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How Texas Pacific Land Trust Makes Money

By Luis Sanchez CFA - Feb 16, 2021 at 10:01AM

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Texas Pacific Land Trust is a land company that has found a way to benefit from fracking in the Permian Basin.

Texas Pacific Land Trust (TPL)is a land holding company with significant interests in the Permian Basin, where significant oil and gas extraction activity occurs. The company has a long and interesting history, but its business model today is truly unique and makes the stock worth considering for anyone interested in the oil and gas sector.

In this video from the Industry Focus podcast recorded on December 10, Motley Fool contributor Luis Sanchez and Industry Focus host Nick Sciple discuss the company's history and its business model.

Nick Sciple: Yeah, you mentioned the history of this company, Luis. We were talking about it as we were prepping for the show. You can find old clips from Warren Buffett in the 1960s talking about Texas Pacific Land Trust and a thesis for the company. But you mentioned, the investing thesis for the company today is probably significantly different than from when Warren Buffett was talking about it in the 1960s, predominantly because of this huge rise of fracking in West Texas and the Permian Basin.

Luis Sanchez: Yeah, absolutely. The key assets for the company, they own 900,000 acres of land in West Texas and that's the Permian Basin, essentially. The Permian Basin has been around for a long time actually. It's been repurposed in the last 10 years. From about 1970s until about the mid-2000, the rate of oil production in the Permian Basin was on the decline. But then 10, 15 years ago, there was a lot of innovation in the oil and gas sector, and techniques like horizontal drilling and hydraulic fracturing has made extracting oil and gas from the Permian Basin a lot more achievable and affordable. Texas Pacific has been a beneficiary of the oil and gas fracking boom and in the last 10 years, has really taken on a whole new life, and the value of their land has increased quite a bit.

Nick Sciple: Right. You mentioned that the value of the land comes from a few different things. You've got these royalties, so that means when oil gets pulled out of the ground on the land that they have royalty rights on, Texas Pacific receives income, and this is obviously incredibly high-margin income. You don't pay any of the cost of production, but you get this royalty stream that comes in. They also have other land rights that are significant for oil and gas production as well, talking about easements and things like that. You want to talk about that, Luis?

Luis Sanchez: Yes. So the business model can get a little lumpy and there's a lot of very specific things that they are doing to take advantage and to monetize their landholdings. But to really boil it down to the one sentence explanation of what Texas Pacific is, is they own a bunch of land in West Texas, and if you want to extract oil from their land, you have to pay them, one way or another. So they basically have four different ways to monetize their land. The first is what's called surface access rights. So if you build a pipeline that goes over their land, you have to pay them a toll. If you build a drilling rig on their land, you're going to have to pay rent on that drilling rig. And they also have a little over 20 thousand acres of oil royalty rights, and that entitles them to a percentage of the income generated from selling the oil. So a small percentage of the income from the oil rig. And then finally, also, in 2017, they established a subsidiary that sells water to the producers. So water's used as a part of hydraulic fracturing. So if you want to do some hydraulic fracturing, you might want to buy water from them too. That's been another interesting area for them to make money, and finally, occasionally, they sell land and they also buy land, and they do a little bit of land speculation there.

Nick Sciple: Right. So they've got access to these important rights in an area where significant oil production is taking place. A stat from one of their investor presentations is 25 percent of the hydraulic fracturing rigs in the US are located in the Delaware Basin, which is where Texas Pacific land is predominantly located in. Another important thing to point out is a lot of their customers are some of these big operators like Exxon, Chevron. So they have exposure to some pretty significant, strong businesses. Now, agreed, obviously these companies have struggled, but they're continuing to produce oil in the Permian Basin.

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