With the fiscal cliff drama behind us, I have decided to reexamine my thesis on BP Prudhoe Bay Royalty Trust (BPT). The article will delve into the three main categories that have impacted share performance along with their expected impact going forward. At the end of the article I will detail what I believe to be the two main risks to BPT's very generous dividend and the likelihood of it being dramatically reduced.
With the fiscal cliff uncertainty behind us, BPT has risen quite substantially since January 1st, broadly outpacing the market. It is my belief the negotiations scared investors causing some liquidations at what I believe to be less than advantageous pricing. If we examine the deal, the impact on BPT is nil. The dividend was never classified by the IRS as an ordinary dividend eligible for the fifteen percent tax levy. Effectively, if the shares were held outside of a tax sheltered account the dividend was treated as income subject to the holder's income tax bracket.
The fiscal cliff uncertainty also caused significant uncertainty in regards to the treatment of long term capital gains. Long term holders of BPT shares have significant capital gains accrued and may have decided to lock in their gains at a lower tax rate that what may have been available in future years. With the resolution of the cliff and more certainty as to future tax rates the downward pressure on shares should abate.
BPT is a royalty trust designed to give trust holder's a quarterly royalty stream based on the production from the trust owned field. The following excerpt taken from the most recent 10-K sums up the trust. "The Royalty Interest represents the right to receive a per barrel royalty (the "Per Barrel Royalty") of 16.4246% on the lesser of ((A)) the first 90,000 barrels of the average actual daily net production of oil and condensate per quarter or ((B)) the average actual daily net production of oil and condensate per quarter from BP Alaska's working interests as of February 28, 1989, in the Prudhoe Bay field situated on the North Slope of Alaska (the "1989 Working Interests"). Trust Unit holders are subject to the risk that production will be interrupted or discontinued or fall, on average, below 90,000 barrels per day in any quarter.
The distribution paid out for October was for $1.82 per royalty trust share based on production of 66,592 barrels per day. The significant drop in the amount of barrels produced per day was due to scheduled maintenance on the field and not from a sudden decline in oil field vitality. The trust recently announced a fourth quarter payment of $2.31 per share based on production of 92,595 barrels per day. Production levels are comparable to what has been produced quarterly for the last 4 years and are well over the 90,000 barrel per day maximum level. Granted the trust's production will begin to decline at some point in the future, it seems that time is at least a few years away.
The third and most critical aspect for the future of the trust is the ability of the price of West Texas intermediate crude to remain at these levels or rise. As we can see from the chart above, the price of oil collapsed in 2009 along with the world economy. The trust was able to pay a dividend of $3.04 per share in March of 2008 only to see the payout shrink to $1.63 per share in March of the following year. A collapse in demand for oil across the world will prevent the trust from paying high dividends. The risk of oil prices is the main risk in owning shares of the trust. Barring a long term collapse in price the trust should be able to generate hefty dividends going forward.
A second risk for the trust is maintenance or any type of shutdown to operations. Any sort of temporary shutdown to the operation will impact distributions, however they should be short lived. An example of this is the recent shutdown for summer maintenance. The shutdown caused a decrease in production to less than 70,000 barrels per day which caused a smaller payout than anticipated. As we can see from the recent dividend announcement operations are back to normal.
In summary my original bullish thesis on BPT remains intact. The fiscal cliff drama in my opinion has caused the equity to decline to an attractive level for long-term shareholders. In a time of paltry bond returns, BPT offers an attractive yield with the potential for some future increases based on the price of oil. Thank you for reading and I look forward to your comments.
Disclosure: I am long BPT.
Additional disclosure: Thank you for reading the following article. The article is intended for informational purposes only and is not actual investment advise.