CHK - Black Stone Minerals: Can This 11.8%-Yielding Oil And Gas Play Sustain Its Cash Distribution?

2023-07-18 08:14:33 ET

Summary

• Black Stone Minerals currently offers a yield of 11.8%. Can the pure-play owner of oil and gas mineral rights and royalties sustain its cash distribution?
• In this article, I take an in-depth look at the operations to answer the above question.
• I believe that the expected near-term production growth and a favorable hedge program support the company's commitment to maintaining or slightly increasing cash distributions.

Black Stone Minerals, L.P. ( BSM ) is a master limited partnership that owns mineral rights in the U.S. As a master limited partnership, Black Stone Minerals allows investors to own a share of the income generated from its oil and gas properties in the form of cash distributions. It issues a K-1 tax form.

Now, let's analyze Black Stone Minerals as an income investment.

Business overview

Black Stone Minerals is the largest owner of oil and gas minerals and royalties in the United States, with approximately 20.8 million mineral and royalty acres or 7.4 million net acres, particularly in the emerging Haynesville play, as depicted in Figures 1 and 2.

As seen in Figure 2, Black Stone Minerals has not experienced any significant growth in its mineral and royalty interests since 2017. Consequently, its proven reserves have not grown during this period, as depicted in Figure 3. Therefore, it is fair to conclude that Black Stone Minerals may not prioritize growth by asset acquisition to the same extent as Viper Energy Partners LP ( VNOM ).

Royalty production

Average total oil and gas production declined by 21.6% from the pre-Covid levels in 2019 to 2021. Since then, production has been maintained at around 37,000-38,000 boe/d, as shown in Figure 4.

Without aggressive acquisition of additional acreage, how does Black Stone Minerals replace production and replenish its oil and gas assets, which have been gradually depleting, as depicted in Figure 5?

Black Stone Minerals actively promotes its 74% unleased acreage to operators for development. In 2020, the company entered into a development agreement with Aethon Energy concerning the undeveloped Shelby Trough Haynesville and Bossier shale acreage in Angelina County, Texas. Under the agreement, Black Stone will reduce royalty rates, and in exchange, Aethon will commit to drilling a minimum of 4-15 wells per year. In 2021, Black Stone initiated a second development program with Aethon in San Augustine County, targeting 5 wells per year initially and increasing to 12 wells per year. Additionally, Black Stone has test programs with multiple operators in the Austin Chalk play .

Distribution

Mainly due to changes in production and realized oil and gas prices, the revenues, gross profit, EBITDA, operating income, net income, and distributable cash flow of Black Stone Minerals have experienced significant variations over time, as depicted in Figure 6.

That is why Black Stone Minerals has maintained a variable cash distribution to unitholders. Over the past nine years, Black Stone has paid out an average of approximately 76% of the distributable cash flow, as evidenced in Figure 7.

In the 1Q2023, Black Stone paid out nearly 92% of the distributable cash flow. Looking ahead, will the partnership be able to sustain the quarterly cash distribution of $0.475 per share?

Here is what CEO Tom Carter stated during the 1Q2023 earnings conference call :

Despite some challenges with natural gas prices. We're confident in our guidance and we are able to maintain the highest distribution Blackstone has had as a public company at $0.475 per unit for the first quarter. Overall, it was a great start to the year and we continue to work on our new and existing operators to continue driving activity on our acreage."

And Evan Kiefer, VP of Finance, added:

And so right now with a 1.04 times coverage and really just with where the balance sheet is today, we do feel comfortable [to] maintain a little bit lower coverage in the near-term. Something that we always look for as we establish our distribution policy and what we look for going forward is something that we can have a stable to slightly growing distribution as we look at our forecasts... with the Aethon development agreements and even the Austin Chalk, where we expect to see ramping up production for the second half of the year, we still see growing volumes, potentially from those areas that may mitigate some of the risks and the others. And that gives us confidence in the current guidance that we have outstanding."

Risks

It is generally believed that U.S. LNG exports will increase substantially in the foreseeable future. The Haynesville/Bossier play, located in close proximity to the LNG facilities on the Gulf Coast, holds an advantage over competing shale gas provinces. Black Stone Minerals has a significant exposure to the Haynesville/Bossier play (Figure 1) and is therefore well-positioned to benefit from the anticipated rise in LNG exports.

As mentioned earlier, the depletion of proven reserves presents another risk to the long-term sustainability of Black Stone's assets. By the end of 2022, its proven reserve life was 4.7 years, which is relatively short compared to Topaz Energy Corp. ( TPZEF ), a Canadian royalty company with a natural gas-weighted asset portfolio (5.8 years), Chesapeake Energy ( CHK ), a U.S. gas producer (8.9 years), Tourmaline Oil ( TRMLF ), Canada's leading natural gas producer (10.5 years), or Diversified Energy ( DECPF ), a U.S. gas producer also operating on the Gulf Coast (16.4 years).

Black Stone Minerals maintains an extensive hedge program, which helps mitigate the volatility of oil and natural gas prices. During the crash in oil and gas prices in the 1Q2023, the hedge program generated $13.3 million in realized hedge gains. In the rest of the year, the hedge program will continue to provide support for cash flow in the relatively low price environment. It is largely due to the hedging gains that the share price has not followed the natural gas spot price down so sharply, as illustrated in Figure 8.

Investor takeaways

Investors seeking high yields may consider Black Stone Minerals. The pure-play oil and gas mineral rights and royalty owner currently offers a yield of 11.84%. The insiders, who own 25% of the company, have expressed optimism about maintaining or slightly increasing distributions to unitholders. They are encouraged by a positive outlook on the distributable cash flow, driven by expected near-term production growth, a favorable hedge program, and a debt-free balance sheet. Additionally, with Henry Hub currently at $2.55/MMbtu, there is probably more potential for upside than downside.

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