SJT

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended September 30, 1998, for the San Juan Basin Royalty Trust. The Trust holds a 75% net overriding royalty interest in oil and gas properties in the San Juan Basin, managed by working interest owner Burlington Resources Oil & Gas Company (BROG). The Trust is a fixed investment trust taxed as a grantor trust, with 46,608,796 units outstanding as of November 14, 1998. Financial statements are prepared on a modified cash basis and have been reviewed, but not audited, by Deloitte & Touche LLP.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Royalty income decreased significantly compared to the prior year periods. For the three months ended September 30, 1998, income dropped 35.7% year-over-year. For the nine-month period, the decline was 33.7%.
• Price and Volume Impact: The decrease in income is primarily attributed to lower average gas prices ($1.62/Mcf in Q3 1998 vs. $1.76/Mcf in Q3 1997) and lower oil prices ($12.03/bbl vs. $17.67/bbl). Gas production volumes also decreased slightly.
• Increased Capital Costs: Capital expenditures attributable to the underlying properties rose sharply to $3.75 million in Q3 1998 from $1.54 million in Q3 1997. For the nine-month period, capital expenditures were $10.05 million compared to $5.65 million in 1997. These costs are deducted before calculating the Trust's royalty income.
• Expense Reduction: General and administrative expenses decreased due to timing differences and lower consulting/audit fees.

Outlook, Risks, and Contingencies

• Management Commentary: BROG increased its estimated 1998 capital budget from $10 million to $10.9 million, with significant allocation toward increasing density and productivity in the Fruitland Coal. A new two-year gas sales contract with El Paso Energy Marketing Company began January 1, 1998, pricing gas based on published indices.
• Year 2000 Issue: The Trust relies on third-party suppliers (Trustee, BROG, vendors) for royalty calculations and distributions. While suppliers are addressing Year 2000 compliance, failure to do so could materially impact the Trust's ability to receive and distribute income.
• Legal Proceedings:
  • Class Action Litigation: A consolidated class action suit (San Juan 1990-A, L.P., et al. v. El Paso Production Company) alleges underpayment of royalties. Class certification was denied, but if plaintiffs succeed, Trust income could decrease.
  • MMS Claim: The U.S. Department of the Interior (MMS) has initiated an administrative claim against BROG regarding a 1990 gas contract settlement, alleging additional royalties are due on federal and Indian leases. If successful, this could reduce Trust income.
• Tax Credit Uncertainty: The ability of Unit holders to utilize Section 29 tax credits for coal seam gas production is subject to ongoing litigation regarding FERC certification requirements. The outcome of the appeal is unpredictable.

Investor Verification Checklist

• Verify the impact of BROG's increased capital expenditure budget ($10.9M) on future distributable income, as these costs are deducted prior to royalty calculation.
• Monitor the status of the consolidated class action litigation and the MMS administrative claim, as both pose risks to future royalty income.
• Confirm the status of Year 2000 compliance for BROG and the Trustee to ensure uninterrupted royalty payments.
• Review the terms of the new gas sales contract with El Paso Energy Marketing Company and its effect on pricing relative to market indices.
• Assess the uncertainty surrounding the Section 29 tax credit for coal seam gas and its potential impact on net returns for Unit holders.