Permian Basin Royalty Trust Upgraded After It Plunged 56% Over The Last Year (PBT)

The recent confusion over the 2024 CAPEX plans by Blackbeard Operating seems to have more of an impact on Permian Basin Royalty Trust (NYSE:PBT) units than the swings in either oil or natural gas prices. After soaring over the last few years because of increased CAPEX, underlying oil production seems to have leveled off. If the latest monthly distribution of $0.041340 per unit continues at approximately the same level going forward, PBT would have a yield of 4.3%. PBT has dropped over 56% since my April 2023 sell recommendation article, compared to an almost 21% increase in the S&P 500 Index. I am upgrading PBT at the current price of $11.54 to a “hold” because there is an implied embedded oil call option in PBT units, and any dramatic war developments could cause energy prices to soar.

2024 CAPEX Budget Reporting Confusion

Currently, I would never consider buying PBT because of confusion over numbers contained in their reports. When they filed their 10-K on February 29, many PBT investors were shocked to read on page 12 that “Blackbeard provided the Trustee with a preliminary capital expenditures budget of approximately $301 million (gross) and a development plan reflecting the number of wells it expects to drill in 2024”. That $301 million was a huge shock because there was another statement in that same 10-K on page 12 that “Blackbeard has advised the Trustee that the total amount of capital expenditures for 2023 with regard to the Waddell Ranch properties totaled $135 million (gross)”.

The $135 million included about $19 million for some remedial and maintenance activities, which were reported on the income statement as part of operating expenses.

If CAPEX were going to increase so dramatically from $135 million (gross) to $301 million (gross) it would be fairly likely that there would be no monthly distributions from Waddell Ranch for a long time and that the only monthly distributions would be from Texas Royalties.

On March 18, however, they filed a news release regarding the monthly distribution that contained this statement:

Blackbeard has advised the Trustee that the proposed budget for 2024 has not been finalized; however, it has provided the Trustee with a preliminary capital expenditure budget of approximately $301 million (gross) $106.11 million (net).

What? A 75% net overriding royalty interest would imply that the NET amount of CAPEX to the trust would be $225.75 million. A table in that release showed that the 2023 CAPEX budget was actually $325.12 million (gross) and $121.92 million (net) to the trust. That gross CAPEX for 2023 was completely different than the gross CAPEX statement in the 10-K. The $106.11 million indicates that NET CAPEX will drop from $121.92 million in 2023. This could mean less risk that CAPEX amounts for a month will result in no distributions. (See below.)

That same March news release stated that the CAPEX was $11,547,978 (gross) for January. It also stated that “Blackbeard has advised the trustee that approximately 7% of that preliminary budget has been incurred related to January 2024 activity.” Using that 7% and $11,547,978 (gross), the implied total CAPEX for 2024 would be about $165 million (gross). The reported numbers are very confusing for investors.

It gets worse. The trustee, Argent Trust, filed a corrected March news release regarding the gas production and average gas prices at Waddell Ranch. The monthly distribution amount of $0.041340 per unit stayed the same. While the error was not major, it does cause a concern for some investors regarding their reported numbers.

Litigation Against Blackbeard

Argent Trust brought a suit against Blackbeard seeking “$15 million in damages to the Trust resulting from overhead costs and other expenses the Trustee alleges were impermissibly deducted from royalty payments to the Trust” The trustee alleged a breach of contract under 28 U.S.C. § 1332. The case, Argent Trust Company v. Blackbeard Operating, LLC, 4:23-cv-01253, (N.D. Tex), was filed on December 18, 2023, but Argent Trust then filed a Notice of Dismissal Without Prejudice on March 5. (docket 9).

While $15 million is only about $0.32 per PBT unit, a judgement could force Blackbeard to be more diligent going forward with their cost accounting reports. I was disappointed that Argent Trust was not fully prepared to continue this case in March and filed the dismissal notice. I am assuming that there could be a new filing at some point in the future because the dismissal was without prejudice, or there could be some future negotiated settlement.

