Business Context and Reporting Period
The San Juan Basin Royalty Trust (the "Trust") is a widely held fixed investment trust created under Texas law. It holds a 75% net overriding royalty interest in oil and gas properties located in the San Juan Basin of northwestern New Mexico. The Trust is a passive entity with no employees, officers, or directors; all administrative functions are performed by the Trustee, Compass Bank. The principal operator of the underlying properties is Burlington Resources Oil & Gas Company LP ("BROG"), a subsidiary of ConocoPhillips. The Trust's income is derived almost entirely from natural gas production.
Reporting Period: Fiscal year ended December 31, 2009.
Key Financial Metrics
| Metric | 2009 | 2008 | 2007 |
|---|---|---|---|
| Royalty Income | $31,888,681 | $144,588,156 | $113,803,339 |
| Distributable Income | $30,173,056 | $143,081,245 | $113,221,235 |
| Distributions per Unit | $0.647367 | $3.069833 | $2.429184 |
| Total Assets (Dec 31) | $22,185,213 | $25,377,265 | $28,923,416 |
| Trust Corpus (Dec 31) | $16,843,731 | $17,927,498 | $19,880,888 |
| Units Outstanding | 46,608,796 | 46,608,796 | 46,608,796 |
Production and Pricing (2009):
- Gas Production (Attributable to Royalty): 9,823,255 Mcf (Average Price: $3.48/Mcf).
- Oil Production (Attributable to Royalty): 15,961 Bbls (Average Price: $53.45/Bbl).
- Total Production Costs (Underlying Properties): $77,490,462 (Average: $2.21/Mcf).
- Capital Expenditures (Deducted): $33,596,883.
Material Changes vs. Prior Period
The Trust experienced a significant decline in financial performance in 2009 compared to 2008:
- Revenue Decline: Royalty Income decreased by approximately 78% (from $144.6 million in 2008 to $31.9 million in 2009). Distributable Income fell by 79%.
- Price Volatility: The average realized price for natural gas dropped from $8.28/Mcf in 2008 to $3.48/Mcf in 2009. Oil prices also declined from $99.32/Bbl to $53.45/Bbl.
- Production Volumes: While total gas production from the underlying properties remained relatively stable (35.1 million Mcf in 2009 vs. 34.5 million Mcf in 2008), the volume attributable to the royalty interest dropped significantly due to the allocation formula and cost structures.
- Reserve Reduction: Proved natural gas reserves decreased from 139.8 million Mcf in 2008 to 127.8 million Mcf in 2009, primarily due to lower average gas prices and regulatory changes in reserve reporting methodologies.
Outlook, Risks, and Contingencies
Guidance and Outlook: The Trustee does not provide forward-looking projections for future distributions due to the speculative nature of the oil and gas industry and the Trust's lack of control over operations. BROG estimates 2010 capital expenditures between $10 million and $45 million, with a budgeted estimate of $17.9 million for new projects plus $6.8 million for prior year carryovers.
Key Risks:
- Commodity Prices: Distributions are highly sensitive to natural gas prices, which are subject to global economic conditions, supply/demand dynamics, and weather.
- Depleting Assets: The underlying properties are depleting assets. Without significant development, production will decline.
- Regulatory Environment: New air quality rules and environmental regulations in New Mexico could increase compliance costs and reduce the number of drilling projects.
Legal Proceedings and Contingencies:
- Arbitration Litigation: The Trust is engaged in litigation against BROG regarding an arbitration award of approximately $5 million. A trial on the merits is scheduled for May 2011.
- Jicarilla Apache Nation Dispute: An ongoing dispute regarding royalty valuation methods ("major portion analysis") on Native American leases remains unresolved. A judgment or settlement could require BROG to seek reimbursement from the Trust for past periods, though no estimate of potential loss has been provided.
- Gathering Contracts: BROG is in an administrative proceeding with Enterprise Field Services (EFS) regarding gathering rates and services. Gas is currently gathered on a month-to-month basis.
Investor Verification Checklist
- Gas Price Sensitivity: Verify current natural gas prices in the San Juan Basin, as they are the primary driver of the Trust's cash flow.
- Capital Expenditure Execution: Monitor BROG's actual capital spending against the $10M-$45M range to assess future production maintenance.
- Legal Resolution: Track the status of the arbitration litigation against BROG and the Jicarilla Apache Nation dispute, as adverse outcomes could materially reduce future income.
- Contract Renewals: Confirm the status of gas sales contracts, noting that all gas is currently contracted through March 31, 2011.
- Reserve Estimates: Review the impact of the regulatory change in reserve reporting (from spot price to 12-month average price) on future reserve disclosures.