Mesa Royalty Trust - 10-Q Summary (Period Ended September 30, 2012)
Business Context and Reporting Period
Mesa Royalty Trust is a passive entity holding a 90% overriding royalty interest in specified oil and gas properties located in the Hugoton field (Kansas), San Juan Basin (New Mexico and Colorado), and Yellow Creek field (Wyoming). The Trust distributes cash to unitholders quarterly. This report covers the three and nine months ended September 30, 2012. As of November 9, 2012, there were 1,863,590 units outstanding.
Key Financial Metrics
| Metric | Three Months Ended Sep 30, 2012 | Nine Months Ended Sep 30, 2012 |
|---|---|---|
| Royalty Income | $737,229 | $2,926,291 |
| Interest Income | $80,040 | $80,137 |
| General & Administrative Expense | ($128,460) | ($235,424) |
| Distributable Income | $688,809 | $2,771,004 |
| Distributable Income Per Unit | $0.3696 | $1.4869 |
| Cash and Short-Term Investments | $1,688,809 (as of Sep 30, 2012) | |
| Net Overriding Royalty Interest (Book Value) | $4,701,686 (Gross $42.5M less Accumulated Amortization $37.8M) | |
| Distributions Payable | $688,809 |
Material Changes vs. Prior Period
- Revenue Decline: Royalty income decreased approximately 65% in Q3 2012 ($737k vs. $2.08M in Q3 2011) and 42% for the nine-month period ($2.93M vs. $5.02M in 2011).
- Drivers of Decline: The decrease is primarily attributed to lower natural gas and natural gas liquids (NGL) prices and reduced production volumes across all fields.
- Price Volatility: Average natural gas prices dropped from $3.66/Mcf in Q3 2011 to $1.91/Mcf in Q3 2012. Average NGL prices fell from $42.84/Bbl to $27.19/Bbl.
- Expense Increases: General and administrative expenses increased significantly due to expenses incurred in Q3 2012 expected to be reimbursed by working interest owners in Q4 2012.
- Reserve Withholding: Unlike the prior year, no cash was withheld for contingent liabilities in 2012 as the $1.0 million reserve target was reached in 2011.
Outlook, Risks, and Contingencies
- Production Trends: Production declines are natural and ongoing. Capital expenditures increased in Q3 2012 due to drilling activity, particularly in the San Juan Basin.
- Market Risk: Distributions are highly dependent on natural gas prices, which fluctuate based on global economic conditions, weather, and supply/demand dynamics.
- Legal and Tax Contingencies:
- Tax Assessment: A Kansas tax assessment was settled in December 2011 for $2 million. The Trust's portion ($84,719) was withheld from distributions in January 2012.
- Litigation: Working interest owners (Pioneer, ConocoPhillips, BP) are subject to ordinary course litigation. While owners do not expect material adverse effects, any charges against royalty income could impact future distributions.
- Termination Trigger: The Trust will terminate if royalty income falls below $250,000 for two successive years. Current income levels remain well above this threshold.
Investor Verification Checklist
- Verify the current status of natural gas and NGL spot prices and their correlation to the Trust's distribution schedule.
- Confirm the reimbursement status of the Q3 2012 administrative expenses by working interest owners in Q4 2012.
- Monitor production volume reports from Pioneer Natural Resources (Hugoton), ConocoPhillips (San Juan NM), and BP (San Juan CO) for signs of accelerated decline.
- Review any updates regarding the settled Kansas tax assessment to ensure no further liabilities exist.
- Check for any new litigation developments involving the working interest owners that could result in charges against royalty income.