10-Q: San Juan Basin Royalty Trust Reports Sharp Decline in Q2 2024 Distributable Income Amid Lower Gas Prices and Higher Costs

The San Juan Basin Royalty Trust saw a significant drop in distributable income for the second quarter of 2024, primarily due to decreased natural gas prices and increased production costs.

Summary

• The San Juan Basin Royalty Trust reported a substantial decrease in distributable income for Q2 2024 compared to Q2 2023.
• Distributable income fell by approximately 87%, from $8.1 million in Q2 2023 to $1.1 million in Q2 2024.
• The decline is mainly attributed to a sharp decrease in natural gas prices and increased capital expenditures by Hilcorp, the primary operator of the Trust's properties.
• Average natural gas prices dropped from $3.69 per Mcf in Q2 2023 to $1.92 per Mcf in Q2 2024.
• Production costs also rose, with capital expenditures increasing by about $707,669 and lease operating expenses increasing by $0.6 million in the quarter.
• For the six months ended June 30, 2024, distributable income decreased by approximately 88% compared to the same period in 2023, from $44.1 million to $5.2 million.
• Hilcorp's 2024 capital expenditure plan estimates $34.0 million in spending, focusing on drilling projects and well recompletions.
• The Trust did not receive any Royalty Income in May, June, and July 2024, and interest income was insufficient to pay Trust liabilities.
• The Trust will draw upon the cash reserve amount or borrow funds against the Royalty to cover the Trusts operating expenses until its cash reserve can be replenished from subsequent Royalty Income payments from Hilcorp.

Sentiment

Score: 3

Explanation: The sentiment is low due to the significant decline in distributable income, lower natural gas prices, increased production costs, and the need to draw upon cash reserves. The overall tone reflects financial challenges and uncertainty.

Positives

• Hilcorp's 2024 capital expenditure plan includes $25.0 million for two drilling projects in the Mancos formation and $8.0 million for 36 well recompletions and workovers.
• The Trust maintains a system of internal disclosure controls and procedures that is designed to ensure that the information required to be disclosed in the Trusts filings under the Exchange Act is recorded, processed, summarized, and reported within the times specified in the SECs rules and forms.
• The Trustee has evaluated the Trusts internal disclosure controls and procedures as of June 30, 2024, and has concluded that such disclosure controls and procedures are effective, at the reasonable assurance level.

Negatives

• Royalty income significantly decreased due to lower natural gas prices and higher production costs.
• Distributable income saw a sharp decline of 87% in Q2 2024 compared to Q2 2023.
• Natural gas production volumes decreased for both the Subject Interests and the Royalty.
• Lease operating expenses and property taxes increased in Q2 2024 compared to the same period in 2023.
• The Trust did not receive any Royalty Income in May, June, and July 2024, and interest income was insufficient to pay Trust liabilities.

Risks

• The Trust's income is heavily dependent on natural gas prices, which are subject to market volatility.
• Future production volumes are uncertain due to the depleting nature of the Subject Interests.
• Hilcorp's capital expenditure plans and operational decisions significantly impact the Trust's financial performance.
• Weather conditions, particularly winter storms, can disrupt production and access to the fields.
• The Trust has limited control over the amount and timing of production costs incurred by Hilcorp.
• The Trust is reliant upon Hilcorp to accurately and timely report information regarding Hilcorp and its affiliates; the Subject Interests, including the operations, acreage, well and completion count, working interests, production volumes, sales revenues, capital expenditures, operating expenses, reserves, drilling plans, drilling results and leasehold terms related to the Subject Interests, and factors and circumstances that have or may affect the foregoing.

Future Outlook

The Trust's future performance will likely continue to be impacted by natural gas price fluctuations and Hilcorp's operational decisions. The Trust expects to draw upon cash reserves or borrow funds to cover operating expenses until royalty income replenishes the reserves, given the increased expenditures anticipated in Hilcorp's 2024 Plan.

Management Comments

• 'The Trust did not receive any Royalty Income, and interest income received was insufficient to pay Trust liabilities.'
• 'In the event the Trust does not receive Royalty Income from Hilcorp and interest income sufficient to pay its liabilities in future months, which is expected to occur given the significantly increased expenditures anticipated in Hilcorp's 2024 Plan, the Trust will draw upon the cash reserve amount or borrow funds against the Royalty to cover the Trusts operating expenses until its cash reserve can be replenished from subsequent Royalty Income payments from Hilcorp.'

Industry Context

The announcement reflects broader trends in the natural gas industry, where prices have been volatile, impacting the profitability of royalty trusts. The increase in capital expenditures by operators like Hilcorp is a common strategy to maintain or enhance production levels in a fluctuating price environment.

Comparison to Industry Standards

• The San Juan Basin Royalty Trust's performance is consistent with other royalty trusts that are heavily reliant on natural gas revenues, such as the Permian Basin Royalty Trust (PBT) and the Mesa Royalty Trust (MTR).
• PBT also reported decreased distributions in recent quarters due to lower commodity prices and increased operating costs.
• MTR similarly experienced a decline in distributable income, reflecting the challenges faced by natural gas-focused royalty trusts in the current market environment.
• Compared to diversified energy companies like ExxonMobil (XOM) or Chevron (CVX), which have integrated operations and can mitigate commodity price risks through downstream activities, royalty trusts like SJT are more directly exposed to commodity price fluctuations.
• XOM and CVX have reported relatively stable earnings despite commodity price volatility, benefiting from their diversified business models.

Management Changes

Corporate Governance

Stakeholder Impact

• Shareholders: Negatively impacted by the decrease in distributable income and the lack of a monthly cash distribution for July 2024.
• Creditors: The Trust may need to borrow funds to cover operating expenses, potentially increasing financial risk.
• Suppliers: Hilcorp's increased capital expenditures could positively impact suppliers involved in drilling and well recompletion projects.

Next Steps

• The Trust will continue to monitor natural gas prices and production costs.
• The Trust plans to replenish the cash reserves and increase them to $2.0 million before making any distributions to Unitholders.
• The Trustee will continue to engage with Hilcorp regarding its accounting and reporting to the Trust.
• The Trust's third-party compliance auditors will continue to audit payments made by Hilcorp to the Trust.

Key Dates

Keywords

San Juan Basin Royalty Trust, SJT, Royalty Income, Natural Gas Prices, Production Costs, Capital Expenditures, Hilcorp, Distributable Income, Unit Holders, Subject Interests, Net Overriding Royalty Interest, Oil Production, Gas Production, Mancos Formation, Mesaverde Formation, Fruitland Coal Formation, Argent Trust Company, Trustee