Business Context and Reporting Period
Company: San Juan Basin Royalty Trust (Trust)
Reporting Period: Quarter and nine months ended September 30, 2018
Trustee: Compass Bank
Operator: Hilcorp San Juan L.P. (acquired Subject Interests from Burlington on July 31, 2017)
Structure: The Trust holds a 75% net overriding royalty interest in oil and gas properties in the San Juan Basin. It is a fixed investment trust taxed as a grantor trust. Distributions are based on net proceeds from production after costs, taxes, and capital expenditures.
Key Financial Metrics
| Metric | Three Months Ended Sep 30, 2018 | Nine Months Ended Sep 30, 2018 |
|---|---|---|
| Royalty Income | $3,001,153 | $12,638,486 |
| Total Income | $3,005,801 | $12,652,376 |
| Distributable Income | $2,829,974 | $11,589,262 |
| Distributable Income per Unit | $0.060718 | $0.248650 |
| Cash and Short-term Investments | $902,091 | (Balance Sheet Item) |
| Net Overriding Royalty Interest (Net of Amortization) | $6,046,968 | (Balance Sheet Item) |
| Trust Corpus | $6,046,968 | (Balance Sheet Item) |
| Units Outstanding | 46,608,796 | 46,608,796 |
Production Data (Three Months Ended Sep 30, 2018):
- Natural Gas: 8,589,309 Mcf (Subject Interests); Average Price: $1.76/Mcf (after true-up)
- Oil/Condensate: 10,149 Bbls (Subject Interests); Average Price: $61.49/Bbl (after true-up)
Material Changes vs. Prior Period
- Revenue Decline: Royalty Income decreased 80% for the quarter and 58% for the nine-month period compared to 2017. This was driven by lower natural gas prices (down from $2.54/Mcf to $1.76/Mcf for the quarter), revenue reductions due to "true-ups" (reconciliations of estimated vs. actual data), and the absence of a $7.5 million litigation settlement received in Q3 2017.
- Capital Expenditures Spike: Capital expenditures increased significantly (2,191% for the quarter) due to an error where Hilcorp charged the Trust for well recompletion costs that did not burden the Trust's royalty interest. This resulted in $140,780 in gross excess production costs for the September 2018 distribution month, leading to a $0.00 distribution for that month.
- Production Volume: Natural gas production volumes increased approximately 33% for the quarter and 29% for the nine-month period compared to 2017, attributed to Hilcorp's recompletion and reactivation programs.
- Operating Expenses: Lease operating expenses and property taxes increased 25% for the quarter, primarily due to increased activity and operator differences.
Outlook, Risks, and Unusual Items
- Subsequent Event - Capital Expenditure Reversal: Following an audit, Hilcorp agreed to reverse approximately $2.4 million in erroneously charged capital expenditures for well recompletions. This reversal, plus interest, was included in the October 2018 report. Hilcorp also recouped the $140,780 in excess production costs from the September distribution.
- True-Up Uncertainty: Due to the transition from Burlington to Hilcorp, significant portions of 2018 revenue were based on estimates. Hilcorp is still reconciling ("truing-up") data for distribution months from January 2018 through October 2018. Future distributions may be adjusted based on these reconciliations.
- Liquidity: The Trust withdrew $98,000 from its cash reserve in September to cover expenses. The reserve was replenished to $1.0 million in October 2018. The Trust has no debt and is not liable for production costs beyond the royalty interest.
- Market Risk: The Trust's income is heavily dependent on natural gas prices. There were no material changes to market risk disclosures, but price volatility remains a primary risk factor.
Investor Verification Checklist
- Capital Expenditure Reversal: Verify the timing and amount of the $2.4 million reversal of erroneous capital expenditures in future distribution reports.
- True-Up Adjustments: Monitor upcoming filings for adjustments to distributions related to the reconciliation of estimated revenues for Jan 2018 through Oct 2018.
- Natural Gas Pricing: Track the impact of current natural gas prices on future royalty income, given the Trust's high exposure to gas production.
- Production Costs: Confirm that future capital expenditure charges are accurately allocated to the Trust's 75% interest and do not include non-burdened costs.
- Cash Reserve Status: Monitor the $1.0 million cash reserve to ensure it remains sufficient to cover general and administrative expenses during low-income months.