Business Context and Reporting Period
Company: San Juan Basin Royalty Trust (the "Trust")
Reporting Period: Quarter and nine months ended September 30, 2014
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 does not operate the properties; Burlington Resources Oil & Gas Company LP ("Burlington") is the operator. The Trustee is Compass Bank.
Units Outstanding: 46,608,796 (as of November 10, 2014)
Key Financial Metrics
| Metric | Q3 2014 | Q3 2013 | 9M 2014 | 9M 2013 |
|---|---|---|---|---|
| Royalty Income | $16,076,429 | $13,743,934 | $48,726,954 | $23,653,832 |
| Total Revenue | $16,078,329 | $13,745,174 | $48,801,021 | $23,655,736 |
| Distributable Income | $15,692,706 | $13,456,291 | $47,494,809 | $22,389,268 |
| Distributable Income per Unit | $0.336690 | $0.288708 | $1.019009 | $0.480366 |
| Cash and Short-term Investments | $5,504,178 | N/A | $5,504,178 | N/A |
| Net Overriding Royalty Interest (Asset) | $9,737,465 | N/A | $9,737,465 | N/A |
| Distributions Payable | $5,317,936 | N/A | $5,317,936 | N/A |
Note: The Trust has no debt. Liquidity is derived from royalty income and short-term investments.
Material Changes vs. Prior Period
- Revenue Growth: Royalty income increased 17% in Q3 2014 and 106% in the nine-month period compared to 2013. This was driven primarily by higher average natural gas prices ($4.47/Mcf in Q3 2014 vs. $3.64/Mcf in Q3 2013) and reduced capital expenditures by the operator.
- Production Volumes: Gas sales volumes decreased slightly (85,639 Mcf/day in Q3 2014 vs. 95,880 Mcf/day in Q3 2013), but higher prices offset the volume decline.
- Expenses: General and administrative expenses increased due to legal costs associated with ongoing litigation against Burlington. Lease operating expenses decreased due to reduced contract maintenance and repair labor.
- Capital Expenditures: Burlington's capital expenditures attributable to the properties dropped significantly to approximately $1.2 million in Q3 2014 from $1.6 million in Q3 2013, and $4.4 million for the nine months of 2014 compared to $20.9 million in 2013.
Guidance, Outlook, Risks, and Contingencies
Outlook and Operations
Burlington suspended its drilling program in March 2013 but plans to commence drilling four new wells by the end of 2014. The estimated capital expenditure budget for 2014 was revised upward to approximately $9.5 million from an initial $4.8 million estimate. No conventional wells were completed in the first nine months of 2014.
Legal Proceedings and Contingencies
- 2014 Litigation: On July 31, 2014, the Trust filed a lawsuit against Burlington seeking monetary relief in excess of $12,000,000 for breach of contract and failure to properly account for royalties. Discovery is in early stages.
- Severance Tax Overpayment Claim: Burlington claims it overpaid the Trust approximately $3.25 million due to improper severance tax allocation between 2007 and 2012. Burlington is recouping this amount in installments of $361,215 through November 2014. The Trust is analyzing this claim.
- Historical Settlement Deduction: The Trust disputes a $4.9 million deduction made by Burlington in 2008 related to a third-party settlement (Wright case), arguing the claim predated a 1996 mutual release.
- Regulatory Risk (Jicarilla Apache Nation): Ongoing litigation regarding "major portion" gas valuation calculations could impact future royalty income. Burlington cannot currently estimate the potential loss range as the Department of Interior has not provided necessary calculations for the 1984-1988 period.
Accounting Basis
Financial statements are prepared on a basis differing from GAAP, customary for royalty trusts. Revenues are not accrued in the month of production; expenses are recorded when paid; and amortization is charged directly to the Trust corpus.
Investor Verification Checklist
- Legal Exposure: Verify the status of the $12M+ lawsuit against Burlington and the potential impact of the $3.25M severance tax recoupment on future distributions.
- Production Trends: Monitor the decline in gas production volumes (Mcf/day) and the operator's ability to maintain prices in a volatile market.
- Capital Spending: Confirm if the planned drilling of four new wells in late 2014 proceeds and how it affects the capital expenditure budget and future net proceeds.
- Regulatory Developments: Track the "major portion" valuation litigation involving the Jicarilla Apache Nation and the Department of Interior, as a settlement could retroactively reduce royalties.
- Contract Expirations: Note that key gas sales contracts with EDF and Shell expire March 31, 2015, and the Chevron contract extends through 2016; monitor renewal terms.