Oil and gas trusts are among the highest-yielding stocks in the stock market, making them attractive candidates for income investors. On the other hand, in contrast to the well-known oil majors, such as Exxon Mobil (XOM) and Chevron (CVX) , they offer a different distribution every month, which is highly volatile due to the gyrations of the prices of oil and gas.

Therefore, investors should examine whether the current generous distributions of these trusts are sustainable in the long run before purchasing these stocks.

Below, we’ll discuss three oil and gas royalty trusts offering exceptionally high distribution yields. 

Royal Oil

Sabine Royalty Trust (SBR) is an oil and gas trust that was formed 1983. The trust consists of royalty and mineral interests in oil and gas properties in Florida, Louisiana, Mississippi, New Mexico, Oklahoma and Texas. It generates approximately two-thirds of its revenues from oil and the remaining one-third from gas.

Sabine Royalty Trust is one of the highest quality oil and gas trusts. At initiation, it had an expected reserve life of only 9-10 years but it has lasted for four decades and is likely to remain in business for several more years; The trust has static assets, i.e., it cannot add new properties in its portfolio. This is a major difference from the well-known oil majors, which can expand to new areas. Another difference is the pure upstream nature of the trust, which renders the trust more sensitive than the integrated oil majors to the cycles of the prices of oil and gas.

Just like all the oil companies, Sabine Royalty Trust was hurt by the collapse of the oil price caused by the pandemic in 2020. However, the trust proved much more resilient than expected. Its distributable cash flow (DCF) per unit decreased only 25% in 2020. This is an admirable performance amid one of the fiercest downturns in the history of the energy sector. To be sure, most oil majors and all the refiners incurred excessive losses in that year.

Even better, Sabine Royalty Trust is thriving right now thanks to the sanctions imposed by Europe and the U.S. on Russia for its invasion in Ukraine. Before the sanctions, Russia was producing about 10% of global oil output and one-third of natural gas consumed in Europe. Due to the sanctions, the global oil and gas markets have become exceptionally tight. As a result, the prices of oil and gas rallied to 13-year highs this year.

Sabine Royalty Trust has greatly benefited from the above tailwind. The trust has offered total distributions per unit of $8.65 in 2022. This is a 10-year high for the trust. The total distributions in 2022 are more than double the previous 10-year high annual distributions of $4.03, which were achieved in 2013 and 2014. The total distributions in 2022 correspond to a yield of 10.1%, which is a nearly 10-year high for the stock. Overall, the current business landscape is ideal for Sabine Royalty Trust.

On the other hand, given the high cyclicality of oil and gas prices, it is prudent to expect these prices to deflate in the upcoming years. It is also important to note that the aforementioned rally of oil and gas prices has caused a global energy crisis, which has put numerous households under extreme pressure. This has led most countries to initiate a record number of renewable energy projects in an effort to diversify away from fossil fuels. When all these projects come online, they are likely to take their toll on the prices of oil and gas. It is thus reasonable to expect oil and gas prices to moderate in the upcoming years.

Notably, they have already incurred a sharp correction off their recent peaks and thus they are now trading below their level just before the onset of the war in Ukraine. This is a strong bearish signal, as it indicates that the impact of the war has already been absorbed by the global energy market. To sum up, Sabine Royalty Trust is one of the highest-quality and most resilient oil and gas trusts but still it is risky at its all-time high, given the cyclicality of the prices of oil and gas.

Meanwhile, Back at the ‘Ranch’

Permian Basin Royalty Trust (PBT) is an oil and gas trust (about 70% oil and 30% gas), which is based in Dallas and was founded in 1980. Its unitholders have a 75% net overriding royalty interest in Waddell Ranch Properties in Texas and a 95% net overriding royalty interest in the Texas Royalty Properties.

Permian Basin Royalty Trust has similar characteristics to Sabine Royalty Trust but it has exhibited a more volatile and less reliable performance. In 2020, it incurred a 43% decrease in its DCF per unit. Even worse, despite the strong recovery of the energy market from the pandemic in 2021, Permian Basin Royalty Trust failed to benefit from that recovery due to high operating costs on the Waddell Ranch properties and thus its DCF per unit dipped another 4% in that year.

