Business Context and Reporting Period
Mesa Royalty Trust (MTR) is a Texas grantor trust created in 1979, holding a 90% overriding royalty interest in net proceeds from specified oil and gas properties in the Hugoton field (Kansas) and the San Juan Basin (New Mexico and Colorado). The Trust has no employees; administrative functions are performed by The Bank of New York Mellon Trust Company, N.A. The reporting period covers the fiscal year ended December 31, 2011.
Key Financial Metrics
| Metric | 2011 | 2010 |
|---|---|---|
| Royalty Income | $6,661,178 | $6,686,481 |
| Distributable Income | $6,507,541 | $6,521,193 |
| Distributable Income Per Unit | $2.9554 | $3.4992 |
| Total Assets (Year End) | $7,438,593 | $6,948,580 |
| Cash and Short-Term Investments | $2,351,895 | $1,390,833 |
| Units Outstanding | 1,863,590 | 1,863,590 |
Liquidity and Reserves: Effective January 1, 2011, the Trustee began withholding cash to establish a reserve for contingent liabilities. By December 31, 2011, a total of $1.0 million was withheld, reducing the distributable income available for distribution to $5,507,541 for the year.
Material Changes vs. Prior Period
- Revenue Stability: Royalty income decreased slightly by approximately 0.4% ($25,303) compared to 2010. This was driven by higher natural gas liquids (NGL) prices offset by lower natural gas prices.
- Regional Performance:
- Hugoton (Kansas): Income decreased 4% to $2,691,646 due to lower natural gas prices and capital costs, partially offset by higher NGL prices and a severance tax refund received in 2010.
- San Juan Basin (New Mexico): Income increased 1% to $3,564,205, driven by higher NGL prices despite lower natural gas prices and increased operating/capital costs.
- San Juan Basin (Colorado): Income increased significantly to $465,327 from $299,553, primarily due to higher natural gas production volumes.
- Production Volumes: Net production volumes attributable to the Royalty decreased slightly overall. Natural gas production in the Hugoton field declined due to natural production decline.
- Capital Expenditures: Hugoton capital expenditures dropped 50% to $102,315 due to reduced drilling activity. Conversely, San Juan Basin (New Mexico) capital expenditures rose 10% to $443,976 due to increased drilling.
Outlook, Risks, and Contingencies
- Commodity Price Risk: Distributions are highly sensitive to natural gas and NGL prices. Average wellhead prices for natural gas decreased to $3.95 per Mcf in 2011 from $4.16 in 2010.
- Reserve Estimates: Proved reserves as of December 31, 2011, totaled approximately 7,996 Mcf of gas and 573 Mbbl of liquids. The standardized measure of future net royalty income discounted at 10% was $29.9 million, a decrease from $44.8 million in 2010, largely due to net changes in prices and production costs.
- Contingent Liabilities:
- Tax Assessment: A settlement was reached in December 2011 regarding a Kansas Department of Revenue assessment. The portion net to the Trust is approximately $85,000, to be withheld from distributions in January 2012.
- Severance Tax Refunds: The Trustee is monitoring a $3.0 million severance tax refund filed by Pioneer Natural Resources (PNR), with an estimated $167,000 share due to the Trust. Approval is not guaranteed.
- Operational Risks: The Trustee has no control over the operations of the working interest owners (Pioneer, ConocoPhillips, BP). Risks include operator decisions to abandon wells, environmental liabilities, and regulatory changes regarding greenhouse gas emissions and hydraulic fracturing.
Investor Verification Checklist
- Reserve Accuracy: Verify the reliance on third-party reserve estimates (DeGolyer and MacNaughton) and the impact of price assumptions ($4.29/Mcf Hugoton, $2.97/Mcf San Juan) on future income projections.
- Operator Performance: Monitor the drilling and development activities of working interest owners, as the Trust cannot compel additional development projects.
- Contingent Reserve Usage: Track the utilization of the $1.0 million cash reserve established for contingent liabilities and expenses.
- Regulatory Environment: Assess the potential impact of evolving EPA regulations on greenhouse gas emissions and state-level regulations on hydraulic fracturing in Kansas, New Mexico, and Colorado.
- Tax Settlements: Confirm the final resolution of the Kansas tax assessment and the status of the pending severance tax refund claims.