Mesa Royalty Trust - 10-Q Summary (Period Ended September 30, 2010)
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 based on net proceeds from production. This report covers the quarterly period ended September 30, 2010, and the nine-month period ended on the same date. As of November 6, 2010, there were 1,863,590 units of beneficial interest outstanding.
Key Financial Metrics
| Metric | Three Months Ended Sep 30, 2010 | Nine Months Ended Sep 30, 2010 |
|---|---|---|
| Royalty Income | $1,454,204 | $5,268,104 |
| Distributable Income | $1,415,381 | $5,130,360 |
| Distributable Income Per Unit | $0.7595 | $2.7529 |
| General & Administrative Expenses | $(38,857) | $(137,898) |
| Cash and Short-Term Investments | $1,415,381 | $1,415,381 (as of Sep 30, 2010) |
| Net Overriding Royalty Interest (Carrying Value) | $5,649,913 | $5,649,913 (as of Sep 30, 2010) |
| Debt | None reported | None reported |
Material Changes vs. Prior Period
- Revenue Growth: Royalty income increased approximately 58% in the third quarter of 2010 compared to the same period in 2009 ($1.45M vs. $0.92M). For the nine-month period, income increased approximately 88% ($5.27M vs. $2.80M).
- Price Drivers: The increase in income is primarily attributed to higher natural gas and natural gas liquid prices. Average sales prices for natural gas rose to $3.44/Mcf in Q3 2010 from $2.53/Mcf in Q3 2009.
- Production Volumes: While prices increased, actual production volumes from the Hugoton properties decreased due to natural decline. However, net production volumes attributable to the royalty in the San Juan Basin (New Mexico) increased.
- Expenses: General and administrative expenses decreased in both the quarter and nine-month periods compared to 2009. Operating costs for the Hugoton field decreased due to a severance tax refund.
Outlook, Risks, and Contingencies
Management Commentary: The Trust is a passive entity with no control over operations. Distributions are highly dependent on commodity prices and production volumes managed by working interest owners (Pioneer Natural Resources, ConocoPhillips, and BP).
Legal and Tax Contingencies:
- Kansas Tax Assessment: Pioneer Natural Resources (PNR) received a final assessment from the Kansas Department of Revenue for approximately $4.5 million (including penalties and interest). The portion net to the Trust is approximately $197,000. PNR intends to challenge this assessment, but no assurance of success is provided.
- Severance Tax Refunds: PNR has filed for approximately $3.0 million in severance tax refunds with Kansas. The estimated share due to the Trust is approximately $167,000. Approval is not guaranteed.
- Excess Production Costs: Excess production costs related to San Juan Basin-Colorado properties were approximately $0 as of September 30, 2010. These costs must be recovered by operators before royalty income is distributed.
Risks: The Trust faces significant market risk regarding natural gas price volatility. Additionally, the Trustee relies entirely on working interest owners for operational data and reserve estimates.
Investor Verification Checklist
- Verify the status of the Kansas Department of Revenue tax assessment challenge and the potential $197,000 liability to the Trust.
- Monitor the approval status of the $3.0 million severance tax refund filed by PNR, which could impact future distributions.
- Review commodity price trends for natural gas and natural gas liquids, as these are the primary drivers of Trust income.
- Confirm the ongoing production decline rates in the Hugoton field versus price increases in the San Juan Basin.
- Check for any updates on litigation involving the working interest owners that could result in charges against royalty income.