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Introduction

The Treasure Island Royalty Trust (OTC:TISDZ) is owed an overriding royalty interest "ORRI" on several lease blocks in the shallow waters of the Gulf of Mexico, see figure 1 below. Since its inception in 2002, the trust has yet to produce any distributions for TISDZ unitholders, however recent events are providing optimism for unit holders that royalty income may start trickling in by the beginning of 2013. This article aims to provide readers with a detailed Net Asset Valuation of the trusts ORRI at several key properties including Blackbeard East "BBE", Blackbeard West "BBW", and Lafitte.

TISDZ Lease Blocks BBW BBE Ship Shoal Lafitte
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Figure 1, TISDZ royalty interests. Data taken from Treasure Island quarterly reports. Chart created by James Duade.

Current Resource Potential Found on Treasure Island Lease Blocks

As the reader can see below in Figure 2, the current resource potential found on Treasure Island lease blocks is 7 Trillion Cubic Feet of Energy "Tcfe". The resource potential is broken down in this way:

Blackbeard West- 4.4 Tcfe (Miocene 2.4 + Oligocene 2.0)

Blackbeard East- 1.3 Tcfe (Miocene 0.8 + Frio 0.5)

Lafitte- 1.3 Tcfe (Miocene 1.3)

The lease blocks in which Treasure Island has an interest are all being drilled by McMoran Explorations (NYSE:MMR) and Energy XXI (NASDAQ:EXXI). Images from a recent investor presentation are used in this article in order to help illustrate the location and progress of the McMoran wells drilling on TISDZ lease blocks. Readers can review the presentation at the following link.

As McMoran is currently drilling at Blackbeard East, Lafitte and Ship Shoal 188, there is a good chance that additional resource potential will be found. This topic will be discussed in a little more detail later on. For the purposes of this article, all valuations assumed that no further resource potential would be discovered on the above lease blocks.

TISDZ McMoran Resource Potential
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Figure 2, McMoran Ultra Deep Resource Potential, Source McMoran Presentation December 2011.

Clarifying the Trusts G&A Costs And its Impact on Future Cash Flow

As no production has occurred on Treasure Island lease blocks since the trust's inception, the trust has been dependent upon loans from Newfield Exploration Company (NYSE:NFX). As the reader can see from Figure 3 below, the trust has borrowed $663,847 and incurred interest of $244,520. The yellow cells in the figure below illustrate projections put together by the author indicating what TISDZ may owe up until the end of 2013. The projection has stopped after 2013 as in the author's opinion the trust will likely be generating revenue at that point, and will be able to start paying off its debts to Newfield. An additional assumption made by the author was that annual G&A costs would be $65,000 till all loans and interests were paid off to Newfield.

TISDZ Borrowing and Interest To Date
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Figure 3, TISDZ borrowing and Interest. Chart created by James Duade. Data obtained from recent TISDZ quarterly reports.

An attempt was made by the author to model out a projected payoff of TISDZ borrowing and interests to Newfield. According to the Trusts Annual report, up to 8% of TISDZ revenues can be used by the trustee at his discretion to pay for General and Administrative "G&A" costs, to pay off loans and interests (i.e., the Newfield loans described above), or to set aside cash reserves to smooth out future distributions to unitholders.

As readers will see in figure 4, the payoff of the Newfield loans and interests is clearly sensitive to natural gas prices, and could occur as soon as December 31st, 2015 if natural gas prices average $5 an Mmbtu. The below chart illustrates the funds available to the TISDZ trustee, which will be used to pay off the Newfield borrowings. For instance, the $14,251 in the highlighted yellow cell actually represents 8% of TISDZ revenues at $3 Natural Gas minus $65,000 used for normal trust operations. Regarding the total amount owed column, see below for an example of how this was calculated.

TISDZ Total Amount Owed Example

  • (Total Borrowing&Interest * Annual Interest Rate)-Funds available to pay off loans
  • ($1,217,689 * 1.08)-$252,003= $1,063,101

The green cells in the figure below indicate when the trust will have paid off its loans to Newfield. Once the loans to Newfield are paid off then extra funds will be available to the trustee to distribute to unitholders. In the following valuation charts below it is assumed that after the Newfield loans are paid that 2% of TISDZ revenues will be set aside by the trustee in order to cover trust expenses.

TISDZ Projected Loan Pay Off
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Figure 4, Projected loan and interest pay-off. Chart created by James Duade.

Valuation Assumptions

Key assumptions for the following valuations are described in Figure 5 below. It should be emphasized that these are assumptions, and that once the trust begins producing natural gas they will need to be re-examined in order to see how accurate they are. As the below figure indicates, a flow rate of 75,000 Mmbtu's per day are expected to be produced per day, per well. Wells are expected to be added at a rate of 1 per year after production begins in each area. Readers can look at a year by year production schedule for BBE, Lafitte, and BBW in the valuation charts below.

