Black Stone Minerals royalty interests. Source: SEC Filing

The partnership generates cash flow via several routes. The mineral interests themselves grant ownership of the oil and natural gas under a tract of land and the rights to explore for, drill for, and produce oil and natural gas on that land or to lease those exploration and development rights to a third party. When those rights are leased, the lessee generally pays an upfront cash payment called a lease bonus. The partnership retains a mineral royalty that entitles it to a cost-free percentage of the drilling proceeds, typically 20% to 25% of production or revenue.

The partnership also receives revenue from nonparticipating royalty interests, which are royalty interests that represent the right — typically perpetual — to receive a fixed, cost-free percentage of production or revenue from production, without an associated right to lease or receive a lease bonus.

BSM’s objective is to grow reserves, production, and cash generated from operations while paying a growing quarterly distribution to unitholders. The partnership plans to achieve this objective by 1) Acquiring additional mineral and royalty interests in oil and natural gas properties; 2) Participating in low-risk drilling opportunities that generate attractive returns; and 3) Maintaining discipline on capital spending.

The revenue generated from these mineral and royalty interests was $340.4 million in 2014, but is forecast by the partnership to decline to $194.8 million in the 12 months ending June 30, 2016. Estimated oil and natural gas revenue resulting from non-operated working interests for the 12 months ending June 30, 2016 is forecast at $87.6 million, compared with $124.4 million in 2014.

This projected revenue decline is primarily in anticipation of lower realized prices for oil and natural gas in the near future as well as slightly lower production on some properties in response to the lower prices.

BSM’s interests are weighted toward natural gas production, which is expected to account for  ~71% of total production in which it has a stake for the 12 months ending June 30, 2016. However, because of the higher realized prices for crude oil and condensate, these commodities are expected to deliver slightly more revenue to BSM than natural gas.

BSM has not yet indicated a minimum quarterly distribution or targeted yield, although it does project there will be $223 million available for distribution for the 12 month-stretch starting in July. Regardless of how it fills in those blanks, there is precious little in this space for comparative purposes. Thus far there has only been one public offering focused on royalty interests.

On June 18, Viper Energy Partners (NASDAQ: VNOM) was spun off from Diamondback Energy (NASDAQ: FANG) in a $100 million IPO. Viper Energy Partners owns mineral rights on 14,804 acres in the Permian Basin in West Texas, with an average 21% royalty interest on the oil and gas production. VNOM debuted to strong demand just before oil prices crashed. That, plus a $100 million secondary offering in September, have combined to drive its unit price down 45% since the IPO. So far VNOM has had two quarters of $0.25/unit distributions, giving it a forward-looking projected yield of 5.6%.

The only other royalty-based MLP has yet to go public. Terryville Mineral & Royalty Partners (TRVL) was formed by Memorial Resource Development (NYSE: MRD) to own and acquire royalty interests and mineral interests from MRD and third parties. TRVL filed initial paperwork with the SEC in November to raise up to $150 million via an IPO. TRVL owns royalty interests in 44 of Memorial Resource’s 46 horizontal producing wells as well as in the undeveloped acreage surrounding those wells. Unlike VNOM, which has a variable distribution, TRVL intends to pay a minimum quarterly distribution (as will Black Stone Minerals).

My advice to investors last year was to avoid Viper Energy Partners for several reasons, one of which was the high degree of commodity risk. I continue to offer that advice for the upcoming royalty-based MLP IPOs. These MLPs will likely soar if oil and gas prices strongly recover, but as illustrated by VNOM, there is significant downside risk. This is the type of MLP that’s too risky for all but the most aggressive investors.

(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)

Portfolio Update

Delek Not Slowing Down

Recent portfolio addition and the even more recent #9 Best Buy Delek Logistics Partners (NYSE: DKL) is delivering exactly as hoped so far.

The refinery logistics supplier posted a 64% increase in fourth-quarter distributable cash flow, providing 1.7x coverage for a distribution increased 23% year-over-year. It plans to increase its payouts by at least 15% annually over the next few years.

New contracts with non-affiliated shippers for the Paline crude pipeline in east Texas are expected to boost annual distributable cash flow by 13 million, or 16% of last year’s total.

On Monday, Delek Logistics announced a 50/50 joint venture with Plains All American Pipeline (NYSE: PAA) for a new $100 million crude pipeline originating like the Paline in Longview and running 80 miles south to Shreveport, Louisiana. Delek will also take a 33% stake in a new $125 mile crude pipeline in West Texas. Both projects feature the partnership’s sponsor as a shipper.

The unit price is up 3% over the last month. Buy DKL below $42 while you still can.          

— Igor Greenwald