Business Context and Reporting Period
Company: San Juan Basin Royalty Trust (the "Trust")
Reporting Period: Quarter and nine months ended September 30, 2012
Structure: The Trust is a passive entity holding a 75% net overriding royalty interest in oil and gas properties in the San Juan Basin, New Mexico. It does not operate the properties; Burlington Resources Oil & Gas Company LP ("BROG") is the operator. The Trust distributes all distributable income to Unit Holders.
Units Outstanding: 46,608,796 (as of November 9, 2012)
Key Financial Metrics
| Metric | Q3 2012 | Q3 2011 | 9M 2012 | 9M 2011 |
|---|---|---|---|---|
| Royalty Income | $4,926,020 | $17,886,286 | $30,359,217 | $48,843,626 |
| Total Revenue | $4,937,970 | $17,887,615 | $30,928,903 | $49,529,481 |
| Distributable Income | $4,617,291 | $17,660,076 | $29,620,716 | $48,253,440 |
| Distributable Income per Unit | $0.099066 | $0.378900 | $0.635520 | $1.035285 |
| Cash and Short-term Investments | $658,629 | $7,101,319 (Dec 31, 2011) | N/A | N/A |
| Net Overriding Royalty Interest (Net) | $12,277,518 | $13,145,058 (Dec 31, 2011) | N/A | N/A |
| Debt | None | None | None | None |
Production Data (Q3 2012 vs Q3 2011):
- Gas Sales: 8,503,327 Mcf (Avg Price: $2.44/Mcf) vs 8,565,498 Mcf (Avg Price: $4.94/Mcf)
- Oil Sales: 14,290 Bbls (Avg Price: $76.52/Bbl) vs 14,701 Bbls (Avg Price: $84.89/Bbl)
Material Changes vs. Prior Period
- Revenue Decline: Royalty income decreased by approximately 72% in Q3 2012 compared to Q3 2011. This was primarily driven by a significant drop in average natural gas prices (from $4.94 to $2.44 per Mcf) and a reduction in oil prices.
- Calculation Error Correction: BROG identified a "2012 Calculation Error" where lease operating expenses and capital expenditures were understated by approximately 25% for April through July 2012. This resulted in an overpayment of royalty income to the Trust of approximately $3.39 million. BROG is recovering this overpayment by offsetting it against future royalty distributions, reducing payments in August, September, October, and November 2012.
- Capital Expenditures: Capital costs deducted by BROG in Q3 2012 were approximately $4.1 million, compared to $6.5 million in Q3 2011. However, actual drilling costs were higher in 2011; the reported difference is partly due to the timing of the calculation error correction.
- Administrative Expenses: Increased slightly in Q3 2012 ($320,679) compared to Q3 2011 ($227,539) due to timing differences in payments.
Outlook, Risks, and Contingencies
- Guidance: The filing does not provide specific forward-looking guidance on future distributions or production volumes. BROG's 2012 capital budget is estimated at $20.8 million, with a range of $5 million to $35 million depending on regulatory approvals and gas prices.
- Litigation Risks:
- Jicarilla Apache Nation Case: A dispute regarding "major portion" royalty calculations remains outstanding. The U.S. Court of Appeals remanded the matter to the Department of the Interior (DOI) in 2011. BROG cannot currently estimate a loss range as the DOI has not provided the required calculations for the 1984-1988 period. A settlement or judgment could impact royalty income.
- Abraham et al. v. BP America: The Trust is a member of the plaintiff class in a case regarding royalty underpayments. A 2011 verdict was reversed by the Tenth Circuit in July 2012, and the case was remanded for a new trial. The materiality of any future distribution to the Trust is uncertain.
- Market Risk: The Trust's income is heavily dependent on natural gas prices. The Trust has no debt and does not use derivatives, but it is exposed to commodity price volatility.
- Operational Risk: The Trust relies entirely on BROG for information and calculations. The recent calculation error highlights the risk of reliance on the operator's reporting accuracy.
Key Facts for Investor Verification
- Impact of Calculation Error: Verify the ongoing reduction in distributions through November 2012 due to the $3.39 million overpayment recovery.
- Gas Price Sensitivity: Confirm current natural gas prices in the San Juan Basin, as a significant portion of income is derived from gas sales at prices significantly lower than the prior year.
- Litigation Status: Monitor the status of the Jicarilla Apache Nation case and the DOI's progress on the "major portion" calculation, as a negative outcome could result in retroactive royalty reductions.
- Contract Expirations: Note that several gas sales contracts expire on March 31, 2013, which could impact future pricing and volume commitments.
- Production Trends: Review BROG's drilling activity and well completion rates, as production volumes have remained relatively flat while prices have declined.