Business Context and Reporting Period
Company: San Juan Basin Royalty Trust (the "Trust")
Reporting Period: Quarter and six months ended June 30, 2008
Trustee: Compass Bank
Outstanding Units: 46,608,796
Business Overview: The Trust holds a 75% net overriding royalty interest in oil and gas properties in the San Juan Basin, New Mexico. It is a passive entity; all administrative functions and property operations are managed by the Trustee and the operator, Burlington Resources Oil & Gas Company LP ("BROG").
Key Financial Metrics
| Metric | Three Months Ended June 30, 2008 |
Three Months Ended June 30, 2007 |
Six Months Ended June 30, 2008 |
Six Months Ended June 30, 2007 |
|---|---|---|---|---|
| Royalty Income | $35,612,146 | $26,288,314 | $61,188,564 | $50,237,063 |
| Total Revenue | $35,631,879 | $26,377,346 | $61,372,676 | $50,950,876 |
| Distributable Income | $35,039,101 | $25,795,551 | $60,169,824 | $49,803,434 |
| Distributable Income per Unit | $0.751770 | $0.553449 | $1.290954 | $1.068543 |
| Cash and Short-term Investments | $14,069,428 | N/A | $14,069,428 | N/A |
| Net Overriding Royalty Interest (Asset) | $18,975,921 | N/A | $18,975,921 | N/A |
| Distributions Payable | $13,954,570 | N/A | $13,954,570 | N/A |
Note: The Trust has no long-term debt. Liquidity is maintained through royalty income and short-term investments.
Material Changes vs. Prior Period
- Revenue Growth: Royalty income increased 35.5% for the quarter and 21.8% for the six-month period compared to 2007. This was driven primarily by higher commodity prices.
- Commodity Prices: Average gas prices rose from $6.38/Mcf (Q2 2007) to $8.51/Mcf (Q2 2008). Average oil prices rose from $57.98/Bbl to $94.81/Bbl.
- Production Volumes: Despite price increases, gas and oil sales volumes decreased. Gas sales dropped from 8,636,056 Mcf (Q2 2007) to 7,837,532 Mcf (Q2 2008). The decline is attributed to unplanned downtime at a third-party facility and natural production decline.
- Legal Settlement Impact: In March 2008, royalty income was reduced by $4,921,578 (Trust's portion) due to a settlement of a legal matter with the U.S. Department of the Interior regarding underpayment of royalties on Native American leases.
- Operating Costs: Lease operating expenses increased due to higher contract service costs and an adjustment in the COPAS overhead rate from 6.4% to 7.7%.
Outlook, Risks, and Contingencies
- Capital Expenditures: BROG's 2008 budget for capital expenditures is $24.4 million, with a potential range of $15 million to $50 million depending on regulatory approvals and gas prices. Approximately 35% is allocated to Fruitland Coal formation projects.
- Contract Terminations: Two major gas sales contracts (ChevronTexaco and Coral) are set to terminate on March 31, 2009. Requests for proposals for replacement contracts will be circulated.
- Legal Proceedings:
- Arbitration Award Litigation: The Trust is suing BROG to recover approximately $5.025 million related to an arbitration award from 2005. The case was removed to federal court in New Mexico in June 2008, with venue disputes ongoing.
- Major Portion Calculation: A dispute regarding royalty valuation methods (major portion analysis) with the Jicarilla Apache Nation remains outstanding. A judgment could require reimbursement from the Trust, though no estimate of potential loss has been provided by BROG.
- Market Risk: The Trust is exposed to volatility in oil and gas prices. It holds no derivative instruments and has no foreign currency exposure.
Investor Verification Checklist
- Production Decline: Verify the extent of the "unplanned down-time" at the third-party facility and its expected duration to assess future volume recovery.
- Legal Settlement Audit: Confirm the Trust's consultants' findings regarding the $4.9 million deduction for the U.S. government settlement to ensure the allocation was accurate.
- Arbitration Outcome: Monitor the status of the federal court litigation regarding the $5 million arbitration award and the venue dispute.
- Gas Contract Renewals: Track the progress of new gas sales contracts to replace those expiring in March 2009, as pricing terms will impact future revenue.
- Capital Spend Execution: Compare actual 2008 capital expenditures against the $24.4 million budget to gauge development activity levels.