10-K: San Juan Basin Royalty Trust Reports Decreased Distributable Income Amidst Lower Natural Gas Prices

The San Juan Basin Royalty Trust's annual report reveals a significant decrease in distributable income due to lower natural gas prices and increased capital expenditures.

Summary

• The San Juan Basin Royalty Trust's primary asset is a 75% net overriding royalty interest in oil and gas properties in the San Juan Basin.
• The Trust's distributable income decreased by 33.5% to $51.6 million in 2023, compared to $77.6 million in 2022, primarily due to lower natural gas prices.
• Royalty income decreased from $79.0 million in 2022 to $53.2 million in 2023.
• The average natural gas price decreased from $5.54 per Mcf in 2022 to $4.69 per Mcf in 2023.
• The average oil price decreased from $86.73 per Bbl in 2022 to $66.34 per Bbl in 2023.
• Hilcorp's capital expenditures for the Subject Interests increased to $2.2 million in 2023 from $1.0 million in 2022.
• The Trust's proved natural gas reserves were estimated at 66,622 MMcf and crude oil and condensate reserves at 186 MBbls as of December 31, 2023.
• Hilcorp plans to spend $34.0 million in capital expenditures in 2024, including two drilling projects in the Mancos formation and 36 well recompletions and workovers.
• The Trust anticipates increasing its cash reserves to $2.0 million in 2024 due to the projected increase in capital expenditures by Hilcorp.

Sentiment

Score: 4

Explanation: The document presents a negative outlook due to decreased distributable income and reliance on a single operator. While there are no immediate solvency concerns, the dependence on volatile commodity prices and the depleting nature of the assets create a cautious sentiment.

Positives

• The Trust has established cash reserves of $1.0 million as of December 31, 2023.
• The Trust has a formal protocol with Hilcorp for compliance audits.
• The Trust has a third-party independent reserve engineer, Cawley, Gillespie & Associates, Inc., to provide reserve estimates.
• The Trust has a cyber risk management program in place.

Negatives

• The Trust's distributable income decreased significantly due to lower natural gas prices.
• The Trust is dependent on Hilcorp for operational and financial information.
• The Trust has limited control over Hilcorp's operations and capital expenditures.
• The Trust's assets are depleting, and future income is dependent on Hilcorp's development activities.
• The Trust is subject to risks related to oil and gas price volatility, operating risks, and regulatory changes.
• The Trust's units may be delisted from the NYSE if the price falls below $1.00.

Risks

• Fluctuations in oil and gas prices can significantly impact the Trust's income.
• The Trust's reserve estimates are subject to uncertainties and may not be accurate.
• Operating risks, such as blowouts and environmental incidents, can affect the Trust's distributions.
• A bankruptcy of Hilcorp or any third-party operator could adversely affect the Trust.
• The Trust's assets are depleting, and the rate of depletion may be higher than expected.
• Increased production and development costs can reduce the Trust's distributions.
• War, military invasions, terrorism, and geopolitical hostilities could adversely affect the Trust.
• The Trust can be terminated if its gross revenue falls below $1.0 million for two consecutive years or if 75% of unit holders vote to terminate.
• Unit holders have limited voting rights.
• The Trust's units may be delisted from the NYSE if the price falls below $1.00.
• The Trust is subject to extensive governmental regulation, including environmental regulations.
• Cybersecurity threats could have a material adverse effect on the Trust.
• Unit holders are required to pay U.S. federal income taxes on their share of the Trust's income, even if they do not receive cash distributions.
• A portion of any gain recognized on the disposition of the Trust Units could be taxed as ordinary income.
• The IRS may challenge the Trust's method of allocating income and deductions between transferors and transferees of the Trust Units.
• If the IRS determines the Trust is not a grantor trust, the Trust could be subject to more complex and costly tax reporting requirements.

Future Outlook

Hilcorp plans to spend $34.0 million in capital expenditures in 2024, including two drilling projects in the Mancos formation and 36 well recompletions and workovers. The Trust anticipates increasing its cash reserves to $2.0 million in 2024 due to the projected increase in capital expenditures by Hilcorp. The Trust's future income is dependent on natural gas and oil prices, production volumes, and Hilcorp's development activities.

Management Comments

• Hilcorp has informed the Trust that, for wells operated by Hilcorp, it generally did not intend to accrue lease operating expenses to the Trust.
• Hilcorp has informed the Trust that its 2024 Plan will allocate approximately $25.0 million of the 2024 Plans budget toward two drilling projects in the Mancos formation.
• Hilcorp has informed the Trust that its planned project status for 2024 is subject to revision if Hilcorp revises its assumptions underlying the 2024 Plan.

Industry Context

The San Juan Basin is a mature oil and gas producing region, and the Trust's performance is heavily influenced by natural gas prices and Hilcorp's operational decisions. The decrease in natural gas prices in 2023 has negatively impacted the Trust's income, reflecting broader trends in the energy market. The planned capital expenditures by Hilcorp in 2024 indicate a focus on maintaining and potentially increasing production in the region.

Comparison to Industry Standards

• The San Juan Basin Royalty Trust is a unique entity, structured as a grantor trust, which makes direct comparisons to traditional oil and gas companies difficult.
• Unlike typical E&P companies, the Trust does not directly operate wells or control capital expenditures, relying instead on Hilcorp's operations.
• The Trust's performance is directly tied to the net profits from the Subject Interests, making it more sensitive to price fluctuations and operating costs than companies with diversified assets.
• The Trust's reserve estimates are based on data provided by Hilcorp and evaluated by an independent engineer, which is a common practice for royalty trusts.
• The Trust's reliance on a single operator and a specific geographic region makes it more vulnerable to localized risks compared to companies with broader portfolios.
• The Trust's distribution model, which is based on monthly cash flows, differs from the quarterly or annual dividend payments of most public companies.

Management Changes

Corporate Governance

Legal Proceedings

• A lawsuit against the Trust was dismissed on March 27, 2024.

Stakeholder Impact

• Unit holders will receive lower distributions due to decreased royalty income.
• Unit holders are exposed to risks related to oil and gas price volatility and Hilcorp's operations.
• The Trust's employees (who are employees of the Trustee) are not directly impacted by the Trust's financial performance.
• Hilcorp's operations are critical to the Trust's performance, and any changes in Hilcorp's strategy or financial health will impact the Trust.

Next Steps

• The Trust will continue to monitor Hilcorp's operations and capital expenditures.
• The Trust will increase its cash reserves to $2.0 million in 2024.
• The Trust will continue to engage with Hilcorp regarding its ongoing accounting and reporting.
• The Trust will continue to audit payments made by Hilcorp to the Trust.

Key Dates

Keywords

San Juan Basin Royalty Trust, natural gas, oil, royalty income, distributable income, Hilcorp, reserves, capital expenditures, production costs, unit holders