Mesa Royalty Trust 10-Q Summary
Business Context and Reporting Period
Mesa Royalty Trust is a passive entity holding a 90% overriding royalty interest in specified oil and gas properties in the Hugoton field (Kansas), San Juan Basin (New Mexico and Colorado), and Yellow Creek field (Wyoming). The Trust distributes cash to unitholders derived from net proceeds of production. This report covers the quarterly period ended September 30, 2015. As of November 13, 2015, there were 1,863,590 units outstanding.
Key Financial Metrics
| Metric | Q3 2015 | Q3 2014 | YTD 2015 | YTD 2014 |
|---|---|---|---|---|
| Royalty Income | $401,139 | $1,810,554 | $1,647,067 | $5,542,798 |
| Distributable Income | $411,962 | $1,773,998 | $1,516,824 | $5,416,434 |
| Distributable Income Per Unit | $0.2211 | $0.9519 | $0.8139 | $2.9065 |
| Distributions Payable | $347,952 | $1,117,114 | N/A | N/A |
| Cash and Short-Term Investments | $1,357,526 | $2,117,114 | N/A | N/A |
| Net Overriding Royalty Interest (Book Value) | $2,791,090 | $3,013,833 | N/A | N/A |
Note: Net Overriding Royalty Interest is calculated as Gross Asset ($42,498,034) less Accumulated Amortization.
Material Changes vs. Prior Period
- Revenue Decline: Royalty income decreased approximately 78% in Q3 2015 compared to Q3 2014, and 70% on a year-to-date basis. This was driven primarily by significantly lower natural gas and natural gas liquids prices and reduced production volumes.
- Price Volatility: Average sales prices for natural gas dropped from $3.79/Mcf in Q3 2014 to $1.93/Mcf in Q3 2015. Oil/condensate prices fell from $25.03/Bbl to $14.99/Bbl over the same period.
- Production Volumes: Net production volumes attributable to the royalty decreased across all regions. Hugoton natural gas production fell from 72,886 Mcf to 36,205 Mcf in Q3. San Juan Basin (New Mexico) natural gas production increased slightly, but liquids production dropped significantly.
- One-Time Items in Prior Year: The 2014 figures included significant one-time audit settlements and adjustments totaling approximately $1.3 million (including $881,595 from PNR in April 2014 and $369,585 from BP in September 2014), which inflated the prior year's comparables.
- Cost Management: Operating costs decreased in Q3 2015 compared to Q3 2014 due to cost-saving initiatives and lower severance taxes resulting from lower volumes and prices. However, capital expenditures in the San Juan Basin (New Mexico) increased by 45% due to facility spending.
Outlook, Risks, and Contingencies
- Market Risk: The Trust has no control over commodity prices. Distributions are highly sensitive to fluctuations in natural gas and natural gas liquids prices, which are subject to global economic conditions, weather, and supply/demand dynamics.
- Excess Production Costs: As of September 30, 2015, there were $192,109 in excess production costs (costs exceeding revenue) that must be recovered by working interest owners before royalty distributions resume for specific properties. Approximately $187,089 of this relates to San Juan Basin (Colorado) properties operated by BP.
- Contingent Liabilities Reserve: The Trustee maintains a reserve for unknown contingent liabilities and expenses. As of September 30, 2015, this reserve was $1,009,574, included in cash and short-term investments.
- Legal Proceedings: No pending legal proceedings name the Trust as a party. However, working interest owners (Linn, ConocoPhillips, BP) are subject to ordinary course litigation which could materially impact future royalty income if settled adversely.
- Termination Trigger: The Trust will terminate if royalty income falls below $250,000 for two successive years. Current income levels remain above this threshold, but the significant decline warrants monitoring.
Investor Verification Checklist
- Commodity Price Exposure: Verify current natural gas and NGL prices against the Trust's break-even points, given the 78% revenue drop.
- Excess Production Costs: Monitor the recovery status of the $192,109 in excess production costs, particularly the $187,089 related to BP-operated Colorado properties, as these delay distributions.
- Reserve Adequacy: Confirm the sufficiency of the $1.0 million contingent liability reserve against potential future audit adjustments or legal settlements.
- Production Decline Rates: Assess the natural decline rates of the Hugoton and San Juan Basin fields to forecast future cash flows absent price recovery.
- Operator Performance: Review the operational strategies of Linn Energy (Hugoton), ConocoPhillips (San Juan NM), and BP (San Juan CO) regarding capital spending and cost recovery.