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What to Do About Natural Gas Trusts Right Now

By Matt Badiali, editor, S&A Resource Report
Wednesday, June 6, 2012

Despite a dramatic fall... and despite "looking" cheap... natural gas trusts are still dangerous.
They're still a dividend trap.
"Royalty trusts" exist to extract natural resources and pass the cash flows of that production on to shareholders. Back in April, I noted these popular income vehicles were headed for a collapse.
That collapse has arrived.
Six weeks ago, shares of San Juan Basin Trust (NYSE: SJT), one of the best in the sector, traded for $17.28... and sported a trailing 12-month yield of 8.3%.
It looked attractive... but the market hadn't factored in the massive decline in the price of natural gas. The drop in natural gas was going to cause a decline in San Juan's distributions. The drop in distributions was going to crush the share price.
It played out just like I predicted. The company's May dividend was down 17% from the month before. And you can see what's happened to San Juan Basin in the chart below...
San Juan (SJT) Shares Have Lost 30% In Three Weeks
San Juan shares have lost 30% of their market value in the past three weeks.
But I don't think the drop is over.
You see, the May dividend distribution was based on February's production. The June dividend, which is the same as May's dividend, is based on March production.
In March, the company received $3.52 per thousand cubic feet (mcf) for its natural gas. That's 30% over today's prices. The average price so far in 2012 is $2.29 per mcf...
The price of natural gas didn't bottom until mid-April. The average price for the month of April was $1.90 per mcf. We'll see that reflected in July's distribution.
When natural gas bottomed in 2009, San Juan received $3.10 per mcf for its gas production. It paid out just $0.01 per share. San Juan Basin's shares bottomed at $12.46.
I believe this July's distribution will be smaller... it could even be zero. Since the company's shares are already at $12.95 today, I think we will see San Juan Basin's shares fall farther than they did in the financial crisis.
And its peers could do the same. As I said in April, any energy trust that gets a substantial portion of its revenue from natural gas is in big trouble. That includes names like Mesa Energy Trust, Sabine Royalty Trust, and Permian Basin Royalty Trust. Mesa and Sabine have cut their monthly dividends 59% and 28%, respectively, since January, and Permian cut its monthly dividend 16% since February.
We will return to this trade eventually, but I want to see the natural gas royalty trusts work through the bottom in natural gas prices. Until then, I'd stay far away from these companies.
Good investing, 
Matt Badiali

Further Reading:

Back in April, Matt warned Growth Stock Wire readers about the dangers of natural gas royalty trusts. "If you hold a natural gas trust in your portfolio," he wrote, "you might be holding a ticking time bomb." The four companies he said to avoid are down an average of 20% in just six weeks. Read his original argument here: Dangerous Income Trap for Commodity Investors.

In The Daily Crux
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