BP Prudhoe Bay Royalty Trust: Why Worry About This High Yielder?

Jan.25.12 | About: BP Prudhoe (BPT)

By Nathan Slaughter

Last week, I told you about Chesapeake Granite Wash Trust (NYSE: CHKR) -- a royalty trust paying a double-digit yield.

Royalty trusts boast some of the highest yields on the market -- typically 6% to 8%, but payouts north of 10% aren't uncommon. And aside from writing generous paychecks every quarter, many of these securities have also delivered triple-digit share price appreciation.

One of the best examples of what these securities can do is BP Prudhoe Bay Royalty Trust (NYSE: BPT).

This trust operates in the Prudhoe Bay oil field located on the North Slope in Alaska -- the largest oil field in North America. The field covers 213,543 acres and is responsible for about 10% of the United States' total oil output.

If you owned BPT, you'd own royalty interests in 150,000 acres of the Prudhoe Bay oil field. And you'd be getting paid a royalty on thousands of barrels of crude pulled from this reserve.

As you would expect, that's been pretty profitable. In the past 10 years, BPT has earned a total return of 2,248%. A $5,000 investment just 10 years ago would be worth $117,400 right now.

To give you an idea of how strong a return that is, integrated oil giant Chevron (NYSE: CVX) returned 231% over the same period. That would have turned $5,000 into $16,550. Not bad, but nowhere near what BP Prudhoe Bay Royalty Trust did.

Chevron digs up about 2.8 million barrels of black gold every day and is one of the industry's biggest producers. But Chevron also has to shoulder the enormous expenses and risks that come with being a big oil company.

In a recent quarter, it generated $64 billion in revenue... BUT $52 billion of that went toward employee salaries, marketing campaigns, administrative overhead and other operating expenses. And then Uncle Sam took $5.5 billion in corporate taxes.

That still left a respectable $7.7 billion in pure profit. But the vast majority of that was pumped right back into the business to find and develop new sources of oil.

In the end, only $0.78 per share was set aside for stockholder dividends. Today the dividend has risen slightly to $0.81 per share. That's a yield of 3.0% at today's prices.

Compare that with the $9.40 per unit BPT paid out in 2011, giving a yield of 8.1%. What's the secret behind BPT's success? Well, like clockwork, the trust pays royalties every 90 days.

Since January of 2004 the royalty checks have averaged $2.03 per unit each quarter. That's an average of $8.12 per unit each year -- turning every 1,000 units you own into an extra $8,000 in your pocket. (These royalty trusts can yield up to 17.1%.)

And those royalties are on top of capital gains. BPT's share price gained 667% during the past 10 years thanks to rising oil prices, while Chevron's stock price went up only 137%.

The thing is, BPT not only beat Chevron... it beat out just about every major oil company over the same period.

And that's only part of the equation. Go back a few more years, and the major oil and gas companies aren't even in BPT's league.

BPT has generated total returns of 5,089% since 1990 -- beating the "big" names in the oil and gas industry. Chevron... Exxon (NYSE:XOM) ... Shell (NYSE:RDS.A)... you name it.

So am I saying you need to load up on BPT? No. In fact, I'd steer clear of the investment.

Royalty trusts are born with a fixed amount of land that can be milked for hydrocarbons. And since there's a finite amount of oil and gas that can be economically extracted from any given acre, all trusts will eventually deplete their resources and run dry. When that happens, the trust is essentially closed down.

Generally speaking, I tend to favor newer trusts over those that were created decades ago. BPT went public back in 1989. It's been paying royalties for more than 20 years. Newer trusts allow us to get in earlier to the production life.

That's not to say investors can't or won't make money in BPT. But I'd much prefer to put my money to work in trusts formed more recently, like Chesapeake Granite Wash Trust, which I shared last week.

Disclosure: Nathan Slaughter does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC owns shares of CHKR in one or more if its “real money” portfolios.

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