Gulf Coast Ultra Deep Royalty Trust (GULTU) – A Very Special Situation

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In a recent interview (here), T. Boone Pickens was asked about Gulf Coast Ultra Deep Royalty Trust (GULTU) and he immediately changed subjects. Odd, isn’t it, that a guy who has a lot to say about everything all the sudden doesn’t want to talk?

It was his reaction that piqued my curiosity. So I dug in. And what I learned makes me believe Gulf Coast Ultra Deep Royalty Trust is a very special situation.

GULTU was created in connection with Freeport-McMoRan Copper & Gold’s acquisition of McMoRan Exploration, which was completed on June 3, 2013. Immediately prior to the merger, McMoRan created a trust and conveyed a 5% gross overriding royalty interest in the future production from 20 specified shallow water ILTC (Inboard Lower Tertiary / Cretaceous) exploration prospects located on the Shelf of the Gulf of Mexico and onshore South Louisiana.

The nature of the overriding royalty interest means that GULTU owns a share of future production yet doesn’t have to pay any of the operating expenses or development costs. So the holders in GULTU are getting a free ride on the back of McMoRan’s exploration and development efforts in the Gulf and Southern LA.

There are a few things that are notable about the Trust:

The last part is important: FCX has a call option which means if McMoRan is successful in the ILTC, the upside to unitholders is limited to $10 / share plus whatever distributions are paid prior to June 2018.

So we have a tax-free entity (pass through) with very little / no costs that owns the following interests:

GULTU Interests
Note: the last 3 (Highlander, Lineham Creek and Tortuga) are located in onshore South Louisiana. The rest are offshore targets. Additional targets acquired by McMoRan on or before December 5, 2017 in the Lafitte, England or Morgan blocks are also subject to an overriding royalty interest by GULTU.

All of these targets are located in the ultra-deep (generally greater than 18,000 total vertical depth), making each well unusually expensive to drill. This means that for McMoRan to go ahead and develop a target, they have to find something truly elephant-sized. And if they do, I believe unitholders will find their shares at or near $10 in a hurry.

I have no special insight into the success or failure of individual prospects. But I am aware that recent advances in technology have increased the odds of success for oil exploration companies (read about some of those advances here). Perhaps what’s most interesting to me is that I get to share in the economics of 20 large exploration blocks (with likely hundreds of individual exploration targets) while a large, well-capitalized company pays the bills. It’s hard to find a better deal than that in the public markets.

It seems I am not the only investor that finds GULTU “interesting”. Big, well known funds have been quietly buying in size. Just take a look at the top shareholders:

Four investors hold nearly 60% of the stock! At today’s price, investors are paying $680MM for assets that have been assigned an initial value of $400MM (obviously that value is subject to change with exploration success or failure). One successful well and it’s probable that FCX buys you out at $10 in June 2018. Multiple failures and it’s probable that McMoRan continues its work trying to locate that elephant.

In the meantime, GULTU is working on listing their units on the Nasdaq (source).

Special indeed.

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