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Oil and gas trusts are among the highest-yielding stocks in the stock market, making them attractive candidates for income investors. On the other hand, in contrast to the well-known oil majors, such as Exxon Mobil (XOM) and Chevron (CVX), they offer a different distribution every month, which is highly volatile due to the gyrations of the prices of oil and gas.

Therefore, investors should examine whether the current generous distributions of royalty trusts are sustainable in the long run before purchasing these stocks.

Sabine Royalty Trust (SBR), Permian Basin Royalty Trust (PBT), and Hugoton Royalty Trust (HGTXU) offer exceptionally high distribution yields. This article will discuss these three royalty trusts.

Sabine Royalty Trust

Sabine Royalty Trust is an oil and gas trust that was formed 1983. The trust consists of royalty and mineral interests in oil and gas properties in Florida, Louisiana, Mississippi, New Mexico, Oklahoma and Texas. It generates approximately two-thirds of its revenues from oil and the remaining one-third from gas.

Sabine Royalty Trust is one of the highest-quality oil and gas trusts. At initiation, it had an expected reserve life of only 9-10 years but it has lasted for four decades and is likely to remain in business for several more years.

Just like all the oil companies, Sabine Royalty Trust was hurt by the collapse of the oil price caused by the pandemic in 2020. However, the trust proved much more resilient than expected. Its distributable cash flow (DCF) per unit decreased only 25% in 2020. This is an admirable performance amid one of the fiercest downturns in the history of the energy sector. To be sure, most oil majors and all the refiners incurred excessive losses in that year.

In early May, SBR reported (5/8/23) financial results for the first quarter of fiscal 2023. Production of oil and gas grew 6% and 11%, respectively, over the prior year’s quarter. In addition, the average realized prices of oil and gas grew 5% and 111%, respectively, primarily thanks to the sanctions of western countries on Russia. Nevertheless, due to a steep increase in general and administrative expenses, distributable cash flow per unit remained essentially flat.

The price of gas has collapsed in recent months due to warm winter weather, but the price of oil has remain elevated thanks to the Ukrainian crisis and deep production cuts of OPEC and Russia. Based on its distributions in the first five months of the year, SBR is offering an annualized distribution yield of nearly 10%.

Cross Timbers Royalty Trust

In mid-May, CRT reported (5/12/23) financial results for the first quarter of fiscal 2023. Production of oil decreased -63% due to an adjustment in last year’s quarter but gas output more than tripled thanks to timing of sales. In addition, the average realized price of gas dipped -21% but the average price of oil grew 34%. As a result, distributable cash flow (DCF) per unit essentially doubled. The price of gas has plunged this year due to unfavorable (warm) weather but the price of oil has remained high thanks to the war in Ukraine and deep production cuts of OPEC and Russia.

On the positive side, the trust has been in continuous existence for 32 years paying an average 9.3% yield in the last decade (albeit with some volatility in the distributions). However, future distributions are highly unpredictable due to the absence of any guidance and the unknown path of oil and gas prices. Based on its distributions in the first five months of the year, CRT is offering an annualized yield of 12%.

Hugoton Royalty Trust

Hugoton Royalty Trust was created in late 1998 when XTO Energy conveyed 80% net profit interests in some predominantly gas-producing properties in Kansas, Oklahoma, and Wyoming to the trust. Net profits in each area are calculated by subtracting production costs, development costs, and labor costs from revenues.

Hugoton Royalty Trust has a key difference from the aforementioned oil and gas trusts; it is focused primarily on natural gas. It produces roughly 88% natural gas and 12% oil. As a result, it is much more sensitive to the cycles of the price of natural gas than most oil and gas trusts. Its unitholders are well aware of this sensitivity.

In mid-May, Hugoton reported (5/12/23) financial results for the first quarter of fiscal 2023. Its realized prices of oil and gas grew 5% and 57%, respectively, thanks to the sanctions of Europe and the U.S. on Russia for its invasion in Ukraine. Therefore, even though gas output dipped -6% due to natural decline, distributable income per unit jumped from $0.00 in last year’s quarter to $0.25. Gas prices have plunged this year due to a warm winter. Given the distributions of $0.022 in the last two months, the stock is offering a 20% annualized yield.

Hugoton has generated an average distributable cash flow (DCF) of $0.27/unit per year for the past decade, though with a noticeable decrease in the last eight years. Given the 6%-8% long-term natural decline of the production of producing wells, the long-term downtrend in cash flows should be expected. On the other hand, the trust posted an 8-year high DCF per unit in 2022 thanks to the sanctions of Western countries on Russia.

The Bottom Line

Royalty Trusts have thrived in recent months thanks to the sanctions of Western countries on Russia, which have resulted in record LNG exports from the U.S. to Europe, thus tightening the U.S. gas market. However, the price of natural gas has plunged this year and could remain low in the upcoming years due to the record number of renewable energy projects that are in their development phase.

These royalty trusts offer extremely high yields, but also have variable distributions and could drastically reduce their payouts if commodity prices continue to decline. Due to their high risks, the stocks are only appealing for risk-tolerant investors.

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