BP Prudhoe Bay Royalty Trust Was Obliterated in March -- and It May Get Worse

Image source: BP.

What: Shares of BP Prudhoe Bay Royalty Trust (BPT), a royalty interest trust in the Prudhoe Bay oil field located on the North Slope of Alaska, collapsed in March, with its share price plunging 44% according to data from S&P Global Market Intelligence. There appear to be three primary culprits for the tumble.

So what: First, BP Prudhoe Bay Royalty Trust is dependent on rising crude oil prices to pay out its handsome and highly coveted cash distribution. But as we all know, crude prices have sunk by roughly two-thirds in less than two years, crushing the average per-barrel royalty that BP Prudhoe Bay Royalty Trust would net by 63% between Q3 2011 and Q3 2015. All the while, its contractual costs are rising.

Image source: Pictures of Money via Flickr.

Second, in March BP (BP -1.17%) announced that it would be cutting production in the Prudhoe Bay region of Alaska to just two rigs from the current five, largely on account of persistently low crude oil prices. BP Prudhoe Bay's royalty interest allows the company to receive a royalty on up to 90,000 barrels a day, but it appears as if production in the region is about to be slashed, hurting its royalty-earning capacity. That's also bad news for investors who count on the cash distribution.

The final nail in the coffin came from the company's 10-K, which suggested that the Trust is on pace to fund cash distributions through 2020, but did not expect to pay out any distributions thereafter. Here's the pertinent information from BP Prudhoe Bay Royalty Trust's 10-K:

Based on the 2015 twelve-month average WTI Price of $50.28 per barrel, current Production Taxes, and the Chargeable Costs adjusted as prescribed by the Overriding Royalty Conveyance, it is estimated that royalty payments to the Trust will continue through the year 2020, and would be zero in the following year. Therefore, no proved reserves are currently attributed to the BP Prudhoe Bay Royalty Trust after that date. 

Now what: With an end to cash distributions in sight, we're simply witnessing investors not overpaying for future distributions, which is a smart move.

Royalty trusts can offer substantial yields that can lure in inexperienced investors who are chasing yield, but their distributions are based solely on their ability to control their costs and maintain production, all while their primary product, oil in this case, rises in price. Right now, we're seeing BP Prudhoe Bay's costs rise each and every year, as expected. Meanwhile, production is falling, crude prices remain weak, and an end may be in sight for the Trust. Keep in mind that when it discontinues paying cash distributions, its share price would be expected to head to $0.

What could BP Prudhoe Bay Royalty Trust pay in cash distributions over the next five years? That depends on a number of factors, but the general consensus (that I happen to agree with) is that BP Prudhoe Bay is a huge gamble even after a nearly 50% haircut in a month. I'd suggest you avoid this mess altogether.