Owning Oil in Royalty Trusts

Includes: BPT, DTO, SBR, SCO, SJT, UCO
by: Bruce Vanderveen

The price of oil is again dramatically down, with lots of volatility. On January 13 WTI Crude dipped below $37 only to bounce back above $39 the next day. You can make — or lose — a great deal of money fast by trading the relevant Exchange Traded Funds (ETFs) and Exchange Traded Notes (ETNs). See UCO, SCO, DXO and DTO. If this is your cup of tea (I mean java), you like lots of excitement and are a market timing whiz, take this route. Your brokerage firm will love it.

However, for those of us who like to sleep at night, there are alternatives. Cash or the US dollar is a good safe place when oil prices seem high. Or you can pick up oil royalty trusts, when prices are down. There are both Canadian and US trusts available. The trusts are obligated to pay out most of their earnings in dividends, 7-13% is typical. The high dividends keep them from jumping up and down as much as the ETFs and oil stocks

Dividends track oil prices, so today's low oil prices may be a good time to purchase the trusts. Keep in mind that trust income often comes from fields which are in decline, meaning every year they may produce less oil. That is not a problem if unit price rises. Most depletion schedules go out some 10-20 years. Since all the action now is short term, I don't look at depletion as a major concern. Also, newer technology, such as horizontal drilling, coaxes more and more oil and gas from existing wells than ever before, so potential reserves may rise.

As far as I know, world governments haven't yet figured out how to print barrels of oil. Oil royalty trust reserves are buried treasure which you don't need a map for. Again, while it is true that lower oil prices will bring lower dividends, you have a proven asset. These assets are valued in paper units — dollars — which may be printed in large quantities in the near future. We will have more and more dollars chasing less and less oil. You will want to hold the oil, not the dollars.

Royalty trusts have special tax considerations and may do best in deferred tax retirement accounts, so consulting your CPA is a good idea. Here are some oil trusts to get you started: BP Prudhoe Bay Royalty Trust (NYSE:BPT), Permian Basin Royalty Trust (NYSE:PBT), San Juan Basin Royalty Trust (NYSE:SJT) and Sabine Royalty Trust (NYSE:SBR).

Disclosure: Author holds long positions in SCO and BPT