Business Context and Reporting Period
Company: San Juan Basin Royalty Trust (the "Trust")
Reporting Period: Quarterly period ended June 30, 2012 (Form 10-Q)
Trustee: Compass Bank
Operator: Burlington Resources Oil & Gas Company LP ("BROG"), a subsidiary of ConocoPhillips.
Business Model: The Trust holds a 75% net overriding royalty interest in oil and gas properties in the San Juan Basin. It is a passive entity that distributes net proceeds from production to Unit Holders. The Trust has no employees or debt.
Key Financial Metrics
| Metric | Three Months Ended June 30, 2012 | Six Months Ended June 30, 2012 |
|---|---|---|
| Royalty Income | $10,582,704 | $25,433,196 |
| Total Revenue (Royalty + Interest) | $10,792,745 | $25,990,932 |
| Distributable Income | $10,378,729 | $25,003,425 |
| Distributable Income per Unit | $0.222678 | $0.536454 |
| Cash and Short-term Investments (as of June 30, 2012) | $3,449,102 | |
| Net Overriding Royalty Interest (as of June 30, 2012) | $12,475,033 | |
| Units Outstanding | 46,608,796 |
Production Data (Three Months Ended June 30, 2012):
- Gas Sales: 8,130,030 Mcf (Average Price: $3.31/Mcf)
- Oil Sales: 9,670 Bbls (Average Price: $90.26/Bbl)
Material Changes vs. Prior Period
- Revenue Decline: Royalty income decreased significantly compared to the prior year. For the three months ended June 30, 2012, royalty income was $10.58 million versus $15.57 million in the same period in 2011. For the six-month period, it was $25.43 million versus $30.96 million.
- Price Impact: The decline is primarily attributed to lower natural gas prices. The average gas price dropped from $4.81/Mcf in Q2 2011 to $3.31/Mcf in Q2 2012. Oil prices also decreased slightly ($91.18 to $90.26 per barrel).
- Expense Reduction: General and administrative expenses decreased to $414,016 in Q2 2012 from $526,817 in Q2 2011, largely due to timing differences.
- Capital Expenditures: Reported capital costs for Q2 2012 were approximately $3.9 million, down from $5.6 million in Q2 2011. However, this decrease is partially due to a calculation error by the operator (see below).
Outlook, Risks, and Unusual Items
2012 Calculation Error and Overpayment Recovery
BROG identified a miscalculation ("2012 Calculation Error") for the months of April through July 2012, which understated lease operating expenses and capital expenditures by approximately 25%. This resulted in an overpayment of royalty income to the Trust of approximately $3,386,861. BROG intends to offset this overpayment against future royalty income payable to the Trust over four consecutive months beginning in August 2012. Estimated reductions to distributions are:
- August 2012: ~$742,779
- September 2012: ~$1,090,583
- October 2012: ~$767,122
- November 2012: ~$786,377
Litigation and Contingencies
- Jicarilla Apache Nation Case: A dispute regarding "major portion" royalty calculations for Native American leases remains outstanding. The U.S. Court of Appeals remanded the matter to the Department of the Interior (DOI) in October 2011. BROG cannot currently estimate a range of loss for the Trust as the DOI has not provided the necessary calculations for the 1984-1988 period.
- Abraham et al. v. BP America: The Trust is a member of the plaintiff class in a case regarding royalty underpayments. A $9.74 million verdict was reversed by the Tenth Circuit in July 2012, and the case was remanded for a new trial. The materiality of any future distribution to the Trust is uncertain.
Operational Outlook
BROG's estimated capital expenditure budget for 2012 is $20.8 million, though actual spending could range from $5 million to $35 million depending on regulatory approvals and gas prices. Approximately 383 projects are anticipated for 2012.
Investor Verification Checklist
- Calculation Error Impact: Verify the specific impact of the $3.39 million overpayment recovery on upcoming quarterly distributions (August through November 2012).
- Gas Price Sensitivity: Monitor natural gas prices in the San Juan Basin, as the Trust's income is heavily dependent on gas production and pricing.
- Litigation Status: Track developments in the Jicarilla Apache Nation case and the Abraham v. BP America case, as outcomes could materially affect future royalty calculations or result in unexpected liabilities/recoveries.
- Operator Changes: Note the spinoff of Phillips 66 from ConocoPhillips (completed May 2012) and monitor any changes in the operational structure of BROG.
- Contract Expirations: Review the status of gas sales contracts, particularly those expiring March 31, 2013, and the replacement of the terminated NMGC contract.