Business Context and Reporting Period
Company: MESA ROYALTY TRUST
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 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), the San Juan Basin (New Mexico and Colorado), and the Yellow Creek field (Wyoming). The Trust receives 90% of the Net Proceeds attributable to these properties, subject to a 1985 assignment that reduced the Trust's interest to 11.44% of the original royalty. The Trustee is The Bank of New York Mellon Trust Company, N.A.
Key Financial Metrics
| Metric | Three Months Ended June 30, 2011 |
Three Months Ended June 30, 2010 |
Six Months Ended June 30, 2011 |
Six Months Ended June 30, 2010 |
|---|---|---|---|---|
| Royalty Income | $1,503,570 | $2,043,341 | $2,942,774 | $3,813,900 |
| Distributable Income | $1,460,069 | $1,984,740 | $2,853,408 | $3,714,979 |
| Distributable Income Per Unit | $0.7835 | $1.0650 | $1.5311 | $1.9934 |
| Distributions Paid Per Unit | $0.6493 | $1.0650 | $1.2628 | $1.9934 |
| Cash and Short-Term Investments | $1,710,069 (as of June 30, 2011) | |||
| Net Overriding Royalty Interest | $5,367,600 (as of June 30, 2011) |
Note: Distributions paid per unit for the three months ended June 30, 2011, were reduced due to a cash withholding reserve established for future contingent liabilities.
Material Changes vs. Prior Period
- Revenue Decline: Royalty income decreased approximately 26% in Q2 2011 and 23% in the first six months of 2011 compared to the same periods in 2010. This decline was driven primarily by lower natural gas prices and reduced production volumes.
- Price Volatility: Average natural gas sales prices dropped significantly. In Q2 2011, the average price was $3.38 per Mcf compared to $4.43 in Q2 2010. For the six-month period, the average was $3.32 per Mcf versus $4.11 in 2010.
- Production Volumes: Net production volumes attributable to the royalty decreased across key fields. Hugoton natural gas production fell from 116,652 Mcf (Q2 2010) to 80,359 Mcf (Q2 2011). San Juan Basin (New Mexico) natural gas production declined from 145,372 Mcf to 129,091 Mcf in the same period.
- Cost Increases: Capital expenditures in the Hugoton field increased by approximately 2,143% in Q2 2011 due to increased drilling activity. Operating costs also rose in the Hugoton field by 44% in Q2 2011.
Guidance, Outlook, Risks, and Unusual Items
- Cash Withholding Reserve: Effective January 1, 2011, the Trustee began withholding $83,333 per month from distributions to build a reserve for future unknown contingent liabilities. The target reserve is $1.0 million. As of June 30, 2011, $500,000 had been withheld.
- Tax Assessment Contingency: 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 has appealed this assessment to the Court of Tax Appeals in Kansas. If the appeal fails, this amount could adversely affect future distributions.
- Market Risk: The Trust has no control over operations or commodity prices. Distributions are highly dependent on natural gas prices, which are subject to political conditions, weather, and supply/demand dynamics.
- Legal Proceedings: There are no pending legal proceedings where the Trust is a named party. 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. Current income levels are well above this threshold.
Investor Verification Checklist
- Commodity Prices: Verify current natural gas and NGL spot prices against the Trust's historical averages to project future royalty income.
- Tax Appeal Status: Monitor the outcome of PNR's appeal regarding the $4.5 million Kansas tax assessment, as a loss could reduce distributions by approximately $197,000.
- Production Decline: Review operator reports for the Hugoton and San Juan Basin fields to assess the rate of natural production decline versus capital expenditure efforts to offset it.
- Reserve Build-up: Confirm the timeline for the Trustee to reach the $1.0 million cash withholding reserve, which will impact the duration of reduced distributions.
- Operator Reliance: Acknowledge that the Trustee relies entirely on working interest owners for production data and reserve estimates, introducing a layer of operational risk outside the Trust's control.