BP PRUDHOE BAY ROYALTY TRUST BPT S
June 09, 2014 - 9:22am EST by
Reaper666
2014 2015
Price: 94.45 EPS $0.00 $0.00
Shares Out. (in M): 21 P/E 0.0x 0.0x
Market Cap (in $M): 2,021 P/FCF 0.0x 0.0x
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT 0.0x 0.0x
Borrow Cost: NA

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  • dividend cut
  • Oil
  • Income Trust
  • Oil Price Exposure
  • Depleting Asset
 

Description

BP Prudhoe Bay (BPT) is a royalty trust which we estimate will stop paying dividends after 2023.  We believe that shorting BPT is a compelling risk/reward opportunity.  We estimate that the current stock price exceeds the remaining distributions by over 105%. We believe that the stock price is driven by the dividend, which is almost certain to drop steadily in the short and long-term.  The retail investor base may also have been fooled into driving up the premium to remaining distributions by recent rising dividends caused by a one-time change in tax code, a momentary jump in production and a rise in oil prices.  A declining dividend could cause the yield demanded by investors to rise and thus accelerate the stock’s fall.

 

Business: 

BPT is a royalty trust which receives 16.4246% of up to 90,000 barrels per day (oil and condensate) of BP’s working interest in the Prudhoe Bay oil field in Alaska.  The royalty is based a strict formula of the WTI oil price – a predetermined cost which rises over time and is also multiplied by a CPI factor, the trust  must then pay production taxes based on this net price. BPT is an incredibly simple entity the only variables are inflation, production and most importantly the oil price.

 

Why distributions should decline and eventually cease:

Prudhoe Bay is a very old oil field. Production, though still the largest oil field in North America, is in slow decline. Production peaked in 1988 and has declined an average of 3.7% per year since 2005. In addition to declining production, the trust’s costs are also rising. The base charge of $16.90 (over $31.00 after the CPI adjustment) is set to rise a dime per year through 2017 and then start rising roughly $3.00 per year. This rate rise is further multiplied by the CPI rate.  The cumulative effect of these increases will eventually wipe out BPT’s margin. The largest part of the dividend decrease over the next 12 months will likely come from falling oil prices. The current oil price is $103.48, but the 1Q 2015 price is $96.52. The cumulative effect of these drivers (see exhibit 1 below) will cause the dividend to decrease xx%, which will more than [?] the dividend over the next year, and thus the short will have a positive return even if BPT’s stays flat and thus becomes more overvalued. We would note that oil prices (based on futures prices) are predicted to decline through 2022.

 

Exhibit 1: Drivers of Dividend & 12 Month Return

Production Decline

8.9%

Cost Increase

1.3%

Oil Price fall

13.1%

Dividend Decrease

21.8%

Dividend Paid

11.6%

Net Return

10.2%

Valuation:

We used forward futures for oil through 2022 and an inflation rate after.  We assumed 3% inflation and a 3% production decline along with an 8% discount rate for our DCF value.

 

Exhibit 2: Model & Valuation

Year

Production

Oil Price

Cost

Tax Rate

Dividend

2013

83.1

$95.66

$30.06

39.2%

$9.25

2014

80.6

$100.43

$31.14

35.0%

$10.10

2015

78.2

$92.86

$32.27

35.0%

$8.56

2016

75.8

$88.07

$33.43

35.0%

$7.48

2017

73.6

$85.71

$34.63

35.0%

$6.77

2018

71.4

$84.43

$41.48

35.0%

$5.51

2019

69.2

$83.54

$50.73

35.0%

$4.06

2020

67.1

$83.16

$58.31

35.0%

$2.96

2021

65.1

$83.06

$66.29

35.0%

$1.91

2022

63.2

$83.05

$74.70

35.0%

$0.88

2023

61.3

$85.54

$83.55

35.0%

$0.14

2024

59.4

$88.11

$92.86

35.0%

$0.00

 

Remaining Distributions

 

DCF Value

   
 

$45.82

 

$38.62

   
 

