BP Prudhoe Bay Royalty Trust (BPT) – Distribution Cut – 50%+ Upside

Current Price – $26.44

Expected Price – <$10.00

Upside – 50%+

Expiration Date – April 2019

 

BPT is oil royalty trust established back in 1989. The company has entitlements to 16% of production in BP Alaska Prudhoe Bay field. Currently it is a high yielding stock - see dividend history here.

The thesis here is simple - due to drop in oil prices as well as annual step up in chargeable costs Q1 distributions will be cut from the latest $1/share quarterly to almost zero. I am expecting this to have a negative effect on the share price. The residual value/optionality beyond Q1 does not justify current share price either as chargeable costs will continue to rise annually and WTI needs to be above $55 for BPT to start generating any income in 2020.

When distribution was cut to almost zero back in Q1 2016, BPT traded around $13/share with 3 additional years of runway left.

BPT borrow is non-existent and expensive (100%+). However, in the money June 2019 options have breakeven at around $18-$22/share (depending on exercise price). These options are quite illiquid and bid/ask spreads are wide.

So the bet here is two-fold:

1) WTI prices stay around $50/share (can be hedged by buying oil index funds or oil E&Ps);

2) Market reacts negatively to the Q1 2019 distribution cut.

If either of the two do not work out as expected, the trade fails.

Worth noting that this is not an undiscovered situation - it has been covered on a number of SA articles as well as other sites over the last half a year. Reading through the comments on these articles gives a bit of a hint why BPT is so mispriced - high yield seeking clueless retail investor base + short squeeze. Judging by high borrow fees, this is quite a crowded short.

 

Royalty structure

Historical royalty calculations can bee seen from the table below. Average per barrel royalty is calculated by deducting inflation adjusted chargeable costs and production taxes from the average quarterly WTI price. Then this is multiplied by the 16.4246% of quarterly oil production with 90m b/d cap.

BPT

Important factor is the step up in chargeable costs every year going forward.

BPT2

Assuming WTI prices stay at the current levels ($52) and production is flat at 78.7m b/d, distribution for Q1 2019 should be only $0.2/share vs $1/share in the latest quarter.

The table below depicts quarterly distributions at various WTI price levels for the upcoming years. I have assumed flat production (although it has been on the downward trend in recent years), 2.8% annual inflation, 3.5% production taxes and $1.2m in annual trust expenses.

BPT dividends 3

 

As can be seen, WTI prices need to increase sharply every year for BPT to continue with at least small distributions. Even assuming that WTI reverts promptly to $75 after Q1 and stays at this level, cumulative undiscounted dividends sum up to only $11.5/share.

18 COMMENTS

  1. over2u

    Double checked the calculation and agree there is very low value in the stock (~3x less compared to the spot). The one anticipating oil shoot out can hedge this stock through buying OTM call on WTI. It won’t cost much at $75.
    It will be interesting to see the price reaction at low dividends. Will the market remain insane?)

  2. Michael Lax

    John Maynard Keynes: The market can remain irrational longer than you can remain solvent.
    Michael

    1. dt

      Definitely a risk here, but if you have short position through options, at least there is no need to worry about solvency.

    1. dt

      That’s dividend for the last quarter and was known already for couple of weeks. Q1 dividend will be much lower it current oil prices prevail.

  3. iFindValue

    How hard is it to enter into this trade? What’s the float at right now?

  4. DendriteResearch

    BPT is definitely massively overpriced vs. the future distributions it will pay. But how far will it trade down once the distribution cut is announced? In April 2016, dist dropped from $1.20 to $0.07. The stock dropped 10% on the announcement, but quickly bounced back higher. I don’t know what idiots own this, but maybe cutting the distribution won’t be enough for them to sell.

    1. Vincent

      This was after market close so we will see the market price reaction on monday I guess..

  5. iFindValue

    Stock is materially lower from time this idea was posted. Closed today @ $9.35. Anyone get put options on this?

    1. dt

      This is a clear zero next year or in 2021 (unless oil prices rebound strongly). But the problem is that borrow is not available / expensive and put options are expensive with short term maturities. So you never know if stock will drop enough in particular time period to compensate for these costs.

  6. Michael Lax

    What about buying a put spread for March, 2020 or writing uncovered calls for the same date?

    1. dt

      Options are illiquid and payoff from put spreads is too small.

      Eg. 15.0 / 7.5 spread costs $6 with max payoff of $7.5, which is only 25% upside. Also you have no guarantee that the stock will trade below $7.5 at expiration – even-though its a terminal zero, it can still pop up (like yesterday’s +13%)

      OTM calls are also too cheap considering volatility of the stock.

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