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Summary

  • Royalty trust ROYT is down due to a pending ballot which jeopardizes its business.
  • ROYT options are not pricing this in, as volatility is around 30.
  • ROYT is now trading at .8 x PV-10 versus peers of 1.5x. Dividend yield approaching 20%.

ROYT has dropped from 13 to 10.4 in the past couple of days. Reason is due to an anti fracking measure which goes to the ballot in November 2014. Since ROYT's properties are onshore in the Santa Maria and Los Angeles basin, this could be seen as a ballot on ROYT's business. It uses hydraulic and steam fracking techniques, which are part of the ballot. Link pertaining to the ballot:

www.independent.com/news/2014/jul/15/sta.../

This article mentions Jan of 2015 but I believe it to be in November of 2014 based on ballotpedia:

ballotpedia.org/November_4,_2014_ballot_...

The March expiration will cover both.

If the ballot does not pass, ROYT is a perpetual trust that deserves to trade at a premium to PV-10, like other perpetual trusts. Its PV-10 currently is around 470mm, and with no legal issues ROYT should be trading around $14 and higher. ROYT is trading at .8x its PV-10, whereas its perpetual trust peers trade around 1.5x PV-10. At current levels we are looking at close to a 20% dividend yield.

This event is much like a biotech FDA event: it will make or break the trust. The options are not pricing this in yet. Dec and March 12.5 are trading at 10 cents and 15 cents. This is around a 30 vol. Dec and March 10 puts are trading at a sub 30 vol. Both represent great value.

I personally believe the ballot will not pass, and very much like the risk reward profile of the calls, but vol players should look at both. I have no legal edge in this. A prior fracking moratorium bill was defeated in May (S.B. 1132) with support from democrats and Governor Brown. I also believe the upside move can be larger than the downside move. The main risk for ROYT are its steam recovery wells. We can see from its productive zones that it is a minority:

Productive Zone

Recovery Method

Working Interest

Net Revenue Interest

Monterey / Point Sal

Waterflood

94

%

89

%

SX Sand

Waterflood

100

%

100

%

Diatomite

Cyclic steam

100

%

100

%

Careaga

Collection

100

%

100

%

Field

Operator

Recovery
Method

Working
Interest

Net Revenue
Interest

West Pico(1)

PCEC

Waterflood

95.4

%

78.5

%

Sawtelle

BBEP

Waterflood

37.6

%

29.0 - 30.5

%

East Coyote

BBEP

Waterflood

37.6

%

35.2

%

This is roughly a third of production. Hence I am partial to the calls, but I mainly believe that future realized volatility will be higher than what is priced in currently. Similar trust blowups (VOC and HGT) led to extended periods of 70+ realized volatility and 60+ implied vol.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Long ROYT volatility