BTU - Permian Basin Royalty Trust: A New Addition To My Energy Watchlist

Summary

• Energy companies have had a good run in the last couple years, and the Permian Basin Royalty Trust is no exception.
• The company owns royalties on two properties in the Permian Basin, primarily the Waddell Ranch property.
• There are several quirks to owning shares of a royalty trust like PBT.
• The distributions were impressive in 2022, but they have come down in recent months. If energy prices spike again in 2023, the distributions could rise significantly.
• Investors bullish on energy prices might want to add PBT to their watchlist. An increase in oil prices could lead to a spike in distributions, which are paid monthly.

Over the last couple months, I have been looking for way to add energy exposure to my portfolio in a way that will diversify away from the midstream sector. Enterprise Products Partners ( EPD ) is still my largest holding, but I have been adding bits and pieces to different holdings. I really like the upside potential of Transocean ( RIG ) and the whole offshore sector in general, but I also added Peabody Energy ( BTU ), which is a large coal company and dirt cheap. I also have added a speculation in Pantheon Resources ( PTHRF ), one that I plan to continue to add to in coming weeks. One of the stocks that recently made it onto my watchlist is the Permian Basin Royalty Trust ( PBT ), a royalty company with interests in Texas.

Business Overview

This is normally where I put my investment thesis, but today I will just be doing a writeup on the business overview and some of the quirks of the trust. I'm not bullish or bearish at the current price, but I do think investments in the energy sector are still in for a good couple of years, which is why PBT recently made it onto my watchlist. With the oil price spike in the middle of 2022, PBT paid out huge distributions. The units of the trust look like a hold to me for now, but that is mostly due to the massive outperformance of the last couple years as energy prices spiked. If you think oil prices head higher from here and plateau at higher prices, that will likely lead to large distributions in the next couple years.

The Permian Basin Royalty Trust's (the "Trust") principal assets are comprised of a 75% net overriding royalty interest carved out by Southland Royalty Company ("Southland") from its fee mineral interest in the Waddell Ranch properties in Crane County, Texas ("Waddell Ranch properties"), and a 95% net overriding royalty interest carved out by Southland from its major producing royalty properties in Texas ("Texas Royalty properties"). The interests out of which the Trust's net overriding royalty interests were carved were in all cases less than 100%. The Trust's net overriding royalty interests represent burdens against the properties in favor of the Trust without regard to ownership of the properties from which the overriding royalty interests were carved. The net overriding royalties above are collectively referred to as the "Royalties." The properties and interests from which the Royalties were carved and which the Royalties now burden are collectively referred to as the "Underlying Properties."

- Permian Basin Royalty Trust Website

One of the things that's interesting about PBT is that it is basically two royalty streams, and the Waddell Ranch royalty is the vast majority of the company's income stream. For example, the Waddell Ranch royalty had $82.7M in gross proceeds from 2022 Q3, while the Texas Royalty properties had $6.6M in gross proceeds for the quarter. Potential investors should be aware of some of the potential quirks for the Permian Basin Royalty Trust, which are different from the average stock or partnership.

The Nuances of Owning PBT

While most publicly traded stocks are C-Corps, Permian Basin Royalty Trust is somewhere between a corporation and a partnership. There are several things worth mentioning for potential investors thinking about buying units. Most investors considering a royalty trust with a monthly dividend are going to look at PBT as an income investment, and there a couple things that are worth noting. PBT's distributions are considered as ordinary income and are taxed at each investor's marginal rate. However, unlike some partnerships that can create problems for investors in retirements accounts, PBT is not an issue for investors looking to own units in a retirement account.

The other potential thing to be aware of is the potential end of the trust and what could lead to the end of the trust. There are two conditions that could lead to the termination of the trust:

• The royalties fail to generate net revenue for the Trust of at least $1,000,000 per year over any consecutive two year period,
• Or a unitholder vote of 75% or more.

Once the decision has been made to terminate the Trust, the Royalty Properties will be sold for market value and the cash received from the sale less any applicable administrative costs will be distributed to the Unitholders of record at that time. While I don't think PBT will terminate the trust anytime soon, I'm not sure about the valuation of the trust.

Valuation

The valuation of PBT isn't as straightforward as some other partnerships, but I would think of it this way: if oil prices go up, PBT is going to increase the royalties it collects, and that will lead to increased distributions. The distributions might lag a couple months, but if you are bullish on energy prices, PBT is probably a solid choice as it will perform well in a rising energy price environment.

The distributions spiked in July and started to decrease significantly after October. We will see what happens in 2023 with energy prices, but I lean towards higher energy prices in 2023 and beyond due to a mismatch in supply and demand for oil. PBT isn't an investment that investors can rely for consistent distribution hikes, but for those that are bullish on energy, PBT might be an interesting play on higher energy prices.

Conclusion

There are other royalty plays out there, including the well-known Texas Pacific Land Trust ( TPL ). PBT is a smaller player with a market cap of $1.1B, but they have outperformed in the last couple years with the spike in oil prices. Most of their royalty stream comes from the Waddell Ranch royalty, but PBT is an interesting way to play an increase in oil prices for investors that are bullish on oil prices heading into 2023 and beyond.

Because I'm bullish on energy, specifically the offshore sector, I have been adding new positions to my portfolio with asymmetric upside. One of my favorites is Transocean, but I have been looking at other companies like Tidewater ( TDW ) and Valaris ( VAL ) to complement Transocean's debt laden balance sheet. The royalty companies like PBT are interesting, which is why they are on my watchlist for the rest of 2023. While I don't have a buy or sell opinion on the Permian Basin Realty Trust today, I will be watching to see if something changes where it makes sense to add units to my portfolio as a way to add monthly distribution income to my portfolio from higher energy prices.

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