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BPT Shows Power of Royalty Trusts in a Dividend Portfolio

If you have someone to deal with the tax complications, putting your money in BPT for a year or two may be the right call

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“What are your thoughts on the BP Prudhoe Bay Royalty Trust (NYSE:BPT)? A number of articles have come out as to how bad this investment is but quarter after quarter and year after year the yield has held and the price has as well.”

It was only a matter of time before royalty trusts started popping up again. These mega-yield players are always sought after when times are tough and interest rates are low – but they are not without risk.

The short answer: Like MLPs, royalty trusts are attractive because the companies enjoy big tax breaks and pass on big dividends – in the case of BPT, over 8% based on its last four payouts. Used correctly they can be a dividend goldmine. And in this environment, parking your cash in BPT for a year or even two could be a very wise move.

But before you dive in, understand that this is not like playing common stock. There are complicated tax rules; you get a K-1 like an MLP.

But most importantly, these trusts have a finite shelf life. Royalty trusts like BPT will literally all disappear two or three decades down the road.

Royalty Trusts are Pure Commodity Plays

The bottom line is that royalty trusts are worth little more than the underlying reserves. In the case of BPT, there are no oil rigs, no employees, no nothing on the balance sheet — just a well of crude oil in Alaska.

That’s it. Period.

Royalty trusts often bear the name of an energy company that services them – in this case, the oil major BP (NYSE:BP) – but they are wholly separate when it comes to dividends and share pricing. The operations of a trust are simply the profits made as the energy or minerals are extracted and sold. And as a tax-free pass through instead of a corporation, these aren’t really stocks in the conventional sense. They are simply a vehicle for the profits to trickle through to shareholders (technically “unit holders”) as dividends (technically “distributions”).

As you can understand, that means royalty trusts are a pure bet on commodity prices. In the case of the BP Prudhoe Bay Royalty Trust, it is driven by how much crude oil is extracted and how much the market price is when that crude leaves Prudhoe Bay. Logically if crude oil is going up in value then the trust goes up as it sells its oil for more on the open market, and vice versa.

For a commodity play, you can’t do better. The Eca Marcellus Trust (NYSE:ECT) is almost 100% natural gas, and thus lives and dies by the price of gas. Some trusts are a mix of energy sources. Some like Great Northern Iron Ore Trust (NYSE:GNI) do metals. But all are locked to the price of their underlying assets and how much of those assets they produce each quarter.

Watch the Depletion and Volatility

There’s one catch, of course. Royalty trusts are also called “depletion trusts” because as they have a finite life cycle. After they extract all the oil or gas from the ground they are literally worthless – shares go to zero, dividends stop, game over.

So you better be darn sure you know how long a royalty trust is going to be around before you buy in.

I’ll repeat that: These investments will go to zero eventually. You cannot ignore this if you want to buy a royalty trust.

However, most investors can mitigate this very easily by simply sitting in a trust while reserves are plush and the depletion date is far down the road. There is never a precise count on reserves and estimates fluctuate, but building in cushion ensures you won’t get burned.

All this information is available in quarterly reporting from the trusts to shareholders and the SEC.

Article printed from InvestorPlace Media,

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