Oil and Natural Gas Prices

Since 86% of their revenue was from oil in 2023, many investors focus mostly on oil prices and the underlying oil production. Oil prices recently seem to be just driven by one crisis after another. First there was the pandemic, which was then followed by the Ukraine War. Now it is the constant crisis in the Middle East. Because the trust can’t hedge, holders of PBT are directly impacted by oil and natural gas price changes. Their underlying operator, Blackbeard, can hedge and can, therefore, adjust their CAPEX plans according to their hedge positions. If Blackbeard hedges at relatively high prices, they could still continue a CAPEX program even if spot prices for oil and natural gas plunge. (As I submit this article, I am short WTI oil because I don’t think Israel will attack Iran at this time. At some point in the future, Israel may, but I doubt they will within the next few days.)

Crude Oil Futures

If you factor out the various international military actions, the domestic oil market is actually fairly bearish. The cumulative daily crude oil production for the lower 48 states is up 7.7% from the same time period in 2023 according to the latest EIA report released April 17, and crude oil storage is currently down only 1.1%. If international tensions stabilize, oil prices could drift lower into the mid $70’s. Natural gas prices remain weak because much of the country had a fairly warm winter and the heating season is mostly over.

Regional Spot Natural Gas Prices

Oil Production

The underlying oil production has soared over the last few years. In 2019, it was 2,388 Bbls/day, 2,277 (2020), 3,423 (2021), 6,295 (2022), and 8,090 (2023). This dramatic increase was because the total CAPEX from 2019 to 2023 was $324.93 million [$120.46 million (2023), $124.28 million (2022), $66.56 million (2021), $10.32 million (2020), $3.31 million (2019)]. Oil production, however, seems to have leveled off in the last few months. The August 2023 news release reported total oil production was effectively 8.870Bbls/day. The reported numbers for subsequent months were 8,584 (September), 9,180 (October), 8,671 (November), 8,693 (December), and 8,716 (January 2024).

Assuming that Blackbeard is actually able to complete their planned 95 new drill wells (gross) and 24 recompletions (gross) in 2024, I would not expect a dramatic change in oil production in 2024 because they drilled 77 new wells (gross) and 142 recompletions (gross) in 2023. I am, however, expecting a continued lowering trend over the remainder of the year. It is difficult to make specific estimates because Blackbeard does not disclose details on new wells or recompletions. (Remember Blackbeard has no fiduciary responsibility to the trust or PBT unit holders.)

Monthly Distributions

While there is effectively an oil call option embedded in PBT units that impacts PBT unit prices as oil prices rise and fall, many investors buy PBT for the monthly distributions. The problem for these income seeking investors is that very large CAPEX associated with the Waddell Ranch over the last few years resulted in very modest monthly distributions based solely on Texas Royalties. Any CAPEX liability rolls over to the next month, and not until there is no deficit can distributions be paid from Waddell Ranch production. Finally, in October 2023 there was no longer a CAPEX deficit and there was a distribution that included net profit interests from Waddell Ranch.

Lower CAPEX numbers in 2024 most likely will result in continued distributions from Waddell Ranch, but there could be some months when there is a significantly larger CAPEX amount that could negatively impact distributions for that month because drilling project expenses can vary from month to month.

If you annualize the latest distribution of $0.041340 per unit declared in March, you get a total annual distribution of approximately $0.496 per unit. This distribution was for January production that had an average oil price for Waddell Ranch of $72.45. Since I am expecting oil prices to remain slightly higher than $72.45 for the rest of 2024, and I also am expecting oil production to slightly decline over the remainder of 2024, an annualized distribution of $0.50 to $0.55 for PBT is realistic, in my opinion. There could be large swings in distributions, partially based on CAPEX and energy price volatility. Using the midpoint of $0.525 and the latest PBT price of $11.54 you get a yield of 4.3%.

Conclusion

This is an update to my prior Permian Basin Royalty Trust articles. I am cautious about investing in energy trusts because of the reported numbers. The latest issue regarding the size of the 2024 CAPEX and the $15 million litigation reinforces my concerns.

In theory, PBT could soar if a major war develops in the Middle East. Without the impact of international military actions, WTI oil prices would be significantly lower because domestic oil production is up 7.7% from last year and domestic demand has not increased by the same percentage. While their distribution yield is not really very attractive, I am upgrading PBT to “hold” from “sell” after it dropped 56% and there is a potential price increase from an international event.