2024-01-12 14:45:43 ET
Summary
- BP Prudhoe Bay's Trustee, The Bank of New York Mellon, announced that BPT will make no quarterly distribution in January for the fourth consecutive quarter.
- This is due to oil prices again being less than the artificially high and rapidly increasing chargeable cost the Trust must pay.
- The breakeven price has increased by more than $7 as of January 1; oil must now average $93 or more for BPT to breakeven; oil is now under $75.
- The Trustee's reserve for administrative expenses would need to be replenished if BPT does make a profit, increasing the minimum oil price required for unit owners to actually receive a payment by $1.50-$2 or more.
Recent Events
BP Prudhoe Bay's ( BPT ) Trustee, The Bank of New York Mellon, announced on January 5 that BPT would make no quarterly distribution for the recently ended quarter, the fourth time in a row, as the average price for West Texas Intermediate ((WTI)) oil was well below the "breakeven" price. Here are the details from the press release :
The shortfall is actually more than the reported $6.44 per barrel. I have written a number of articles about BPT on Seeking Alpha over the past decade, including my most recent one last July, " BP Prudhoe Bay Royalty Trust: The Termination Clock Is Ticking ."
One of the points I have regularly made is that the production taxes the Trustee reports are the production taxes at the average actual WTI oil price for the quarter, not at the breakeven WTI, which increases as the actual oil price increases. Therefore, production taxes at the breakeven price for the most recent quarter would have likely been about $.15 higher, at about $2.90 per barrel, making the breakeven price, prior to administrative fees, about $85.06.
Of course, as of January 1, the cost per barrel the Trust is charged has further increased by over $7 per barrel. This is due to the structure of the Trust, not real costs. I discuss this aspect of the Trust in more detail below.
Impact of Administrative Expenses
Administrative expenses also have an impact on the breakeven price. Although the Trustee references the administrative expenses and quantifies the subtraction from the distribution when the result is positive, it does not mention this in the 8-Ks when the result is negative. The amounts average about $400,000 per quarter. On the surface, it sounds miniscule. However, per the 2022 10-K:
The "Royalty Production" for each day in a calendar quarter is 16.4246% of the lesser of (i) the first 90,000 barrels of the actual average daily net production of crude oil and condensate for the quarter from the Prudhoe Bay (Permo-Triassic) Reservoir and saved and allocated to the oil and gas leases owned by HNS (as successor to BP Alaska) in the Prudhoe Bay field as of February 28, 1989 (the " 1989 Working Interests "), or (ii) the actual average daily net production of crude oil and condensate for the quarter from the 1989 Working Interests.
This means that the 68,000 average barrels of production reported in the 8-K includes the full Hilcorp allocation, not just the BPT portion, which is only 16.4246% of the 68,000 barrels, or less than 11,169 barrels per day. As a "side note," I find it a bit misleading that the Trustee reports the full 68,000 figure, rather than simply BPT's portion.
This is material because at 11,169 barrels per day, the total for a 91-day quarter is a bit over one million barrels. A $400,000 administrative expense represents about $.40 per barrel, further increasing the breakeven point per barrel, so the real breakeven point for earnings last quarter was about $85.46.
An Updated Table
The table below is mainly an update to the table in my July article, starting with the most recent actual quarter results which were available then (Q2 '23) and now shows my projections through the first quarter of next year.
I have added a line for estimated administrative costs per barrel to this table. It is only a rough quarterly estimate, though. The administrative costs are a fixed amount, so the per barrel impact depends upon total volume in a quarter. Volumes are typically lower in the summer when the pipeline is undergoing maintenance. The expenses are also variable from quarter to quarter, with them generally being highest in the winter when the audit is performed.
The administrative costs are important for two reasons. First, it raises the breakeven cost by $0.25-$0.50 per barrel per quarter. Secondly, these expenses are now being paid out of the previously funded reserve account, which would likely need to be replenished before any earnings are paid out. There have been no earnings for the past year, so the current deficit is likely in the $1.50-$2.00 per barrel range and increasing every quarter.
