Business Context and Reporting Period
Company: San Juan Basin Royalty Trust (the "Trust")
Reporting Period: Quarter and nine months ended September 30, 2006
Structure: The Trust is a passive entity holding a 75% net overriding royalty interest in oil and gas properties in the San Juan Basin, New Mexico. It has no employees; administrative functions are performed by the Trustee, Compass Bank. The operator of the underlying properties is Burlington Resources Oil & Gas Company LP ("BROG"), a subsidiary of ConocoPhillips.
Key Financial Metrics
| Metric | Three Months Ended Sep 30, 2006 | Nine Months Ended Sep 30, 2006 |
|---|---|---|
| Royalty Income | $30,779,508 | $109,792,831 |
| Interest Income | $601,349 | $1,136,032 |
| Total Income | $31,380,857 | $110,928,863 |
| General & Administrative Expenses | $293,291 | $1,418,453 |
| Distributable Income | $31,087,566 | $109,510,410 |
| Distributable Income per Unit | $0.666989 | $2.349564 |
| Cash and Short-Term Investments | $10,656,319 | (Balance Sheet Item) |
| Net Overriding Royalty Interest (Asset) | $22,293,862 | (Balance Sheet Item) |
| Distributions Payable | $10,541,461 | (Balance Sheet Item) |
Note: The Trust has no debt. Liquidity is maintained through cash reserves and short-term investments pending distribution.
Material Changes vs. Prior Period
- Quarterly Comparison (Q3 2006 vs. Q3 2005):
- Royalty Income: Decreased by approximately $2.05 million (from $32.83M to $30.78M). This decline was driven by a decrease in average gas prices (from $5.85 to $5.79 per Mcf) and lower gas production volumes.
- Interest Income: Increased significantly (from $44,893 to $601,349) due to interest received on a partial payment of an Arbitration Award and higher interest rates.
- Expenses: Administrative expenses decreased by approximately $292,000 compared to the prior year quarter.
- Nine-Month Comparison (YTD 2006 vs. YTD 2005):
- Distributable Income: Increased by approximately $3.96 million (from $105.55M to $109.51M). This increase was primarily due to higher gas prices during the first half of 2006.
- Capital Expenditures: Capital costs deducted by BROG increased significantly to approximately $30.8 million for the nine months ended Sep 30, 2006, compared to $14.4 million in the prior year period. This reflects an increased capital budget and drilling activity.
Outlook, Risks, and Unusual Items
Unusual Items and Litigation
An Arbitration Award of $7,683,699 was issued in favor of the Trust in November 2005 regarding joint interest audit issues. BROG appealed the award. As of September 30, 2006, a portion of the award ($1,325,826 grossed up) plus accrued interest ($539,812) was paid to the Trust in July 2006. The balance remains pending the appeal, which is currently before the First Court of Appeals in Houston, Texas. BROG has posted a Supersedeas Bond to secure the balance.
Operational Outlook
BROG's 2006 capital expenditure budget for the underlying properties is estimated at $37.6 million, with a range of $20 million to $45 million depending on regulatory approvals and gas prices. The budget includes drilling 103 new wells (52 conventional, 51 coal seam) and working over existing wells. There is a strategic shift toward increased development of conventional gas.
Risks
- Commodity Price Volatility: Distributable income is highly sensitive to fluctuations in oil and natural gas prices.
- Production Decline: The Trust's income is subject to the natural decline of reserves in the underlying properties.
- Legal Proceedings: Adverse outcomes in legal proceedings involving BROG could materially decrease Royalty income.
- Tax Legislation: Production from coal seam wells no longer qualifies for the Section 45 tax credit under current law; future legislation is uncertain.
Investor Verification Checklist
- Arbitration Status: Monitor the status of the appeal regarding the remaining balance of the $7.68 million Arbitration Award.
- Capital Expenditure Impact: Verify the actual capital expenditures incurred by BROG, as higher costs directly reduce the net proceeds available for royalty distribution.
- Production Volumes: Track monthly gas and oil production volumes, noting the shift from coal seam to conventional wells and the associated production rates.
- Commodity Prices: Monitor San Juan Basin natural gas and oil prices, as these are the primary drivers of revenue.
- Contract Expirations: Note that gas sales contracts with ChevronTexaco, Coral, and PNM are extended through March 31, 2008, but are subject to termination with 12 months' notice.