One further clarification on TISDZ revenues: revenues for the trust were calculated net of the 3.5% transportation and marketing expense, and the G&A withholding of up to 8%. See below for an example.

TISDZ Distributable Income Example

  • ORRI*(((Mmbtu production per year * $per Mmbtu)*100-Transportation and marketing)*100-G&A withholding of up to 8%)
  • .0125*(((27,375,000*$3)*.965)*.92)= Distributable trust income of $911,382
  • TISDZ Valuation Assumptions


(Click to enlarge)

Figure 5, Valuation assumptions. Chart created by James Duade.

Blackbeard East Valuation

As described in Figure 2 above, Blackbeard East has resource potential of 1.3 Tcfe located in Miocene and Frio aged sands. The BBE well is located on the South Timbalier 144 lease block and sits atop approximately 80 feet of water. As the reader can see from Figures 6, the BBE well is currently drilling around 33,000 feet, and McMoran is targeting a depth of 34,000 feet in hopes of finding additional resource potential in the deeper and older sands below.

TISDZ BBE Property Map

Figure 6, Blackbeard East & West lease blocks. Source, McMoran's December 2011 Presentation

Readers can look at a cross section of the well in figure 7 below. The small red asterisk shapes indicate areas where resource potential is thought to be located. It should also be noted that TISDZ only has a 1.25% ORRI for the South Timbalier 144 lease block, and will not receive royalty income from other nearby lease blocks like that of South Timbalier 164 where Queen Anne's Revenge is located.

TISDZ BBE Drill Cross Section
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Figure 7, Blackbeard East cross section. Source, McMoran's December 2011 Presentation.

As discussed in the Valuation Assumptions section, see figure 5 above, the Blackbeard East well is assumed to begin production by early 2013 with a single well flowing at 75,000 Mmbtu's per day. In years 2014 and 2015 one additional well was added to the complex in order to enhance production rates. Production was scheduled to continue until 2029 at which point the current BBE resource potential will have been completely produced. A present value analysis of the cash flows was conducted -- including zero dollar figures for year 2012 -- with a 10% discount rate. As the reader can see, depending on the price of natural gas the present value of the BBE complex to TISDZ unit holders ranges from $.43 at $3 an Mmbtu to $.72 at $5 an Mmbtu.

TISDZ BBE PV Chart

Figure 8, Blackbeard East present value analysis of future cash flows. Chart created by James Duade.

Lafitte Valuation

Lafitte was first spud in October of 2010, and has resource potential of 1.3 Tcfe. Below in figure 9 the reader can look at the location of Lafitte in the Gulf of Mexico as well as some key statistics on the well. The current Lafitte well is located on the Eugene Island 223 lease block and sits atop 140 feet of water. The well has been drilled to a vertical depth of 30,600 feet as of early December, 2011 and has a targeted depth of 32,000 feet. Unlike the BBE complex, TISDZ unit holders have a 1.25% ORRI on the adjacent lease block Eugene Island 222.

TISDZ Lafitte Property

Figure 9, Lafitte lease blocks. Source, McMoran's December 2011 presentation.

In figure 10 below readers can look at a cross section of the Lafitte well. Again, the red asterisks in the sands below the well indicate areas of resource potential.

TISDZ Lafitte Drill Results

Figure 10, Lafitte cross section. Source, McMoran's December 2011 presentation.

As discussed in the Valuation Assumptions section, see figure 5 above, the Lafitte well is assumed to begin production by early 2014 with a single well flowing at 75,000 Mmbtu's per day. In years 2015 and 2016 one additional well was added to the complex in order to enhance production rates. Production was scheduled to continue until 2030 at which point the current Lafitte resource potential will have been completely produced.

A present value analysis of the cash flows was conducted -- including zero dollar figures for years 2012 and 2013 -- with a 10% discount rate. As the reader can see, depending on the price of natural gas the present value of the Lafitte complex to TISDZ unit holders ranges from $.39 at $3 an Mmbtu to $.66 at $5 an Mmbtu.

TISDZ Lafitte PV
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Figure 11, Lafitte present value of future cash flows. Chart created by James Duade.

Blackbeard West Valuation

Blackbeard West sits on 80 feet of water on Gulf of Mexico lease block South Timbalier 168. As figure 6 above indicates BBW is the deepest well in the Gulf of Mexico and has resource potential of up to 4.4 Tcfe. Treasure Island has a 1.25% ORRI on the well, and on the nearby lease blocks South Timbalier 167 and Ship Shoal 188. Ship Shoal 188 is currently being drilled by McMoran and has reached a vertical depth of 3,100 feet as of early December with a potential terminal depth of 26,000 feet. As no resource potential has been found at Ship Shoal 188 this well was not factored into the Net Asset Value of the Trust. For more information on Ship Shoal 188 please see the "Three Reasons For Further Upside Potential" section below.

