BPT: The Dangers of an Emotional Yield Chase
It has been said, practically since the dawn of time, that one of the greatest enemies investors face is their own emotions. Adopting affection or disdain for a stock as it is real person that can return those feelings usually ends poorly for investors. BP Prudhoe Bay Royalty Trust's (NYSE: BPT) is starting to prove as much.
For those that have not actively followed BP Prudhoe Bay Royalty Trust, here is a brief rundown of what has been happening since late August. For starters, some royalty trust basics are needed. BPT and scores of other royalty trusts are prized by income investors for high yields, strong payouts and tax advantages that are not found with ownership of common shares.
Along those lines, it is vital to note that while an energy-based royalty trust may be able to extract oil from a certain location for years upon years, the legal structure of U.S. trusts forbids the acquisition of new assets, meaning that at some point, royalty trusts are sitting on top of depleting assets. Granted, full depletion for many trusts, BPT included, is well into the future.
So this is what has been happening with BPT, the most recognizable brand name among royalty trusts, since late August. On August 24, the Wall Street Journal publish an article questioning BPT's market value while highlighting recent distribution cuts from other royalty trusts. The Journal piece was followed by this one on August 29 that highlighted some of the dangers income investors need to be aware of with royalty trusts.
What ensued was a firestorm of controversy. Between the Journal piece and the other article published on Seeking Alpha, nearly 60 comments were left on the two web sites, few of which were flattering. Acknowledging the obvious difficulty in summarizing almost 60 comments from dozens of different people, the crux of the criticisms of both articles was that since BPT had fallen from $120 on August 17 to below $77 on August 29, the sell-off combined with the seductive payout meant a buying opportunity.
Additionally, many BPT bulls all but acknowledged that oil production in Alaska is waning, but said the income offered by BPT is too compelling to ignore. Here is a harsh reality about Alaskan oil production. Peak production was reached in the 1988-1990 time frame. Alaska has been usurped by North Dakota as the No. 2 oil-producing state behind Texas. Alaska's 2010 oil output was the lowest since 1977.
Simply put, Alaska produced almost 2.1 million barrels per day in 1988. In 2011, that number plunged to 608,000.
Falling Knife Those audacious enough to ignore all those facts and get involved with BPT in high $70s or low $80s, at a time when the units looked like a falling knife, could have done quite well for themselves. That is if they traded BPT, which is often used as a long-term instrument, as a trade.
An unfortunate reality of investing is that few investors are able to buy at a stock's absolute bottom and sell right at its peak. In other words, it is unlikely a lot of retail investors caught BPT at $76 and some change on August 29. More than likely, those investors were lured in by the yield sometime over the next few days in the $87-$89.
That made for a decent trade, assuming those folks dumped BPT on one of the multiple occasions the units hit $94 later in September. Chances are that did not happen because the primary reason investors own royalty trusts in the first place is the dividends. BPT's ex-dividend date was October 11 and the record date was four days later.
By the time payout arrived on October, investors that got involved in the $87-$88 area were out of the money by a couple of bucks, but the dividend would have them close to breakeven. That is not terrible, but now BPT is within spitting distance of its August low. BPT's almost 14 percent loss in the past month is nearly seven times as the SPDR S&P 500's (NYSE: SPY).
Flawed Reasoning To be sure, some BPT bulls have made strong arguments. Read a few of them and it is clear this stock has some intelligent, savvy supporters. Unfortunately, a lot of those arguments revolve around the assumption that BPT will be able to pump 90,000 barrels of oil per day for as much as another 15 years.
Alaska's declining production numbers do not bode well for any company operating there being able to say with any modicum of certainty that it will be able to produce a static number of barrels for 15 months let alone 15 years. BPT proves as much. Third-quarter output was less than 66,000 barrels per day. That is down from less than 86,000 bpd in the second quarter and over 94,000 bpd in the first quarter.
Bottom line: It can be inferred from reading the comments of BPT supporters that these investors either believe Alaska's faltering crude output does not pertain to BPT or that BPT units and the dividend can at least remain stable in the face of that declining output.
The Dividend Then there is the matter of the dividend. Since the payout from many trusts is based on production levels, dividends from trusts fluctuate. Said another way, assuming no increases, investors no that next year, Exxon Mobil (NYSE: XOM) will pay $2.28 a share in dividends. BPT's dividend is anything but static. That is not necessarily a bad thing, but dividend cuts have hit royalty trusts in force this year.
Hugoton Royalty Trust (NYSE: HGT) has seen seven consecutive months of lower dividends. Three of the past four payouts from Permian Basin Royalty Trust (NYSE: PBT) have been lower than the previous months. Same goes for San Juan Basis Royalty Trust (NYSE: SJT).
And like the dividend, BPT's proved reserves fluctuate, another factor investors have a hard time acknowledging. It might be an oversimplification, but the trust's proved reserves total moves in tandem with oil prices.
At the end of the day, there are some irrefutable truths about BPT. Investors are emotional about this stock. It has a seductive yield and payout. Oil production in Alaska is declining. Those that bought the stock in early to mid-September are now sitting on loser of a trade, the percentage loss of which cannot be covered by the most recent dividend. If another $4 or $5 comes off the units, BPT will be trading at its lowest levels in over three years. None of this sounds attractive, does it?
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