Sabine Royalty Trust (NYSE:SBR) was created in 1982 to hold royalty interests on oil and gas properties located in Florida, Louisiana, Mississippi, New Mexico, Oklahoma and Texas. Initially, the trust's life was expected to be 9-10 years; however, the energy assets continue to produce for more than 30 years after its creation. As of January 1st, 2013, independent consultants estimate the trust's properties have reserves of 6.5M barrels of oil and 41.6B cubic feet of gas - a year-over-year increase of 12% in oil reserves and a 14% increase in natural gas reserves. The trust generates approximately 42% of its revenues from natural gas production and 58% from oil production.
Sabine has gained 30% year-to-date due to the rebound in commodity prices and an increase in reserves but is overpriced at $52.09. The trust pays a healthy yield of 9.2% but with the high yield the investor is taking a "leap of faith" in production and commodity assumptions.
Production Data is Difficult to Obtain
It is difficult to project the future production for the properties underlying Sabine Royalty Trust because the operator, Hunt Oil Company, is not obligated to release detailed information on its operations. Sabine's 2012 10K states the trust's lifespan "could" be estimated at 8 to 10 years. This figure has been used for over a decade because the properties' production lives have been extended by advances in technology and higher commodity prices. If the trust has a remaining lifespan of ten years then units should be priced well below $50 per unit. A 6% discount rate and a remaining production life of 10 years have been used in all scenarios.
Below is a table with the annual production of the properties for the last nine years. The table shows that natural gas production has increased 26% while oil production has dropped 27%. Please note 2013 oil production has increased during the first half of the year and it appears the trust will receive income on approximately 440,000Bbl this year which would be a decline of 16% from 2004 production.
The most recent audit on reserves is shown in the table below. Although there has been a slight increase in reserves compared to 2011, there is no evidence the reserves will last for more than ten years.
Oil and gas field production rates decrease over time unless new technology is developed to increase the life of the asset. If the trustee has determined the lifespan of the trust could be 8 to 10 years than production will start to taper significantly within the next five years because the trust is terminated when gross revenues are below $2m per annum. A unit holder who feels SBR is fairly valued above $50 is assuming new technology will increase the life of the underlying asset for greater than ten years.
An informative production estimate can't be determined from the information provided by the trustee. The trustee is not violating any laws because it does not have details. The trust's operating rules do not obligate the operator to release detailed production data or give an estimate on future production. Therefore, the investor is left trying to justify the current unit price by adjusting production levels and commodity prices.
The first scenario shows that a $40 unit price can't be justified if annual production increases 20% from 2014 to 2016 then remains constant for seven years at 2012 production levels. The income is based on the natural gas strip and the WTI oil strip traded on the Chicago Mercantile Exchange (NASDAQ:CME). Investors should note that a PV of $37.35, approximately $15 below its October 17, 2013 closing price, is attained with a lofty production increase from new technology. So if this production increase did happen then the PV of the income would equal $37.35 per unit.
Scenario two evaluates the effect of a significant increase in commodity prices. In order to justify a PV above $40.00 natural gas prices need to average $6/Mcf and oil needs to average $120/Bbl for the next three years. These are lofty price expectations, especially for natural gas. The Energy Information Administration (NYSEMKT:EIA) is forecasting natural gas prices to average $4/Mcf and for oil to average $96.21 during 2014. Natural gas will remain under $5/Mcf until the end of 2016 because demand will remain low. Natural gas exports will not begin until 2016 because the facilities have not been constructed. Oil will likely average around $100Bbl because of the increase in supply that will be created by domestic production. US economic growth would increase demand for oil and natural gas but the source of that growth is not apparent at this time.
The final scenario keeps production constant at 5% above 2012 levels while the revenue assumption is based on annual average future price from the CME. The remaining two years of revenue is based on a $5/Mcf and a $105/Bbl. This scenario equates to a $35.43 present value. Even with this lofty production assumption, i.e. production would decline towards the end of life of the trust and not stay constant, the PV is significantly below the current price.
Sabine Royalty Trust is not an easy investment to value because pertinent information about the royalty properties is not being released to the market. I would not invest in SBR because it is overvalued - even when assuming generous production and price levels. If you think production from the properties will jump 20% during the next three years or commodity prices will experience a significant increase then your price target is around $37 to $42. The reserves could also increase due to higher commodity prices or production gains through advances in technology but these factors seem to be priced into the unit. This trust might be worth watching but it is too expensive to purchase at these levels.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.