Hugoton Royalty Trust: The Natural Gas Play I Like Best

| About: Hugoton Royalty (HGT)

There is plenty of talk currently about the overvaluation of natural gas royalty trusts and natural gas in general. In fact, Moody's cut their outlook on natural gas prices to $2.75/MMBtu a full $.75 decline in the ratings agency's previous assumption. Moody's attributes the decline to a variety of factors including; a mild winter in the Northeast and rising supply from existing shale developments.

Current inventory levels also received attention when on January 25th the Department of Energy announced that current levels are at a 5-year high. We know that the commodities markets are by their nature fickle and can be much more volatile than the equities market so it should come as no real surprise then that prices for natural gas are hovering in the $2.605/MMBtu (a drop of 4.5%) in New York based on the recent announcements reinforcing what the market was already feeling; natural gas has (for the time being) hit its high.

Yet, let us for a moment step back from the realities of the commodities market, as so much of what happens there is based on what happens in that strange and far off place called Washington DC or in this particular case Las Vegas. President Obama was in Las Vegas on Thursday where he gave a speech attempting to counter the criticism he and his administration have recently been receiving regarding the Keystone XL Pipeline. In his speech the President drew attention to the efforts he has made to push America toward energy independence by way of alternative-fuels (i.e. so-called Clean Energy).

Now, regardless of where you stand on the Keystone XL Pipeline or on the back-and-forth bickering that occupies America's political landscape, one thing of interest did come out of the President's speech. The President announced that he would be introducing tax incentives for companies that invest in natural gas vehicles (he gave the speech at a UPS Hub). The argument can be made that even if companies with massive fleets like UPS (NYSE:UPS) and FedEx (NYSE:FDX) invest in completely transforming their fleets into "clean" fleets the existing supply will still not warrant a higher price assumption for natural gas. However, as we know, the market rarely responds rationally.

Of the myriad ways to play natural gas, the one I like the most is the royalty trusts (think REITs). Royalty trusts have very little overhead (generally administrative), are not capital intensive (the trust does not own the equipment or perform the actual mining) and provide handsome yields. The greatest benefit of the royalty trust that I like is that unlike income that corporations generate, which are subject to double-taxation, the income made by a royalty trust (provided that a certain percentage of the income is passed on to investors) is not subject to corporate taxation.

Normally, the trust will purchase the rights to mine and will then "sell" those rights to the actual miner. The miner gets a percentage of the units in the trust while the rest is passed through to the trust itself. The trust is then made available on the open market for investors to purchase shares of, like they would in any other equity instrument. In addition to the potential price movements of the instrument on the market the trust pays a monthly dividend much like a bond would.

Of the royalty trusts currently in play the one I like the most is Hugoton Royalty Trust (NYSE:HGT). The trust is a venture between XTO Energy Inc. (Grantor) and NationsBank N.A. (Trustee). The agreement established between the two parties conveyed 80% interests in properties in Kansas, Texas and Oklahoma. HGT has a handsome dividend monthly dividend yield of 9.9%. HGT is also trading near its 52-week low of $13.82. The stock is also currently trading extremely close to its pivot point ($15.60) and its first level resistance point ($15.88). XTO Energy Inc. is a wholly-owned subsidiary or ExxonMobil (XOM).

The Trust just announced its January Cash Distribution of $0.082003 per unit. This is taking into account a decrease of approximately 200,000 Mcf for October 2011 production due to scheduled maintenance. At its current trading price HGT looks like an attractive play for positioning for a bump in natural gas prices while earning a healthy dividend to boot.

So why take the risk? The upside looks very attractive if the gamble pays off. And at its current price HGT is a bargain when compared with other Royalty Trusts like CHKR and SBR.

I frankly like HGT and CHKR for a commodities play, but for the price HGT seems much more attractive and with more of an upside if it can break through its first level resistance point. At the end of the day, it really comes down to how much volatility you can stomach and if you believe that at least in the short-term the President's push for more natural gas usage will create enough demand to see the price of the "clean" commodity start to spike.

The first thing that came to mind after I watched the President's speech Thursday was the spike in tortilla prices after the President's big push for Ethanol. Tortillas - who would have thought that tortilla consumption would have moved the global corn market?

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in HGT over the next 72 hours.

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