Business Context and Reporting Period
Company: San Juan Basin Royalty Trust (the "Trust")
Reporting Period: Quarterly period ended June 30, 2014 (Form 10-Q)
Structure: The Trust is a passive entity holding a 75% net overriding royalty interest in oil and gas properties in the San Juan Basin, New Mexico. It has no employees or officers; Compass Bank serves as Trustee. Burlington Resources Oil & Gas Company LP ("Burlington") operates the underlying properties.
Units Outstanding: 46,608,796 as of August 11, 2014.
Key Financial Metrics
| Metric | Three Months Ended June 30, 2014 |
Three Months Ended June 30, 2013 |
Six Months Ended June 30, 2014 |
Six Months Ended June 30, 2013 |
|---|---|---|---|---|
| Royalty Income | $18,124,799 | $6,237,669 | $32,650,525 | $9,909,897 |
| Total Revenue | $18,195,512 | $6,237,867 | $32,722,692 | $9,910,561 |
| Distributable Income | $17,712,260 | $5,536,683 | $31,802,103 | $8,932,976 |
| Distributable Income per Unit | $0.380019 | $0.118790 | $0.682319 | $0.191658 |
| Cash and Short-term Investments | $6,613,844 | $4,650,682 (Dec 31, 2013) | N/A | |
| Net Overriding Royalty Interest | $10,164,223 | $10,968,996 (Dec 31, 2013) | N/A | |
| Distributions Payable | $6,427,602 | $4,464,440 (Dec 31, 2013) | N/A |
Production Data (Three Months Ended June 30, 2014):
- Gas Sales: 7,591,679 Mcf (Avg Price: $5.23/Mcf)
- Oil Sales: 14,387 Bbls (Avg Price: $86.87/Bbl)
Material Changes vs. Prior Period
- Revenue Surge: Royalty income increased 191% for the quarter and 230% for the six-month period compared to 2013. This was driven primarily by higher average natural gas prices ($5.23/Mcf in Q2 2014 vs. $3.42/Mcf in Q2 2013) and significantly lower capital expenditures by Burlington.
- Capital Expenditures: Burlington's capital costs deducted from proceeds dropped to approximately $1.8 million in Q2 2014 from $6.8 million in Q2 2013. For the six months ended June 30, 2014, capital expenditures were $3.1 million compared to $19.3 million in 2013.
- Drilling Activity: No conventional wells were completed in the first half of 2014, compared to 17 gross wells in the same period in 2013. Burlington has suspended its drilling program in the San Juan Basin for 2014.
- Operating Expenses: Lease operating expenses decreased slightly to $9.3 million in Q2 2014 from $10.0 million in Q2 2013, attributed to reduced contract maintenance and repair costs.
Guidance, Outlook, Risks, and Contingencies
Outlook and Management Commentary
- Capital Budget: Burlington estimates a 2014 capital budget of $4.8 million, though actual spending could range from $2 million to $15 million depending on gas prices and regulatory approvals. Approximately $3 million of this budget relates to prior years' projects.
- Drilling Suspension: Burlington plans to have no drilling rigs operating in the Basin during 2014 but will monitor gas prices to potentially restart the program in the future. Workovers on existing wells will continue to maintain production.
- Contractual Obligations: Gas sales contracts with Chevron, Shell, EDF, and NMGC are in place through 2015 or 2017. Gathering and processing contracts with Williams Four Corners and Enterprise Field Services are in place for 15-year terms.
Risks and Contingencies
- Legal Proceedings (Burlington Lawsuit): On July 31, 2014, the Trust filed a lawsuit against Burlington seeking over $12 million in damages for breach of contract and failure to properly account for royalties. The claim involves unresolved audit exceptions regarding revenue and expense calculations.
- Severance Tax Overpayment Claim: Burlington identified an alleged overpayment of approximately $3.25 million to the Trust due to improper severance tax allocation between 2007 and 2012. Burlington is recouping this amount in installments of $361,215 from March 2014 through November 2014. The Trust is analyzing this claim.
- Jicarilla Apache Nation Litigation: Ongoing litigation regarding "major portion" royalty calculations for production between 1984 and 1988 remains unresolved. Burlington cannot currently estimate a loss range for the Trust as the Department of the Interior has not provided the necessary calculations. Burlington reserves the right to seek reimbursement from the Trust if a judgment or settlement requires additional payments.
- Market Risk: The Trust's income is heavily dependent on natural gas prices. While prices improved in 2014, volatility remains a primary risk factor.
Investor Verification Checklist
- Verify the status of the July 2014 lawsuit filed by the Trust against Burlington seeking >$12 million and the potential impact on future distributions.
- Confirm the impact of the $3.25 million severance tax recoupment on net proceeds and whether the Trust contests the validity of Burlington's claim.
- Monitor the Jicarilla Apache Nation litigation regarding major portion calculations for 1984-1988, as a future settlement could require the Trust to reimburse Burlington for past royalties.
- Assess the sustainability of current gas prices ($5.23/Mcf in Q2 2014) given the Trust's heavy reliance on natural gas revenue and the suspension of new drilling.
- Review Burlington's capital expenditure plans for 2014 and beyond, as reduced spending boosts current distributions but may impact long-term production levels.