MTR

Mesa Royalty Trust (MTR) - Q3 2019 Filing Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended September 30, 2019. Mesa Royalty Trust is a passive entity created in 1979 that holds an overriding royalty interest equal to 11.44% of 90% of the Net Proceeds from specific oil and gas properties in Kansas (Hugoton), New Mexico (San Juan Basin), and Colorado (San Juan Basin). The Trust has no employees; administrative functions are performed by The Bank of New York Mellon Trust Company, N.A. The Trust relies entirely on Working Interest Owners (Riviera Resources, Hilcorp San Juan LP, BP, and Red Willow) for operations and financial data.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Royalty income for Q3 2019 decreased approximately 55% compared to Q3 2018. This was primarily driven by lower natural gas and natural gas liquids prices, decreased net production volumes, and increased operating costs and capital expenditures.
• Property-Specific Performance:
  • Hugoton (Kansas): Income dropped to $69,339 from $118,628 due to lower gas prices and volumes.
  • San Juan Basin (New Mexico): Income fell to $103,679 from $291,449. This significant drop is attributed to lower commodity prices, decreased production, and a transition from estimated payments to actual reconciled payments by the new operator, Hilcorp.
  • San Juan Basin (Colorado): Income decreased to $30,142 from $39,479, primarily due to lower natural gas prices.
• Expense Reduction: General and administrative expenses decreased year-over-year for the nine-month period, largely due to a timing difference where $70,460 in expenses were paid in January 2018 rather than December 2017.

Outlook, Risks, and Unusual Items

• Hilcorp Reconciliation Risk: A critical uncertainty involves the San Juan Basin-New Mexico properties. Following Hilcorp's acquisition of these assets, payments were based on estimates until March 2019. Actual payments began in April 2019. Hilcorp has identified significant incremental costs (approx. $1.1 million) from a 2018 well that will be recovered by withholding future Net Proceeds. This could materially reduce future distributions.
• Contingent Reserve: The Trust maintains a Contingent Reserve of $1,000,812 (included in cash) for unknown future liabilities. Adjustments to this reserve impact distributable income available for distribution.
• Interest Rate Environment: The Trustee was unable to secure an interest-bearing account yielding the required rate (1.5% below prime) due to market conditions. Consequently, the Trustee allocated a portion of its fees to meet the minimum interest obligation to the Trust.
• Termination Trigger: The Trust will terminate if royalty income falls below $250,000 for two successive years. Current income levels remain above this threshold, but the downward trend in commodity prices poses a long-term risk.

Investor Verification Checklist

• Verify Hilcorp Reconciliation Status: Confirm the progress of the reconciliation between estimated and actual Net Proceeds for the San Juan Basin-New Mexico properties and the specific impact of the $1.1 million cost recovery on future cash flows.
• Monitor Commodity Prices: Assess the sensitivity of the Trust's income to fluctuations in natural gas and natural gas liquids prices, which constitute the majority of revenue.
• Review Operator Financial Health: Evaluate the financial stability of the Working Interest Owners (Riviera, Hilcorp, BP, Red Willow), as the Trust has no control over their capital expenditures or operational decisions.
• Check Contingent Reserve Movements: Monitor future filings for any significant withdrawals from or additions to the $1.0 million Contingent Reserve.