As discussed in the Valuation Assumptions section, see figure 5 above, the Blackbeard West well is assumed to begin production by early 2014 with a single well flowing at 75,000 Mmbtu's per day. In years 2015 through 2018 one additional well was added to the complex in order to enhance production rates. Production was scheduled to continue until 2047 at which point the current BBW resource potential will have been fully produced. A present value analysis of the cash flows was conducted -- including zero dollar figures for years 2012 and 2013 -- with a 10% discount rate. As the reader can see, depending on the price of natural gas the present value of the BBW complex to TISDZ unit holders ranges from $.74 at $3 an Mmbtu to $1.24 at $5 an Mmbtu.

TISDZ BBW PV Chart
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Figure 12, Blackbeard West present value of future cash flows. Chart created by James Duade.

Treasure Island Net Asset Valuation

The Net Asset Valuation for TISDZ simply combines the production schedules of all three complexes (i.e., Blackbeard East, Blackbeard West, and Lafitte). As the reader can see in Figure 13 below, production begins with a single well in 2012 at Blackbeard East, and peaks with 11 producing wells in 2018. Production continues at its peak till 2029, and then declines till production stops in 2047.

As with the other valuations the combined Net Asset Valuation was conducted with a 10% discount rate to all cash flows. As the reader can see, depending on the price of natural gas the Net Asset Value of TISDZ property interests ranges from $1.56 at $3 an Mmbtu to $2.63 at $5 an Mmbtu. Additionally, as discussed earlier, the green cells in the chart below indicate when the Newfield loans are projected to be paid off. At the point that the Newfield loans are paid off it's assumed that the TISDZ trustee will withhold only 2% of net TISDZ revenues.

TISDZ Cummulative PV Chart

Figure 13, Treasure Island Net Asset Valuation. Chart created by James Duade.

Additionally, the reader can see a breakdown of the Net Asset Value by production complex in Figure 14 below.

TISDZ PV Chart

Figure 14, TISDZ Net Asset Valuation summary. Chart created by James Duade.

Three Reasons For Further Upside Potential

In addition to the current resource potential at BBE, BBW, and Lafitte additional value could be generated for TISDZ unitholders. Below, in no particular order, are three catalysts that could add to the current valuation of TISDZ units.

1) Potential for liquids in addition to natural gas, particularly in the upper strata of Blackbeard East and the Lafitte lease blocks. While the current valuation assumes that only natural gas will be produced from the current lease blocks, it's possible that other forms of hydrocarbons could be produced as well. If this were the case then the trust NAV would likely be a good deal higher.

2) McMoran plans to continue drilling at BBE and Lafitte lease blocks. Drilling at both Lafitte and BBE is ongoing, and additional resource potential may be discovered. Obviously, additional resource potential would add to the current NAV of TISDZ units.

3) Drilling at Ship Shoal 188 is not included in the current Net Asset Value of TISDZ. McMoran is currently drilling Ship Shoal 188, and as of early December was below 3,100 feet, see figure 6 above. The trust has a 1.22391% ORRI on the lease block, and any resource potential found at Ship Shoal 188 would certainly add to the NAV of TISDZ. As readers can see in Figure 15 below, a velocity anomaly analysis conducted by McMoran in the Summer of 2011 has indicated that the Ship Shoal 188 lease block has the potential to hold additional resource potential similar to that of the upper strata of BBE.

TISDZ Ship Shoal 188 Velocity Anomaly
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Figure 15, Velocity anomaly at Ship Shoal 188. Source, McMoran's December 2011 presentation.

Conclusion

With a share price of $1.50 (Closing price as of 12/26/2011) the Treasure Island Royalty Trust currently trades just below its Net Asset Value with a discount rate of 10% and a conservative long term price per Mmbtu of $3. Treasure Island offers income investors the opportunity to receive decades of distributions at a relatively attractive entry point. Furthermore, the opportunity for additional resource potential at BBE, Lafitte, and Ship Shoal 188 or the production of liquid hydrocarbons from trust lease blocks could enhance distributable income and the Net Asset Value of the trust significantly. As always investors are encouraged to do their own due diligence and assess their own risk tolerance before taking any position.

I encourage readers to leave comments and questions below.

Disclosure: I am long OTC:TISDZ. I have been long TISDZ.PK since November 2010, and plan to maintain my position for years to come.

Source: Treasure Island Royalty Trust: A Net Asset Valuation Of The Trust's Core Property Interests