PBT

Business Context and Reporting Period

Company: Permian Basin Royalty Trust (PBT)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2009
Trustee: Bank of America, N.A. (U.S. Trust, Bank of America Private Wealth Management)
Business Model: PBT is a passive express trust holding net overriding royalty interests in oil and gas properties in Texas. It has no employees and does not engage in business operations. Income is derived from a 75% interest in the Waddell Ranch properties and a 95% interest in various Texas Royalty properties. Distributions are made monthly to Unit holders based on net proceeds from production.

Key Financial Metrics

Production & Pricing (2009 vs 2008):
- Average Oil Price: $51.82/bbl (2009) vs $102.04/bbl (2008).
- Average Gas Price: $4.67/Mcf (2009) vs $10.55/Mcf (2008).
- Total Oil Sales (Royalties): 549,923 barrels (2009) vs 760,258 barrels (2008).
- Total Gas Sales (Royalties): 2,269,900 Mcf (2009) vs 3,673,068 Mcf (2008).

Reserves (Dec 31, 2009):
- Total Proved Oil Reserves: 5,495,000 barrels.
- Total Proved Gas Reserves: 18,402,000 Mcf.
- Standardized Measure of Discounted Future Net Cash Flows (10%): $211,207,000.

Material Changes vs. Prior Period

• Revenue Decline: Royalty income decreased by approximately 65% from 2008 to 2009, dropping from $112.3 million to $39.0 million. This was primarily driven by a sharp decline in crude oil and natural gas prices.
• Price Volatility: The average realized price for oil fell by roughly 49% and gas by roughly 55% compared to 2008 levels.
• Production Volume: Total oil production attributable to royalties decreased by approximately 28%, and gas production decreased by approximately 38%. The Trust attributes the volume decline to normal production decline and reduced revenue allocation formulas tied to lower prices.
• Capital Expenditures: Capital expenditures included in the royalty calculation were $11.5 million in 2009, up from $9.1 million in 2008. However, the operator (BROG) budgeted a 40% decrease in capital expenditures for 2010 ($14.5 million) compared to 2009 actuals, with zero new drill wells planned for 2010.
• Operating Expenses: Lease operating expenses on the Waddell Ranch properties increased by $7.0 million in 2009 compared to 2008, largely due to increased management costs.

Outlook, Risks, and Management Commentary

Management Commentary:
The Trustee notes that the Trust is a passive entity with no control over operations. The significant drop in 2009 income is attributed to global market conditions, including the U.S. recession, tightened credit markets, and rising crude supplies. Oil and gas prices are expected to remain volatile.

Risks and Contingencies:
- Price Sensitivity: Distributions are highly dependent on commodity prices. Lower prices reduce net proceeds and may cause operators to delay or eliminate development projects. - Depleting Assets: The Trust holds depleting assets. Without additional development by operators (BROG and Riverhill Energy), production will decline. The production index is approximately 9.2 years. - Operator Control: Unit holders have no influence over operations. Operators may abandon wells or transfer interests without Trust consent. The Trust has no right to replace an operator. - Termination Trigger: The Trust must sell its royalties and terminate if net revenue falls below $1,000,000 per year for two consecutive years. (Note: 2009 revenue was well above this threshold). - Accounting Basis: Financial statements are prepared on a modified cash basis, not GAAP. Revenues are recognized when received, not when produced.

Investor Verification Checklist

• Commodity Price Exposure: Verify current and projected oil and gas prices, as they are the primary driver of cash flow.
• Operator Capital Plans: Confirm the 2010 capital expenditure budget of $14.5 million and the decision to drill zero new wells, as this impacts future reserve replacement.
• Reserve Estimates: Review the independent reserve report by Cawley, Gillespie & Associates, noting that estimates are sensitive to price assumptions.
• Termination Threshold: Monitor annual net revenue to ensure it remains above the $1,000,000 threshold required to avoid mandatory termination.
• Tax Implications: Confirm the classification of distributions as return of capital vs. income for tax purposes, as the Trust is a grantor trust.