BP Prudhoe Bay: High Dividends, Gathering Risk

Many high-income securities have appreciated so much in recent years that it's a challenge finding investments that satisfy yield-oriented investors. Real estate investment trusts that yield 3% or junk-bond funds that pay 6% just don't do the trick.

Oil and gas royalty trusts and master limited partnerships remain the exceptions. They continue to offer high and reasonably consistent yields even as their share prices have also risen. One trust that has always caught my eye is BP Prudhoe Bay Royalty Trust (symbol BPT). At $61.70, the price at which it closed on March 21, the stock yields a rousing 13.7% based on the past four quarterly distributions, which totaled $8.48 a share. The total payout would have been at least 50 cents a share higher had not BP been forced last summer to shut part of its production for six weeks to fix corroded pipeline.

The trust gets the revenue from a 16% interest in a specific Alaska oil field with some 81 million barrels of proved reserves. The price of crude oil remains below last year's highs, but with production fully restored, the January 2007 quarterly dividend of $2.01 was the fifth-highest in the trust's history. The record is $2.59 per unit, made last July.

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Those rich dividends of the past year are based on crude ranging from $50 to $77 a barrel. If crude goes much lower than $58.31 a barrel, the price at which West Texas Intermediate closed on March 21, it's likely that the dividends will be cut. And it's unlikely that dividends will rise unless oil prices go out of sight and there's no cut in demand. Keep in mind that the first $30 to $35 per barrel of BP Prudhoe Bay's income goes for taxes and production costs.

The dividend outlook is iffy for several reasons. First, the trust's field is maturing. Daily production flows peaked in 1998. So, although geologists' reports to the stockholders say there are many, many years of reserves, the speed with which the wells can turn these reserves into cash flow is slowing.

Second, the state of Alaska raised and overhauled its oil production tax last year. Formerly 15% plus a small surcharge, the tax is now 22.5% plus a higher variable rate on every dollar that oil sells above $40 a barrel. The surcharge is also up a bit. As a result, whereas shareholders of the trust effectively paid $4 a barrel in taxes in 2003, they now pay more than $10.

Next comes the matter of production costs. The trust pays an overhead factor called "chargeable costs." That covers the trust's share of costs for engineering, transportation and other services in the field. The figure has been almost flat in the past few years but is scheduled to begin accelerating, from $12.75 a barrel now to $16.70 in 2012.

Subtract overhead costs, taxes and pocket change for auditing and shareholder services from the price of a barrel of oil, and 100% of what's left is income for investors. And that's what makes investing in this trust like having your own oil well: You don't have to worry about excessive debt, risky acquisitions or drilling gambles. You don't have to fret over dumb management moves, such as backdating stock options. The trust has zero employees. In fact, in what may be unique among New York Stock Exchange listings, BP Prudhoe Bay doesn't even have a Web site.

However, you can read its quarterly and annual SEC filings online, and that is where you can see the charges, the taxes and the moving parts. The trustee, the Bank of New York, will send you the annual statement that lists what percentage of the dividends are taxed now and which represent a return of capital or are exempted from taxes because of depletion allowances.

If these complications make you suspicious that this is an entity that works better for its sponsors than for the stockholders, there is a reassuring number: 358%. That's the total return over the past five years. Over that same period, ExxonMobil returned 66%. With that kind of a record -- it figures to 26% a year -- and a substantially lower share price than the $91 it reached last year, BP Prudhoe Bay is one high-dividend investment that appears worth any trouble -- at least for now.