WHITING USA TRUST I WHX S
September 06, 2010 - 5:04pm EST by
RoboCop
2010 2011
Price: 20.00 EPS $0.00 $0.00
Shares Out. (in M): 14 P/E 0.0x 0.0x
Market Cap (in $M): 277 P/FCF 0.0x 0.0x
Net Debt (in $M): -0 EBIT 0 0
TEV ($): 277 TEV/EBIT 0.0x 0.0x
Borrow Cost: NA

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Description

Overview: Whiting USA Trust I (WHX or the trust) is a high yielding (~15%) oil and gas trust that is a great short candidate. WHX owns a 90% Net Profits Interest (NPI) conveyed from Whiting Oil and Gas on certain oil and natural gas properties located in the Rocky Mountains, Mid-Continent, Permian Basin, and Gulf Coast regions. Much like GNI, the iron ore royalty trust that is set to expire in 5 years and cease existence, WHX also has a high yield, finite life, and a stock price above its likely total future distributions. The trust will expire when 9.11 MMBOE have been produced and sold from the underlying properties. WHX filings state the reserve quantities are projected to be produced by October 31, 2017, based on the reserve report for the underlying properties as of December 31, 2009. WHX's assets consist solely of the NPI and a minimal cash balance ($181k). It distributes approximately 100% of the income it earns quarterly.

 

The trust is set up to capture 90% of the profit of certain operating properties, defined as total revenues less certain allowable production expenses plus hedging gains. The trust was formed in April 2008, with cumulative production through the 2nd quarter of 2010 of 3.74 MMBOE, leaving ~5.37 MMBOE remaining under the trust's NPI.  There are no additional distributions after the payments from the NPI and dissolution of the trust. The total future trust distributions are likely to be below the current market cap, with the time value of money eroding away additional value. I see this as a low risk/low reward type of play. While the expected return on the short isn't spectacular, it is hard to lose money on this short, and it should provide a good general market or energy exposure hedge if that is what you are looking for. I think the true value of the trust is closer to its 4/30/08 historical cost ($123.6MM) than its current market cap of $277MM. While it definitely understates WHX's value, the YE 2009 PV-10 of the trust ($77.5MM) is another reference one may find useful.

 

Factors Determining Present Value:

The present value of WHX depends on three primary factors: the timing of the production, the production mix between oil and gas, and the future price of oil and gas. Ceteris paribus, a longer production life, a higher percentage of gas production (on a MMBOE basis), and lower future oil and gas prices equate to a lower present value.  

 

At current production levels, the trust would expire in about 4 years. The trust management and reserve engineers predict a life closer to 7 years, due to production declines. Management estimates an average year over year production decline of 14.6% for the remainder of the trust. A lower production decline assumption will reduce the life of the trust and increase the NPV of WHX, although it may actually increase the IRR of the short if it increases the speed investors realize the trust is going to zero. The recent historical production profile has been around 59% oil, while the year end 2009 reserves are composed of 66% oil. It appears that the trust incurs a discount of about 5% from the price differential of its wellhead sales price vs. benchmark prices.

 

Hedging

Whiting, the operator of the underlying properties has in place collars consisting of a floor/ceiling price for a portion of oil and gas production through 2012. Payments to/from the hedging counterparty will increase/reduce operating expenses used to calculate the NPI. In the arrangement, the counterparty (JPM) makes a payment to Whiting for the difference between the floor price and the commodity settlement price if the settlement price is below the floor price while Whiting makes a payment to the counterparty for the difference between the settlement price and the ceiling price if the settlement price is above the ceiling price. The trust has hedged 1.16 MMBOE of oil with a floor/ceiling price of ~75/$140 and 4,382 MMCF/.73 MMBOE of gas at ~$6.45/$14.25. The hedges provide a floor to the realized oil and gas prices for about 60% of production for the next two years, and 30% of production for the third year. WHX is prohibited from engaging in any additional hedge contracts.

 

Reserves

The underlying properties have reserves of 8.6 MMBOE with WHX receiving the NPI of the first 5.37 MMBOE produced. The 2009 SEC reserves were calculated at prices of $57.90/Bbl and $3.64/MMBtu. The trusts reported book value is based on the PV-10 value of WHX's share of the reserves. The reserves have a higher mix of oil (66%) than recent production (59%). I used the reserve report mix in my base case for the sake of conservatism.

