Is There Any Value Left In The Whiting Oil Trust?

| About: Whiting USA (WHZT)
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Summary

Whiting Oil Trust II (WHZT) has gone to the pink sheets.

Latest distribution is zero (as forecast).

Is there any future? Do asset sales matter?

Is there a broader lesson to be learned?

Whiting Oil Trust II (formerly WHZ and now WHZT) was formed at the height of the oil price market in December of 2011 (oil price around $100), and has since run head on into the buzz saw of sub-$30 prices. This has caused the price of the trust to drop below $1 per unit, and led to a delisting on January 7, 2016. I've followed this trust for about two years, and it was the subject of my very first SA article, so it's something of a sentimental favorite. I don't know if this article will prove to be an obituary, or whether there is still some value in the trust. The units are trading around $0.36 as I write, down from roughly $10 in late 2014. The February 2014 distribution alone was $0.33.

There are two sources of potential value in the trust. The first and obvious one is a return to distributions if oil prices rise. The second path is the sale of underlying assets by Whiting Oil. The second source is hinted at by the latest distribution, but limited by the terms of the trust. I'll look at both of these sources and estimate their future value under a few different conditions.

There were a few surprises in the February distribution report, relative to the assumptions in my model. Although the model was very accurate for production (actual 337.8K BOE vs. 333.6K in the model), prices fell a bit more than estimated ($35.18 per barrel vs. the model's $39.36). Gross proceeds were $10.4M. The costs were much lower than estimated ($10.5M actual vs. $12.1M in the model). Development costs were down about $300K, and lease costs were down about $1.3M. There isn't enough data to be sure, but I suspect that costs included a collapse in the amount of ad valorem tax collected. Even with no tax, the costs were considerably lower than in any previous quarter. There is no incentive for Whiting to reduce the costs associated with the wells they operate, but the other roughly 50% operated by other companies may be costing Whiting less and they have to pass that along to the trust. Or the costs could have changed do to entirely different reasons (there is just no way to tell because there is no transparency in the trust cost structure). The cost structure going forward is the biggest uncertainty in the estimating process.

The bottom line for proceeds to the trust in February was a loss of $92,438. This loss was covered by the first asset sales. Whiting sold 9 wells (out of 388.5 net wells). The trust received $332K for the trust's interest in the wells. This leaves a "tentative distribution" of $238,095. Enter the Bank (BNY/Mellon at last information). The "provision for trust expenses" (fee to the trustee/bank) was $238,095, leaving a net distribution of $0. Trustee fees have typically been $250K per quarter, but have varied from $200-300K. In the November distribution, the fee was reduced to $90K. This allowed the trust to deliver a distribution of about a penny. So what gives with the fee structure? Was November a "one time discount" to maintain a positive distribution in the hope that prices would recover? Was allocating the entire potential distribution to fee in February a capitulation on the part of the trustee? Let's look at asset sales.

There is a restriction on asset sales under the terms of the trust. Whiting cannot sell more than 0.25% of total production in a 12 month period. They sold 9 wells. If all wells (388.5 net) produced the same, the 9 wells represent 0.283% of production. Seems close enough for a rough estimate, and this means that Whiting sold the maximum amount allowed under the trust. There is also a provision that they cannot sell more than $1M in trust assets per year, but at current prices the production limit is clearly more extreme, since the trust received only $332K. My conclusion is that this was a one-time thing for last year, and that the trustee took advantage of the sale to recover some of the fee. A similar sale could happen in 2016 (in any given quarter), but is unlikely to generate anything that would exceed the trustee costs. Remember that there are two conditions under which the wells revert to Whiting: no distributions for two years, or the end of the calendar period of the trust (December 31, 2021). In either case, the trust gets nothing. I conclude that asset sales could add a small amount to otherwise positive distributions, but without such positive distributions any asset sales will be eaten up by trust expenses.

