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All Contents © 2020The Kiplinger Washington Editors
By Lisa Springer, Contributing Writer
| August 9, 2018
Royalty trusts can be great holdings for investors who want income that rises in sync with commodity prices. These trusts hold interests in oil, gas or mineral production and collect more income when energy prices rise, resulting in bigger distributions (similar to dividends) and high yields for their investors.
So far in 2018, royalty trust investors have benefited from a 12% improvement in sale prices for benchmark West Texas Intermediate (WTI) crude oil, which was recently trading at $67 a barrel. Prices are now up nearly 150% from their low of about $27 per barrel two years ago.
Royalty trusts typically offer high yields, frequently better than 7%. And many of these trusts have increased their distributions multiple times this year thanks to higher energy prices.
The principal drawback: Distributions decline over time because the trust’s energy reserves deplete; royalty income from oil and gas sales gradually drops to zero. Royalty trusts are required to disclose and annually update estimates of their remaining reserve life – though conservative estimates mean many trusts live on well past their expected termination date.
Royalty trust distributions also can move along with energy prices, which means they don’t just rise – they can drop, too. And that tax advantage comes with more complex tax reporting; investors sometimes must pay income taxes to multiple states if the trust’s assets are spread over several jurisdictions.
Still, royalty trusts’ high-income potential should earn them a spot in most portfolios. These 10 royalty trusts in particular offer high yields that fly far under Wall Street’s radar.
Data is as of Aug. 8, 2018. Distribution yields are calculated by annualizing the most recent distribution and dividing by the share price. Distributions are similar to dividends but are considered a return of capital, rather than income, and taxed at the lower capital gains rate. Taxes also are deferred until the trust is sold or terminated.
Market value: $679.4 million
Distribution yield: 6.1%
Founded in 1982, Sabine Royalty Trust (SBR, $46.95) collects royalties on oil and gas properties in Florida, Texas, Louisiana, Mississippi, New Mexico and Oklahoma. Its portfolio of drilling properties covers nearly 2.1 million acres.
During 2017, Sabine’s distributable income rose 26% to $34.7 million, or $2.38 per share, as a result of increased oil production and higher average selling prices. Oil volume increased 6% to more than 550,000 barrels and selling prices improved 18% to nearly $47 a barrel. These gains were modestly offset by lower production of natural gas due to reduced demand from a warmer-than-usual winter.
Experts estimated Sabine had enough oil and gas reserves to last nine or 10 years at the time the trust was established – 36 years ago. Since then, new discoveries obviously have extended the trust’s life, produced oil and gas volume more than twice original reserve estimates and enabled the trust to reward investors with more than $1.31 billion in distributions. The most recent analysis by petroleum engineers estimated the remaining life of Sabine’s reserves at eight to 10 years.
Sabine makes monthly distribution payouts and has already increased distributions five times since the beginning of 2018. Of course, there were a couple of declines, too, including from 28.12 cents in July to 23.99 cents in August. Still, the year-to-date payout annualized would come to $3,01, or a roughly 6.4% yield.
Market value: $427.4 million
Distribution yield: 7.1%
Permian Basin Royalty Trust (PBT, $9.19) generates royalty income from oil and gas wells located on the Waddell Ranch site in Crane County, Texas and 33 other Texas locations. Waddell Ranch is the trust’s principal asset. The owner/operator of the drilling properties is ConocoPhillips (COP) subsidiary Burlington Resources. Burlington established the trust in 1980 and since then has drilled nearly 1,000 producing gas wells across 79,000 acres of Waddell Ranch oil and gas properties.
Production from the Permian trust properties increased 11% last year to roughly 545,000 barrels. Volume gains, higher selling prices and a third consecutive year of lower production costs generated 50% growth in the trust’s distributable income, which rose to $29.3 million, or 63 cents per share.
The value of Permian’s remaining reserves is estimated at $129.9 million and the trust’s remaining life is likely to range between eight and 11 years. These reserve estimates may prove conservative since Burlington plans to invest an extra $3 million in drilling activities this year. Burlington plans to work over two wells, improve infrastructure and complete several well redevelopment projects that began last year.
Monthly distributions are tracking changes in production, so they’ve been up and down throughout the year. But applying the average monthly rate from the first seven payouts of the year to full-year 2018 suggests a distribution of 70 cents – up 11% year-over-year and good for a yield of 7.6%.
Market value: $91.7 million
Distribution yield: 9.9%
Cross Timbers Royalty Trust (CRT, $15.09) has existed since 1991 and earns royalty income from Texas, Oklahoma and New Mexico drilling properties. Most of the trust properties are located in the prolific San Juan Basin and all are owned and operated by the XTO Energy subsidiary of Exxon Mobil (XOM). Production comes from 4,900 oil and gas wells spread across nearly 60,000 acres.
