How can any investment be this bad?
When BP created its Prudhoe Bay Trust more than 25 years ago, it included some odd provisions, including an escalating cost allocation that moves up each year. For years this cost moved up mostly with inflation, but starting in 2018 the escalations become much more meaningful, subtracting more than $5 per barrel of oil from BPT's distributions every year going forward. By 2020, we estimate BPT's break-even oil price will be >$55, and by 2025 it could exceed $90
What if I expect crude to rally?
For BPT to justify a valuation around $20, crude oil would need to rally to more than $70. Not only is that unlikely, but the expected return on buying USO (an ETF that tracks crude oil prices) or any high quality E&P company would be much higher if that transpires
Could losses be even greater than HITE's forecast?
BPT is only entitled to royalties on a portion of the first 90,000 barrels per day of crude and condensate produced from its properties, or actual production, whichever is less. We modeled the estimated losses assuming that production at this level, but the reality is likely to be worse.
According to page 32 or BPT’s 2016 10-K, production was only 89,000 barrels per day in 2016 and is likely to be below the 90,000-barrel mark in all future years. Consequently, the losses will almost certainly be higher than the estimates we produced.
The downside could be even greater however. Production taxes were unusually low in 2016 with an effective rate below 5%. While we modeled production taxes based on recent figures, the effective rate was about 20% in 2014, representing significant downside to our estimates. Higher taxes are particularly likely to reduce the benefit of a substantial rise in crude prices.
The bottom line is the losses we model are likely the best case scenario
Is it wise to hold on for another quarter or two of dividends?
It is difficult to predict when exactly BPT will move toward its fair value of $5 per share, but it will move there eventually, and the clock is ticking. Since BPT is highly likely to terminate, every distribution you receive lowers its remaining value. Note that on BPT’s most recent dividend date, 4/11/2017, it was down 6%, including the benefit of the distribution received
Apart from an extremely sharp rally in crude prices, the only event that could save BPT would be a renegotiation of the contract with BP to reduce its cost, which is extremely unlikely. BP created this contract structure originally, disclosed it in BPT’s IPO prospectus and in more than 25 years of 10-Ks, and is the direct beneficiary of this structure. Other royalty trusts have terminated contractually without any relief from their sponsor, including WHITING USA TRUST I (delisted, last report on sec.gov on 8/27/15)