Oil prices have climbed steadily since bottoming out around the $30 mark in 2008, and shares of energy related stocks have followed the same upwards projection. The broad based Energy Select Sector SPDR (NYSE:XLE) is up nearly 15% year to date and could see its share price continue to rise well into 2010. While all this price appreciation is great for a portfolio, investors wanting income from the energy patch are often left out in the cold. The Energy SPDR yields only 1.7% and most oil and gas plays pay nothing. Only the major integrated energy companies such as Chevron (NYSE:CVX) and its 3.4% dividend, pay a respectable yield.
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There are options for investors wanting real income from their oil and gas investments. United States Royalty Trusts, which are different from their Canadian cousins, generate dividend income from the development of natural resources such as coal, natural gas, and crude oil. These cash flows are subject to the prices of the underlying commodity. If oil is at all-time highs, the dividends will reflect that. And, unlike the Canroys, American Trusts are strictly finance vehicles with no production operations.
Deep Dividends and Terrific Tax Breaks
The first thing investors will notice about trust investments is their high dividend yields, typically within the 7 to 13% range. Their corporate tax structure requires that essentially all of the royalty income received must be paid to unit holders. This high yield comes with some tax advantages as well. Trusts are not allowed to add to their resource base, so when the wells run dry, the trust dissolves. Thus, due to resource depletion and deprecation, dividends received from trusts are not considered income by the IRS. These distributions reduce the unit owner's cost basis, consequently reducing the capital gains tax on the unit. Some unit holders may also benefit from tax credits for producing energy from unconventional sources.
Three Top Notch Trusts
British Petroleum (NYSE:BP) operated BP Prudhoe Bay Royalty Trust (NYSE:BPT) came to the attention of investors when CNBC reported a pipeline rupture that caused a large oil spill. The Prudhoe Bay Trust covers royalties from approximately 150,000 acres of the total 213,500 acres in the Alaskan field. The trust pays a quarterly distribution and yields around 8%.
Carving out a 75% royalty of the Waddell Ranch in West Texas and 95% in overriding royalties for various other properties throughout the state, the Permian Basin Royalty Trust (NYSE:PBT) is one of the largest publicly traded trusts. Currently the assets of the trust are managed by ConocoPhillips (NYSE:COP) and have an estimated reserve life of 8.3 years. Due to enhanced drilling techniques, however, the trust's life may be longer. The units pay a monthly dividend and currently yield around 9%.
Holding an 80% royalty on natural gas properties in the rich Hugoton Natural Gas Area, the Hugoton Royalty Trust (NYSE:HGT) allows investors to play one of the largest natural gas fields in the country. The units pay a lower dividend than the oil trusts on list due to recent lows in natural gas prices. However, the fund has been raising the distributions as natural gas continues feature prominently in the U.S. plans to achieve energy independence. The trust pays monthly and yields around 7.3%.
The Bottom Line
The share prices of oil and gas investments have increased steadily over the course of the past year because the underlying prices of the commodities have risen. Yet, for the most part, many of these investments leave income investors hurting with low yields. Royalty trusts offer a way for investors to profit from rising natural resource prices as well as providing great income. Trusts like Sabine Royalty (NYSE:SBR) and the preceding three units are great places to start adding royalty income to a portfolio. Unit investment trusts provide direct exposure to the energy sector, fueling better returns. (To learn more, check out Investing In Oil And Gas UITs.)
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