 

Historical Results and Life of Trust Estimates

 

Year 2005 2006 2007 2008 2009 2010 1H Base Case Life of Trust Estimate
Beginning Trust Reserves


        9.11       7.50        6.04                           5.37
Oil Production MBbls        893        946        956           884        847          397                         3,560
Natural Gas MMcf     5,082     5,057     4,441       4,228     3,664      1,652                      10,832
Total Production MMBOE       1.74       1.79       1.70         1.59       1.46        0.67                           5.37
WHX Production


        1.61       1.46        0.67                           5.37
Production Decline   -2.8% 5.2% 6.3% 8.2%  7.8% 10%                    
Ending Balance            -              -              -           7.50       6.04        5.37                           0.00
Oil Price     48.72     56.24     62.17       92.97     62.50      67.55                         75.00
Gas Price       7.11       6.21       6.36         8.16       5.39        4.68                           5.00
Revenue     79.64     84.61     87.68     116.69     56.06      34.54                      321.18
Production Cost BOE     12.52     15.61     17.68       22.34     20.66      20.31                         20.00
Production Cost      21.78     27.92     30.00       35.48     30.11      13.65                      107.31
Hedging Gain               0.18     16.66        1.97                           7.45
Net Expenses     21.78     27.92     30.00       35.31     13.45      11.68                         99.86
Income     57.86     56.69     57.68       81.38     42.61      22.86                      221.32
90% NPI     52.07     51.02     51.92       73.24     38.35      20.57                      199.19
Trust Expenses


        0.79       1.13        0.59                           5.32
Distributable Income     52.07     51.02     51.92       72.45     37.22      19.98                      193.87

 

Scenario Assumptions and NPV Estimates

 

Below is my estimate of value for WHX under different oil/gas mix, production decline, and pricing scenarios. As you can see, it takes pretty high commodity price assumptions to make this short a loser. I estimate it will take prices of around $108/$9 for the current stock price to be justified.

 


Base Case Bear Case Bull Case
Oil/Gas Mix 66% 58% 70%
Production Decline 10.0% 14.6% 6%
Approx. Duration 5.5 7 5
Average Oil Price/Bbl 75 75 105
Average Gas Price/Mcf 5 5 8.75
Production Cost/BOE            20.00         20.00         21.00
Discount Rate 7% 7% 7%
Total Distributions      193.87      179.44      315.69
Total Distributions/Share         13.98         12.94          22.77
NPV/Share         11.73         10.78         19.13

Why is it Overvalued?

With the exception of Whiting, which owns a 15.8% of the shares, the stock is primarily owned by retail investors looking for yield. The 15+% yield certainly looks attractive at first glance. I think investors are either A) purchasing the stock looking for yield without knowing the short life expectancy of the stock, or B) they are playing the greater fool game thinking they can collect a few dividends and get out before the price collapses. While this stock has a catalyst in form of the production quota, it could take several years before the price of the stock finally collapses to its value. Although higher returns may be achieved by waiting a couple of quarters to short while production depletes the NPI reserves and distributions are paid out, I would bet the market is efficient enough that the price collapses sooner rather than later.

In addition to the final catalyst of the dissolution of the trust, two factors should naturally put downward pressure on the stock price: 1 As the front loaded production volumes are sold near current commodity prices and the NPI reserve base declines, it becomes harder to justify the stock price regardless of future commodity price assumptions. 2: As the production rates decline and quarterly production volumes are reduced, the NPI will shrink and the dividend will be cut, further lowering the stock price.  For an example of 1, if two years of production are sold at prices of $75/$5, it would then take commodity prices for the remaining years in the range of $141/11.75 to justify the current stock price. For issue 2, with prices remaining constant, the dividend should get cut roughly in line with the production declines - anywhere from ~6 -14% a year. 

Risks

  • Higher commodity prices - especially oil - although you should be able to hedge this
  • Continued irrational evaluation by investors - the biggest risk is that it takes several years instead of several quarters for the price to collapse (but this would also create a great opportunity for future short positions)

Catalyst

  • Production declines
  • Dividend cuts
  • Investor realization of finite life of trust
  • Completion of production and dissolution of trust
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