2023-05-15 07:16:55 ET
Summary
- Only a very tiny, if any, monthly distribution is expected to be announced on May 19.
- The reported yield of over 47% is misleading.
- Their underlying interests are very mature natural gas and oil fields.
- Years ago, Hugoton Royalty Trust had a total equity capitalization of over $1.5 billion compared to the current $50 million.
Hugoton Royalty Trust ( OTCQB:HGTXU ) rose from the dead last year and was up 40x at one point last August from its low a few years ago. HGTXU unit prices have since dropped sharply as the monthly distributions have plunged because of lower natural gas prices. Because of high planned development expenses and expected low natural gas prices this trust may go back into its coffin until energy prices soar again, which may never happen. Because I am expecting a very tiny, if any, monthly distribution when it is announced on May 19 and it is unlikely there will be any distributions in the near future, I rate HGTXU a sell.
Background Information
Hugoton Royalty Trust was created by XTO Energy, which is now a subsidiary of Exxon Mobil ( XOM ), in 1998 and the trust gets 80% of the net proceeds from the sale of gas and oil from the underlying properties, which are located in Oklahoma (Hugoton and Anadarko Basin), Wyoming (Green River Basin), and Kansas (Hugoton). Years ago, the total equity capitalization value of the trust was over $1.5 billion compared to the current capitalization of $50 million. The units traded below $0.08 a few years ago. In July 2021 XTO and the trustee at that time negotiated the purchase of the trust's interest for $6.6 million. Lucky (very lucky) for HGTXU unitholders they never received the needed 80% approval, so the deal was called off.
Many readers may already know these issues, but they are critical, so I am covering them. The trust has no control over operations and can't hedge, which results in the potential to being squeezed. For example, in 2018 XTO started drilling four horizontal wells in Oklahoma for an expected cost of $30-$35 million, which meant monthly development costs would increase from about $280k to $2.2 million. (The development costs were actually $21.8 million in 2018 and $18.1 million in 2019.) The trustee and the unitholders had no say in this. The problem is that if monthly income does not cover these costs there is no distribution from Oklahoma operations and the unpaid development costs roll over to the next month, plus interest, until these costs are paid. These cumulative excess costs eventually totaled $26,119,674 as of June 30, 2021. This had to be paid before any future distributions could be paid to HGBTXU unitholders.
XTO can hedge future expected production, but the trust could not. When natural gas prices drop the trust bears the full impact whereas XTO is most likely hedged against the price drop. If XTO is hedged properly they have an incentive to increase production, but that production may actually result in losses for the unhedged trust.
The reality is that the production from the mature fields continues to decline. In 2005 the total natural gas production was 29,986,698 Mcf (41 gross gas wells were completed in 2005) and by 2015 it was down to 15,736,066 Mcf (no gross wells completed in 2015). Natural gas production in 2022 was only 9,771,977 Mcf (1 gross dry well and 1 gross developed well completed in 2022).
Because of the trend of lower production and low natural gas/oil prices for a number of years, the trust was able to cover the development costs. Their financial situation got so bad that there were "going concern" warnings in 2021 financial reports. The trust owed the trustee, Simmons Bank, $1,217,857 at the end of 2021 for expenses that were not covered by the trust's revenue but were paid by Simmons.
In 2018 there was a tiny distribution of $0.009251 per unit and there were no monthly distributions until the announcement in July 2022. The announcement in July 2022 was for a distribution of $0.068699 per unit payable in August was based on May 2022 production at an average natural gas price of $7.53 Mcf. They were finally able to make distributions again after paying off their prior unpaid expenses.
In addition, there has been critical litigation that has impacted Hugoton Royalty Trust for years. The litigation started December 17, 2010 when some royalty owners filed a lawsuit against XTO Energy in Coal County, Oklahoma (eventually called Chieftain Royalty Company v XTO Energy, Inc.) The final impact on HGTXU unitholders is still not final. There was a settlement of $80 million for the class action case in 2018 and XTO has been asserting that part of this settlement amount should be considered development costs to be paid by Hugoton Royalty Trust. There was arbitration and it currently appears that the trust is going to get stuck with about $14.6 million. (This litigation is the primary reason why I stopped following HGTXU years ago because I really dislike trying to trade based on some future opinions by an unknown judge or judges.)
Recent Results
Hugoton Royalty Trust filed their 1Q 10-Q on May 12. The actual production time period for 1Q is November 2022 - January 2023 because of the two months delay.
