MTR

Mesa Royalty Trust 10-Q Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended September 30, 2016, for Mesa Royalty Trust, a passive entity holding a 90% overriding royalty interest in specified oil and gas properties (Hugoton, San Juan Basin). The Trust distributes cash to unitholders based on net proceeds from production. As of November 14, 2016, there were 1,863,590 units outstanding.

Key Financial Metrics

Note: Net Overriding Royalty Interest is calculated as Gross Interest ($42,498,034) less Accumulated Amortization.

Material Changes vs. Prior Period

• Quarterly Performance: Royalty income increased 13% in Q3 2016 compared to Q3 2015. This increase was driven by significantly lower capital expenditures and operating costs, which offset declines in commodity prices and production volumes.
• Year-to-Date Performance: Royalty income decreased 49% for the nine months ended September 30, 2016, compared to the same period in 2015. This decline was primarily due to lower natural gas, natural gas liquids (NGL), and oil prices, as well as reduced production volumes.
• Regional Variance:
  • Hugoton Field: Income increased slightly due to lower operating costs despite lower prices and volumes.
  • San Juan Basin (New Mexico): Income decreased significantly due to lower prices and volumes.
  • San Juan Basin (Colorado): Income increased to $109,815 in Q3 2016 from $0 in Q3 2015, driven by increased production volumes and lower operating costs.
• Reserve Activity: The Trustee increased the reserve for future unknown contingent liabilities and expenses by approximately $108,471 in Q3 2016, primarily due to royalty income received from BP after the distribution announcement.

Outlook, Risks, and Management Commentary

• Operator Bankruptcy Risk: A critical risk factor is the Chapter 11 bankruptcy filing by Linn Energy, LLC (operator of the Hugoton field) and its affiliates in May 2016. While the Trust is not a debtor, the restructuring process may result in reduced production of reserves and decreased distributions to unitholders. The extent of the impact remains unclear.
• Market Risk: Distributions are highly dependent on natural gas and NGL prices, which are volatile and subject to global economic conditions, weather, and supply/demand dynamics.
• Excess Production Costs: As of September 30, 2016, there were $12,199 in excess production costs (costs exceeding revenue) that must be recovered by operators before royalty income is paid to the Trust. This is a decrease from $78,591 at year-end 2015.
• Interest Rate Environment: The Trustee was unable to obtain an account yielding the required 2.0% return (1.5% below prime) due to low interest rates. Consequently, the Trustee is allocating a portion of its fees to offset the interest due to the Trust.

Investor Verification Checklist

• Linn Energy Restructuring: Monitor the progress of Linn Energy's Chapter 11 plan and its specific impact on Hugoton field production volumes and capital spending.
• Commodity Prices: Verify current natural gas and NGL spot prices against the Trust's historical averages to assess future income potential.
• Excess Production Costs: Track the recovery of the $12,199 in excess production costs, particularly those related to San Juan Basin properties operated by BP and Red Willow.
• Reserve Utilization: Review future filings to see if the $1.1 million reserve for contingent liabilities is released or further increased.
• Operator Financials: Assess the financial stability of ConocoPhillips and BP, the other primary operators, to ensure continued operations in the San Juan Basin.