Stock Price Premium

 

Stock Price Premium

   
 

106.1%

 

144.5%

   

 

 

Reasons for Overvaluation:

The low yield environment is forcing investors to stretch for yield.  BPT’s shareholder base is almost entirely retail investors. The dividend was recently pushed up by a likely temporary jump in production and a change in tax rate that lowered the rate in the short-run but increased it in the long-run (likely from 2016 on).  Production increased over 16% in the last two quarters from the two preceding quarters.  Production can vary quarter to quarter, even if this extremely old field were to suddenly show a large sustainable increase in production BPT holders would not benefit materially from this since their share is capped at 90K BPD and last quarter’s production was 86.937 BPD.  The Alaskan royalty tax formula was changing, the new rate was roughly 35% in 1Q vs. the old rate equating to roughly 43%, but the new rate has a minimum of 35% vs. 25% previously and should lower long-term value for BPT shareholders.

 

Additional Downside Factors and Catalysts:

Higher inflation, interest rates and lower oil prices could all undermine BPT’s share price.  The rising amount and types of yield oriented products, such as MLPs and other royalty trusts competing for investor dollars is another factor against BPT shares. Another royalty trust Whiting USA Trust I (WHX) fell over 50% in two trading sessions when Russian Hill Capital, LP issued a press release on March 28 pointing out the warning in the 10-K filing.  While the exact same phrases do not appear in BPT’s 10-K and WHX is a lot closer to ending dividends, we could see a similar strategy or statement impacting BPT shares.  We would note that WHX shares have not rebounded substantially since.

 

Risks:

Given the straight-forward nature of the trust, most of the risk in shorting BPT is short-term.  If oils prices are to rise, then BPT shares could spike.  Long-term oil prices would have to rise over 50% in order to justify the current stock price of BPT.  

I do not hold a position of employment, directorship, or consultancy with the issuer.
Neither I nor others I advise hold a material investment in the issuer's securities.

Catalyst

Declining Dividend, falling oil prices, rising interest rates
    sort by    

    Description

    BP Prudhoe Bay (BPT) is a royalty trust which we estimate will stop paying dividends after 2023.  We believe that shorting BPT is a compelling risk/reward opportunity.  We estimate that the current stock price exceeds the remaining distributions by over 105%. We believe that the stock price is driven by the dividend, which is almost certain to drop steadily in the short and long-term.  The retail investor base may also have been fooled into driving up the premium to remaining distributions by recent rising dividends caused by a one-time change in tax code, a momentary jump in production and a rise in oil prices.  A declining dividend could cause the yield demanded by investors to rise and thus accelerate the stock’s fall.

     

    Business: 

    BPT is a royalty trust which receives 16.4246% of up to 90,000 barrels per day (oil and condensate) of BP’s working interest in the Prudhoe Bay oil field in Alaska.  The royalty is based a strict formula of the WTI oil price – a predetermined cost which rises over time and is also multiplied by a CPI factor, the trust  must then pay production taxes based on this net price. BPT is an incredibly simple entity the only variables are inflation, production and most importantly the oil price.

     

    Why distributions should decline and eventually cease:

    Prudhoe Bay is a very old oil field. Production, though still the largest oil field in North America, is in slow decline. Production peaked in 1988 and has declined an average of 3.7% per year since 2005. In addition to declining production, the trust’s costs are also rising. The base charge of $16.90 (over $31.00 after the CPI adjustment) is set to rise a dime per year through 2017 and then start rising roughly $3.00 per year. This rate rise is further multiplied by the CPI rate.  The cumulative effect of these increases will eventually wipe out BPT’s margin. The largest part of the dividend decrease over the next 12 months will likely come from falling oil prices. The current oil price is $103.48, but the 1Q 2015 price is $96.52. The cumulative effect of these drivers (see exhibit 1 below) will cause the dividend to decrease xx%, which will more than [?] the dividend over the next year, and thus the short will have a positive return even if BPT’s stays flat and thus becomes more overvalued. We would note that oil prices (based on futures prices) are predicted to decline through 2022.

