“Texas Oil & Gas Royalty Trusts Are An Income Investor’s Dream And The Best Kept Secret On Wall Street”

Sleuthing out the trust teased by Leeb Income Millionaire

By Travis Johnson, Stock Gumshoe, February 5, 2014

It’s fair to say that we get more than our share of teasers for commodity and natural resources stocks here at Stock Gumshoe — those kinds of stocks take up a big chunk of the newsletter world, with only tech stocks and biotech maybe keeping up. They’re areas where it’s easy to have (or pretend to have) real insider knowledge that sounds impressive to regular folk like you and I, and sectors where the shockingly big winners we all lust after are sometimes found.

That’s for the growth jockeys, the mining enthusiasts, the folks who watch the corn and oil futures markets or pore through assay results to sniff out their opportunity at the next commodity supercycle or the next mega gold mine — but there’s also the pocket of the natural resources world where you find appealing income investments, companies who spit cash out to shareholders and make retirees smile. In that world we find the pipeline and producting MLPs, timber REITs, the almost-gone-but-not-forgotten Canadian royalty trusts, and, beneficiaries of a resurgence of investor interest in recent years, the US oil trusts. It’s one of the latter that’s being teased today by Stephen Leeb for his Leeb Income Millionaire newsletter.

And we’ll get to the specific one in a moment (yes, the mighty Thinkolator has solved the puzzle yet again!), but first a quick word on what oil trusts are:

Publicly traded oil trusts in the United States are owners of land or royalty/mineral rights that cover a specific area or oil field. They are not operating companies, they have no employees and make no business judgements about what to produce or where to drill, they are passive participants in the process and they simply collect their share of whatever the operating company (often the company that created the trust in the first place) produces from or earns from that oil or gas well or field. In most cases, the Trust is managed by a bank officer and its only real expense is a few board members or auditors who oversee the Trust and the administrative costs of collecting the money and spitting it out to shareholders/unitholders like you or I.

Trusts are sometimes perpetual, and sometimes have a specific dissolution point that’s driven either by a cumulative production level being reached, or production declining to a certain point, or by other specific factors — but in truth none of them are really perpetual because they are passive owners of a finite resource, so they are expected to gradually see production decline as the oil or gas is produced from their fields… they can certainly have reserves that last far longer than expected, because their rights may end up covering more oil than was thought to be there when the trust was created, or the producer might do more infill drilling or well stimulation and produce more than expected, but they can’t go out and acquire new assets or expand themselves. Trusts do not pay taxes, they simply pass along their income and any tax liability to shareholders — and often that tax liability is quite low, just like with MLPs, because of the non-cash impact of depletion or depreciation (the trust is in part paying out a share of its assets, not actual income).

But really, what you look for when you’re looking at a royalty trust like these is: for how long will its wells produce oil or gas, and at what rate of decline? Beyond that, it’s really just a question of what you think the oil and gas prices will be in the years that the trust is active — if oil and gas prices rise it will obviously produce more cash flow from the expected oil pumped out of the ground, but higher prices can also push the producer to do more to enhance oil recovery or drill more wells, which can help depending on how the trust is set up (some cover physical regions or fields, some cover a specific number of planned wells). In general, production is fairly steady and predictable because these trusts are set up as a way for oil and gas producers to offload their slow-decline, long-lived producing assets to the income-focused folks who will value them more highly, which lets them pay off debt or reinvest in making new discoveries.

So after that long spiel … which trust is being pitched by Stephen Leeb’s letter? Here’s how he gets us excited:

“The ‘Super-Giant’ Of Income Investments from the Seventh Oil Wonder of the World …

“A little-known Texas oil and gas trust sports a whopping 11.12% yield. But, that’s not the only reason the billionaires who back this outfit call it the ‘boring’ way to get insanely rich. There were once six super-behemoth oilfields in history. Now, there is a lucky seventh…”

That seventh “super-behemoth” field that they’re pitching is the Permian Basin, the fields roughly centered around Midland in West Texas that produced oil and minted new millionaires for decades in the first Texas oil rush but were thought largely “done” twenty or thirty years ago … and have been given a new lease on life by horizontal drilling and hydraulic fracturing which have enabled the vast shales of “trapped” oil, like the Cline and the Wolfcamp, to be produced. That’s not news to most folks who follow the oil industry at all, of course, the shales of the Permian Basin are the hot ticket, foremost in investor minds after they spent a couple years focused on the Eagleford in South Texas, and a few years before that on the Bakken in North Dakota.

And then Leeb gives his pitch about what the most profitable investments in the Permian are:

“Texas Oil & Gas Royalty Trusts Are An Income Investor’s Dream And The Best Kept Secret On Wall Street

“T. Boone Pickens created the first Texas Oil & Gas Royalty Trust in 1979 involving Mesa Petroleum. Investors received monthly distribution checks and scored huge nest eggs as the stock quadrupled.

“Texas Oil & Gas Royalty Trusts are powerful income investment vehicles for people who wish to invest directly in extraction of petroleum or mining of other materials, but who do not have the resources or risk tolerance to buy their own well or mine.

“These Trusts often own hundreds of individual wells, oil fields, or mines, and they represent a convenient way for the individual investors to diversify investments across a number of properties.

“And Texas Oil & Gas Royalty Trusts have a go