The Trust terminates if the "net revenues to the trust" are less than $1,000,000 two years in a row. One full year has already occurred, and net revenues for the first quarter of 2024 are likely to be negative as well.
The breakeven for this quarter has just increased by about $7.50 per barrel, according to my estimates. The Chargeable Cost has increased by $2.75 as of January 1, per the Trust indenture, while the CPI factor (multiplier) is approaching 2.4, increasing the Adjusted Chargeable Cost by over $7. Breakeven production taxes have likely just increased by about $.30 per barrel as well.
Significantly, it should be noted that my estimated breakeven WTI for Q1 of next year is over $103, an increase of more than $10 above my estimated amount for the current quarter. My estimate is based upon a 3/4% per quarter CPI increase, or about 3% annually.
Oil bulls should be aware that a large increase in oil prices over the next year would likely impact the CPI index, making the breakeven price even higher. It is hard to envision a scenario where oil increases by 30% while the overall CPI increase remains at about 3%. In this respect, the Trust is kind of chasing its tail.
The Bigger Picture
BPT Royalty Trust was created in 1989 as part of British Petroleum's effort to finance its share of the development cost of the massive Prudhoe Bay oil field. The Chargeable Cost factor for BPT went up by minimal amounts for the first 30 years or so of the Trust (generally 10c per year), meaning the cost per barrel charged to the Trust went up each year by only a bit more than the CPI index/factor increase. However, starting in 2018, it began going up by dramatically larger amounts.
In 2018, the increase was $2.80 per barrel, in 2019, $3.75, and in all years thereafter, it is $2.75 per year per barrel. These figures are then of course multiplied by a CPI index, now well over 2, so the breakeven prices are increasing by over $8 per year and increasing at a more rapid pace every year, as even modest CPI increases have an impact.
The $2.75 annual increase is an artificial figure, totally divorced from the underlying economics but was in the original Trust indenture and disclosed every year. As a result, the structure should not surprise or upset any current BPT investor.
The Trust appears to have been structured this way to ensure that it would terminate 30-40 years after its creation. If it had been structured as a perpetual trust of some type at its creation in 1989, BP would likely have received at best a few more pennies per unit. It made perfect sense for the company to structure the Trust in such a way as to ensure it wouldn't last forever, along with all the administrative hassle that goes with it.
The Bottom Line
The average price of WTI needs to be roughly $93 or more to reach breakeven this quarter while its current price is almost $20 less than that. The quarter is now about 15% over, which means that WTI must average $96 or more for the remainder of the quarter for the Trust to reach breakeven. Even then, possibly $2 or so would need to be utilized to replenish the Trustee's reserve account. As a result, WTI would need to average close to $100 for the remainder of the quarter for there to be any payment in April, an event I consider extremely unlikely.
For the second quarter, the breakeven price increases another 75c or so to about $93.65. Then, of course, the increasing shortfall in the reserve account would need to be funded ($2+ per barrel) before there would be any payment to Trust owners in July.
In order for BPT to not legally terminate at the end of this year, WTI would need to average at least 30% above the current price of about $75 per barrel for a full quarter later this year. Although not impossible, I find this circumstance extremely unlikely.
I have tagged BPT as a "short idea" (my current position) which seems to be the most appropriate one among the choices Seeking Alpha has presented to me. However, my preferred recommendation would be "sell" if you are long and simply "avoid" if you are not invested. I would not recommend opening a new short position at the current price for two reasons. First, there is a substantial stock borrow fee, which has recently ranged from about 15-20% annually. Secondly, BPT tends to increase in price when WTI increases, even if the breakeven WTI price is hopelessly above the actual WTI.
For further details see:
BP Prudhoe Bay Royalty Trust: Likely Termination This Year With No Further Distributions