WHAT IS 'Royalty Units'

Royalty units are ownership shares in a royalty income trust, which owns the income rights to oil and gas wells or coal mines. A royalty unit gives the holder a stake in the income generated by the energy holdings of the trust. The royalty trust receives the income or cash flow that the energy extraction generates, then passes this income on to the royalty unit holders of that trust.

BREAKING DOWN 'Royalty Units'

Royalty units are seen as an attractive investment for a number of reasons. Most importantly, in the U.S. as long as roughly 90 percent of the profits are distributed to the unit owners as dividends, there is no corporate tax on profits. The only tax is the relatively low individual income tax on dividends. Since most royalty trusts include many different wells or mines, royalty units are inherently diversified, at least within the mineral extraction sector. Another advantage of royalty units is that they allow an investor to participate in the oil and gas sector without buying an actual well or mine, or dealing in the complex futures commodity markets. In addition, like other commodities the trusts are considered a hedge against inflation. Finally, returns have been historically high, often double-digit, and are often up when financial instruments are down.

Royalty Units Are Managed by a Third Party

Royalty trusts have been around since the 1950s, but Texas oil baron T. Boone Pickens popularized them in the 1980s. The trusts themselves are always managed by a third party, such as a bank; the actual operator of the well or mine does not run the trust, and the bank trust officer may be the only employee. Royalty units are traded like stocks. Examples of public U.S. royalty trusts include BP Prudhoe Bay Royalty Trust, which is traded on the New York Stock Exchange (NYSE); and TEL Offshore Trust, which is traded on the NASDAQ exchange.

Risks associated with buying royalty units include the depletion of resources and the consequent reduction in income. As most oil and gas fields in North America are past peak production, this is not a theoretical risk. Moreover, in the U.S., royalty trusts cannot add new properties; once the existing properties are depleted of resources, the trust will wind down. By contrast, Canadian royalty trusts are allowed to be actively managed. However, that country’s recent Tax Fairness Plan has eliminated much of the tax advantage to royalty units. As a result, many Canadian trusts or CanRoys have converted to a conventional corporate structure.

  1. Royalty Income Trust

    A royalty income trust is a type of special-purpose financing ...
  2. Royalty Interest

    A Royalty Interest in the oil and gas industry refers to ownership ...
  3. Cash Distribution Per Unit (CDPU)

    Cash distribution per unit is a measure that refers to the amount ...
  4. Trust Company

    A trust company is a legal entity that acts as fiduciary, agent ...
  5. 25% Rule

    The 25% rule is the idea that a local government's long-term ...
  6. Wasting Trust

    A wasting trust holds assets when a qualified plan is frozen ...
Related Articles
  1. Managing Wealth

    How to Set Up a Trust Fund in Canada

    You don't have to be rich to make use of a trust fund. Rules can be complex. Here's what you'll need to discuss with your lawyer.
  2. Investing

    Establishing a revocable living trust

    This arrangement allows you to have more control over your estate — both before and after your death.
  3. Investing

    Oil: A big investment with big tax breaks

    Oil and gas investments can provide unmatched tax deduction potential for accredited investors.
  4. Investing

    A Look Into Creating a Trust Fund With ETFs (VCIT, SDIV)

    Learn the basics of how a trust works and the two most common types. Discover how to use ETFs to fund a trust and the different strategies.
  5. Retirement

    How to set up a trust fund if you're not rich

    You don't need to be wealthy to create your own trust fund. Here's why and how to go about it.
  6. Financial Advisor

    Advisors: Tips for When to Employ Living Trusts

    Revocable living trusts accomplish estate planning objectives that aren't possible with a will. Here are some of the cases that show when to use a trust.
  7. Investing

    SandRidge's 3 Most Profitable Lines of Business (SDOC)

    Learn about the three most profitable lines of business for SandRidge Energy Inc., an oil and natural gas exploration company headquartered in Oklahoma.
  8. Retirement

    You’ve Created Your Living Trust, Now Fund It!

    You set up a trust with your estate planning attorney, but is it actually funded?
  9. Investing

    Portola Pharmaceuticals Inks $150M Royalty Deal

    Portola got $150 million in exchange for future royalties from AndexXa, which currently is on hold.
  1. What is the difference between revocable and irrevocable intervivos trusts?

    Learn what an inter vivos trust is, the difference between an irrevocable and a revocable inter vivos trust, and why it is ... Read Answer >>
Hot Definitions
  1. Futures Contract

    An agreement to buy or sell the underlying commodity or asset at a specific price at a future date.
  2. Yield Curve

    A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but ...
  3. Portfolio

    A portfolio is a grouping of financial assets such as stocks, bonds and cash equivalents, also their mutual, exchange-traded ...
  4. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  5. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
  6. Intrinsic Value

    Intrinsic value is the perceived or calculated value of a company, including tangible and intangible factors, and may differ ...
Trading Center