SJT

Business Context and Reporting Period

Company: San Juan Basin Royalty Trust (SJT)
Reporting Period: Quarter and nine months ended September 30, 2019
Trustee: BBVA USA
Operator: Hilcorp San Juan L.P.
Business Model: The Trust holds a 75% net overriding royalty interest in oil and gas properties in the San Juan Basin, New Mexico. Distributions to Unit Holders depend on net proceeds from production after deducting production costs, taxes, and capital expenditures. The Trust has no employees; all administrative functions are performed by the Trustee.

Key Financial Metrics

Note: The Trust reported zero royalty income for Q3 2019 because production costs exceeded gross proceeds.

Material Changes vs. Prior Period

• Revenue Decline: Royalty income dropped to zero in Q3 2019 compared to $3.0 million in Q3 2018. Year-to-date royalty income decreased 29% to $8.96 million.
• Cost Overruns: Production costs exceeded gross proceeds by $2.0 million (net) in Q3 2019, resulting in no distributable income. This was driven by increased capital expenditures ($4.7 million in Q3 2019 vs. $2.8 million in Q3 2018) and lower natural gas volumes/prices.
• Capital Expenditures: Hilcorp increased capital spending significantly in 2019. However, in October 2019, Hilcorp revised its full-year 2019 CapEx plan down to $8.0 million from a May estimate of $12.6 million due to permitting delays.
• Liquidity: Cash reserves decreased from $1.0 million at year-end 2018 to $0.58 million at September 30, 2019, as the Trust utilized reserves to cover administrative expenses during the quarter with no royalty income.

Outlook, Risks, and Contingencies

• Permitting Delays: An environmental lawsuit against the Bureau of Land Management (BLM) has stalled permitting processes, creating uncertainty regarding when Hilcorp can conduct additional capital expenditure drilling.
• Excess Production Costs: As of November 1, 2019, accumulated gross excess production costs were $2.6 million ($2.0 million net). The Trust will not make cash distributions until future net proceeds are sufficient to cover these costs and replenish cash reserves.
• True-Up Adjustments: Hilcorp is still reconciling estimated revenue and severance tax numbers for periods from October 2017 through August 2019. Future distributions may be adjusted (plus interest) based on these true-ups. There is a potential negative adjustment of up to $2.0 million related to estimated "Other" revenue from late 2017/early 2018.
• Market Risk: The Trust's income is heavily influenced by natural gas prices and volumes. Average natural gas prices decreased to $1.26 per Mcf in Q3 2019 from $1.76 in Q3 2018.
• Borrowing Capacity: If cash reserves are insufficient to fund administrative expenses, the Trust has the ability to borrow funds against its royalty interests.

Investor Verification Checklist

• Zero Distribution Status: Confirm that no distributions were paid in Q3 2019 and that the Trust is currently absorbing costs from cash reserves.
• Excess Cost Recovery: Monitor the timeline for recovering the $2.0 million net accumulated excess production costs before distributions resume.
• BLM Permitting: Track the status of the environmental lawsuit against the BLM, as it directly impacts Hilcorp's ability to drill and generate future production.
• True-Up Impact: Watch for future adjustments to distributions related to the reconciliation of historical data (Oct 2017–Aug 2019), which could result in reduced future payments.
• CapEx Revisions: Verify if the revised $8.0 million CapEx plan is sufficient to maintain production levels or if further cuts are necessary due to permitting issues.