Mesa Royalty Trust 10-Q Summary
Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended September 30, 2014. Mesa Royalty Trust is a passive entity holding a 90% overriding royalty interest (reduced to 11.44% of the original interest due to a 1985 assignment) 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 quarterly. As of November 14, 2014, there were 1,863,590 units outstanding.
Key Financial Metrics
| Metric | Q3 2014 | Q3 2013 | YTD 9M 2014 | YTD 9M 2013 |
|---|---|---|---|---|
| Royalty Income | $1,810,554 | $917,038 | $5,542,798 | $2,646,517 |
| Distributable Income | $1,773,998 | $883,834 | $5,416,434 | $2,523,264 |
| Distributable Income Per Unit | $0.9519 | $0.4743 | $2.9065 | $1.3540 |
| Cash and Short-Term Investments | $2,773,998 | N/A | $2,773,998 | $1,939,254 (Dec 31, 2013) |
| Net Overriding Royalty Interest (Net of Amortization) | $3,120,201 | N/A | $3,120,201 | $3,729,958 (Dec 31, 2013) |
| Trust Corpus | $4,120,201 | N/A | $4,120,201 | $4,729,958 (Dec 31, 2013) |
Note: The Trust has no debt. Liquidity is derived solely from royalty income and interest on cash reserves.
Material Changes vs. Prior Period
- Revenue Surge: Royalty income increased 97% in Q3 2014 and 109% for the nine months ended September 30, 2014, compared to the prior year periods.
- Drivers of Growth: Increases were driven by higher natural gas and natural gas liquids (NGL) prices, increased production volumes, and significantly lower capital expenditures (down ~98% in Hugoton and ~79% in San Juan Basin for Q3).
- Unusual Items: Q3 2014 income included $52,868 from Pioneer Natural Resources (PNR) and $369,585 from BP related to audit settlements and adjustments for prior periods. Additionally, Q2 2014 included an $881,595 settlement from PNR regarding audit exceptions from 2006-2013.
- Asset Sale: On September 11, 2014, PNR sold all Hugoton field assets to Linn Energy Holdings, LLC. PNR continues as operator under a transition agreement through December 31, 2014.
Outlook, Risks, and Management Commentary
- Operational Transition: Linn Energy Holdings is expected to become the operator of the Hugoton Royalty Properties upon expiration of the transition agreement (potentially extendable to January 31, 2015).
- Market Risk: Distributions are highly dependent on natural gas prices, which fluctuate based on global economic conditions, weather, and supply/demand dynamics. The Trust does not hedge against these risks.
- Legal Proceedings: No pending litigation names the Trust as a party. However, working interest owners (PNR, ConocoPhillips, BP) are subject to ordinary course litigation that could materially impact future royalty income if settled adversely.
- Contingencies: A $1.0 million reserve was withheld in 2011 for unknown contingent liabilities and remains in cash and short-term investments as of September 30, 2014.
- Termination Trigger: The Trust will terminate if royalty income falls below $250,000 for two successive years.
Investor Verification Checklist
- Audit Settlements: Verify the sustainability of income, noting that Q3 2014 results were boosted by ~$422,000 in one-time audit adjustments from PNR and BP.
- Operator Transition: Monitor the transition of Hugoton field operations from PNR to Linn Energy Holdings and any potential impact on reporting or efficiency.
- Commodity Prices: Assess current natural gas and NGL price trends, as the Trust's revenue is directly correlated to these spot prices without hedging.
- Capital Expenditures: Confirm that the significant reduction in capital expenditures (drilling) is a permanent trend or a temporary pause, as this directly impacts future production volumes.
- Excess Production Costs: Note that $478 in excess production costs remain unrecovered for San Juan Basin (New Mexico) properties, which must be recovered before future distributions from those specific wells.