MTR

Mesa Royalty Trust (MTR) - Q3 2020 Filing Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended September 30, 2020. Mesa Royalty Trust is a passive entity holding an overriding royalty interest equal to 11.44% of 90% of the Net Proceeds from specific oil and gas properties in the Hugoton field (Kansas) and the San Juan Basin (New Mexico and Colorado). The Trust has no employees; administrative functions are performed by The Bank of New York Mellon Trust Company, N.A. The Trust relies entirely on revenues from these properties and interest on cash reserves for distributions.

Key Financial Metrics

Note: For Q3 2020, the Trust utilized $23,781 from cash reserves to cover Trust expenses, resulting in zero distributable income.

Material Changes vs. Prior Period

• Revenue Decline: Royalty income for Q3 2020 decreased approximately 75% compared to Q3 2019. YTD 2020 royalty income decreased approximately 54% compared to YTD 2019.
• Primary Drivers: The decline is attributed to substantially lower natural gas, natural gas liquids, and oil prices due to the COVID-19 pandemic and oversupply. Additionally, net production volumes decreased, and operating costs increased for natural gas and oil/condensate.
• Zero Distributions: For each month in Q3 2020 (July, August, September), the Trust announced no distribution to unitholders because costs and expenses attributable to the Royalty properties exceeded revenue.
• Excess Production Costs: Total excess production costs (costs exceeding revenue) rose to $247,961 as of September 30, 2020, from $34,918 at year-end 2019. A significant portion ($185,635) is attributed to the Hugoton Royalty Properties operated by Scout Energy Group V, LP.

Outlook, Risks, and Management Commentary

• COVID-19 Impact: The pandemic and containment measures have severely impacted demand and commodity prices, adversely affecting the Working Interest Owners' operations and the Trust's distributions. There is no indication of when distributions may resume.
• Historical Reconciliations: Hilcorp (operator of San Juan Basin-New Mexico Properties) is reconciling historical estimated payments made between 2017 and 2019. For the nine months ended September 30, 2020, this resulted in a charge of $9,184. Future adjustments could materially reduce Net Proceeds.
• Incremental Costs: Hilcorp reported significant incremental costs of approximately $1.1 million attributable to the Trust from a 2018 well, which will reduce future Net Proceeds as they are reconciled.
• Termination Risk: The Trust will terminate if royalty income falls below $250,000 for two successive years. Given the current revenue levels, this risk is elevated.
• Interest Rate Environment: Due to low interest rates, the Trustee was unable to earn the contractually required interest rate on cash reserves. The Trustee is allocating a portion of its fees to offset the interest shortfall.

Investor Verification Checklist

• Excess Production Costs: Verify the status of the $185,635 in excess costs at the Hugoton properties and the timeline for their recovery from future revenues.
• Hilcorp Reconciliation: Monitor the ongoing reconciliation of historical amounts by Hilcorp for the San Juan Basin-New Mexico properties, as this could lead to further charges against Net Proceeds.
• Commodity Price Sensitivity: Assess the impact of current natural gas and oil prices on the ability of the Working Interest Owners to generate Net Proceeds exceeding operating costs.
• Termination Threshold: Track quarterly royalty income to determine proximity to the $250,000 annual threshold that could trigger Trust termination.
• Contingent Reserve: Review the balance of the Contingent Reserve ($974,496 as of Sept 30, 2020) and the Trustee's policy on its usage for future distributions.