A simple formula for calculating the annual pay out for a given WTI oil price is
[(WTI - Costs) x 5398481] / 21.4 million. Divide by 4 to get the quarterly payout.
This permits you to estimate the pay out for any WTI scenario in a given year.
With this year’s bear market in oil, the WTI price is below the contracted cost for year 2020, which means no payouts at all starting in 2020 unless oil prices rise.
We can calculate the pay out for the rest of the 2019 based on any given WTI oil price. The benchmark for 2020 is $55.05 (assuming full production of 90,000 barrels per day which has not happened in years.)
The WTI tonight is $54.00. For the rest of 2019, this price will produce a total payout of $1.23 for 2019, and then payouts should stop. With the share price of BPT at $18.18, investors do not seem to recognize the severe risks in holding BPT. Share price - intrinsic value = a loss $16.95 at current oil prices. The July payout if WTI oil price persists at $54 will be 57-64 cents, depending on production.
If the WTI rose tomorrow to $60 and remained there, the total payouts would be $2.59 before the Trust stopped payments in 2021. These are hypothetical scenarios but give a clear look at what changes in oil prices will do for BPT. In the case of an immediate rise to $60, not much.
Investors seem to drive the share price of BPT based on small changes in oil prices. In this situation, that is irrational. Fluctuations in the WTI price below the 2020 “death line” actually have little effect on the intrinsic value of BPT. The total pay outs at WTI $54 is $1.23. If the WTI averages $51 for the rest of 2019, the payouts total $0.80. Either is a complete disaster for a BPT share holder. It’s like a drowning man worrying about whether he is 20 feet or 30 feet below the surface of the water.
The only salvation for BPT shareholders is a dramatic increase in oil prices. Bullish factors could include war in the Persian Gulf, an end to trade wars which would increase global confidence and growth, or a reduction in US oil production. Bearish factors could include increased US production as drillers here produce more to compensate for the decreased price of oil, a continued slackening in global oil demand, and a continued decline in Saudi Arabia’s ability to control oil prices.
I do not pretend to know the future of oil prices. But it is clear that if oil prices drop, BPT is doomed. If oil prices stay where they are today, BPT is doomed. Only if oil prices increase dramatically could BPT's market value be salvaged. If you strongly believe oil prices will rapidly increase soon, you would make much more money buying oil futures or the USO fund than BPT (which is wildly overvalued at current oil prices).
There have been frequent arguments on SA on the value of the BPT trust at termination. It is very likely to be virtually zero. The 10 K states that the sole purpose of the purpose of the Trust is owning and administering the Royalty Interest. The Royalty Interest value at termination should be zero unless the total Royalty Interest income for the year is between 0 and $1 million (not enough for pay outs to shareholders.) This would produce a value of 4 cents to 25 cents per share, depending on whether BPT exercised its option to buy and what an investment bank consultant would value the Royalty Interest at termination. The Trust is currently withholding a very small percentage of pay outs to cover costs of termination, which I take as a hint of their expectations (see page 4 of 10K). If anyone has a definite logical estimate of a higher valuation at termination that would make current share holders break even (e.g. $17), it would be great to hear it here.
Straightforward short selling has problems. The short seller is liable for the dividend pay outs, and these can be significant. Also, the short seller faces short term risks such as war in the Persian Gulf which is quite possible. A spike in oil prices and BPT share price could be absolutely disastrous for a short seller. Also, the borrowing costs for shorting shares of BPT are significant, as previous articles have highlighted.
Puts for BPT have a significant spread and are costly. Nevertheless, given the potential for a major decline in the BPT share price, long term puts are the path I have chosen. I currently have puts for December 20 2019 with a strike price of $20. I would have preferred January, but they were not available. If BPT maintains its current price while the WTI price drops below $49, I will probably add OTM shorter time puts in anticipation of a share price collapse. Eventually reality takes hold, even with BPT. If USO drops to 10 (unlikely) I will probably buy 2 USO calls @ 11 December 20 2019 for every BPT put. This would guarantee a profit on USO if the WTI started to rise toward crossing the "death line" and would hedge my BPT puts at a low cost. In any case, BPT puts are expensive and have the risk of a complete loss if the oil price spikes. Therefore, BPT puts are a very small portion of my portfolio.
Summary
At current oil prices, BPT is a tremendously overvalued security. Either the shareholders are supremely confident of a major oil price increase or they are mesmerized by the trailing dividend yield of 22% and don’t understand at all how BPT works and its risks. While BPT has dropped 80% in the last decade and shorting it can still be considered.
Good Luck to all Investors. Read the 10K!!!
Disclosure: I am/we are short BPT. 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: I am short BPT with long term put options. IF the USO price should decline, I may purchase USO calls as a hedge.
I am not an investment adviser and do not offer investment advice. All investors should do their own research and due diligence, especially a careful reading of the BPT 10K.
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