Permian Basin Royalty Trust Positioned For Rebounding Oil Prices

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About: Permian Basin Royalty Trust (PBT)
by: Bram de Haas
Summary

The Permian Basin Royalty Trust got hammered in the sell-off of WTI.

WTI rebounded strongly year-to-date and I expect that rebound to continue.

With a trust, you have an open-ended position to profit from high oil prices in the future.

The Permian Basin Royalty Trust (PBT) owns a 75% royalty interest in certain Waddell Ranch and a 95% royalty interest in Southland Texas Royalty properties. It doesn't matter who owns or operates those energy properties, PBT is always taking its cut. Recently, the trust sold off quite a bit to ~$6.6 and it is now an attractive pick-up.

Chart Data by YCharts

These trust vehicles are often traded on the yield:

Chart Data by YCharts

And that's what's happening now:

Chart Data by YCharts

The trust price went down a little bit faster because the sharp drop in oil prices has been hard to miss. Distributions lag sales. So, sales taking place in January will be distributed to unitholders in a few months. That's why units sold off in advance while the distributions held up for a little while. Now, distributions are down and they will stay there for a few months.

What happened is that WTI got really smashed between October and the end of '18:

Chart Data by YCharts

Then, price reversed course and year-to-date WTI is up 17%.

I think oil prices will rebound over '19 and here's why:

OPEC got fooled by U.S. President Trump. He pressured them through tweets (and perhaps other means) to raise production. Which they did.

Source: CNBC's guide to President Trump his oil tweets

Likely, thinking this would be balanced out by the supply going offline through Iran sanctions that were being implemented.

But then, 3 days before the Iran sanctions would take effect, the U.S. issued waivers to 8 unnamed countries to continue to buy Iranian crude.

There has also been a surprise widening of the gap between U.S. WTI prices and Brent crude.

Chart Data by YCharts

This happens from time to time, but it is rather unusual in historical terms. With additional pipeline capacity coming online, I believe this discount will come down.

Meanwhile, OPEC has curtailed production at the end of December and Saudi Arabia made additional aggressive cuts in January.

For the above reasons, it would surprise me if WTI doesn't surge in '19.

If WTI does surge in '19, it is a sweet time to acquire PBT and other oil trusts.

You could argue it would be better to bet on that with options. However, I'm not THAT confident I'm right.

I really love these trusts because they have no set maturity date. As long as the operating companies pump oil and gas up from its properties, it keeps collecting cheques. Because of operating leverage involved at the underlying operating companies, you will see distributions spike when oil prices go up substantially. But it doesn't need to happen this year or next year. Which limits the downside.

These trusts have an unusual risk profile because they don't execute. If the operator goes bankrupt, the royalty remains in effect on the land. There are obscure ways the trust can get wrapped up, but that's extremely unlikely to happen. Even in that case, the underlying property is sold and proceeds are distributed to unitholders (though it likely will be a pittance in that scenario). If oil prices are down in the doldrums, you can expect to get paid very little for stretches of time, but you'll rarely lose your investment. Investing in an operating company is a very different ball game where that is a realistic option.

Chart Data by YCharts

At current prices, I expect to make a nice but unimpressive return. But if I'm willing to hold these things indefinitely, it is very, very unlucky if I lose money here. Meanwhile, I'm exposed to the incredible upside. There have been years where the units distributed ~$2.4 on an annual basis. That's how I like my investments.

Disclosure: I am/we are long PBT. 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.