What is an oil investor to do when the wells it has invested in start to run dry? Investors in BP Prudhoe Bay Royalty Trust (BPT) are likely wondering the same thing and the answer seems to be: not much.
The trust, which was established in 1989, holds a royalty interest in minerals produced from the Prudhoe Bay oil field, which is operated by BP's (BP) Alaska unit, along the state's northern coast. The trust is entitled to a quarterly royalty of 16.4% on the average actual daily net production of crude oil and condensate, which is not to exceed 90,000 barrels. Over the last three years, daily production in the wells has been less than 90,000 a day.
As a result of declining production, royalty revenues have decreased 37% over the last five years to $126.8 million in 2015, which resulted in a corresponding decrease in annual cash distributions to $5,863 per unit, according to the trust's 10-K filing. Meanwhile, shares of the trust have fallen 66% to $18 over the last year.
In the filing, the trust also stated that at current West Texas Intermediate prices, royalty payments are expected to continue in the trust through 2020 but they would be zero the following year. In addition to the risks posed by falling oil prices, future royalty payments are also threatened by risks that the well could be shut down and the rise of natural gas.
With respect to a production shutdown, the trust noted that BP Alaska shut down the eastern side of Prudhoe Bay in 2006 due to damage to the field's pipelines and equipment. Future defects could cause future shutdowns -- temporary or permanent -- that could have adverse effects on royalty payments. Additionally, the trust noted that BP Alaska is not required to make investments in Prudhoe Bay, which would yield additional proved reserves. (The trust's interest in Prudhoe Bay is "non-operational," meaning that it does not have the right to make decisions about the wells' operations.)
Finally, the trust acknowledged that a construction of a natural gas pipeline on Alaska's northern coast could "accelerate the decline" in royalty production. The economics of natural gas production could be more favorable than crude oil production. Making matters worse, extraction of natural gas would lower the oil reservoir's pressure, which would make oil production even more difficult.
Project planning to build a natural gas pipeline is well underway with Exxon Mobil (XOM), ConocoPhillips (COP), and BP leading the charge. While such a project could face headwinds due to environmental concerns and increased natural gas competition, it is a project that the trust is keeping a close eye on. (The trust is only entitled to royalties from oil, not natural gas.)
With no control over future production -- and royalties -- investors are likely questioning their stake.