PermRock Royalty Trust: An In-Depth Analysis of Its 10-K Filing and Investment Potential

Investors looking for income-generating opportunities in the energy sector sometimes turn to royalty trusts. In this post, we dive deep into the 10-K filing of PermRock Royalty Trust to assess its business model, financial performance, risks, and overall investment potential.

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Business Overview

PermRock Royalty Trust is structured as a Delaware statutory trust whose sole asset is an 80% Net Profits Interest in a portfolio of oil and natural gas properties. These assets, located in the prolific Permian Basin, generate revenue when oil and natural gas are produced and sold by operators, primarily Boaz Energy. The Trust was established in 2017 and has since been providing investors with monthly cash distributions derived from its underlying interests.

Key Features of the Business Model:

• Passive Income Structure: The Trust does not engage directly in exploration or production. Instead, it receives a share (80%) of the net profits from oil and gas sales, after deducting various operating expenses.
• Monthly Cash Distributions: Investors benefit from monthly cash flows, which can be attractive for income-oriented portfolios.
• Dependence on Boaz Energy: Operational control largely resides with Boaz Energy, the third-party operator responsible for developing and managing the Underlying Properties. This means that decisions made by Boaz Energy directly impact the Trust's performance.
• Underlying Assets: The Trust’s assets are concentrated in the Permian Basin—a region known for its significant oil and gas reserves but also subject to the volatility of commodity markets.

Financial Performance

Revenues and Net Profits

The financial performance over the past few years has been a mixed bag:

• 2022: Net profits income was approximately $13.16 million.
• 2023: Net profits income decreased to about $7.13 million.
• 2024: The latest filing reports net profits income of approximately $5.96 million.

This downward trend highlights two primary factors:

1. Production Decline: As the natural life cycle of oil and gas wells, production volumes gradually decline.
2. Commodity Price Volatility: Lower average sales prices for both oil and natural gas in 2024 impacted gross profit margins, reducing the net profits passed on to the Trust.

Key Financial Metrics:

• Distributable Income: After various administrative fees and expense deductions, the Trust reports a distributable income of approximately $5.16 million for 2024. This figure translates to an average distribution of about $0.424 per Trust unit monthly.
• Standardized Measure of Discounted Cash Flows: A critical metric is the calculation of the present value of estimated future net cash flows (PV-10). For the period ending in 2024, this figure is around $64.45 million, reflecting the estimated future recovery from the underlying reserves but also underscoring the challenges of declining asset values.

Risk Factors

The 10-K filing outlines a range of risk factors that have a direct bearing on the Trust’s performance and investment potential. Here are some of the most significant:

1. Commodity Price Volatility

Oil and natural gas prices are notoriously unpredictable. Fluctuations in prices can drastically alter the net income from production, and as seen in the recent trend, lower prices in 2024 directly contributed to a decrease in net profit income.

2. Reserve Depletion

The Trust’s revenue is tied to the production from proved reserves. Over time, as the reserves are depleted, production—and consequently revenue—will decline. The decline in net profits from 2022 to 2024 reflects this natural progression.

3. Operational Dependency

Since the Trust is essentially a passive investor in these oil and gas assets, it relies heavily on the decisions and performance of Boaz Energy. Any operational missteps, capital expenditure delays, or management issues on Boaz Energy’s part can have an outsized effect on the Trust’s income.

4. Regulatory and Environmental Risks

The energy sector is subject to a plethora of regulations, including environmental laws that affect production methods. Changes in regulations or costly environmental liabilities can reduce profitability. This is especially true in regions like the Permian Basin where regulations and local environmental conditions are continuously evolving.

5. Pending Transaction

There is a pending Purchase and Sale Agreement under which Boaz Energy, along with its related affiliates, is expected to sell its interests in the Underlying Properties—and its Trust units—to T2S Permian Acquisition II LLC. This transaction, if consummated, could introduce additional risks and transitional uncertainties, potentially impacting cash flow or altering the distribution structure.

Investment Considerations

Opportunities:

• Stable Cash Flow: For income-driven investors, the monthly cash distribution can be a reliable source of dividend income regardless of broader market conditions, provided that the production continues at forecasted levels.
• Simplicity: The Trust offers a straightforward investment vehicle that directly links oil and gas production profitability to investor returns.
• Exposure to the Permian Basin: Investing in the Trust provides exposure to one of the most prolific oil and gas regions in the United States without the complexities of managing a production company.

Concerns:

• Declining Trends: The net profits income from the Trust has notably decreased from 2022 to 2024, signaling potential long-term issues related to reserve depletion and lower production volumes.
• Reliance on a Single Operator: Because the Trust is entirely dependent on Boaz Energy for operational control, any adverse developments within Boaz Energy’s strategy or operations can directly affect the Trust.
• Liquidity and Market Risks: The Trust units are traded on the NYSE. However, if the Trust fails to meet certain listing criteria or if large blocks of Trust units are sold (for instance by Boaz Energy as part of the pending sale), market price and liquidity could be negatively impacted.
• Environmental and Regulatory Pressures: Increasing pressures to address climate change and evolving environmental regulations imply potential costs and operational restrictions that could further reduce the Trust’s cash flows.

Operational and Strategic Outlook

2024 Performance & 2025 Outlook:

The 10-K report outlines a series of operational activities for 2024 that included:

• Participation in non-operated drilling and recompletion projects
• Execution of waterflood methods to enhance oil recovery, particularly in the Permian Abo and Shelf areas
• Reentry and repair projects aimed at returning older wells to production

Looking ahead to 2025, Boaz Energy has ambitious plans including:

• Drilling new producing wells, especially in the Permian Platform
• Investing in workovers and waterflood pattern conformance projects
• Reactivating wells that are currently shut in

However, the outlook is qualified by the anticipated transaction under the Purchase and Sale Agreement. If carried out, the Buyer will assume control over the Underlying Properties, potentially leading to a change in operating practices and impacting future distributions.

Final Assessment

While PermRock Royalty Trust offers a compelling avenue for investors seeking a steady monthly yield from oil and gas production, the investment is accompanied by a set of significant risks. Declining net profits, exposure to commodity price swings, and an inherent dependence on a single operator are issues that cannot be overlooked. Additionally, the pending sale introduces an element of uncertainty regarding future control and operations.

Given these factors, the Trust’s investment potential is moderate. The Trust’s monthly distributions provide an income stream that many investors appreciate, but the long‐term risks related to reserve depletion and market volatility may limit its upside potential. Therefore, for investors prioritizing income over capital appreciation and comfortable with the inherent risks of the oil and gas sector, PermRock Royalty Trust might hold some appeal. On a scale of 1 to 10, where 10 signals a high potential for return on investment, this investment ranks at about a 5.

Conclusion

PermRock Royalty Trust represents a classic royalty trust—offering investors a chance to tap directly into the oil and gas production revenues of the Permian Basin. With its 80% Net Profits Interest, the Trust offers monthly distributions and a simple business model. However, the declining income figures and heavy reliance on Boaz Energy’s operational performance should prompt potential investors to exercise caution. Significant risks, from commodity price volatility to regulatory challenges and the expected transition under the pending sale, contribute to a balanced yet uncertain investment outlook.

Investors should weigh these factors carefully, considering their own risk tolerance and income requirements, before deciding whether PermRock Royalty Trust fits within their broader portfolio strategy.