BP Prudhoe Bay Royalty Trust (BPT)

First, everyone talks about the "dividend." It's a distribution from the trust based on the royalties the trust receives from its interest in producing wells in the Prudhoe Bay field of Alaska. Production in Prudhoe Bay peaked in 1988. It has been on a steady decline ever since.





The current "high yield" will come crashing to Earth with WTI trading in the $40 barrel range. At current production rates and a $75 price, BPT will yield about 3.6% ($2.71 in annual distributions). Some analsysts think oil should settle in the $60-$80 range. At those prices for WTI, assuming current production rates, and a $75 price, the trust would yield 10-15%. That's pretty attractive, but what people are missing is the following.





1. Production is declining quickly. Here are the average wellhead production rates in bpd:





Year   Avg wellhead bpd


1998   740


1999   660


2000   620


2001   546


2002   375


2003   350


2004   317


2005   293


2006   240* adjusted for temp shutdown


2007   232





2. BP and the other major oils involved in BPT production are slashing cap-ex. That means drilling fewer wells, maintaining fewer wells, shuttering enhanced recovery projects. This is due to the higher cost of capital resulting from the credit crunch exacerbated by the plunge in oil prices. If/when oil recovers, this could reverse itself, but I don't see that happening in the next 2-3 years.





3. Production will fall of a cliff once TransCanada's gas pipeline is built as resevoir pressure will decline with the extraction of nat gas. This will be a farily sharp decline. BPT has no rights to the gas production. The forces working against expanding production (#2) are also working against construction of the pipeline, but AK needs the gas revenues, the oils need the gas revenues, and nat gas has a brighter future than oil, so I believe this will happen and won't be greatly delayed by the falling prices and tight credit markets.





People are holding this as an inflation hedge. The problem with that strategy is that the trusts costs are linked to the CPI. As inlfation rises, the adjusted cost of production is increased to compensate for inflation. The base production cost also steps up, presumably to account for the increased cost of extraction as the resevoir is depleted. So, as inflation rises, the adjusted cost per barrell also rises reducing the amount available to be paid to the trust holders. Furthermore, the new AK royalty tax has a highly progressive tax on the oil revenues that increases as the price of oil increases. This too limits BPT usefulness as an inflation hedge.





At $75, with an assumed average WTI price of $70 for the next 5 years, I assign a fair value of $48 to BPT. At $75 it is wildly overvalued.