Not all oil and gas trusts are the same
As those familiar with my articles know, I estimate a trust's future distributions by considering forecasts of production, sales prices, and expenses, as well as its unique underlying circumstances. Typical assumptions include:
- Total production is forecast based on historical performance and expected future well completions and work overs
- Sales prices are forecast based on NYMEX Henry Hub and WTI futures, adjusted for historical spreads
- Costs (such as operational, transportation, development, lease, tax, and administrative) are forecast separately based on reported historical values and expected future revenues, production, or inflation, as applicable
- A trust's termination, terminal value, share subordination, and passive income from hedges are forecast based on a detailed reading of trust documents and expected production, sales, costs, etc., as appropriate
- Published reserves are explicitly excluded
Using these estimates, I calculate an expected return on investment (or ROI) for each trust given its market value on 3/14/14 and net present values (or NPV) at 8% and 10% discount rates. The table below ranks each trust by ROI.
Source: SEC filings and author's analysis
As shown, there are substantial differences in the expected return rates. While Pacific Coast Oil Trust (NYSE:ROYT) has an expected ROI of 8.8%, others offer much lower returns, including several with negative ROI that suggest that future distributions may fall short of the current market price.
Trust-specific comments and suggestions
Predominantly Gas Trusts
Three of the trusts have income that is primarily from natural gas:
- ECA Marcellus Trust I (NYSE:ECT) is a terminal trust with wells in the Marcellus Shale formation in Pennsylvania. I like ECT's ROI, but investors should note that ECT's trailing yield (19.0%) is misleading and that the trust will not receive any additional wells or work overs; once production is lost, it will not return.
- San Juan Basin Trust (NYSE:SJT) is a perpetual trust with wells in northwestern New Mexico. SJT's estimated ROI is lower than ECT, but, in my opinion, it has lower production risk, due to the age of its wells and the potential for additional well development.
- Hugoton Royalty Trust (NYSE:HGT) is a perpetual trust with wells in Kansas, Oklahoma, and Wyoming. The rise in winter gas prices and HGT's ongoing lawsuits may cause a substantial near-term rise in the trust's distribution. However, dropping production and a $1M/month and growing "overhead" charge, are bad news for buy-and-hold investors. Those considering long positions in HGT may wish to look at SJT, instead.
Perpetual Oil Trusts
Two trusts have income primarily from oil production and have no fixed termination date (so-called "perpetual" trusts):
- ROYT has wells in southern California operated by a subsidiary of BreitBurn Energy Partners, LP (BBEP). I like ROYT; it offers a trailing yield of 13.3% and expects to receive additional revenues from a long-term well development program.
- Enduro Royalty Trust (NYSE:NDRO) has wells in Texas, Louisiana, and New Mexico operated by Enduro Resource Partners. Last year, NDRO's substantial well development program didn't do much for production. A new program is now under way, but unless the total production numbers start to rise, ROYT appears to be a much better alternative.
Terminal Oil Trusts
Five trusts are terminal oil trusts, including three operated by SandRidge (NYSE:SD) and two affiliated with Vess:
- VOC Energy Trust (NYSE:VOC) has wells in Kansas and Texas. VOC's ROI is 7.6%, which is 3rd-best among all trusts. However, those considering an investment should note that VOC's royalties will expire in Dec. 2031 and yield no terminal value. The higher trailing yield (13.1%) and terminating royalty could cause VOC to have greater fluctuation in market price than other trusts. I like VOC at prices under $15.
- SandRidge Permian Trust (NYSE:PER) is a SandRidge trust with wells in Texas. PER still has a substantial number of wells that will be added, but the distribution is likely to stay flat and then decline precipitously. I like PER for near term distributions and have a long position acquired at a lower price, but investors should be aware that PER is not likely to hold its market value over the medium term.
- SandRidge Mississippian Trust II (NYSE:SDR) is a SandRidge trust with wells in the Mississippian formation in Oklahoma and Kansas. SDR still has additional wells to be completed, but the performance of the existing wells has been abysmal (see my SDR article). At this point, SDR investors may wish to consider PER, which is a similar trust but has better valuation.
- MV Oil Trust (NYSE:MVO) has wells in Kansas and Colorado. Like VOC, MVO offers $0 terminal value and a trailing yield around 13%. However, MVO is set to expire 5 years earlier than VOC and, as a result, has a negative ROI. MVO should be considered a gamble, not an investment. Those considering MVO may wish to look at VOC, instead.
- SandRidge Mississippian Trust I (NYSE:SDT) is the third SandRidge trust and has wells in the Mississippian formation of Oklahoma and Kansas. While SDT, like its brethren, has had terrible well production, it is in worse shape because it has already received its full allotment of wells. PER is a similar alternative with better valuation.
Disclosure: I am long ECT, PER. 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 may initiate long positions in VOC, SJT, or ROYT depending on market price fluctuations during March/April.