As the current stock market bull market starts to look long in the tooth, I have broadened my search for income investments that are not directly tied to company business results and share prices. Direct commodity exposure provides one way to diversify a portfolio that is loaded with dividend paying stocks. Yet, I want all my investment recommendations to generate cash incomes. Royalty trusts produce income derived from the production and sales of commodities, typically oil and natural gas.
An energy royalty trust earns all or the majority of the profits from oil and gas production out of acreage designated to the trust. These are not companies, and there are no management teams. A trustee collects the trust’s shares of earned royalties or profits and passes them on to investors. When you invest in a trust you purchase units, not shares. Most royalty trusts pay monthly distributions which vary from payment to payment.
The amount you earn from a royalty trust can go up with rising energy prices and if the operator of the trust properties increases the amounts produced. Some of these trusts have existed since the 1970’s and have paid distributions for decades. Newer recovery techniques developed over the past decade allow operators to “restart” production in older wells, boosting trust income. Keep in mind, as a trust unit owner, you are not investing in the oil company operating the wells. You are receiving a portion of the profits from the oil and/or gas produced by the wells.
The obvious downside to these trusts is that if energy commodity prices fall, so will the distributions and the trust unit prices. These commodities are priced based on global supply and demand forces. Especially crude oil, with natural gas moving towards a global system. My research shows that the low oil prices of 2015 through 2017 led to significant under investment by energy companies in new production capacity. Over the last year the global crude oil market has moved from over supply to balanced supply.
The lack of investment over the last few years means the market could easily go to under supply —and much higher oil prices—as global demand continues to grow. The International Energy Agency forecasts that current oil demand of 98 million barrels per day will grow by an average of 1.2 million barrels per day per year for the next five years. The combination of growing demand and several years of under investment point steadily or even sharply rising prices for crude oil. Energy royalty trust prices as well as distributions move in parallel with the price of crude. This chart shows three trust values compared to the United States Oil (NYSE: USO) ETF for the last five years.
I view these trusts as a way to get direct exposure to energy commodity prices and to own assets with values not driven by stock market sentiment. Here are three trusts to consider.
Mesa Royalty Trust (NYSE: MTR), incorporated on November 1, 1979, owns property interests in the Hugoton Area (Kansas) and the San Juan Basin (Northwestern New Mexico and Southwestern Colorado). The Trust does not engage in any operations.
An average of the last four distributions gives MTR an 8.5% yield on the current $14.35 unit price. Remember that for all royalty trusts, monthly distributions will vary, sometimes dramatically.
Sabine Royalty Trust (NYSE: SBR) was established as of December 31, 1982. The trust holds royalty and mineral interests in producing and proved undeveloped oil and gas properties in Florida, Louisiana, Mississippi, New Mexico, Oklahoma and Texas.
The total distributions paid from 2014 through 2017 show how the payments mirror the change in the price of crude oil. Note that oil reached its recent peak in 2014 and low in early 2016. Here are the total distributions per unit for the four year period:
Recent distributions give SBR a current yield of 6.9%.
Permian Basin Royalty Trust (NYSE: PBT) incorporated in 1980. The trust owns royalty interests in 33 Texas counties with most of the production coming from the Waddell Ranch properties located in Crane county, which is in the heart of the Permian oil play.
Six major fields on the Waddell Ranch properties account for more than 80% of the total production. The Waddell Ranch properties are mature producing properties, and all the major oil fields are currently being waterflooded to facilitating enhanced recovery.
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