Royalty Trusts

A royalty trust collects and distributes income from oil and gas or mining operations. There are ~ 30 royalty trusts in the U.S. with a combined market value of ~ $12 billion. Most are designed to self-liquidate in 20 years or less; these trusts have no employees or physical assets. A royalty trust holds the right to receive income from a fixed number of properties.

 

Once established, the trust is frozen and cannot acquire any new assets. Since oil and gas as well as mines are depleting assets, yields from royalty trusts almost always decline as years pass by. When no money is left, these trusts disappear; unlike bonds, there is no remaining underlying principal. A number of investors do not realize that royalty trusts are not really a fixed-income alternative.

 

Royalty trusts describe the likely income an investor will receive over the life of the trust. For example, one trust shows future available cash for distribution to be an estimated $1.4 billion, yet total market value was $2.3 billion. Another trust projects future payouts of $109 million and a market value of $123 million. Both sets of numbers show that investors will not even receive their principal back over the life of the trust, based on current market valuations.

 

If total payouts are expected to be $1.4 billion and market value is $2.3 billion, investors appear to be willing to pay 61% more up front than what they will be cumulatively receiving over the trust’s life (remember, there is no return of principal at the end). This example would be a great opportunity for short sellers to arbitrage the difference, but royalty trusts are very thinly traded.