     

    Exhibit 1: Drivers of Dividend & 12 Month Return

    Production Decline

    8.9%

    Cost Increase

    1.3%

    Oil Price fall

    13.1%

    Dividend Decrease

    21.8%

    Dividend Paid

    11.6%

    Net Return

    10.2%

    Valuation:

    We used forward futures for oil through 2022 and an inflation rate after.  We assumed 3% inflation and a 3% production decline along with an 8% discount rate for our DCF value.

     

    Exhibit 2: Model & Valuation

    Year

    Production

    Oil Price

    Cost

    Tax Rate

    Dividend

    2013

    83.1

    $95.66

    $30.06

    39.2%

    $9.25

    2014

    80.6

    $100.43

    $31.14

    35.0%

    $10.10

    2015

    78.2

    $92.86

    $32.27

    35.0%

    $8.56

    2016

    75.8

    $88.07

    $33.43

    35.0%

    $7.48

    2017

    73.6

    $85.71

    $34.63

    35.0%

    $6.77

    2018

    71.4

    $84.43

    $41.48

    35.0%

    $5.51

    2019

    69.2

    $83.54

    $50.73

    35.0%

    $4.06

    2020

    67.1

    $83.16

    $58.31

    35.0%

    $2.96

    2021

    65.1

    $83.06

    $66.29

    35.0%

    $1.91

    2022

    63.2

    $83.05

    $74.70

    35.0%

    $0.88

    2023

    61.3

    $85.54

    $83.55

    35.0%

    $0.14

    2024

    59.4

    $88.11

    $92.86

    35.0%

    $0.00

     

    Remaining Distributions

     

    DCF Value

       
     

    $45.82

     

    $38.62

       
     

    Stock Price Premium

     

    Stock Price Premium

       
     

    106.1%

     

    144.5%

       

     

     

    Reasons for Overvaluation:

    The low yield environment is forcing investors to stretch for yield.  BPT’s shareholder base is almost entirely retail investors. The dividend was recently pushed up by a likely temporary jump in production and a change in tax rate that lowered the rate in the short-run but increased it in the long-run (likely from 2016 on).  Production increased over 16% in the last two quarters from the two preceding quarters.  Production can vary quarter to quarter, even if this extremely old field were to suddenly show a large sustainable increase in production BPT holders would not benefit materially from this since their share is capped at 90K BPD and last quarter’s production was 86.937 BPD.  The Alaskan royalty tax formula was changing, the new rate was roughly 35% in 1Q vs. the old rate equating to roughly 43%, but the new rate has a minimum of 35% vs. 25% previously and should lower long-term value for BPT shareholders.

     

    Additional Downside Factors and Catalysts:

    Higher inflation, interest rates and lower oil prices could all undermine BPT’s share price.  The rising amount and types of yield oriented products, such as MLPs and other royalty trusts competing for investor dollars is another factor against BPT shares. Another royalty trust Whiting USA Trust I (WHX) fell over 50% in two trading sessions when Russian Hill Capital, LP issued a press release on March 28 pointing out the warning in the 10-K filing.  While the exact same phrases do not appear in BPT’s 10-K and WHX is a lot closer to ending dividends, we could see a similar strategy or statement impacting BPT shares.  We would note that WHX shares have not rebounded substantially since.

     

    Risks:

    Given the straight-forward nature of the trust, most of the risk in shorting BPT is short-term.  If oils prices are to rise, then BPT shares could spike.  Long-term oil prices would have to rise over 50% in order to justify the current stock price of BPT.  

    I do not hold a position of employment, directorship, or consultancy with the issuer.
    Neither I nor others I advise hold a material investment in the issuer's securities.

    Catalyst

    Declining Dividend, falling oil prices, rising interest rates

    Messages


    Subjectproduction increase
    Entry06/09/2014 11:27 AM
    Membersugar
    Hi, can you please talk about the production increase and why you think it is temporary? Thanks for the idea.

