MTR

Business Context and Reporting Period

Mesa Royalty Trust (MTR) is a Texas grantor trust created in 1979, holding a 90% overriding royalty interest in net proceeds from specified oil and gas properties in the Hugoton field (Kansas) and the San Juan Basin (New Mexico and Colorado). The Trust has no employees; administrative functions are performed by The Bank of New York Mellon Trust Company, N.A. The reporting period covers the fiscal year ended December 31, 2012.

Key Financial Metrics

Reserves (Proved, Dec 31, 2012): 4,014,127 Mcf of natural gas and 297,927 Bbls of oil/condensate/NGLs. The standardized measure of future net royalty income discounted at 10% was $11.7 million.

Material Changes vs. Prior Period

• Revenue Decline: Royalty income decreased approximately 43% from 2011 to 2012, primarily driven by lower natural gas and natural gas liquids prices.
• Price Volatility: Average sales prices for natural gas dropped significantly:
  • Hugoton: $3.03/Mcf (2012) vs. $4.28/Mcf (2011).
  • San Juan Basin (NM): $2.02/Mcf (2012) vs. $2.99/Mcf (2011).
  • San Juan Basin (CO): $1.74/Mcf (2012) vs. $2.78/Mcf (2011).
• Production Volumes: Net production volumes attributable to the Royalty decreased across all regions due to natural decline and lower prices affecting economic production thresholds.
• Expenses: General and administrative expenses increased to $260,203 in 2012 from $153,753 in 2011, largely due to joint venture auditor costs incurred during the Trustee's review of working interest owner calculations.
• Capital Expenditures: Hugoton capital expenditures dropped 94% due to reduced drilling activity, while San Juan Basin (NM) capital expenditures increased 72% due to increased drilling activity.

Outlook, Risks, and Contingencies

• Market Risk: Distributions are highly dependent on natural gas prices, which are volatile and subject to global economic conditions, weather, and supply/demand dynamics. The Trust does not hedge against these price fluctuations.
• Reserve Uncertainty: Reserve estimates are based on assumptions regarding future prices and costs. Actual production and revenues may differ materially from estimates.
• Operator Control: The Trustee and unitholders have no control over the operation or development of the underlying properties. Working interest owners (Pioneer, ConocoPhillips, BP) may abandon wells or cease development if not economically viable.
• Contingent Liabilities: A $1.0 million cash reserve was established in 2011 for unknown contingent liabilities. No additional withholding occurred in 2012 as the target was met.
• Legal/Tax Matters: A tax assessment dispute with the Kansas Department of Revenue regarding Pioneer Natural Resources was settled in December 2011 for $2 million. The Trust's portion ($84,719) was withheld from distributions in January 2012. No other material pending litigation was identified.
• Termination Trigger: The Trust will terminate if royalty income falls below $250,000 for two successive years. Current income levels are well above this threshold.

Investor Verification Checklist

• Verify current natural gas spot prices and their correlation to the Trust's historical distribution patterns.
• Review the latest reserve reports from DeGolyer and MacNaughton to assess the impact of price changes on proved reserves.
• Monitor the status of the working interest owners' (Pioneer, ConocoPhillips, BP) development plans and capital expenditure budgets for the Hugoton and San Juan Basin fields.
• Confirm the status of any ongoing audits or reconciliations of royalty calculations between the Trustee and working interest owners.
• Assess the impact of potential regulatory changes regarding hydraulic fracturing and greenhouse gas emissions on production costs and volumes.