VOC Energy Trust (VOC) went public on May 5, 2011. Unitholders are entitled to 80 percent of the net profits from a series of 881 wells located in Kansas and Texas.
In 2010 VOC Energy Trust’s underlying properties produced about 2,547 barrels of oil equivalent per day, 90 percent of which was oil. About 60 percent of the trust’s total production currently comes from its wells in Kansas.
Unitholders’ interest in the trust’s net profits will terminate on the later of these two dates: Dec. 31, 2030, or when the underlying fields have produced a cumulative total of 10.6 million barrels of oil equivalent output. Once either condition is met, the trust will dissolve and cease to exist. All rights to these fields reverting to the trust sponsor, the privately-held VOC Energy Partners LLC.
VOC Energy Trust focuses on mature fields that entail little to no exploration and development risk. On average, the fields in the VOC Energy Trust have been in production for more than 38 years; the sponsor has a long history of well data to draw on when it estimates the rate at which production will decline.
In addition, the work needed to maintain output from mature fields is relatively inexpensive, and the trust won’t be exposed to the big cost increases that operators in a number of shale fields have faced in recent years. The trust’s prospectus estimates production expenses at $19.21 per barrel of oil equivalent. The operator and its predecessor, Vess Oil, have about 30 years of experience in Kansas and a shorter history in Texas, so management knows the ropes.
The sponsor is entitled to receive the 20 percent of the net proceeds not distributed to public unitholders. In addition, VOC Partners has retained about a 25 percent position in the trust units. Combined, these stakes are a powerful incentive for management to operate the wells in a way that maximizes value for unitholders.
In addition, the operator of the wells intends to do significant low-risk development, particularly around its Texas wells. With these enhancements, management believes that the trust’s production will grow in the near term and slow the rate of decline over the next few years.
In particular, the sponsor plans to spend about $2.5 million drilling and completing 13 additional wells in its Kansas properties. The trust already has 742 wells in Kansas, and these new wells will be low-risk infill drilling opportunities. Infill drilling refers to new wells drilled in between wells that are already in production.
In addition, the sponsor intends to spend another $0.7 million on well recompletions and workovers. In a recompletion, the operator might decide to extend an existing well to a deeper depth to target another productive layer of oil-bearing rock. Alternatively, the operator could plug a portion of the well and then produce hydrocarbons from a shallower formation. Workovers involve performing maintenance work on wells to improve the rate of production or remove obstructions.
In east Texas, the sponsor intends to spend $22.5 million drilling and fracturing horizontal wells in a formation called the Woodbine C sand. The sponsor firm had already drilled four horizontal wells in this formation prior to forming the trust. These wells featured a relatively short lateral segment of 3,000 feet.
Readers of InvestingDaily.com should be familiar with the rapidly growing oil and gas output from unconventional plays such as the Bakken Shale and the Eagle Ford Shale of south Texas. (For a refresher, check out Rough Guide to Shale Oil from Oct. 20, 2010.) To liberate hydrocarbons trapped in shale and other tight reservoir rocks, producers use two key innovations: horizontal drilling and hydraulic fracturing.
Horizontal drilling involves drilling laterally off of a traditional vertical shaft to increase the well’s exposure to the productive portion of the formation. Hydraulic fracturing involves pumping a liquid into a well to crack the reservoir rock and facilitate the flow of oil and gas through the field and into the well. In the nation’s most prolific shale plays, producers are drilling incredibly complex wells that can involve 30 or more fracturing stages and lateral segments that measure more than 12,000 feet in length.
Horizontal drilling and hydraulic fracturing can also enhance the output from mature fields. For example, producers have used these methods with great success in the Permian Basin of west Texas, an area that’s been in production for more than 50 years. VOC Partners has drilled some horizontal wells in its Texas acreage that have yielded solid production rates. This low-risk strategy should provide a modest boost to the field’s output in the near term. The sponsor also plans to spend another $1.5 million or so doing basic recompletion and workover projects on the Texas wells included in the trust.
Members of VOC Partners’ management team were also involved with MV Oil Trust’s (MVO) IPO in 2007. Falling commodity prices hit MV Oil Trust hard in 2008, and SemGroup Corp (SEMG), the company that handled the trust’s oil marketing and sales, declared bankruptcy during the credit crunch. But MV Oil Trust has recovered from these setbacks, and the units now trade at roughly nine times their 2009 low and about double the IPO price.
MV Oil Trust has successfully employed some of the same techniques that VOC Partners plan to use to slow production declines from its mature wells. From January 2007 until the end of 2010, MV Oil Trust’s output has declined just 8.3 percent, from 2,859 barrels of oil equivalent per day to 2,621 barrels of oil equivalent per day--an impressive performance.
VOC Energy Trust should also benefit from a hedge book that covers about 61 percent of its planned production from 2011 to mid-2014. Under the terms of these contracts, oil prices are hedged at $94.90to $102.15. After June 2014, VOC has no hedges in place and isn’t authorized to take on new hedges; at that point, the trust’s exposure to oil prices increases significantly.
VOC Energy Trust has disbursed two dividends thus far in 2011: a payment of $0.86 per unit that covers the first half of the year and a payment of $0.56 per unit for the third quarter. Unitholders received distributions that covered the period beginning Jan. 1, 2011, even though the trust didn’t go public until May. For now, the trust is on track to meet its first-year distribution estimate of about $2.09 per unit. Given the inherent volatility of commodity prices and the fact that VOC Energy Trust doesn’t fully hedge its output, investors should be prepared for significant quarterly volatility in distributions.
Additional production from the drilling projects mentioned earlier should begin to kick in during 2012. The company’s oil hedges also jump to more than $100 per barrel next year. Barring a collapse in oil prices, VOC Energy Trust should pay out about $2 per unit annually, equivalent to a 10 percent yield at current prices. Although these distributions eventually will diminish with production, the decline rate should be slow. A spike in oil prices after 2014 could also provide significant upside.
All told, VOC Energy Trust is an attractive play on oil prices that offers a high current yield.