Business Context and Reporting Period
Company: San Juan Basin Royalty Trust (a Texas grantor trust)
Reporting Period: Quarter and nine months ended September 30, 2002
Trustee: TexasBank (appointed September 30, 2002, replacing Bank One, N.A.)
Operations: The Trust holds a 75% net overriding royalty interest in oil and gas properties operated by Burlington Resources Oil & Gas Company LP ("BROG"). Income is derived from production sales less costs, taxes, and capital expenditures.
Key Financial Metrics
| Metric | Q3 2002 | Q3 2001 | 9M 2002 | 9M 2001 |
|---|---|---|---|---|
| Royalty Income | $12,549,272 | $13,971,820 | $26,034,196 | $78,047,734 |
| Distributable Income | $12,296,335 | $13,714,931 | $24,838,150 | $77,228,189 |
| Distributable Income per Unit | $0.263820 | $0.294257 | $0.532907 | $1.656945 |
| Cash and Short-term Investments | $4,967,812 (as of Sept 30, 2002) | |||
| Net Overriding Royalty Interest (Asset) | $34,891,544 (as of Sept 30, 2002) | |||
| Distributions Payable | $4,852,954 (as of Sept 30, 2002) |
Material Changes vs. Prior Period
- Revenue Decline: Distributable income for the nine months ended September 30, 2002, dropped significantly to $24.8 million from $77.2 million in the same period in 2001. The quarterly decline was from $13.7 million to $12.3 million.
- Commodity Prices: Average gas prices fell from $3.06/Mcf in Q3 2001 to $2.28/Mcf in Q3 2002. Oil prices dropped from $23.72/Bbl to $21.95/Bbl.
- Loss of Val Verde Credit: Effective July 1, 2002, the Trust lost the "Val Verde Credit" (estimated at $1.88 million for the prior 12 months) following the sale of the Val Verde facility by BROG. This increased costs allocated to the Trust.
- Capital Expenditures: Capital expenditures deducted in Q3 2002 were approximately $2.1 million, significantly lower than the $8.1 million deducted in Q3 2001. However, for the nine-month period, expenditures were $16.8 million (2002) vs. $21.5 million (2001).
- Settlement Deductions: Net profits were reduced by approximately $3.6 million due to settlements between BROG and third parties, deducted from distributions in May through August 2002.
Outlook, Risks, and Management Commentary
- Production Trends: Natural gas production averaged 130 MMcf per day in Q3 2002, an increase from 120.6 MMcf per day in Q3 2001, driven by infill drilling and new well completions.
- Development Plans: BROG anticipates drilling 43 new wells in 2002 (36 conventional, 7 coal seam). The New Mexico Oil Conservation Division approved 80-acre infill drilling for the Dakota formation and reduced spacing for the Fruitland Coal formation.
- Legal and Regulatory Risks:
- Qui Tam Litigation: The Trust is exposed to potential losses from consolidated litigation (In re Natural Gas Royalties Qui Tam Litigation) alleging underpayment of royalties to the U.S. government. No estimate of potential loss is available.
- MMS Proceedings: Several administrative appeals regarding royalty valuation (Blanco Pool, Affiliate Proceeds, Coalbed Methane) are stayed pending resolution of the qui tam litigation.
- Sarbanes-Oxley Act: As a pass-through trust without a board of directors, the Trust may face difficulties complying with certain corporate governance rules, potentially requiring indenture amendments.
- Gas Imbalance: A partial settlement regarding gas imbalance was reached in 2000; remaining imbalances are being corrected via volume adjustments.
Investor Verification Checklist
- Verify the impact of the lost "Val Verde Credit" on future royalty calculations and cost allocations.
- Monitor the status of the In re Natural Gas Royalties Qui Tam Litigation and potential allocation of settlement costs to the Trust.
- Review the Trust's ability to comply with Sarbanes-Oxley Act requirements given its structure as a grantor trust.
- Confirm the accuracy of the $3.6 million deduction related to third-party settlements and its effect on net profits.
- Assess the sustainability of production volumes given the reliance on infill drilling and the natural decline of existing wells.