When it comes to investing in oil and/or natural gas, investors pick one of two paths: energy stocks or futures contracts. But there are other ways to play the sector, and one in particular can lead to some awfully high yield.
And that way is royalty trusts.
Royalty trusts own interests in developments involving crude oil, natural gas and coal. They don’t actually do the physical mining or drilling, but they do receive payments based on what these holdings produce. Their corporate tax structure requires that essentially all of the royalty income received must be paid to unitholders in the form of dividends. These cash flows are subject to the prices of the underlying commodity, and typically result in some fairly high yield for investors.
Of course, what’s high yield without a little high risk?
Plunging oil, gas and coal prices (see: today’s environment) can lead to massive dividend cuts and share price declines. Additionally, once set up, royalty trusts can’t add any assets, so once the well has run dry, the trust will dissolve.
Still, despite the risks, royalty trusts are a good way to add high yield to an income portfolio. Don’t bet the farm on any one trust, of course, but if you throw a little speculative money at a few, you can at least pay for a few extra round of golf in retirement.
Today, we look at three high-yield royalty trusts that have their warts, but still are worth a spec investment:
High-Yield Royalty Trusts: Chesapeake Granite Wash Trust (CHKR)
Dividend Yield: 40.9%
As we said, royalty trusts can carry some risks — and a big one is declining distribution rate thanks to dwindling commodity prices.
So, that sky-high yield on Chesapeake Granite Wash Trust (NYSE:CHKR)? Don’t get too excited about that, because the 41% yield isn’t going to stick around for much longer.
In fact, the dividend is already on the way down, with distributions falling from its most recent peak of 69 cents in 2013 to 45 cents as of the latest scheduled payout.
So … why recommend units of CHKR?
Well, it’s a gamble on a rebound in energy prices, pure and simple. Much of the decline in CHKR — both its share price and its distributions — has come from a 1-2 punch of falling oil prices and poor drilling results. Parent and sponsoring firm Chesapeake Energy Corporation (NYSE:CHK) has had a hard time churning out meaningful production from wells within the trusts operating area. Meanwhile, reserve estimates haven’t been up to snuff, either.
However, if Chesapeake can get its act together, and if energy prices rebound — the Granite Wash is an expensive place to drill — you’ll be looking at much higher distributions down the road. In the meantime, you still can collect a sizable yield.
CHKR is a risk, but at least the potential reward is substantial.
High-Yield Royalty Trusts: Permian Basin Royalty Trust (PBT)
Dividend Yield: 10.4%
If CHKR is too risky of a play for you, you might consider the Permian Basin Royalty Trust (NYSE:PBT) instead.
Like many of its sister royalty trusts, PBT has seen its distribution drop over the last few months. Obviously, the fall in oil prices is the main reason, but COP also has allocated more capital spending to the royalty trust’s properties. Since it’s structured as a trust, that capex must come from cash flows, which means lower dividends for shareholders.
But that higher capex might be PBT’s saving grace.
The Permian Basin Royalty Trust has continued to extend its lifespan — currently around 16 years — by using enhanced oil recovery techniques to squeeze more oil out the Permian. The Permian is a great region to use these advanced techniques as it’s already one of the lowest-production-cost regions in the nation.
Investors buying PBT today in hopes of an energy rebound are getting in at mulityear lows and still reaping a high yield of more than 10%.
High-Yield Royalty Trusts: Hugoton Royalty Trust (HGT)
Dividend Yield: 16.8%
Oil-related royalty trusts aren’t the only ones that are suffering. Those that dabble in natural gas are also suffering from dwindling share prices and distributions.
Hugoton Royalty Trust (NYSE:HGT), one of the largest natural gas trust, has fallen about 30% since the start of the year and now yields a whopping 17.6%.
Investors with a head for the longer term should seriously consider this a buying opportunity.
HGT, which was formed by XTO Energy — now a subsidiary of behemoth Exxon Mobil Corporation (NYSE:XOM) — owns an 80% royalty on properties located in Kansas, Oklahoma and Wyoming. Those wells are some of the slowest-declining and longest-life natural gas wells in the country. HGT has about 210 billion cubic feet in reserves at present, and has a lifespan of more than a decade. That’s a good thing as natural gas continues feature prominently in the long-term U.S. plans to achieve energy independence.
Which is exactly why you would want to own HGT in the first place — the long-term demand picture for natural gas. While the short-term picture is full of low distribution growth, the longer term seems quite rosy for HGT’s underlying properties, and the royalty trust’s recent declines allow investors to hop in cheaply.
Yes, HGT could see its dividend cut further if natural gas prices continue to fall, but over the longer term, Hugoton Royalty Trust is less risky than it seems at first glance.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.
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