Business Context and Reporting Period
Company: MESA ROYALTY TRUST
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2011
Units Outstanding: 1,863,590
The Trust is a passive entity holding a net 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 receives 90% of the Net Proceeds attributable to these properties (subject to a 1985 assignment reducing the effective interest to 11.44% of the original 90%). The Trustee is The Bank of New York Mellon Trust Company, N.A.
Key Financial Metrics
| Metric | Three Months Ended Sep 30, 2011 | Nine Months Ended Sep 30, 2011 |
|---|---|---|
| Royalty Income | $2,081,025 | $5,023,799 |
| Interest Income | $54 | $78 |
| General & Administrative Expense | $(28,841) | $(118,231) |
| Distributable Income | $2,052,238 | $4,905,646 |
| Reserve for Contingent Liabilities | $(250,000) | $(750,000) |
| Distributable Income Available for Distribution | $1,802,238 | $4,155,646 |
| Distribution Per Unit | $0.9671 | $2.2299 |
| Cash and Short-Term Investments | $2,552,238 | $2,552,238 |
| Net Overriding Royalty Interest (Net of Amortization) | $5,249,493 | $5,249,493 |
Material Changes vs. Prior Period
- Quarterly Performance (Q3 2011 vs. Q3 2010): Royalty income increased 43% to $2.08 million, driven by higher natural gas and natural gas liquids (NGL) prices and reduced capital expenditures. Distributable income per unit rose to $1.1012 (before reserves) from $0.7595.
- Year-to-Date Performance (9 Months 2011 vs. 9 Months 2010): Royalty income decreased 5% to $5.02 million. This decline was primarily due to lower natural gas prices and reduced production volumes in the first nine months of 2011, partially offset by lower operating costs in some areas.
- Production Volumes:
- Hugoton Field: Net natural gas production increased 23% QoQ (102,310 Mcf vs. 83,141 Mcf) but decreased 9% YTD compared to 2010.
- San Juan Basin (NM): Net natural gas production decreased 9% QoQ (133,482 Mcf vs. 146,856 Mcf) and 9% YTD.
- San Juan Basin (CO): Net natural gas production increased significantly QoQ (62,285 Mcf vs. 26,418 Mcf) and YTD.
- Costs: Hugoton capital expenditures dropped 97% QoQ due to decreased drilling activity. San Juan Basin (NM) operating costs increased 8% QoQ.
Guidance, Outlook, Risks, and Unusual Items
- Cash Withholding Reserve: Effective January 1, 2011, the Trustee began withholding $83,333 per month (up to $250,000 per quarter) to build a $1.0 million reserve for future unknown contingent liabilities. As of September 30, 2011, $750,000 has been withheld. This reduces the cash available for immediate distribution.
- Tax Assessment Contingency: Pioneer Natural Resources (PNR) is appealing a Kansas Department of Revenue tax assessment. The portion net to the Trust is approximately $197,000. If the appeal fails, this could adversely affect future distributions. Conversely, PNR has filed for a severance tax refund of approximately $3.0 million, with an estimated $167,000 share due to the Trust.
- Market Risk: The Trust has no control over operations or commodity prices. Distributions are highly dependent on natural gas prices, which are subject to volatility from weather, global economics, and supply/demand factors.
- Legal Proceedings: No pending litigation names the Trust directly. However, working interest owners (PNR, ConocoPhillips, BP) are subject to ordinary course litigation that could materially impact royalty income if settled adversely.
- Termination Trigger: The Trust will terminate if royalty income falls below $250,000 for two successive years or upon a unitholder vote.
Investor Verification Checklist
- Commodity Price Sensitivity: Verify current natural gas and NGL spot prices against the reported average sales prices ($3.66/Mcf for gas, $42.84/Bbl for liquids in Q3 2011) to assess future income potential.
- Production Decline Rates: Review the natural production decline trends in the Hugoton and San Juan Basin fields, as volumes are generally decreasing year-over-year.
- Tax Litigation Outcome: Monitor the status of the Kansas tax assessment appeal and the severance tax refund claim, as these represent material contingent liabilities and assets.
- Reserve Build-up: Confirm the timeline for the $1.0 million contingent liability reserve to be fully funded, which will impact quarterly distribution amounts until completion.
- Working Interest Owner Performance: Assess the operational strategies of PNR, ConocoPhillips, and BP, as the Trust relies entirely on their reporting and management of the underlying properties.