A good play on California's unique energy dynamics
Pacific Coast Oil has interests in mature and undeveloped fields and yields nearly 10%.
Among royalty trusts, one high-quality company continues to fly under most investors' radars: Pacific Coast Oil Trust (ROYT). But the company stands to benefit from the unique dynamics of California's oil market.
To summarize, a lack of incoming pipelines connecting California to major onshore production and refining centers means that the state relies heavily on waterborne shipments of crude oil from foreign countries.
For this reason, oil prices in California tend to track Brent crude oil, an international benchmark that reflects global supply-demand conditions. In contrast, West Texas Intermediate crude trades at a significant discount. This differential favor producers with acreage in California.
Pacific Coast Oil Trust owns an interest in several fields located in the Santa Maria and Los Angeles basins of Southern California. Crude oil accounts for about 98% of the hydrocarbons produced from this acreage, limiting the trust's exposure to depressed NGL and natural gas prices.
Unitholders are entitled to receive 80% of net profits from the sale of oil and gas production from "the developed properties," which consist of the proved, developed reserves throughout area of mutual interest.
Unlike some trusts, Pacific Coast Oil Trust does not have a predetermined termination date: The trust will cease to exist when 75% of unitholders vote for its dissolution or when its distributable cash flow drops to less than $2 million for two consecutive years. Neither scenario is likely over the next 20 years.
Like most trusts, Pacific Coast Oil Trust distributes virtually of its cash flow to unitholders. However, unlike the majority of its peers, this trust pays a monthly distribution -- an appealing feature for investors seeking regular income.
Management estimates that output from its older wells will contract at an average annual rate of 3.4% between 2012 and 2016.
Meanwhile, producing oil from the trust's undeveloped properties will require significant investment in drilling and production infrastructure.
These high costs should prevent wells in the remaining properties from generating much in the way of profits during first few years of the trust’s existence.
To compensate, unitholders will receive 7.5% of the net proceeds from the sale of oil and gas from Pacific Coast Oil Trust's Orcutt properties when developmental costs exceed the proceeds from hydrocarbon sales. When the Diatomite project yields a profit, the trust is entitled to 25% of the net profits.
In short, the trust generates a slowly declining stream of cash flow from a mature set of wells and offers potential upside from the development of one of Southern California's most exciting oil plays.
Thus far, the trust's wellhead economics and production have exceeded expectations. Production from the Diatomite play also remains ahead of the schedule outlined in the trust's prospectus.
At this rate, the development should turn a profit over the next two to three years -- well before 2020, the target envisaged in the prospectus. The achievement of this milestone should dramatically increase the amount of cash flow distributed to unitholders.
Yielding about 10%, Pacific Coast Oil Trust rates a buy up to $20.00 per unit, with the caveat that prospective investors should use a limit order -- not a market order -- to establish a position.
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