Business Context and Reporting Period
Company: San Juan Basin Royalty Trust (the "Trust")
Reporting Period: Quarter and nine months ended September 30, 2008
Trustee: Compass Bank
Underlying Asset: 75% net overriding royalty interest in oil and gas properties in the San Juan Basin, New Mexico, operated by Burlington Resources Oil & Gas Company LP ("BROG").
Units Outstanding: 46,608,796 (as of November 10, 2008)
Key Financial Metrics
| Metric | Three Months Ended Sep 30, 2008 | Nine Months Ended Sep 30, 2008 |
|---|---|---|
| Royalty Income | $52,541,763 | $113,730,327 |
| Total Revenue | $52,574,271 | $113,946,948 |
| Distributable Income | $52,223,050 | $112,392,874 |
| Distributable Income per Unit | $1.120455 | $2.411409 |
| Cash and Short-Term Investments | $21,133,743 | $21,133,743 |
| Net Overriding Royalty Interest (Asset) | $18,432,462 | $18,432,462 |
| Distributions Payable | $20,977,954 | $20,977,954 |
Note: The Trust has no debt. Expenses are recorded when paid. Amortization is charged directly to the Trust corpus, not as an expense.
Material Changes vs. Prior Period
- Revenue Growth: Royalty income increased 41.7% for the quarter and 30.2% for the nine-month period compared to 2007. This was driven primarily by significantly higher commodity prices.
- Commodity Prices: Average gas price rose from $6.55/Mcf (Q3 2007) to $10.62/Mcf (Q3 2008). Average oil price rose from $64.16/Bbl to $120.99/Bbl.
- Production Volumes: Despite price increases, gas and oil sales volumes decreased due to natural production decline curves and unplanned facility downtime.
- Interest Income: Decreased significantly due to lower interest rates and the absence of large audit settlement interest payments received in 2007.
- Expenses: General and administrative expenses increased due to timing differences and higher legal fees related to ongoing litigation with BROG.
Outlook, Risks, and Contingencies
Management Commentary and Capital Expenditures
BROG estimates 2008 capital expenditures for the Underlying Properties could range from $15 million to $50 million, with a budget of $24.4 million. Approximately 35% is allocated to Fruitland Coal formation projects. Lease operating expenses increased due to higher contract service costs and a rise in the overhead rate to 7.7%.
Legal Proceedings and Contingencies
- Arbitration Award Litigation: The Trust is suing BROG to recover approximately $5.025 million (plus interest and punitive damages) related to an arbitration award from 2005. An appellate court previously vacated the award regarding one of five issues. A hearing on summary judgment motions is set for November 10, 2008.
- Government Settlement: In March 2008, the Trust's distribution was reduced by $4.92 million to cover its portion of a $105.3 million settlement BROG paid to the U.S. government regarding underpaid royalties on Native American leases (1988–2005). The Trust is auditing this allocation.
- Major Portion Calculation: An ongoing dispute regarding royalty valuation methods (major portion analysis) on Native American leases remains unresolved. A judgment could require BROG to pay additional royalties, potentially reducing Trust income.
Market Risks
The Trust is exposed to volatility in oil and gas prices. It holds no derivative instruments and has no foreign currency exposure. The Trust relies entirely on BROG for production data and marketing.
Investor Verification Checklist
- Commodity Price Sensitivity: Verify current natural gas and oil prices against the Trust's historical performance, as income is highly correlated with spot prices.
- Production Decline: Confirm the rate of natural production decline in the San Juan Basin to assess long-term revenue sustainability absent new drilling.
- Legal Resolution: Monitor the status of the $5 million arbitration lawsuit against BROG and the outcome of the summary judgment hearing.
- Settlement Audit: Review the Trust's final audit of the $4.92 million deduction taken for the U.S. government settlement to ensure the allocation was accurate.
- Capital Expenditure Impact: Track BROG's actual capital spending against the $15M–$50M range, as higher spending reduces net proceeds available to the Trust.