?While the prospect of income from underwriting fees for debt and equity issuance is dim now for energy investment bankers, and fee-making from M&A-advisory work is nonexistent, securities advisors are now counting on workout and reorganization assignments to keep the lights on through this half.


Among possible fiscal-reprofiling vehicles is the oil or gas royalty trust. It is not likely this will be a widely used tool by U.S. E&Ps; however, it may prove useful to a few that have greater confidence in their assets’ value tomorrow than the public-equity and asset-acquisition markets do today.


And, if they’re just bold or desperate enough—or both of these—to try it.


Consider the formation of a royalty trust as a loan of assets to a vehicle that is controlled by the E&P, while waiting for a recovery in oil and gas prices. Income continues to be derived from the production at these and future, higher prices. At the pre-determined date of the trust’s expiration, the properties revert back to the E&P.


Meanwhile, the E&P may be less attractive to a hostile buyer seeking to capture a margin off its bet on forward oil and gas prices at a point in the future that is earlier or later than the date of the trust’s expiration.
The trust can aid the E&P by providing some armor in the forming battle for distressed U.S. asset-owners.


The actual profitability potential can be tricky. For example, low-operating-cost properties valued at $1 billion at $50 oil and $6 gas can be put in a royalty trust today, with the E&P giving up half-ownership to unit-holders for $500 million to deploy toward continuing as an ongoing concern. In five years, the trust naturally terminates, and the E&P gets back $1.4 billion worth of properties: $2 billion of new valuation due to $100 oil and $12 gas, minus $600 million of value produced during the five-year period.


Or, maybe the story doesn’t prove that sweet in actual profit gain, but is a success in propping the E&P up to hold onto its other assets, such as shut-in shale gas that may not make its greatest margin until surfaced five years from now.


For example, the $1 billion of properties may be worth $500 million in five years, and have cost $200 million to operate, while gains from distributions come to $100 million. The net loss is $600 million. Meanwhile, though, the properties—still valued at $50 oil and $5 gas—are 100% on the E&P’s books again and may experience improved valuation due to higher commodity prices yet later. The five-year termination may have simply been set too early or came during a new commodity-price collapse.


Another means of burying assets today for greater use tomorrow is the master limited partnership (MLP), which can be dissolved at any time unit-holders agree to tender their units.
There are a few hurdles to overcome in taking the royalty-trust or MLP tack.


• The E&P would have to let go of some assets at today’s prices.


• Enough prospective unit-buyers would have to be found that are in need of an income-producing investment vehicle, at a time when even unrestricted securities-buyers are reluctant to invest in oil and gas.


• The E&P’s shareholders are free to get in and out of the E&P’s stock from one day to another, and few make five-year bets. Enough would have to be convinced of the plan, or not bother to notice.


• The E&P would have to have suitable—that is, low-operating-cost, high PDP (proved developed producing), predictable—properties to contribute.


One I-banker says, “I’m not sure the trust structure would be appealing now, given the huge spreads between Treasuries and high-yield paper. The units would not be regarded as stable or secure, given the uncertainty in oil and gas prices, so they would have to be priced to yield maybe 15%—or even 20%—and I’m not sure people are willing to sell proved production at that discount rate.


“Plus any underwriter would want subsidies or guaranty structures from the issuer.”


Few E&Ps are in, or will come to be in, a position of needing to look at the trust or MLP as a means of setting undeveloped assets aside. However, to see whether this tool is a means of plugging some financial leaks, and for other fiscal-reprofiling solutions, ask your energy investment banker. They’re at the ready for 911 tasks.

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