MTR

Mesa Royalty Trust (MTR) - 2020 Annual Report Summary

Business Context and Reporting Period

Mesa Royalty Trust is a passive Texas grantor trust created in 1979. It holds an overriding royalty interest equal to 11.44% of 90% of the Net Proceeds from specific oil and gas properties in the Hugoton field (Kansas) and the San Juan Basin (New Mexico and Colorado). The Trust has no employees; administrative functions are performed by The Bank of New York Mellon Trust Company, N.A. The reporting period covers the fiscal year ended December 31, 2020.

Key Financial Metrics

Note: The Trust operates on a modified cash basis of accounting. Distributions are made quarterly, but the Trust has not made a distribution since May 2020 (paid July 31, 2020) due to costs exceeding revenues.

Material Changes vs. Prior Period

• Revenue Decline: Royalty income decreased by approximately 54% year-over-year, dropping from $1.81 million to $832,149. This was driven by lower natural gas and oil prices, decreased production volumes, and significantly higher operating and capital costs.
• Excess Production Costs: Accumulated excess production costs surged from $34,918 in 2019 to $486,215 in 2020. This increase was primarily due to the Hugoton Royalty Properties (operated by Scout), where costs exceeded revenues, creating a deficit of $430,888. No distributions are paid from these properties until the deficit plus interest is recovered.
• Operator Changes: In 2020, BP completed the sale of its San Juan Basin-Colorado interests to IKAV Energy Inc. Scout Energy has operated the Hugoton properties since late 2019.
• Reconciliations: Hilcorp (San Juan Basin-New Mexico) reconciled historical estimates from 2017-2018, resulting in a $60,262 charge to the Trust in 2020.

Outlook, Risks, and Management Commentary

• Distribution Status: The Trust has suspended distributions since mid-2020. There is no indication of when future distributions may resume, as costs continue to exceed revenues in key properties.
• Commodity Price Risk: The Trust is highly sensitive to natural gas prices. Henry Hub spot prices averaged $2.04 in 2020, down from $2.57 in 2019. Low prices render certain wells uneconomic, leading to reduced production and increased excess costs.
• Reserve Estimates: As of December 31, 2020, proved reserves totaled 5,373 MMcf of gas, 306 Mbbl of NGLs, and 10 Mbbl of oil/condensate. The standardized measure of future net royalty income (discounted at 10%) was $6.57 million, down from $10.49 million in 2019.
• Termination Risk: The Trust Indenture mandates termination if royalty income falls below $250,000 for two successive years. While 2020 income was above this threshold, the trend is concerning.
• Accounting Basis: Financial statements are prepared on a modified cash basis, not GAAP. This means income is recognized when paid by operators, not when production occurs.

Key Facts for Investor Verification

• Current Distribution Status: Verify if any distributions have been declared for 2021 or subsequent quarters, given the suspension since July 2020.
• Excess Cost Recovery: Monitor the $486,215 in accumulated excess production costs, particularly the $430,888 deficit in the Hugoton field, which blocks all royalty payments from that region until recovered.
• Operator Financial Health: Assess the financial stability of the Working Interest Owners (Scout, Hilcorp, IKAV, Red Willow), as the Trust relies entirely on them for operations and payments.
• Commodity Price Sensitivity: Track natural gas prices (Henry Hub) and regional basis differentials, as the Trust's income is almost entirely dependent on gas sales.
• Reconciliation Adjustments: Watch for further historical reconciliations from Hilcorp regarding the San Juan Basin-New Mexico properties, which could result in additional charges to the Trust.