10-Q: San Juan Basin Royalty Trust Reports Lower Distributable Income Due to Increased Capital Expenditures and Lower Natural Gas Prices

The San Juan Basin Royalty Trust reported a significant decrease in distributable income for the quarter ended September 30, 2024, primarily due to increased capital expenditures and lower natural gas prices.

Summary

• The San Juan Basin Royalty Trust's distributable income decreased significantly for the three and nine months ended September 30, 2024.
• This decrease is primarily attributed to a substantial increase in capital expenditures by Hilcorp, the operator of the underlying properties, and a decline in natural gas prices.
• For the three months ended September 30, 2024, there was no distributable income, compared to $3.9 million in the same period of 2023.
• Distributable income for the nine months ended September 30, 2024, was $5.2 million, a significant drop from $48.0 million in the same period of 2023.
• The average natural gas price decreased from $2.04 per Mcf to $1.49 per Mcf for the three-month period and from $5.42 per Mcf to $2.20 per Mcf for the nine-month period.
• Production of natural gas also decreased slightly, from 5,989,625 Mcf to 5,691,025 Mcf for the three-month period and from 17,466,457 Mcf to 16,743,796 Mcf for the nine-month period.
• Hilcorp's capital expenditures increased by approximately $10.5 million for the three-month period and $12.1 million for the nine-month period.
• Production costs exceeded gross proceeds by $10.3 million for the three months and $11.5 million for the nine months ended September 30, 2024.
• The Trust did not declare a monthly cash distribution for October 2024 due to lower natural gas prices and increased production costs.

Sentiment

Score: 3

Explanation: The document indicates a significant downturn in financial performance due to lower natural gas prices and increased capital expenditures, leading to no distributable income for the quarter and a missed distribution for October. This suggests a negative outlook for the near term.

Positives

• The Trust's internal controls and procedures are deemed effective.
• The Trust has engaged third-party auditors and counsel to ensure compliance with agreements.
• The Trustee is actively engaging with Hilcorp regarding accounting and reporting.

Negatives

• There was no distributable income for the three months ended September 30, 2024.
• Distributable income decreased by approximately 89% for the nine months ended September 30, 2024, compared to the same period in 2023.
• Natural gas prices and production volumes decreased.
• Hilcorp's capital expenditures increased significantly.
• Production costs exceeded gross proceeds, resulting in a cumulative balance of excess production costs of $11.5 million.
• The Trust did not declare a monthly cash distribution for October 2024.

Risks

• The Trust's income is heavily dependent on natural gas prices, which are subject to market fluctuations.
• The Trust's income is dependent on Hilcorp's operations and capital expenditure decisions.
• The Subject Interests are depleting assets, and the Trust cannot acquire new assets.
• Excess production costs must be recovered from future net proceeds before royalty income is paid to the Trust.
• The Trust's ability to distribute income is dependent on the accuracy and timeliness of information provided by Hilcorp.
• The Trust may need to draw upon cash reserves or borrow funds to cover operating expenses if royalty income is insufficient.

Future Outlook

The Trust expects that future royalty income will be impacted by Hilcorp's capital expenditure plans and fluctuations in natural gas prices. The Trust may need to draw upon cash reserves or borrow funds to cover operating expenses if royalty income is insufficient. The Trust plans to replenish cash reserves to $2,000,000.

Management Comments

• The Trustee is actively engaging with Hilcorp regarding its ongoing accounting and reporting to the Trust.
• The Trustee is working with third-party compliance auditors to audit payments made by Hilcorp to the Trust.
• The Trustee is consulting with outside counsel to review the rights of the Trust and evaluate potential legal remedies.

Industry Context

The results reflect the volatility in the natural gas market, with lower prices impacting the Trust's revenue. Increased capital expenditures by operators are common in the oil and gas industry, but can negatively impact royalty trusts in the short term. The transition to a new accounting system by Hilcorp has also created some challenges in reporting and reconciliation.

Comparison to Industry Standards

• The San Juan Basin Royalty Trust's performance is significantly below its previous year's results, reflecting the impact of lower natural gas prices and increased capital expenditures, which is a common challenge for royalty trusts tied to commodity prices.
• Compared to other royalty trusts, the impact of increased capital expenditures is particularly pronounced, as these costs are directly deducted from gross proceeds before royalty payments are made.
• Many royalty trusts are facing similar challenges with fluctuating commodity prices, but the magnitude of the decrease in distributable income for the San Juan Basin Royalty Trust is notable.
• Companies like Permian Basin Royalty Trust (PBT) and Texas Pacific Land Corporation (TPL) also experience fluctuations in their royalty income based on commodity prices and operator activity, but the specific impact varies based on their unique asset portfolios and operating agreements.
• The lack of a distribution for October 2024 is a significant event, indicating the severity of the current financial challenges, which is not typical for royalty trusts unless there are significant operational or market disruptions.

Management Changes

Stakeholder Impact

• Shareholders will experience reduced or no distributions due to lower royalty income.
• The Trust's financial performance may impact investor confidence and the unit price.
• The Trust's reliance on Hilcorp's operations and capital expenditure decisions creates uncertainty for stakeholders.

Next Steps

• The Trustee plans to replenish the cash reserves to $2,000,000.
• The Trustee will continue to engage with Hilcorp regarding accounting and reporting.
• The Trust's third-party compliance auditors will continue to audit payments made by Hilcorp to the Trust.

Key Dates

Keywords

Royalty Trust, Natural Gas, Oil, Production, Capital Expenditures, Distributable Income, Hilcorp, San Juan Basin, Trustee, Net Overriding Royalty