Business Context and Reporting Period
Company: San Juan Basin Royalty Trust (the "Trust")
Reporting Period: Quarter and nine months ended September 30, 2011
Trustee: Compass Bank
Operator: Burlington Resources Oil & Gas Company LP ("BROG"), a subsidiary of ConocoPhillips.
Business Model: The Trust holds a 75% net overriding royalty interest in oil and gas properties in the San Juan Basin, New Mexico. It is a passive entity that distributes net proceeds from production to Unit Holders. The Trust has no employees or operating activities; all functions are performed by the Trustee or the operator.
Key Financial Metrics
| Metric | Three Months Ended Sep 30, 2011 | Nine Months Ended Sep 30, 2011 |
|---|---|---|
| Royalty Income | $17,886,286 | $48,843,626 |
| Total Revenue | $17,887,615 | $49,529,481 |
| Distributable Income | $17,660,076 | $48,253,440 |
| Distributable Income per Unit | $0.378900 | $1.035285 |
| Cash and Short-term Investments | $6,374,847 | $6,374,847 (as of Sep 30, 2011) |
| Net Overriding Royalty Interest (Asset) | $13,582,828 | $13,582,828 (as of Sep 30, 2011) |
| Distributions Payable | $6,219,058 | $6,219,058 (as of Sep 30, 2011) |
| Units Outstanding | 46,608,796 | 46,608,796 |
Production Data (Three Months Ended Sep 30, 2011):
- Gas Sales: 8,565,498 Mcf (Average Price: $4.94/Mcf)
- Oil Sales: 14,701 Bbls (Average Price: $84.89/Bbl)
Material Changes vs. Prior Period
- Revenue Decline: Royalty income decreased by approximately 6% in the quarter and 23% in the nine-month period compared to the same periods in 2010.
- Quarterly: Down from $19.03 million (2010) to $17.89 million (2011).
- Nine-Month: Down from $63.49 million (2010) to $48.84 million (2011).
- Capital Costs: A primary driver of the decline was significantly higher capital expenditures deducted by BROG. Capital costs were approximately $6.5 million in Q3 2011 compared to $3.1 million in Q3 2010. For the nine months, costs were $15.8 million (2011) vs. $8.7 million (2010).
- Commodity Prices:
- Quarterly: Average gas price increased to $4.94/Mcf from $4.72/Mcf. Average oil price increased to $84.89/Bbl from $63.48/Bbl.
- Nine-Month: Average gas price decreased to $4.72/Mcf from $5.00/Mcf. Average oil price increased to $83.12/Bbl from $67.31/Bbl.
- Operating Expenses: Lease operating expenses increased in Q3 2011 ($9.09 million) compared to Q3 2010 ($8.40 million), partly due to timing of expense recognition. Property tax accruals were reduced starting April 2011.
Outlook, Risks, and Contingencies
- Capital Expenditure Outlook: BROG initially budgeted $13.6 million for 2011 but recently projected actual expenditures to range between $17 million and $20 million due to regulatory approvals and project mix. Higher capital spending will reduce distributable income.
- Corporate Separation: ConocoPhillips (parent of BROG) announced a separation of its refining and marketing business from its exploration and production business, expected to complete by the first half of 2012. The Trustee is monitoring the impact.
- Legal Proceedings:
- Jicarilla Apache Nation Litigation: A dispute regarding "major portion" royalty calculations remains outstanding. The U.S. Court of Appeals remanded the case to the Department of Interior in July 2010. A final judgment could impact royalty income, but no estimate of potential loss has been provided by BROG.
- Abraham v. BP America: The Trust is a member of the plaintiff class in a case where a jury awarded plaintiffs ~$9.74 million in damages for underpayment of royalties. The defendant has appealed. Any distribution to the Trust is uncertain and may not be material.
- Wright v. AGIP: A 2008 settlement reduced distributions by ~$4.9 million; consultants continue to analyze its application to the Trust.
- Contractual Obligations: BROG has secured new gas sales contracts with Chevron, PG&E, and Salt River Project effective April 1, 2011, extending through at least March 2013.
Investor Verification Checklist
- Capital Expenditure Impact: Verify the final 2011 capital expenditure figure from BROG, as the increase from $13.6M to a projected $17M-$20M range significantly reduces distributable income.
- Legal Exposure: Monitor the status of the Jicarilla Apache Nation "major portion" litigation, as a negative ruling could require reimbursement of past royalties.
- Production Volumes: Confirm if the slight decrease in nine-month gas production volumes (24.39M Mcf in 2011 vs. 24.60M Mcf in 2010) is a trend or seasonal.
- ConocoPhillips Separation: Assess the operational impact of the planned separation of ConocoPhillips' businesses on BROG's management of the Underlying Properties.
- Contract Renewals: Track the expiration of the Salt River Project contract (March 31, 2012) and the status of the new Enterprise Field Services gathering agreement.