Description

This is a simple one - probably only appropriate for PA/small funds.  I'm seeing borrow at 20%.  That is relatively high but I susepct BPT will be down ~80% over the next 12 months.

I wrote this up in early 2020 but think it is timely again.

BPT is a grantor trust which owns an overriding royalty interest of 16.4% on the lesser of 90,000 bbls/d of crude and condensate or the actual average daily net production of crude and condensate from the working interest of BP Alaska (now Hilcorp) in the Prudhoe Bay field; unlike some other overriding royalty interests, however, BPT’s cash-flow is offset against formulaically increasing costs.

BPT's royalty is calculated as follows:

(Production *.164)*(Qtrly Avg WTI - Adjusted Chargeable Costs - Production Taxes).  It cannot be <$0.

• Production has recently been running 65-70k bbls/d.
• Quarterly average WTI is self-explanatory
• Adjusted Chargeable Costs is calculated by multiplying two items:
  • Chargeable costs are a feature of the trust.  In 2024 they are $37.50 and rise by $2.75/year
  • Cost Adjustment Factor is effectively cumulative change in CPI since the trust was formed.  At present it is ~2.4-2.5.
• Production taxes are hard to predict but, based on the history here, should generally be ~$3 with WTI at $90; ~$6 with WTI at $100; and rising from there.  Historically taxes rose more quickly but legislative reforms to Alaskan oil production taxes have changed that.

BPT will terminate (and liquidate) if net revenues from the Royalty Interest for two consecutive years are less than $1,000,000 per year (excepting force majeure events - of which Covid qualified).  Net revenues in 2023 were less than $1,000,000.  Net revenues YTD have been $0.  With BPT's current breakeven WTI price being ~$95/bbl, the futures curve implies net revenues for 2H '24 will also be $0 and that, as a result, the trust will have to liquidate in early 2025.

The trust has ~$5m of cash (held to cover expenses) which will probably be ~$4.5m when this thing terminates (expenses run ~$1.5m/year).  The only other asset is the royalty which Hilside can unilaterally buy for the greater of fair value or the Company's market cap.  Hilside won't want to pay the market cap (currently ~$50m) so the trustee will then seek to sell the asset.  In some sense, the royalty is a perpetual series of quarterly calls on the price of WTI.  The extent to which this chain of options is out of the money rises very rapidly.  Calculating the fair value of this is pretty burdensome but even just a little work will show that it is way overvalued.

A Dec 2024 $95 WTI call option sells for ~$.44.

A June 2025 $106 WTI call option (my estimate of BPT's 2025 breakeven) sells for ~$.50

The later options ('26 at $120; '27 at $130 etc.) don't trade and are, I think, pretty close to worthless.  By 2027 the futures curve has WTI at ~$67 putting the option almost 100% out of the money.

The implicit value of these options via BPT is ~$2.5-3m through 2025.  Throw in a few $mm more for 2026+ and maybe the royalty is worth $5m in the current environment.  I could see Hilside paying something a little more just for the nuisance value. 

Ultimately, I think the royalty is less valuable than the chain of options it most closely resembles because (i) it is not a fungible/liquid/divisible asset (ii) options would pay off 1:1 with an increase in WTI - the royalty doesn't because the tax take rises with WTI (iii) the royalty more closely resembles a european call rather than the more valuable american call on which I've valued it and (iv) the quarterly average price nature of the royalty would seem to dampen volatlity for the royalty vs an actual option.

So $4-5m of cash and probably a 7-figure amount for the royalty.  My best guess is liquidation value here is ~$8-12m against a market cap of $49m.  At the current borrow it will probably cost you 15-20% to see this through to liquidation.  My guess is the market cap declines over time but, assuming it doesnt, borrow is 20% against downside of ~80%.

One note - borrow has historically spiked for a few days around the distribution announcement dates (I believe because shorts realized that was when the fundamentals tended to have the most impact).  I have not followed this closely enough to know if that still occurs but it may.  Maybe that adds a couple % to costs.

Optionality Value:

Breakeven Price Estimates:

Catalyst

Termination and liquidation in 2025