Royalty investor relief?
Royalty investor relief?
BP Prudhoe Bay Royalty Trust may benefit as Hilcorp takes over from BP
The closing share prices of the BP Prudhoe Bay Royalty Trust (NYSE: BPT) have been in a downward trend recently due to lower oil prices and falling production at the Prudhoe Bay field on Alaska’s North Slope, but there may be some relief in store for trust investors as Hilcorp Alaska assumes ownership of BP’s share of the field.
BP in August announced the sale of its interest in the Prudhoe Bay field, along with its other Alaska assets, to Hilcorp.
The royalty trust has been under pressure as investors eye the potential for continued profitable production at the field in today’s oil price environment. Some analysts have concluded that the field could become uneconomic as early as 2022 if oil prices don’t recover from the current $50-60 range.
As its name implies, the trust relies on royalties from the Prudhoe Bay field, specifically 16.4246% of the first 90,000 barrels of net daily production. Its shares will become essentially worthless should the field shut down.
Since notching a close of $128.75 per share on Jan. 3, 2011, in a triple-digit oil price environment, BPT shares have fallen to close at $8.23 per share on Sept. 4.
Hilcorp is a lean operator, however, with a track record of revitalizing production in aging fields. For BP Prudhoe Bay Royalty Trust and the oil field upon which it relies, Hilcorp may represent the prescription for a longer life span based on lower operating costs and production enhancements extending the life of the field.
Payout since 1989The BP Prudhoe Bay Royalty Trust was founded by Standard Oil Company and BP Exploration on February 28, 1989. Its share price rose to $35 on Sept. 17, 1990, and slumped to under $4.50 per share in 1999 before riding higher oil prices to a share price peak in 2011.
In the second quarter of 2019, the trust recorded a dividend rate of $0.5510499 per unit, based on an actual average daily production for the quarter of 74,254 barrels. This is an increase over Q1 2019 dividend levels, but lower than 2018 quarterly dividend payouts in the range of $1-$1.50 per share.
At an annual dividend rate of $3.28 per share, the annual dividend yield is 39.84% as of Sept. 4. This high yield is primarily a function of share prices falling in 2019, including a 36.6% share price drop in July.
Such a high dividend yield does look juicy, but often an extremely high yield is a danger signal, known as a dividend trap, masking underlying flaws in the security which may result in an unsustainable dividend or worse, an unsustainable business model. Those dangers appear to be largely priced into the current share levels.
With the entrance of Hilcorp, the market’s view of BPT may be excessively pessimistic.
Slope successesLike the BP Prudhoe Bay Royalty Trust, Hilcorp was founded in 1989. It is the largest privately owned oil and natural gas producer in the country.
“Hilcorp is a leader in taking on legacy oil and gas assets across the United States and reinvigorating production with innovation and integrity,” the company said on its website. “We thrive on efficiency and create value through both energy production and the positive impacts it has on the communities where we work.”
In the last five years, Hilcorp has “exponentially increased reserves and production,” the company said.
Hilcorp has been active on the North Slope since 2014, coaxing more oil out of its three producing North Slope oil fields by increased drilling, reworking wells and by reinjecting natural gas and injecting polymer and water into reservoirs.
The company also invests in upgrading old infrastructure to ensure that pipelines and wells can continue to perform effectively into the future.
At the Milne Point unit, which went online in 1985, Alaska economist Ed King said Hilcorp has been doing a “tremendous job squeezing additional life out of this mature asset since purchasing it from BP” in 2014.
According to data from the Alaska Oil and Gas Conservation Commission, 8.3 million barrels were produced from Milne Point in FY19 - a million barrels more than in FY18.
At the Duck Island unit, which holds the Endicott field and went online in 1987, King said Hilcorp was able to “maintain a fairly flat production rate over the last two years.” (Previously Hilcorp had boosted output.)
After starting regular production in 2001, the Northstar field is already nearing the end of its economic life, currently producing about 10,000 bpd for Hilcorp, he said. “In fact, the Northstar unit saw an increase of 317,587 barrels of oil (a 9% increase) over FY18.”
In Alaska’s Cook Inlet, Hilcorp has increased oil production from 10,000 bpd in 2012 to 16,000 bpd in 2019, while revitalizing natural gas production to become the state’s largest producer of natural gas.
If Hilcorp can achieve similar results at Prudhoe Bay, perhaps the shares of the BP Prudhoe Bay Royalty Trust are oversold.