Business Context and Reporting Period
Mesa Royalty Trust is a passive entity created in 1979 to hold an overriding royalty interest in 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 derived from royalty income and interest earnings. This Form 10-Q covers the quarterly period ended September 30, 2013. As of November 12, 2013, there were 1,863,590 Units of Beneficial Interest outstanding.
Key Financial Metrics
| Metric | Q3 2013 | Q3 2012 | YTD 9M 2013 | YTD 9M 2012 |
|---|---|---|---|---|
| Royalty Income | $917,038 | $737,229 | $2,646,517 | $2,926,291 |
| Interest Income | $23 | $80,040 | $107 | $80,137 |
| G&A Expenses | $(33,227) | $(128,460) | $(123,360) | $(235,424) |
| Distributable Income | $883,834 | $688,809 | $2,523,264 | $2,771,004 |
| Distributable Income Per Unit | $0.4743 | $0.3696 | $1.3540 | $1.4869 |
| Cash and Short-Term Investments | $1,883,834 (as of Sept 30, 2013) | |||
| Net Overriding Royalty Interest | $42,498,034 (Gross); $(38,611,899) Accumulated Amortization |
Material Changes vs. Prior Period
- Quarterly Performance: Royalty income increased 24% in Q3 2013 compared to Q3 2012, driven primarily by higher natural gas prices and decreased operating costs. This was partially offset by increased capital expenditures and lower natural gas liquids (NGL) prices.
- Year-to-Date Performance: Royalty income decreased approximately 10% for the nine months ended September 30, 2013, compared to the same period in 2012. This decline was attributed to lower production volumes for natural gas and NGLs, lower NGL prices, and increased capital expenditures, despite higher natural gas prices.
- Interest Income: Interest income dropped significantly from $80,040 in Q3 2012 to $23 in Q3 2013, reflecting lower interest rates on cash reserves.
- Operational Highlights:
- Hugoton Field: Royalty income decreased due to increased capital expenditures (up 3,984% QoQ) and lower NGL prices, despite higher natural gas prices.
- San Juan Basin (New Mexico): Royalty income increased due to higher natural gas prices and volumes, offset by higher costs and lower NGL production.
- San Juan Basin (Colorado): Royalty income surged from $37,752 to $226,986, driven by higher natural gas prices and a significant cost/transportation credit from BP.
Outlook, Risks, and Contingencies
- Market Risk: The Trust's distributions are highly dependent on natural gas prices, which fluctuate based on global economic conditions, weather, supply/demand, and geopolitical factors. The Trust does not use hedging instruments.
- Legal Proceedings: There are no pending legal proceedings where the Trust is a named party. However, working interest owners (Pioneer Natural Resources, ConocoPhillips, BP) are subject to ordinary course litigation that could materially impact future royalty income if settled adversely.
- Tax Assessment Contingency: A tax assessment dispute with the Kansas Department of Revenue regarding the Hugoton properties was settled in December 2011 for $2 million. The Trust's portion ($84,719) was withheld from distributions in January 2012. No further material tax contingencies were reported as of the filing date.
- Reserve for Liabilities: The Trustee withheld $1.0 million in 2011 for future unknown contingent liabilities. As of September 30, 2013, this amount remains included in cash and short-term investments.
- Termination Trigger: The Trust will terminate if royalty income falls below $250,000 for two successive years or upon a unitholder vote.
Investor Verification Checklist
- Production Volumes: Verify the decline in actual natural gas production volumes in the Hugoton field due to natural depletion.
- Capital Expenditures: Confirm the impact of the sharp increase in capital expenditures (particularly in Hugoton) on future royalty income recovery.
- Commodity Prices: Monitor natural gas and NGL price trends, as these are the primary drivers of distributable income.
- Working Interest Owner Reliance: Acknowledge that the Trustee relies entirely on data provided by operators (Pioneer, ConocoPhillips, BP) for production and cost calculations.
- Interest Rate Environment: Note the negligible interest income contribution due to the low-interest-rate environment affecting the Trust's cash reserves.