On the bright side, Permian Basin Royalty Trust has finally begun to benefit from the exceptionally favorable business environment prevailing right now. In 2022, the trust offered a nearly 10-year high distribution per unit of $1.15, which was quintuple the distribution in 2021. The distribution of $1.15 corresponds to a yield of 4.7%. While this yield is much higher than the 1.7% yield of the S&P 500, it is lackluster for a trust. Oil and gas trusts face a strong headwind in the long run, namely the natural decline of their producing wells. As a result, investors need a high distribution yield to be adequately compensated for this risk.

Permian Basin Royalty Trust has offered an average distribution yield of 6.5% over the last decade. However, future distributions are unpredictable due to the unknown path of oil and gas prices. In addition, as mentioned above, the prices of oil and gas are likely to moderate in the upcoming years due to the fading tailwind from the sanctions. Therefore, Permian Basin Royalty Trust is likely to face two headwinds in the upcoming years, namely lower commodity prices and lower production levels.

A Royalty Trust With a Key Difference

Hugoton Royalty Trust (HGTXU) was created in late 1998, when XTO Energy conveyed 80% net profit interests in some predominantly gas-producing properties in Kansas, Oklahoma and Wyoming to the trust. Net profits in each area are calculated by subtracting production costs, development costs and labor costs from revenues.

Hugoton Royalty Trust has a key difference from the aforementioned oil and gas trusts — it is focused primarily on natural gas. In 2021, it produced 88% natural gas and 12% oil. As a result, it is much more sensitive to the cycles of the price of natural gas than most oil and gas trusts. Its unitholders are well aware of this sensitivity.

Between April 2018 and October 2020, the costs of Hugoton Royalty Trust exceeded its revenues by a wide margin, mostly due to suppressed gas prices. Consequently, the trust did not offer any distributions during that period. Even worse, when gas prices began to recover in late 2020, the trust had to wait for its revenues to offset past losses. On July 2, 2021, the drama escalated, as Hugoton Royalty Trust announced that it had agreed to be sold to XTO Energy for $0.165 per unit in cash. That price was approximately 90% lower than the stock price in late 2017.

Fortunately for the unitholders, in the special meeting held in December 2021, the deal was rejected by unitholders. Even better, thanks to the aforementioned rally of gas prices after the onset of the war in Ukraine, Hugoton Royalty Trust resumed paying monthly distributions in August 2022. Nevertheless, the suspension of distributions for more than four years and the failed attempt of Hugoton Royalty Trust to dissolve are stern reminders of the excessive risk of the trust.

Hugoton Royalty Trust has offered total distributions per unit of $0.35 in 2022. This is an eight-year high level, which has resulted from the tailwind of the sanctions imposed on Russia. As Russia was providing about one-third of natural gas consumed in Europe before the war, the sanctions have greatly tightened the global gas market. As a result, Europe is now importing a record number of LNG cargos from the U.S. and thus the U.S. natural gas market has become exceptionally tight. This helps explain the rally of U.S. natural gas prices to a 13-year high earlier this year, though gas prices have recently corrected more than 50% off their peak.

Hugoton has offered an average DCF per unit of $0.30 per year over the last decade, though with a noticeable decrease in the last eight years. The trust is currently offering an exceptionally high distribution yield of 15.0%. This yield is much higher than the yields of Sabine Royalty Trust and Permian Basin Royalty Trust. However, investors should realize that the high yield has probably resulted from the excessive risk of the trust, which came on the brink of dissolving in 2021.

Moreover, given the natural decline of the production of oil and gas wells, the long-term downtrend in the cash flows of Hugoton Royalty Trust should be expected. During the last three years, the total production of the trust has declined at an average annual rate of 5%. Given the exceptionally high comparison base formed this year and the natural decline of oil and gas wells, it is prudent to expect a material decline of DCF per unit in the upcoming years.

Final Thoughts

Thanks to their exceptionally high distribution yields, oil and gas trusts are attractive candidates for the portfolios of income-oriented investors. However, investors should be especially careful due to the dramatic cyclicality of oil and gas prices.

The ideal time to purchase these trusts is during downturns of the energy sector, when these stocks become undervalued from a long-term perspective. Given the multi-year high distributions and stock prices of these trusts right now, investors should probably wait on the sidelines for a more opportune entry point.

(Please note that due to factors including low market capitalization and/or insufficient public float, we consider HGTXU to be a small-cap stock. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.)

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