Keeping this one light and sweet (but not crude…). $ECTM is a nanocap ($8M market cap) oil and gas fixed-term royalty trust (the “Trust”) that receives a share of profits in 52 wells located in the Marcellus formation in Western Pennsylvania. By my calculations, I think assuming $3 natural gas and 7.5% decline rates, this yields around a 17% IRR to the end of life for the royalty trust at the recent high of $0.50.
There are 52 producing wells that the Trust and the operator (“Greylock Energy” or “Greylock”) share an 82% royalty interest in. The distribution between the Trust and the Greylock is as follows:
- 90% to the Trust for the 14 wells drilled prior to the establishment of the Trust
- 50% to the Trust for the 38 wells drilled post establishment of the Trust
The Trust was created in March 2010 during a heady time in oil and gas world (“Peak Oil” was a serious conversation topic back then) and I believe retail investors were (unfortunately) attracted by a superficially high yield. Since then, they’ve made about $10 per unit in distributions, but the Trust price has declined from $20 to as low as $0.07 last year, a pretty incredible record of shareholder destruction. Today it’s rebounded a bit to the $0.40-$0.50 range.
While the return profile is less attractive today than at $0.07, it’s a safer bet now with natural gas steadying around $3. I think this can still generate a 17% IRR to termination of the Trust. $ECTM announced a $0.031/unit quarterly distribution for 1Q, so you should get about a quarter of the price back pretty quickly. The distribution will continue to decrease over time because the last well in this Trust was drilled in July 2011, but if you look at typical Marcellus horizontal well type curves the 10-year decline rates for a 9-10 year well is around 6-7% CAGR (CADR?).
I’ve got a (slightly) more complicated model behind this, but here’s what I’m expecting in terms of distributions:
|Projected Distribution||Y/Y Decline|
The 2030 distribution is based on the fact that on or about March 2030, 50% of the royalty asset will revert to the operator, Greylock, and the remaining stake will be put up for auction. I’m projecting cash flows in the run-off time period using a much lower $300K/yr G&A cost with an 8% discount rate for future cash flows, which gets me to roughly $0.05 in 2030. Distributions in the meantime are subject to my 7.5% decline rate/yr assumption and an assumed 2%/yr increase in G&A costs.
The main bet here is that natural gas prices will remain around where they are today, I’m assuming realized prices hold around 1Q levels going forward. A quick peek at natural gas futures supports this view, at least through at least March 2022. Of course if natural gas ever moons (like they did in Texas in February…) the returns could be sweeter.
To finish tying the numbers the Trust is currently setting aside some money every quarter to boost up reserves to $1.8M, as of 3/31/21 they have $1.1M in cash set aside already. In 1Q this additional reserve was $90K (half a penny/unit), adding that in would foot with my full $0.15/yr projection. If you want to dock the next 2 year’s returns by 4 cents it still yields an IRR of around 14%. I’d note that $1.1M to wind down a trust (including contingent liabilities) feels a bit excessive already, and I’d imagine that we’d see some return of the $1.8M reserve they’re building in 2030 as well.
Primary risk here is uncertain commodity pricing. Secondarily, the Trust terminates if gross proceeds are less than $1.5M in any trailing 4 quarter period, in which case the Trust will be put up for auction and it becomes subject to take-under risk due to its small size (most natural buyer is the sponsor, Greylock).
My rough calculations gets a fair value of around $0.65-$0.70.
Long a 3% portfolio stake