Business Context and Reporting Period
Company: San Juan Basin Royalty Trust (Trust)
Reporting Period: Quarterly period ended September 30, 2017 (Form 10-Q).
Business Overview: The Trust holds a 75% net overriding royalty interest in oil and natural gas properties in the San Juan Basin, New Mexico. The Trustee is Compass Bank. The principal operator of the underlying assets changed from Burlington Resources (a ConocoPhillips subsidiary) to Hilcorp San Juan L.P. effective July 31, 2017. The Trust has no employees; all administrative functions are performed by the Trustee.
Key Financial Metrics
| Metric | Three Months Ended Sep 30, 2017 | Nine Months Ended Sep 30, 2017 |
|---|---|---|
| Royalty Income | $15,120,298 | $30,179,499 |
| Total Income | $15,122,744 | $30,184,804 |
| Distributable Income | $14,835,988 | $28,964,429 |
| Distributable Income per Unit | $0.318308 | $0.621437 |
| Cash and Short-term Investments | $11,099,163 | (Balance Sheet Item) |
| Cash Reserves | $1,000,000 | (Balance Sheet Item) |
| Net Overriding Royalty Interest (Net) | $6,918,611 | (Balance Sheet Item) |
| Units Outstanding | 46,608,796 | 46,608,796 |
Production Data (Three Months Ended Sep 30, 2017):
- Natural Gas: 6,470,208 Mcf (Subject Interests); Average Price: $2.54/Mcf.
- Oil and Condensate: 16,894 Bbls (Subject Interests); Average Price: $34.71/Bbl.
Material Changes vs. Prior Period
Revenue and Income: Royalty Income increased significantly compared to the prior year periods. For the three months ended September 30, 2017, Royalty Income was $15.1 million compared to $4.4 million in 2016 (245% increase). For the nine months, it was $30.2 million compared to $9.0 million in 2016 (237% increase).
Drivers of Change:
- Litigation Settlement: The Trust received $7.5 million in September 2017 to settle the "2014 Litigation" against Burlington. This amount is included in Royalty Income.
- Commodity Prices: Average natural gas prices increased from $1.89/Mcf (Q3 2016) to $2.54/Mcf (Q3 2017).
- Capital Expenses: A $1.0 million credit was recorded for the reversal of accrued capital expenses by Burlington prior to the asset sale.
- Expenses: General and administrative expenses decreased 43% in Q3 and 49% in the nine-month period compared to 2016, primarily due to reduced legal and audit costs associated with the settled litigation.
Outlook, Risks, and Unusual Items
Operator Transition: Hilcorp acquired the Subject Interests on July 31, 2017. Hilcorp is responsible for production reporting starting August 1, 2017. However, Hilcorp lacks complete revenue and expense data decks for August 2017 and may use estimated figures for subsequent distributions until systems are fully installed. Reconciliations between estimated and actual figures will adjust future distributions.
Unusual Items:
- Settlement Proceeds: The $7.5 million litigation settlement is a non-recurring item significantly boosting current period income.
- Interest Income: Interest income was lower in 2017 compared to 2016, which included $161,794 in interest on late payments from Burlington related to audit negotiations.
Risks:
- Reporting Disruptions: The transition to Hilcorp may cause administrative disruptions or delays in accurate reporting.
- Capital Expenditures: Hilcorp may increase capital expenditure budgets compared to Burlington's conservative approach, which could reduce Distributable Income.
- Market Risk: Distributable Income is heavily dependent on natural gas prices and production volumes.
Investor Verification Checklist
- Settlement Impact: Verify the non-recurring nature of the $7.5 million litigation settlement and its exclusion from future recurring income projections.
- Operator Transition: Monitor future filings for reconciliations of estimated vs. actual revenue/expenses provided by Hilcorp, which may adjust prior distributions.
- Capital Budget: Watch for changes in capital expenditure plans under Hilcorp's management, as increased spending will directly reduce net proceeds available for distribution.
- Commodity Prices: Assess the sustainability of the current natural gas price environment ($2.54/Mcf average) relative to historical lows.
- Depletion: Note that amortization of the royalty interest is charged directly to the Trust Corpus, not as an expense, affecting the net asset value over time.