1Q Income Statement (Nov.'22 - Jan.'23 Production)
sec.gov
Natural gas prices have plunged since the period covered in the above quarterly report. The average natural gas price was $4.83 Mcf in February, which was used to determine the distribution of $0.012363 per unit announced on April 18 and payable May 12. This was down from $12.78 Mcf in January, which was used to determine the distribution of $0.120066 per unit announced on March 21 . Natural gas prices have continued to drop since February.
Current natural gas prices for the trust's interest production market are actually even lower than the Henry Hub price. They sell into a number of different markets and the prices received are based on a multiple of different pricing methods, including the Panhandle Eastern Pipe Line Company index. Because the monthly distribution announcements only include average natural gas and average oil prices it is hard to get an accurate picture of their volume/pricing model.
Regional Spot Natural Gas Prices
U.S. Energy Information Administration - EIA - Independent Statistics and Analysis
HGTXU Units Valuation
Investors buy HGTXU units for the distribution yield. They don't buy for new growth or expansion because the trust can't buy additional assets and their underlying property interests are mature oil/gas fields. The problem is investors look at published yields and get yields based on trailing twelve months of distribution. Seeking Alpha shows a yield of 47.13%, for example. The expected future distributions and resulting yield should determine if it is a buy/sell. The future distributions, however, look very bleak.
The distribution announced on April 18 was for $0.012363 but was based on February prices and natural gas has dropped. Even with an average gas price of $4.83 Mcf in February their Oklahoma operation had excess costs of $143k and Kansas had excess costs of $104k. It, therefore, seems that their distribution for that month was based solely on their Wyoming production. The announcement on May 19 may be for no distribution or just a tiny token amount because natural gas prices were lower in March.
For the first quarter there were $1,748,606 development expenses. XTO has indicated they plan to spend about $7 million net to the trust, which means about $5.25 million remains that will have a negative impact future potential distribution. Most of this is for 3 wells in Oklahoma.
The forces behind the spike in energy prices over the prior year have been greatly reduced. There was almost no drilling during the Covid-19 period, which reduced production nationwide, but drilling started to increase significantly in 2021. An extremely cold winter in California dramatically drove up demand and the price for natural gas. The winter is over. Geo-political events/war increased demand for energy and disrupted supply chains, but the supply chains were modified which reduced the speculative demand for oil/gas.
I expect that there most likely be only very tiny, if any, future monthly distributions. Monthly gas prices would have to average over $4.50 Mcf in their market areas, which could have significantly different prices than the Henry Hub price, before there will be future distributions. Even then the distributions are also impacted by future XTO development expenditures.
Hopefully going forward investors will get more detailed information in the monthly announcements because Simmons has just been replaced by Argent Trust as trustee. One wonders if Argent will do some changes in oversight of the trust, but there has been no actual statement by them that they intend to do that. With more detailed monthly data investors will be able to make better analysis of the results. Other oil/gas trusts I have written about on Seeking Alpha give much more complete information each month than Hugoton.
I am reluctant to include this information because it uses much higher prices than current energy prices and uses a 10% discount factor, which I think is too low given long-term interest rates have risen sharply over the last 18 months. Only because many readers always asked for these figures am I including this information in the article.
The $155.645 million is about $3.89 per HGTXU unit. The reality is that this is currently much lower because the estimated figures are based on an average $5.75 per Mcf for gas and oil price of $93.46 per Bbl. In addition, it is unclear how much, if any, future development costs that are deducted before any distributions are included in the above figures.
Conclusion
Hugoton Royalty Trust was able to rise from the dead because natural gas and oil prices soared last year. With continued lower natural gas prices, it is highly unlikely they will pay any significant monthly distributions in the future. If it only pays a few cents in total distribution per year in the future, HGTXU should trade much lower than the current $1.30 price. If energy prices soar again XTO might sharply increase their development expenditures which could offset the positive impact on improved energy prices. Since the trust can't take advantage of higher energy prices because they can't hedge, the trust could get "squeezed".
The reality is this trust is just plain old. XTO is trying to get some additional production from these mature oil/gas fields, but XOM may have better properties to focus on going forward in an industry much of the country wants to end. I rate HGTXU units a sell.
For further details see:
Hugoton Royalty Trust: Don't Be Fooled By The Reported 47% Yield