Mesa Royalty Trust - 10-Q Summary (Period Ended June 30, 2010)
Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended June 30, 2010, for Mesa Royalty Trust, a passive entity created in 1979. The Trust holds a 90% overriding royalty interest (reduced to 11.44% of the original interest following a 1985 assignment) in specified oil and gas properties located in the Hugoton field (Kansas), San Juan Basin (New Mexico and Colorado), and Yellow Creek field (Wyoming). The Trust has no operating activities; its sole purpose is to distribute cash proceeds from the royalty interest to unitholders. As of August 6, 2010, there were 1,863,590 units of beneficial interest outstanding.
Key Financial Metrics
| Metric | Three Months Ended June 30, 2010 |
Six Months Ended June 30, 2010 |
|---|---|---|
| Royalty Income | $2,043,341 | $3,813,900 |
| Distributable Income | $1,984,740 | $3,714,979 |
| Distributable Income Per Unit | $1.0650 | $1.9934 |
| Cash and Short-Term Investments | $1,984,740 | $1,984,740 |
| Net Overriding Royalty Interest (Book Value) | $5,859,043 | $5,859,043 |
| General & Administrative Expenses | $(58,632) | $(99,041) |
Note: The Trust has no debt. Liquidity is derived solely from royalty receipts and interest on cash reserves.
Material Changes vs. Prior Period
- Revenue Growth: Royalty income for the three months ended June 30, 2010, increased by approximately 174% compared to the same period in 2009 ($2.04M vs. $0.75M). For the six-month period, income increased by approximately 103% ($3.81M vs. $1.88M).
- Price Drivers: The increase is primarily attributed to higher average sales prices for natural gas and natural gas liquids. For the quarter, average natural gas prices rose to $4.43/Mcf from $2.98/Mcf, and oil/condensate prices rose to $47.80/Bbl from $23.23/Bbl.
- Cost Reductions: Capital expenditures decreased significantly due to reduced drilling activity. Hugoton capital expenditures dropped 85% quarter-over-quarter, and San Juan Basin (New Mexico) capital expenditures dropped 54%.
- Production Volumes: While actual production volumes from the Hugoton field decreased due to natural decline, net production volumes attributable to the royalty increased in the San Juan Basin (New Mexico) due to better gathering run times.
Outlook, Risks, and Contingencies
Management Commentary: The Trustee notes that the Trust is a passive entity with no control over operations. Future distributions are highly dependent on commodity prices and production volumes managed by working interest owners (Pioneer Natural Resources, ConocoPhillips, and BP).
Legal and Tax Contingencies:
- Kansas Tax Assessment: Pioneer Natural Resources (PNR) received a final tax assessment from the Kansas Department of Revenue totaling approximately $4.5 million. The portion net to the Trust is approximately $197,000. PNR intends to challenge this assessment administratively. If successful, the Trust may avoid this charge; if not, it could adversely affect future distributions.
- Severance Tax Refunds: PNR has filed for approximately $3.0 million in severance tax refunds with Kansas. The estimated share due to the Trust is approximately $167,000, which has already been paid. There is no assurance the state will agree to the refund position.
- Excess Production Costs: Excess production costs for San Juan Basin-Colorado properties were approximately $0 as of June 30, 2010, down from $20,606 at year-end 2009. These costs must be recovered by operators before royalty income is distributed.
Risk Factors: The Trust faces significant market risk regarding natural gas price volatility. Additionally, the Trustee relies entirely on working interest owners for data regarding reserves, production, and litigation, creating a risk of delayed or inaccurate reporting.
Investor Verification Checklist
- Commodity Prices: Verify current natural gas and oil prices against the reported averages ($4.43/Mcf and $47.80/Bbl for Q2 2010) to assess sustainability of income growth.
- Tax Assessment Outcome: Monitor the status of the Kansas Department of Revenue tax assessment challenge by PNR, as a loss could reduce distributions by ~$197,000.
- Production Decline: Review long-term production decline rates for the Hugoton field, as actual production volumes decreased despite higher prices.
- Operator Reliance: Acknowledge the Trustee's lack of control over operational data and the potential for reporting delays dependent on third-party operators.