GuruFocus Premium Membership

Serving Intelligent Investors since 2004. Only 96 cents a day.

Free Trial

Free 7-day Trial
All Articles and Columns »

High Yield Oil Trust: BP Prudhoe Bay

February 15, 2010 | About:
Powerful factors are aligning.

These forces clearly point to an increase in the price of oil.

Consider: Worldwide petroleum use is increasing. A slight pullback caused by the recession notwithstanding, global demand for oil is on the rise as China and other emerging-market countries have begun to industrialize. Worldwide crude consumption rose from 65 million barrels per day in 1980 to more than 85 million barrels per day in 2007. Consumption is anticipated to rise to more than 94 million barrels per day by 2015.

All that oil has to come from somewhere, of course. And the supply from which it comes is dwindling. New sources of oil are increasingly difficult to find. Earth has 1.3 trillion barrels of proven reserves -- only enough for 40 years at current rates, and far less if the uptrend in the world's appetite continues.

The economics are simple: Increased demand and shrinking supply inevitably put upward pressure on prices. History clearly bears this out: Oil was $10 a barrel in 1998. The price rose for years and peaked at $147 a decade later, in 2008. Prices have since fallen, to about $73 per barrel, but the underlying economic dynamics of this commodity undoubtedly point to a strong price going forward.

The second factor influencing the price of oil is the falling dollar. Oil is priced in dollars. As many predict the dollar will continue to decline in value as record deficits continue to escalate with no end in sight, a weak dollar will necessarily push the price of oil up even farther.

Third: The world's economies have begun to recover. Analysts expect demand to resume its rise this year by a consensus average of 1.3 million barrels per day. Goldman Sachs (GS) currently estimates oil will go to $90 per barrel in 2010 and $110 per barrel in 2011.

One of the best ways for income investors to play rising oil prices is BP Prudhoe Bay (BPT). BPT is a royalty trust set up in 1989 by oil giant BP plc (BP) and The Bank of New York Mellon Corporation (BK) to pay royalty interests for revenue from oil producing properties on Alaska's North Slope.

BPT distributes royalties on 16.4% of the first 90,000 barrels of the average actual daily net production (or the total daily production, whichever is less) per quarter from BP's working interest in the Prudhoe Bay Field, the largest oil-producing field in North America.

The trust is set up to simply collect royalties on the oil sold. Obviously, higher oil prices mean higher royalties and better earnings and distributions. Like a master limited partnership (MLP), BPT is not taxed at the corporate level provided the trust pays out the bulk of earnings in the form of distributions. However, unlike most MLPs, which mostly earn fees for the storage and transport of oil and gas, BPT's earnings are highly sensitive to the price of oil.

As oil prices have plunged from record highs in 2008, this sensitivity to oil prices has not been a good thing.

In the first three quarters of 2008, the trust sold oil at an average price of $104.35 per barrel. That average price fell to $53.66 in the same period in 2009. As a result, in the first nine months of 2009, revenues plunged more than -50% to $92.8 million and earnings also plunged by a similar percentage to $91.5 million from the first nine months of 2008.But how did the trust do during the past decade when oil prices were mostly on the rise?

As of January 31, BPT has had a mind-boggling average annual total return of more than +31% per year for the past 10 years -- during which time the broader market's return has been negative. BPT clearly is an investment that does well when oil prices rise. BPT has also paid out a remarkable average dividend yield of 12.2% during the past five years.

Distributions are paid quarterly and, while distributions totaled $11.70 per unit in 2008, they fell to $6.00 in 2009. However, the first distribution for 2010 was $3.61.

That's a yield near 9.5% -- after a reduction. Just imagine what kind of cash this trust could throw off in the future.

That said, even a vast oil field like Prudhoe Bay has a limited life, and as reserves in the oil properties diminish, the trust will eventually expire. As of Dec. 31, 2008, the trust estimated its proven reserves to be about 55 billion barrels. While BPT estimates that it will be able to continue to generate royalties to 2020 and beyond, production should gradually diminish. However, rising oil prices should be a huge benefit to unit holders during the next several years.

Also, because of the aforementioned reasons as well as environmental considerations, there is a strong push toward alternative forms of energy including natural gas, nuclear as well as wind and solar. But, while these energy alternatives should gain in prominence and impact the demand for oil eventually, it probably won't happen any time soon.

Falling oil prices in the recent recession have presented a window of opportunity. While a recovery may be short lived and oil prices could again pull back, the longer term trends are likely to win out eventually. The beautiful thing about that is that you get paid to wait. We've seen it happen with this same exact stock...

High-Yield Investing subscribers had the chance to make an +80.1% gain with BPT when Carla Pasternak recommended owning it between October 2004 and February 2007. To see what's we are recommending today, read this.

sig-tom(1).gif

Disclosure: Tom Hutchinson does not own shares of any security mentioned in this article.

http://www.streetauthority.com/

About the author:

Street Authority
StreetAuthority, LLC is a research-intensive financial publishing firm that aims to level the playing field for small investors by giving them access to the ideas and insights of some of the country's top investment researchers, analysts and writers. Although we specialize in income and international investment research, we publish a wide variety of newsletters that are geared towards helping EVERY kind of investor profit from today's volatile marketplace. Visit StreetAuthority.

Visit Street Authority's Website


Rating: 3.5/5 (8 votes)

Comments

DaveinHackensack
DaveinHackensack - 4 years ago
Why don't you own any BPT if you are so bullish on it?

I've owned some for a few years and have done well with it so far, at least.

Please leave your comment:


Get WordPress Plugins for easy affiliate links on Stock Tickers and Guru Names | Earn affiliate commissions by embedding GuruFocus Charts
GuruFocus Affiliate Program: Earn up to $400 per referral. ( Learn More)
Free 7-day Trial
FEEDBACK