Royalty trust

  1. Mining law and governance
  2. Petroleum
  3. Legal entities
  4. Royalty trusts


A royalty trust is a type of corporation, mostly in the United States or Canada, usually involved in oil and gas production or mining. However, unlike most corporations, its profits are not taxed at the corporate level provided a certain high percentage (e.g. 90%) of profits are distributed to shareholders as dividends. The dividends are then taxed as personal income. This system, similar to real estate investment trusts, effectively avoids the double taxation of corporate income.

Characteristics of royalty trusts

Royalty trusts typically own oil or natural gas wells, the mineral rights of wells, or mineral rights on other types of properties. An outside company must perform the actual operation of the oil or gas field, or mine, and the trust itself, in the United States, may have no employees. Shares of the trust generally trade on the public stock markets, but the trust itself is typically overseen by a trust officer in a bank.

They are a powerful investment tool for people who wish to invest directly in extraction of petroleum or mining of other materials, but who do not have the resources or risk-tolerance to buy their own well or mine. Additionally, since trusts often own numerous individual wells, oil fields, or mines, they represent a convenient way for the average investor to diversify investments across a number of properties. Also, since commodities are considered a hedge against inflation, the popularity of royalty trusts as investments rises as interest rates rise, and their shares often rise as a result.[1]

These trusts often attract investors with their relatively high yields;[2] in 2007, their distributions were often in the 10 to 15 percent annual range. This makes the shares sensitive to interest rates, as share prices are likely to decline in periods of rising interest rates, and to rise when interest rates fall. Additionally, royalty trusts in the United States and Canada usually involve oil and gas fields or mines which are at or past their production peak, and will gradually decline in output as well as revenue; however, the infrastructure to develop them has already been built, so that an investor can expect a reasonably steady income stream.[3]

In addition to allowing investors to achieve high distribution returns, especially during periods of low interest rates, royalty trusts allow investors to speculate directly on commodities such as gas, oil, or iron ore without having to buy futures contracts, or use the other investment vehicles traditionally associated with commodities – since the trusts trade like stocks. During times when a commodity price is rising, the share value as well as the dividend return of a trust engaging in production of that commodity will rise as well.[4]

Canadian versus U.S. royalty trusts

Royalty trusts are found mainly in Canada and the United States; there is also one in Germany. Canadian royalty trusts, called "Canroys" or "CanRoys," typically trade on the Toronto Stock Exchange, while some of the larger trusts also trade on the New York Stock Exchange. Canroys usually offer higher yields than U.S. trusts; for non-Canadian investors, this higher yield is reduced by the 15% foreign tax withholding that is absent in the U.S. trusts.

The most significant difference between Canadian and U.S. royalty trusts involves their legal status in their respective countries. In the U.S., trusts are not allowed to acquire additional properties, once they are formed. Since they are restricted to their original properties – for example, a group of oil fields or natural-gas-bearing rock formations – they can be expected to be depleted over time, the royalties they pay out will correspondingly decline, and eventually the trust will be dissolved. In Canada, trusts may be actively managed, and run as businesses. They may have employees, issue new shares, borrow money, acquire additional properties, and may manage the resources themselves.[5]

The tax status of Canadian trusts is to change in 2011, according to a proposal made by Jim Flaherty, the Canadian Finance Minister on October 31, 2006. Commencing in 2011, trusts would be taxed like all other corporations, at the full 31.5% rate; this would remove the advantage for which they were set up in the first place. Share prices of the trusts dropped immediately after the announcement, which was dubbed the "Halloween Massacre." What prompted the move was that the trusts were costing the Canadian government upwards of $500,000,000 each year in lost revenue.[6]

As of early 2008, the Canadian Liberal Party had drafted a counter-proposal which would allow the trusts to continue at the 10% tax rate previously allowed. This could happen if the Liberal Party were to win the next election, and was being strongly supported by energy interests in western Canada, as well as other groups.[7]

History of royalty trusts

Oklahoma businessman T. Boone Pickens created the first royalty trust in 1979 in response to the difficulty that Mesa Petroleum was having in replenishing its oil reserves. Through royalty trusts, he was able to substantially decrease his amount of effective reserves and avoid the difficulty of replenishing them.

Publicly-Traded Royalty Trusts

Former Publicly-Traded Royalty Trusts, now liquidated

  • Santa Fe Energy Trust (originally traded on NYSE under the symbol SFF) (US: oil and gas in 12 states; trust liquidated in 2008)
  • LL&E Royalty Trust (original NYSE symbol LRT; Pink Sheets symbol LRTR) (US: Florida, Alabama, and in the Gulf of Mexico; oil and gas); the trustee sought to liquidate the trust at December 31, 2010, but unitholders sued to attempt to prevent this. [8] [9]

Private Energy Income Trusts

Notes

  1. ↑ http://www.mcdep.com/cosinnyt41017.htm New York Times article on royalty trusts, by Alex Tarquino: October 2004
  2. ↑ General description of royalty trusts, from Investopedia
  3. ↑ High Yield Investing: a history of royalty trusts
  4. ↑ Morningstar article on royalty trust advantages and disadvantages
  5. ↑ New York Times article on royalty trusts, by Alex Tarquino: October 2004
  6. ↑ Lawyer's Weekly: article on Canadian royalty trusts and the "Halloween massacre"
  7. ↑ Reuters story on Liberal trust plan
  8. ↑ http://www.businesswire.com/portal/site/home/news/company/?vnsId=705
  9. ↑ http://www.businesswire.com/portal/site/home/news/company/?vnsId=705

See also

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