The critical question is then: what oil price is needed before the trust distributes again? I've run some numbers in the model, but remember that the costs allocated to the trust are a major question. If oil prices rise, there is no mechanism to prevent costs from rising back to previous levels. I'll look at the current costs relative to various price levels, and then look at historical costs. The first step is to look at the next distribution (scheduled for May). The May distribution will be based on oil sales in Jan-Mar, and natural gas sales in Dec-Feb. The prices for oil and gas are thus about 50% and 83% booked. If Nymex oil is at about $34 for March, the three month average for the next distribution will be about $32. If the price differential this time of about $8.15 per barrel holds, the trust will get about $23.85 per barrel. The natural gas price has swung from a higher price than Nymex gas to a lower price, presumably due to the collapse in NG liquid prices (a discount of roughly $0.40 last quarter. The same cost structure implies that the trust will receive $1.73 for NG next distribution. At the current (reduced) expenses, the model predicts a loss of $2.87M ($0.16 per share).

Recall that asset sales are unlikely to contribute more than $300-400K, meaning that the trustee won't get paid and there will be no distribution. More important for the plan forward, this loss will stay on the books and have to be overcome before any future distributions are paid. This adds some credence to the thought that the asset sales last quarter were more for the trustee than the trust or Whiting. Whether that was the intent, the effect is the same.

So, we have at least one negative quarter to overcome before the distribution could turn positive. What price would it take? The simple answer is about $42 per barrel received price (or Nymex about $50). I assumed a natural gas price of $2 because it has very little impact on the totals. The $42 price takes the next distribution to a small positive value, but remember that the wells are depleting so that the price must improve by about 8% per year to stay even.

As a quick aside, the trust estimate of depletion in the February statement was increased from 8% to 14%, but there was no evidence of increased depletion in the production numbers. I strongly suspect that the rate was based on the reduced reserves (due to the drop in price, some reserves no longer count). Since most of the wells are strippers, I can't see the rate changing much.

At 8% price increases, the price of oil would have to go to 45, 49, 53, 57 in subsequent years (Nymex 53, 57, 61, 65). This breakeven point assumes that costs don't rise. We have exactly one fiscal quarter of data at lower costs, and I suspect that costs will rise again if the trust generates any cash. Any residual trustee expenses that are recoverable by the trustee would take away some more cash, and the large loss in the next quarter would have to be repaid. Including that in the model raises the Nymex price threshold to a little above 51 (with 55, 60, 64, 70 in subsequent years).

The trust might beat these numbers a bit if costs continue to go down, and asset sales could reduce the price point a bit. Increased transport costs and trustee expenses would increase the price point. These effects are well within the error of estimate of the model. The model's breakeven price projections are not likely to be accurate to better than 10%. The longest current contract for Nymex within the trust period is the December 2020 contract at $48.40. The trust needs the futures curve to steepen or the price to rise by about $25 per barrel by 2021 in order to break even.

In conclusion, the trust is not yet dead, but it's been wounded and next quarter will be a deeper wound. Several more quarters of low prices will dig a hole that the trust won't be able to dig out from. Buying shares of the trust now represent a bet that oil prices will rise significantly. Prices could rise that much, but it seems unlikely. The trust shares are likely to be worthless.

So what, if anything does this mean for the broader oil picture? There are many other equivalents to the trust's situation. CHK is an example. The drop in natural gas prices is killing Chesapeake. CHK has a huge debt, with no cash flow to pay it off. Assets are distressed, and the assets are likely worth less than the debt in the current market. At the top end of the market, the major oil companies are starting to cut dividends, after cost cutting that will have severe impacts on future production. If XOM has its credit rating dropped, can they avoid a dividend cut? Will they make one preemptively to prevent a downgrade? In between the majors and the troubled are the hundreds of smaller oil and gas companies in various stages of distress. Coupled to them are the banks and the bond investors who have fueled the debt-binge. This just doesn't end well. Consolidation lies ahead. With many companies worth less than their debt, some will go bankrupt. Bond holders will get large haircuts. As for banks, that's beyond my area of knowledge.

In a previous article I predicted a price drop due to an oil storage crisis this winter. Despite protestations that the U.S. and the world have plenty of storage capacity, storage in the US is filling up. Cushing may already be at a practical limit where the necessary blending for refineries can't be done because of a lack of tank space. A number of refineries are predicting production cutbacks due to lack of demand. This will back up more crude. At some point, companies will have to stop pumping because there is no place to put the oil. Supply and demand will eventually equilibrate, but it seems unlikely that the new equilibrium will be at high enough prices to save many of the debt-ridden oil companies. The next few weeks will be critical.

Disclosure: I/we 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.

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