Oil Well Photo Credit Davebloggs

Photo credit: davesblog007 via flickr.com

The oil and gas industry is loaded with high yielding income investments, but there are very few with yields as high as BP Prudhoe Bay Royalty Trust (NYSE:BPT). With a dividend yield today north of 13%, anyone who is looking for some walking around money each quarter or wants to start a dividend reinvestment plan will be temped by this stock. However, it's not like most companies on the stock market. In fact, it's technically not a company at all. Let's take a quick look at BP Prudhoe Bay Trust's "business" and what the advantages and disadvantages of owning it are.

Wait, it's not a company? 

I know this sounds a little weird, but BP Prudehoe Bay isn't a company like most stocks you see for sale on the exchanges. Instead, it is a direct investment in the Prudhoe Bay oil field on the north slope of Alaska, and is entitled to a certain portion of the production that comes from the region. According to its 10-K, it receives royalties based on the lesser of these two conditions: 90,000 barrels per day of crude oil production, or 16% of BP (NYSE:BP) Alaska's production from the Prudhoe Bay region. What this means is that the BP Prudhoe Bay Trust is the most direct way to own oil production without going out and drilling a well yourself.

This makes investing in the trust extremely unique, and it provides some very interesting benefits. For example, it doesn't pay taxes at the corporate level because it is considered a grantor trust. Also, since you are a part owner of the oil wells, you are allowed to apply depletion to your royalty interest since you own an asset that depletes in value. 

Why invest in BP Prudhoe Bay Royalty Trust?

If that 13% dividend yield wasn't enough to get you intrigued about owning shares of the BP Prudhoe Bay Trust, perhaps this will. This chart compares BP Prudhoe Trust on a total return basis--which means stock price appreciation plus dividends--compared to the S&P 500 for the past 15 years.

BPT Total Return Price Chart

BPT Total Return Price data by YCharts

No, that is not a mistake. If you had invested in the trust 15 years ago, you would have outperformed the market 62 times over. You want to know what has caused such a passive change over that time? It's all about the price of oil. Pretty much that entire time period, net production to the trust remained pretty flat somewhere around that 90,000 barrel per day threshold, but the price of oil over that time period has increased 357%. Not only has this made the future production more valuable, but it also has increased the cash payouts. 

Why it might not be as good as it looks

So here is the catch with owning a royalty trust. Unlike a company that can allocate spending to search for new oil in other places, a royalty trust is a finite investment. Once the production from the Prudhoe Bay fields dries up, then that's it. According to the stated rules in the trust's 10-K, the Prudhoe Bay Trust will be liquidated when total royalties received by the trust are less than $1 million per year for 2 consecutive years. At that time, the remaining stake in the field will be sold back to the operators of the field at market value. 

Granted, it looks like this will take a while. According to the company there are sufficient reserves in the Prudhoe Bay field to last beyond 2029. However, daily production from the field has started to decline enough that it is starting to go below that 90,000 barrel per day threshold. Lower oil production will mean that royalty payments could decline if oil prices don't increase sufficiently to make up for the difference. 

Also, as a direct owner of a well, your royalty payment is completely reliant on commodity prices, which can vary wildly thanks to the mad, mad, mad, mad world of oil prices. Over the past 15 years, that has been great because of the huge increase in oil prices. If you were to ask someone who owned the BP Prudhoe Bay Trust for the 10 years prior to 1999, they might not sing the same tune as what we have seen more recently.

BPT Total Return Price Chart

BPT Total Return Price data by YCharts

What a Fool Believes

Owning shares of BP Prudhoe Bay could have a similar run like it has over the past 15 years if oil prices continue their upward trajectory, or they could go flat like pre-1999 if we were to see flat oil prices and production from the field starts to decline. That is the greatest risk with owning shares: It's completely dependent upon the price of oil. If you want to truly reap the value of this investment, you need to hold on through the good times and bad and let that dividend take care of you, but if oil prices or production from the Prudhoe Bay field start to significantly decline it might be worth looking elsewhere for your high yield investments. 

Tyler Crowe has no position in any stocks mentioned. You can follow him at Fool.com under the handle TMFDirtyBird, on Google+, or on Twitter @TylerCroweFool.

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