Business Context and Reporting Period
Company: San Juan Basin Royalty Trust (Trust)
Reporting Period: Quarter and nine months ended September 30, 2016
Trustee: Compass Bank
Business Model: The Trust holds a 75% net overriding royalty interest in oil and natural gas properties in the San Juan Basin, New Mexico. It has no employees; operations are managed by the Trustee and the working interest owner, Burlington Resources Oil & Gas Company LP (a ConocoPhillips subsidiary). Distributions are funded by royalty income after expenses.
Key Financial Metrics
| Metric | Three Months Ended Sep 30, 2016 | Nine Months Ended Sep 30, 2016 |
|---|---|---|
| Royalty Income | $4,380,871 | $8,956,081 |
| Total Revenue (incl. interest) | $4,543,440 | $9,119,904 |
| Distributable Income | $4,030,292 | $6,248,186 |
| Distributable Income per Unit | $0.086471 | $0.134057 |
| Cash and Short-term Investments | $2,873,104 | $2,873,104 |
| Cash Reserves | $1,000,000 | $1,000,000 |
| Net Overriding Royalty Interest (Net Book Value) | $8,143,790 | $8,143,790 |
| Units Outstanding | 46,608,796 | 46,608,796 |
Material Changes vs. Prior Period
- Revenue Decline: Royalty income decreased 19% for the quarter and 40% for the nine-month period compared to 2015. This was driven primarily by lower natural gas prices (average $1.89/Mcf vs. $2.26/Mcf in Q3 2015) and reduced production volumes.
- Expense Increase: General and administrative expenses rose 25% for the quarter and 54% for the nine-month period. Increases were attributed to legal and audit costs related to ongoing litigation with Burlington and expenses incurred responding to a proxy campaign by Southwest Bank.
- Capital Expenditures: Capital expenditures by the operator dropped significantly (93% decrease for the quarter) due to the suspension of the drilling program in the San Juan Basin amid low commodity prices.
- Interest Income: Interest income increased significantly due to $161,794 received in Q3 2016 as interest on late payments of gross proceeds related to compliance audit negotiations.
Outlook, Risks, and Unusual Items
- Southwest Bank Proxy Campaign: Southwest Bank is campaigning to replace Compass Bank as Trustee. A special meeting is scheduled for November 21, 2016. The Trustee anticipates continued high legal and administrative costs, which may reduce distributable income. Compass Bank is bearing some proxy solicitation costs to conserve Trust funds.
- Litigation: Ongoing litigation against Burlington regarding revenue and expense audit exceptions. Mediation in September 2016 did not result in a settlement, but parties agreed to a temporary discovery "stand still" to continue negotiations. Trial is expected to be continued until October 2017.
- Production Outlook: ConocoPhillips has suspended its drilling program in the San Juan Basin for 2016 due to uneconomic pricing. No well activity occurred in the first nine months of 2016. Future activity depends on natural gas price recovery.
- Subsequent Events: In October 2016, Burlington notified the Trust of a $17,418 overpayment for September 2016, which was deducted from October royalty income. Additionally, a $759,164 net credit adjustment was included in the October distribution for lease operating expenses and capital costs.
Investor Verification Checklist
- Commodity Price Sensitivity: Verify current natural gas and oil prices against the Trust's break-even thresholds, given the suspension of drilling and reliance on existing wells.
- Proxy Contest Outcome: Monitor the November 21, 2016, special meeting results regarding the Southwest Bank campaign and potential impact on future administrative expenses.
- Litigation Status: Track the progress of the "2014 Litigation" against Burlington, as unresolved audit exceptions directly impact royalty income calculations.
- Capital Expenditure Plans: Confirm if ConocoPhillips resumes drilling in the San Juan Basin, as this is critical for long-term production volume maintenance.
- Cash Reserve Adequacy: Assess if the $1.0 million cash reserve is sufficient to cover the elevated legal and administrative expenses anticipated in Q4 2016.