Reduced gas production and higher development costs in 2017 caused trust distributable income to decline by 5% to $6.05 million, or $1.009 per share. Production volume and the monthly distribution have been erratic in 2018. Cross Timbers has paid out 82.5 cents per share to investors through seven months. As long as the average holds steady, CRT should pay out roughly $1.41 – a 9.3% yield that’s actually less than the projected forward yield using the most recent distribution.
Petroleum engineers recently estimated the value of Cross Timber trust’s remaining oil and gas reserves at $54 million and calculated a remaining reserve life of approximately 11 years.
Market value: $26.4 million
Distribution yield: 9.4%
Mesa Royalty Trust (MTR, $14.25) was created in 1979 by legendary oilman billionaire T. Boone Pickens. Mesa’s property interests are in the Hugoton field in Kansas and the San Juan Basin formation across New Mexico and Colorado. These interests cover more than 140,000 acres and 3,000 producing natural gas wells.
Most of the trust’s resources have already been depleted, hence the tiny $26.4 million market capitalization. Engineers recently estimated the value of Mesa’s remaining proved reserves at $13.35 million, which is enough to support another three to five years of production.
Production from Mesa trust properties improved 65% last year and powered a 142% increase in trust distributable income to $2.94 million, or $1.58 per share.
Mesa’s monthly distributions are trending lower in 2018, unfortunately, due to reduced spot prices for natural gas and reduced production volume. Trust distributions have totaled 73.68 cents through seven payouts in 2018. Assuming the rate holds for the remainder of this year, distributions will be a step down from last year at $1.26 per share. Still, that would come out to an ample yield of 8.9%.
Market value: $370.0 million
Distribution yield: 8.8%
Established in 1961, Mesabi Trust (MSB, $28.25) holds interests in iron ore production from mines located along the Mesabi Iron Range in St. Louis County, Minnesota, covering roughly 9,700 acres. Mesabi Trust collects overriding royalties, which are determined by mining volume and iron ore selling prices, and royalty bonuses, which kick in when iron ore sells above a certain price.
Iron ore production from the trust mines rose 30% last year to 4.8 million tons and fueled a nearly threefold improvement in trust distributable income to $33.2 million or $2.53 per share.
Iron ore producers like Mesabi received a major boost this year from President Donald Trump’s new tariffs on imported steel. Iron ore is used in steel manufacturing, and U.S. steel producers are buying more iron ore and gearing up to meet increased domestic steel demand. The owner/operator of the trust mines, Cleveland-Cliffs (CLF), plans to invest $75 million in mine upgrades this year that will boost production capacity by 3 million tons. It also recently broke ground for a new iron-making facility that will serve customers in the Great Lakes region.
The trust’s proved and probable iron ore reserves were recently assessed at 793.2 million tons. This implies a remaining life of approximately 16.5 years.
As a result of higher selling prices, Mesabi’s royalty income increased 40% in the first quarter of 2018 even though iron ore production was relatively unchanged year-over-year.
Despite the rise in income, Mesabi paid a first-quarter 2018 distribution of 45 cents per share that was 18% below last year’s first quarter payout. The second-quarter rate was 22 cents. Annualized out, that would come to $1.34 per share – a mere 4.7% distribution yield. But the highly erratic nature of this trust’s distributions means that could change for the better in just a few quarters.
Market value: $96.0 million
Distribution yield: 14.5%
VOC Energy Trust (VOC, $5.52) is a relative newcomer compared to most other royalty trusts. This trust was created in 2010 by VOC Brazos Energy Partners LLP to receive royalty income from oil and gas assets covering nearly 90,000 acres across Kansas and Texas. The operator of the trust properties has developed more than 800 oil and gas wells at these sites.
VOC will terminate in one of two ways: It will expire either at year-end 2030 or after the proceeds from the sale of 8.5 million barrels of oil and gas have been distributed to investors. That’s it. In the past eight years, VOC has distributed proceeds from the sale of approximately 4.1 million barrels of oil and gas.
VOC Energy Trust’s proved reserves recently were estimated at 4.29 million barrels and petroleum engineers look for production declines averaging 6.6% a year. However, trust reserves have increased four years in a row and may rise again over the next three years as property operator VOC Brazos plans to invest approximately $22.3 million in drilling and well redevelopment activities.
Although VOC production volume dropped 10% last year, higher selling prices propelled 2017 distributable income 73% higher to $8.5 million, or 39.5 cents per share.
VOC pays out quarterly. Distributions have improved for four consecutive quarters, to 20 cents per share in the most recent period. If the average of the first two payments holds out, 2018 distributions could total 72 cents – nearly twice last year’s payout – yielding almost 13%.
Market value: $114.6 million
Enduro Royalty Trust (NDRO, $3.50) was founded in 2011 by owner/operator Enduro Resource Partners LLC and owns interests in drilling properties located in New Mexico’s Permian Basin and in East Texas. Enduro Resource Partners has an active drilling program on these sites, drilling 14 new wells last year. The production mix from its wells is approximately 75% oil and 25% natural gas.