    Subjectdividend asset bubbles in behavioral finance
    Entry06/09/2014 12:23 PM
    Memberclancy836
    As you may know a lot of work in experimental behavioral finance has focused on characterizing these kinds of anomalies. In most cases, the asset price does not begin to revert toward the fundamental value implied by the present value of all future dividends until very late in the process, when an impending end to any possibility of future cash flows finally becomes overwhelmingly clear to all market participants. It's difficult to pinpoint when this reversion will happen and in BPT's case the decline in payouts could create a near-term catalyst as you suggest; but it's worth keeping in mind that the market can continue to inappropriately capitalize current yields until surprisingly late in the process.
     
     

    SubjectRE: Borrow
    Entry06/09/2014 10:46 PM
    MemberReaper666
    About 4% of shares are held short, I think it should be available.  Puts are also a possibility.

    SubjectRE: production increase
    Entry06/09/2014 10:47 PM
    MemberReaper666
    I simply see no fundamental reason why the production increase in aging field is sustainable.  There have been similar short-term production spikes previously.

    SubjectRE: Production taxes
    Entry06/09/2014 10:49 PM
    MemberReaper666
    From the 10-K:  

    On April 14, 2013, Alaska’s legislature passed an oil-tax reform bill further amending the Production Tax Statutes with the aim of encouraging oil production and investment in Alaska’s oil industry. On May 21, 2013, Alaska Governor Sean Parnell signed the bill into law as chapter 10 of the 2013 Session laws of Alaska (the “Act”). Among significant changes, the Act eliminated the monthly “progressivity” tax rate implemented by 2006 Amendments and ACES, increased the base rate from 25% to 35% and added a

     

    10

     


    Table of Contents

    stair-step per-barrel tax credit for oil production. This tax credit is based on the gross value at the point of production per barrel of taxable oil and may not reduce a producer’s tax liability below the “minimum tax” (which is a percentage, ranging from zero to 4%, of the gross value at the point of production of a producer’s taxable production during the calendar year based on the average price per barrel for Alaska North Slope crude oil for sale on the United States West Coast for the year) under the Production Tax Statutes. These changes became effective on January 1, 2014.


    SubjectRE: RE: RE: production increase
    Entry06/10/2014 02:59 PM
    MemberReaper666
    I don't have the detail you want.  Bu it's not a risk, at least not a big one. BPT's share is capped at 90K/day so if productio were to ramp from here, it would be a positive but the upside is very limited.

    SubjectRE: RE: RE: RE: production increase
    Entry06/12/2014 02:30 PM
    Memberspike945
    thanks for the write up.  good one. 
     
    how sensitive is the model to oil prices remaining flat from here (100 bucks).  i would believe that the thesis still holds.
     
    what borrow rate are you seeing?
     
    thanks and good idea.

    SubjectRE: Costs and Reserve Value
    Entry09/17/2014 08:49 PM
    MemberReaper666
    The costs rise not by actual costs but by a set amount multiplied by the CPI.  I do not value the company on reserves since it is a simple formula to DCF the value.  I think the diffrence may be that the PV-10 assumes flat or rising prices (inflation), vs. a downward forward strip.

    SubjectProduction Taxes
    Entry11/11/2015 04:33 PM
    Membergman

    Production taxes have decreased from $19.28/barrel for Q2 2014 to $2.02 per barrel for Q3 2015. This is a dramatic decrease and has enabled BPT to pay a higher distribution than would have been expected. Does anyone understand how the production tax is calculated. it isnt clear from the filings to me. Thanks


    SubjectRe: Production Taxes
    Entry11/11/2015 04:44 PM
    MemberReaper666

    Haven't looked at this in a while but I believe they were a function of gross profit.


    SubjectRe: Re: Production Taxes
    Entry11/12/2015 10:27 AM
    Membergman

    Great Call BTW!


    SubjectRe: Re: Production Taxes
    Entry11/12/2015 10:28 AM
    Membergman

    where would i be able to find out the specifics on how the production taxes are calculated?

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