Business Context and Reporting Period
The San Juan Basin Royalty Trust (the "Trust") is a Texas express trust holding a 75% net overriding royalty interest in oil and gas properties located in the San Juan Basin of northwestern New Mexico. The Trust is a passive entity; it does not operate the properties, which are managed by Burlington Resources Oil & Gas Company LP ("BROG"), a subsidiary of ConocoPhillips. This Form 10-Q covers the quarterly period ended June 30, 2011. The Trust has 46,608,796 Units of beneficial interest outstanding.
Key Financial Metrics
| Metric | Three Months Ended June 30, 2011 | Three Months Ended June 30, 2010 | Six Months Ended June 30, 2011 | Six Months Ended June 30, 2010 |
|---|---|---|---|---|
| Royalty Income | $15,568,211 | $22,450,139 | $30,957,341 | $44,452,655 |
| Total Revenue | $16,251,271 | $22,454,915 | $31,641,866 | $44,665,744 |
| Distributable Income | $15,724,454 | $21,680,581 | $30,593,364 | $43,209,899 |
| Distributable Income per Unit | $0.337370 | $0.465161 | $0.656385 | $0.927076 |
| Cash and Short-Term Investments | $5,914,592 (June 30, 2011) | $5,223,123 (Dec 31, 2010) | N/A | |
| Net Overriding Royalty Interest (Asset) | $13,986,056 (June 30, 2011) | $14,745,884 (Dec 31, 2010) | N/A |
Production Data (Three Months Ended June 30, 2011):
- Gas Sales: 7,724,467 Mcf (Average Price: $4.81/Mcf)
- Oil Sales: 15,323 Bbls (Average Price: $91.18/Bbl)
Material Changes Versus Prior Period
Distributable income decreased significantly compared to the prior year periods. For the three months ended June 30, 2011, distributable income fell by approximately 27.5% compared to the same period in 2010. For the six-month period, the decline was approximately 29.2%.
Primary Drivers of Change:
- Commodity Prices: Average natural gas prices declined from $5.12/Mcf in Q2 2010 to $4.81/Mcf in Q2 2011. While oil prices increased significantly (from $71.54 to $91.18 per barrel), the Trust's income is heavily weighted toward natural gas production.
- Capital Expenditures: Capital costs deducted by BROG increased from approximately $2.2 million in Q2 2010 to $5.6 million in Q2 2011, reducing net proceeds available for royalty calculation.
- Legal Settlements: The 2010 period included a $2.6 million settlement payment from BROG to the Trust regarding prior litigation, which boosted 2010 income but was not present in 2011.
- Interest Income: Interest income increased in 2011 due to interest received on late payments of net proceeds related to compliance audit adjustments.
Outlook, Risks, and Contingencies
Management Commentary and Outlook:
- Capital Budget: BROG estimates a 2011 capital expenditure budget of $13.6 million for the Underlying Properties, though actual spending could range from $5 million to $35 million depending on regulatory approvals and gas prices.
- Drilling Activity: BROG anticipates 417 projects in 2011, including 38 new wells. As of June 30, 2011, 18 gross conventional wells were in progress.
- Corporate Structure: ConocoPhillips announced a separation of its refining and marketing business from its exploration and production business, expected to complete by the first half of 2012. The Trustee is monitoring the impact of this separation.
Risks and Contingencies:
- Gas Sales Contracts: Several gas sales contracts expired in March 2011. BROG has entered into three new contracts effective April 1, 2011, with Chevron, PG&E, and Salt River Project. However, a dispute with Enterprise Field Services, LLC ("EFS") regarding gathering and processing contracts remains unresolved, though a tentative agreement was reached in March 2011.
- Litigation (Jicarilla Apache Nation): A dispute regarding "major portion" royalty calculations remains outstanding. The U.S. Court of Appeals remanded the matter to the Department of Interior in July 2010. A final judgment could impact royalty income, but no estimate of potential loss has been provided by BROG.
- Litigation (Abraham v. BP): The Trust is a member of a plaintiff class in a case regarding royalty underpayments. A verdict of approximately $9.74 million was entered in May 2011, but the defendant has appealed. It is uncertain if any distribution to the Trust will be material.
- Compliance Audits: Ongoing compliance audits continue to generate adjustments to net proceeds, including $681,548 included in Q2 2011 calculations.
Key Facts for Investor Verification
- Revenue Sensitivity: Verify the correlation between natural gas prices and Trust distributions, as gas constitutes the vast majority of revenue.
- Capital Expenditure Impact: Monitor BROG's actual capital spending versus the $13.6 million budget, as higher spending directly reduces distributable income.
- Contractual Stability: Confirm the finalization of the gathering and processing agreement with EFS and the terms of the new gas sales contracts.
- Litigation Exposure: Track the status of the Jicarilla Apache Nation "major portion" case and the Abraham v. BP appeal, as outcomes could materially alter future cash flows.
- ConocoPhillips Separation: Assess the impact of ConocoPhillips' planned corporate separation on BROG's operational focus and capital allocation.