Due to aggressive drilling, trust reserves grew 20% last year to 4.2 million barrels. These reserves had an estimated value of $66.1 million and a remaining life of just over four years.
Trust distributable income rose four-fold in 2017 to $44.7 million, or $1.36 per share, mainly due to sale proceeds totaling $37.5 million from the divestiture of interests in some properties. Excluding this one-time item, the distribution totaled 20.8 cents per share last year.
This particular trust does have an additional risk to watch out for: Enduro Resource Partners recently filed for bankruptcy and has begun the process of divesting its remaining oil and gas assets. If the trust assets are sold to a less efficient property operator, the trust distributable income could decline.
Enduro has paid out 29.13 cents so far this year, already eclipsing last year’s adjusted distribution. Projected out, that would be a full-year distribution of about 50 cents per share, or a whopping 14.3% yield.
Distribution yield: 19.6%
Pacific Coast Oil Trust (ROYT, $2.38) is a perpetual trust, meaning there is no pre-determined termination event or date. Perpetual trusts offer the advantage that estate taxes are paid only once. Descendants of the original trust holder pay no pay estate taxes on their inheritance.
Pacific Coast Trust holds interests in properties located onshore in California’s Santa Maria and Los Angeles Basins and was created in 2012. The property operator, Pacific Coast Energy Holdings LLC, sells most of its oil and gas production to a nearby Chevron (CVX) refinery.
Energy production from trust properties declined 5% in 2017, but a 40% increase in selling prices produced a nearly 18-fold improvement in trust distributable income, which rose to $4.36 million or 11.3 cents per share last year.
The value of the trust proved reserves was recently estimated at $84.7 million, and the site operator is budgeting nearly $10 million for 2018 drilling projects that are likely to improve trust cash flows and boost return on capital.
Pacific Coast trust was off to a slow start in 2018 due to a temporary shutdown of a nearby pipeline that forced some wells to stop production. The shutdown, which began in December, resulted in a 40% decline in production during the first quarter. The pipeline resumed operations in April, and production from trust assets has returned to normal levels.
Despite the shutdown, the trust paid distributions of 12.5 cents during the first half of 2018, exceeding last year’s full-year payout by 11%. Distributions this year could exceed 31 cents per share, which would amount to a 13.3% yield.
Market value: $144.4 million
Distribution yield: 17.5%
SandRidge Permian Trust (PER, $2.82) owns royalty interests in oil and natural gas properties located along the Permian Basin in Andrews County, Texas. Unlike other royalty trusts, the site operator is no longer actively drilling, and the trust’s production is declining every quarter.
Oklahoma-based driller Sandridge Energy (SD) formed this trust in 2011 and holds a 25% ownership stake. SandRidge also operates two other Permian Basin trusts with property interests in Kansas and Oklahoma. SandRidge Permian Trust is scheduled to terminate in 2031 – and on the termination date, 50% of trust royalty interests will revert to SandRidge Energy, and 50% will be sold, with the sale proceeds distributed to trust investors.
The trust’s proved reserves are valued at $123.2 million, and production has been declined steadily from 1.17 million barrels in 2015 to 869,000 in 2016 and 714,000 in 2017. With no new wells planned, the annual decline is likely to continue.
Trust distributable income has followed a similar pattern, dropping from $81.0 million in 2015 to $25.6 million in 2016 and $24.3 million in 2017. Although higher selling prices are softening the impact of production declines, the general trend in quarterly distributions is lower.
The trust paid a 12.5-cent distribution in the first quarter of 2018, and recently paid out 12.9 cents just a few days ago. Thus, the company is on pace for a 50.8-cent distribution, which would produce an overall yield of about 18%. But this rich rate and yield might be a little misleading, given the high likelihood that distributions will continue to decline with the steady depletion of the trust’s remaining reserves.
Market value: $272.7 million
Distribution yield: 11.9%
San Juan Basin Royalty Trust (SJT, $5.84) was established in 1980 and derives virtually all its royalty income from sales of natural gas. As a result, distribution growth is strongly tied to natural gas prices, which improved 40% in 2017 and are predicted to remain flat this year and next year, according to the Energy Information Administration.
The trust properties are operated by Hilcorp, one of the largest privately owned oil and gas exploration and production companies in the U.S. Hilcorp acquired these assets last year from ConocoPhillips. The trust assets encompass roughly 152,000 acres along the northwestern New Mexico portion of the San Juan Basin.
The trust has natural gas reserves of nearly 98 billion cubic feet, expected to last 12.5 years at planned production rates and valued at $137 million.
While natural gas production from trust assets declined 8% last year, trust distributable income jumped 81% in 2017 to $39.1 million, or 84 cents per share, mainly as a result of higher selling prices. Distributable income also benefitted from $7.5 million received from a litigation settlement.
Distributions are paid monthly, and so far, they’ve come to 20.25 cents. That would mean a full-year payout of 40.5 cents, which would translate to a 6.9% yield – not as much as the forward rate based on July’s distribution, but still respectable nonetheless.