Mesa Royalty Trust: Q2 2012 10-Q Summary
Business Context and Reporting Period
This report covers the quarterly period ended June 30, 2012, for Mesa Royalty Trust, a passive entity holding an overriding royalty interest in oil and gas properties located in the Hugoton field (Kansas), San Juan Basin (New Mexico and Colorado), and Yellow Creek field (Wyoming). The Trust distributes cash to unitholders based on net proceeds from production. As of August 9, 2012, there were 1,863,590 units of beneficial interest outstanding.
Key Financial Metrics
| Metric | Q2 2012 | Q2 2011 | YTD 2012 | YTD 2011 |
|---|---|---|---|---|
| Royalty Income | $919,695 | $1,503,570 | $2,189,062 | $2,942,774 |
| Distributable Income | $881,051 | $1,460,069 | $2,082,195 | $2,853,408 |
| Distributable Income Per Unit | $0.4728 | $0.6493 | $1.1173 | $1.2628 |
| Cash and Short-Term Investments | $1,881,051 | (N/A) | $1,881,051 | $2,351,895 (Dec 31, 2011) |
| Net Overriding Royalty Interest (Book Value) | $4,821,564 | (N/A) | $4,821,564 | $5,086,698 (Dec 31, 2011) |
Note: The Trust has no debt. Liquidity is derived solely from royalty income and interest on cash reserves.
Material Changes vs. Prior Period
- Revenue Decline: Royalty income decreased approximately 39% in Q2 2012 compared to Q2 2011, and 26% on a year-to-date basis. This decline is primarily attributed to lower natural gas prices and reduced production volumes.
- Price Volatility: Average natural gas prices received dropped significantly. In Q2 2012, the average price was $2.13 per Mcf compared to $3.38 in Q2 2011. Oil and NGL prices also declined from $41.01 to $35.51 per barrel.
- Production Volumes: Net production volumes attributable to the royalty decreased across major fields. Hugoton natural gas production fell to 78,326 Mcf (Q2 2012) from 80,359 Mcf (Q2 2011). San Juan Basin (New Mexico) natural gas production dropped to 78,336 Mcf from 129,091 Mcf.
- Cost Structure: Capital expenditures in the Hugoton field decreased by 99.9% due to reduced drilling activity. Conversely, capital expenditures in the San Juan Basin (New Mexico) increased by 158% due to developmental drilling.
- Contingency Reserve: The Trustee completed the accumulation of a $1.0 million reserve for contingent liabilities in 2011. No additional withholdings were made in Q2 2012, unlike the $250,000 withheld in Q2 2011.
Outlook, Risks, and Contingencies
- Market Risk: Distributions are highly dependent on natural gas prices, which fluctuate based on global economic conditions, weather, and supply/demand dynamics. The Trust has no control over these factors.
- Legal and Tax Contingencies:
- Kansas Tax Assessment: A proposed tax assessment of ~$4.5 million was settled for $2.0 million in December 2011. The Trust's share of this settlement ($84,719) was withheld from distributions in January 2012.
- Severance Tax Refunds: The operator (PNR) filed for ~$3.0 million in severance tax refunds. Approximately $167,000 has been paid to the Trust, but future payments are not guaranteed.
- BP Accounting Error: Royalty income from BP (Colorado properties) was previously reduced due to an error in charging pre-main line production costs. Additional royalties will be recorded only when received.
- Operational Control: The Trustee relies entirely on working interest owners (Pioneer Natural Resources, ConocoPhillips, BP) for operational data and reserve estimates. The Trust has no authority over the operation or development of the properties.
Investor Verification Checklist
- Verify the current status of the Kansas severance tax refund filings and the likelihood of future payments beyond the $167,000 already received.
- Monitor natural gas price trends in the Hugoton and San Juan Basin regions, as these are the primary drivers of distributable income.
- Review the BP accounting error resolution to determine if additional royalty income will be received in future periods.
- Confirm the production decline rates in the Hugoton field, which is a mature asset with natural depletion.
- Check for any updates on the $1.0 million contingency reserve to ensure it remains sufficient for unknown liabilities.