Business Context and Reporting Period
The San Juan Basin Royalty Trust (the "Trust") is a Texas express trust holding a 75% net overriding royalty interest in oil and natural gas properties (the "Subject Interests") located in the San Juan Basin of northwestern New Mexico. The Trust is managed by Compass Bank as Trustee. The Subject Interests are operated by Hilcorp San Juan L.P. ("Hilcorp"), which acquired the assets from Burlington Resources in July 2017. The Trust has no employees, officers, or directors and does not engage in business activities other than collecting royalty income and distributing it to Unit Holders. This report covers the fiscal year ended December 31, 2018.
Key Financial Metrics
| Metric | 2018 | 2017 |
|---|---|---|
| Royalty Income | $19,429,923 | $33,222,185 |
| Total Revenue (incl. interest) | $19,467,266 | $40,737,267 |
| Distributable Income | $17,975,968 | $39,130,256 |
| Distributable Income per Unit | $0.385678 | $0.839547 |
| General & Administrative Expenses | $1,491,298 | $1,607,011 |
| Cash and Short-Term Investments (Dec 31) | $2,125,838 | $4,415,851 |
| Trust Corpus (Dec 31) | $5,844,727 | $6,577,380 |
| Cash Reserves (Dec 31) | $1,000,000 | $1,000,000 |
Production and Pricing (2018 vs 2017):
- Natural Gas Production (Royalty): 10,406,632 Mcf (2018) vs 12,122,810 Mcf (2017).
- Oil Production (Royalty): 32,191 Bbls (2018) vs 25,128 Bbls (2017).
- Average Natural Gas Price: $1.89/Mcf (2018) vs $2.68/Mcf (2017).
- Average Oil Price: $52.23/Bbl (2018) vs $35.75/Bbl (2017).
Material Changes Versus Prior Period
Distributable Income decreased by approximately 54% ($21.1 million) in 2018 compared to 2017. The primary drivers for this decline were:
- Lower Natural Gas Prices: The average price for natural gas dropped significantly from $2.68/Mcf in 2017 to $1.89/Mcf in 2018.
- One-Time Settlement Proceeds: The 2017 results included $7.5 million in net settlement proceeds from litigation with Burlington Resources, which did not recur in 2018.
- Increased Capital Expenditures: Capital expenditures deducted from gross proceeds increased by 500% to $2.4 million in 2018 (from $0.4 million in 2017), primarily due to 15 well recompletions.
- Higher Operating Costs: Lease operating expenses and property taxes increased by 21% to $27.8 million, driven by increased activity in the San Juan Basin.
Guidance, Outlook, and Risks
2019 Capital Expenditure Budget: Hilcorp has budgeted approximately $2.6 million for 2019, including $0.7 million for five well recompletions and $1.9 million for one new horizontal well.
Outlook and Commentary: The Trust's income is heavily dependent on natural gas prices and production volumes. The Trustee notes that Hilcorp's reporting methodology for natural gas volumes differs from the prior owner (Burlington), which affects year-over-year comparisons. Hilcorp is currently reconciling historical data ("true-ups") from the transition period, which may result in adjustments to future distributions.
Risks and Contingencies:
- Commodity Price Risk: The Trust has no control over oil and gas prices, which directly impact distributable income.
- Operator Dependency: The Trust relies entirely on Hilcorp for operations, reporting, and capital expenditure decisions. Hilcorp may prioritize other assets over the Subject Interests.
- Reserve Depletion: The Subject Interests are depleting assets with no new wells drilled in 2017 or 2018. Proved reserves decreased to 75,844 MMcf of natural gas and 203 MBbls of oil as of December 31, 2018.
- Legal Matters: While the 2014 litigation with Burlington was settled, the "Jicarilla Matter" regarding royalty valuation on Native American leases remains unresolved, though the Trust believes it is protected by the settlement agreement.
Important Facts for Investors to Verify
- Reporting Methodology Changes: Verify the impact of Hilcorp's switch from wellhead volume reporting (Burlington) to plant residue gas plus NGL equivalents on production volume comparisons.
- True-Up Adjustments: Monitor future distributions for potential adjustments related to the reconciliation of 2017 and 2018 estimated revenues and severance taxes.
- Capital Expenditure Accuracy: Note that in 2018, Hilcorp reversed approximately $2.4 million in capital expenditures that were incorrectly charged to the Trust; verify that future capital charges are accurate.
- Reserve Estimates: Confirm that the decrease in proved reserves (from 97,764 MMcf in 2017 to 75,844 MMcf in 2018) is primarily due to lower commodity prices and higher operating costs rather than physical depletion alone.
- Termination Triggers: Review the Trust Indenture regarding termination conditions, specifically if gross revenue falls below $1 million for two successive years.