MTR

Mesa Royalty Trust (MTR) - Q2 2020 10-Q Summary

Business Context and Reporting Period

This report covers the quarterly period ended June 30, 2020. Mesa Royalty Trust is a passive entity holding 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 Trust's income is derived solely from royalty payments and interest on cash reserves.

Key Financial Metrics

Note: Net Overriding Royalty Interest is calculated as Gross Asset ($42,498,034) less Accumulated Amortization ($40,949,166).

Material Changes vs. Prior Period

• Revenue Decline: Royalty income decreased approximately 53% in Q2 2020 compared to Q2 2019. This was driven by significantly lower natural gas, natural gas liquids, and oil prices, as well as decreased production volumes.
• Commodity Prices: Average sales prices for natural gas dropped from $2.47/Mcf in Q2 2019 to $1.62/Mcf in Q2 2020. Natural gas liquids prices fell from $19.20/Bbl to $10.96/Bbl.
• Excess Production Costs: Total excess production costs (costs exceeding revenue) rose to $203,285 as of June 30, 2020, from $34,918 at year-end 2019. A significant portion ($156,135) is attributed to the Hugoton Properties operated by Scout Energy, where expenses exceeded proceeds for the quarter.
• Contingent Reserve Adjustments: The Trustee adjusted the Contingent Reserve, which reduced the distributable income available for distribution. For Q2 2020, the reserve was increased by $148,476 and decreased by $24,571, resulting in a net reduction of available cash for distribution.

Outlook, Risks, and Management Commentary

• COVID-19 Impact: The pandemic has caused a sharp decline in global demand for oil and gas, severely impacting commodity prices and the operations of the Working Interest Owners (Scout, Hilcorp, BP, Red Willow).
• Distribution Suspension: The Trust announced that no distributions would be paid to unitholders for June 2020 and July 2020 due to the adverse financial conditions.
• Historical Reconciliations: Hilcorp (operator of San Juan Basin-New Mexico) is reconciling historical estimated payments made between 2017 and 2019. Future adjustments could result in material reductions to Net Proceeds. A charge of $3,699 was recorded in Q2 2020 for a January 2018 reconciliation.
• Future Costs: Hilcorp noted significant incremental costs of approximately $1.1 million incurred in 2018 for a new well, which will reduce future Net Proceeds as they are reconciled.
• Termination Risk: The Trust Indenture provides for termination if royalty income falls below $250,000 for two successive years. While Q2 2020 income was above this threshold, the trend is downward.

Key Facts for Investor Verification

• Zero Distributions: Verify the impact of the announced suspension of distributions for June and July 2020 on cash flow expectations.
• Excess Cost Recovery: Monitor the $156,135 in excess production costs at Hugoton Properties; these must be recovered from future gross proceeds before any royalty income is paid to the Trust.
• Hilcorp Reconciliation: Track the ongoing reconciliation of historical payments by Hilcorp, which could lead to unexpected charges or withholdings from future distributions.
• Commodity Price Sensitivity: Assess the Trust's exposure to natural gas prices, which constitute the majority of revenue and have fallen to historically low levels.
• Termination Threshold: Watch for royalty income levels in subsequent quarters to determine if the Trust approaches the $250,000 annual termination threshold.