MTR

Mesa Royalty Trust: Q2 2018 Form 10-Q Summary

Business Context and Reporting Period

This report covers the quarterly period ended June 30, 2018, for Mesa Royalty Trust (the "Trust"). The Trust is a passive entity created in 1979 that owns 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. As of August 14, 2018, there were 1,863,590 units of beneficial interest outstanding.

Key Financial Metrics

Note: The Trust has no debt. Liquidity is derived solely from royalty income and interest on cash reserves.

Material Changes vs. Prior Period

• Revenue Decline: Royalty income decreased approximately 26% in Q2 2018 compared to Q2 2017 ($530,259 vs. $717,229) and 22% for the six-month period. This was driven by lower natural gas, natural gas liquids, and oil prices, decreased net production volumes, and increased operating expenses.
• Operating Costs: Operating costs for the Hugoton Royalty Properties increased significantly (81% in Q2, 126% for six months) due to timing of ad valorem tax payments and higher transportation charges. Conversely, operating costs for San Juan Basin properties decreased.
• Administrative Expenses: G&A expenses increased for the six-month period primarily due to the timing of payments for December 2017 expenses being paid in January 2018.
• Production Volumes: Net production volumes attributable to the Royalty decreased across all commodities (Natural Gas, NGLs, and Oil) compared to the prior year periods.

Outlook, Risks, and Unusual Items

• Operator Changes and Separations: Linn Energy, Inc. (operator of Hugoton properties) announced a plan to separate into two companies, with Hugoton assets moving to Riviera Resources, LLC. The Trustee is discussing the impact of this separation. Hilcorp Energy Company acquired ConocoPhillips' San Juan Basin-New Mexico assets and XTO Energy's assets in the region, continuing estimated payments subject to reconciliation.
• Excess Production Costs: The Trust recovers excess production costs before distributions are made. As of June 30, 2018, total excess production costs were $5,809. The Trust recovered prior period excess costs of $15,498 from Red Willow and $707 from Hilcorp during the six-month period.
• Contingent Reserve: The Trustee maintains a reserve for unknown contingent liabilities. As of June 30, 2018, the reserve stood at $989,126. Adjustments to this reserve affect the distributable income available for distribution.
• Interest Rate Environment: The Trustee was unable to obtain an account yielding the required interest rate (1.5% below prime) mandated by the Trust Indenture. Consequently, the Trustee allocated a portion of its fees to offset the interest shortfall.
• Legal Proceedings: No pending legal proceedings name the Trust as a party, though the Trust may be subject to litigation in the ordinary course of business regarding the Royalty Properties.

Investor Verification Checklist

• Operator Stability: Verify the finalization and impact of Linn Energy's separation plan on the Hugoton Royalty Properties and the continuity of payments from the new operator (Riviera Resources).
• Reconciliation of Estimates: Monitor the reconciliation of estimated Net Proceeds payments made by Hilcorp following its acquisition of San Juan Basin assets, which could result in true-ups or adjustments to future distributions.
• Commodity Price Sensitivity: Assess the Trust's exposure to fluctuating natural gas and NGL prices, which are the primary drivers of the recent decline in royalty income.
• Excess Cost Recovery: Track the status of excess production costs, particularly for the Hugoton properties, to ensure they do not delay future distributions.
• Contingent Reserve Usage: Review future filings for changes to the $989,126 Contingent Reserve, as withdrawals or additions directly impact per-unit distributions.