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SJT > SEC Filings for SJT > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for SAN JUAN BASIN ROYALTY TRUST | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for SAN JUAN BASIN ROYALTY TRUST


9-Nov-2012

Quarterly Report


Item 2. Trustee's Discussion and Analysis of Financial Condition and Results of Operations.

Forward-Looking Information

Certain information included in this Quarterly Report on Form 10-Q contains, and other materials filed or to be filed by the Trust with the Securities and Exchange Commission (as well as information included in oral statements or other written statements made or to be made by the Trust) may contain or include, forward-looking statements. Such forward-looking statements may be or may concern, among other things, capital expenditures, drilling activity, development activities, production efforts and volumes, hydrocarbon prices, estimated future net revenues, estimates of reserves, the results of the Trust's activities, and regulatory matters. Such forward-looking statements generally are accompanied by words such as "may," "will," "estimate," "expect," "predict," "project," "anticipate," "goal," "should," "assume," "believe," "plan," "intend," or other words that convey the uncertainty of future events or outcomes. Such statements reflect the current view of Burlington Resources Oil & Gas Company LP ("BROG"), the working interest owner, with respect to future events; are based on an assessment of, and are subject to, a variety of factors deemed relevant by the Trustee and BROG; and involve risks and uncertainties. These risks and uncertainties include volatility of oil and gas prices, product supply and demand, competition, regulation or government action, litigation and uncertainties about estimates of reserves. Should one or more of these risks or uncertainties occur, actual results may vary materially and adversely from those anticipated.

Business Overview

The Trust is an express trust created under the laws of the state of Texas by the San Juan Basin Royalty Trust Indenture (the "Original Indenture") entered into on November 3, 1980 between Southland Royalty Company ("Southland Royalty") and The Fort Worth National Bank. Effective as of September 30, 2002, the Original Indenture was amended and restated (the Original Indenture, as amended and restated, the "First Restated Indenture") and, effective as of December 12, 2007 the First Restated Indenture was amended and restated (the First Restated Indenture, as amended and restated, the "Indenture"). The Trustee of the Trust is Compass Bank.

On October 23, 1980, the stockholders of Southland Royalty approved and authorized that company's conveyance of a 75% net overriding royalty interest (equivalent to a net profits interest) to the Trust for the benefit of the stockholders of Southland Royalty of record at the close of business on the date of the conveyance (the "Royalty") carved out of that company's oil and gas leasehold and royalty interests (the "Underlying Properties") in properties located in the San Juan Basin of northwestern New Mexico. Pursuant to the Net Overriding Royalty Conveyance (the "Conveyance") the Royalty was transferred to the Trust on November 3, 1980 effective as to production from and after November 1, 1980.

The Royalty constitutes the principal asset of the Trust. The beneficial interests in the Royalty are divided into that number of Units of Beneficial Interest (the "Units") of the Trust equal to the number of shares of the common stock of Southland Royalty outstanding as of the close of business on November 3, 1980. Each stockholder of Southland Royalty of record at the close of business on November 3, 1980 received one freely tradable Unit for each share of the common stock of Southland Royalty then held. Holders of Units are referred to herein as "Unit Holders." Subsequent to the Conveyance of the Royalty, through a series of assignments and mergers, Southland Royalty's successor became BROG. On March 31, 2006, a subsidiary of ConocoPhillips completed its acquisition of Burlington Resources, Inc., BROG's parent. As a result, ConocoPhillips became the parent of Burlington Resources, Inc., which in turn, is the parent of BROG. On May 1, 2012, ConocoPhillips announced that it had completed the spinoff to Phillips 66 of the company's refining and marketing business from its exploration and production business. According to ConocoPhillips, both businesses are now stand-alone, publicly traded corporations. The Trustee will continue to monitor this situation's effect on the Trust, if any.


The function of the Trustee is to collect the net proceeds attributable to the Royalty ("Royalty Income"), to pay all expenses and charges of the Trust and distribute the remaining available income to the Unit Holders. The Trust does not operate the Underlying Properties and, in fact, is not empowered to carry on any business activity. The Trust has no employees, officers or directors. All administrative functions of the Trust are performed by the Trustee.

BROG is the principal operator of the Underlying Properties. A very high percentage of the Royalty Income is attributable to the production and sale by BROG of natural gas from the Underlying Properties. Accordingly, the market price for natural gas produced and sold from the San Juan Basin heavily influences the amount of Royalty Income distributed by the Trust and, by extension, the price of the Units.

Three Months Ended September 30, 2012 and 2011

The Trust received Royalty income of $4,926,020 and interest income of $11,950 during the third quarter of 2012. There was no change in cash reserves. After deducting administrative expenses of $320,679, distributable income for the quarter was $4,617,291 ($0.099066 per Unit). In the third quarter of 2011, Royalty income was $17,886,286, interest income was $1,329, administrative expenses were $227,539 and distributable income was $17,660,076 ($0.378900 per Unit). Based on 46,608,796 Units outstanding, the per-Unit distributions during the third quarter of 2012 were as follows:

                  July . . .. . . . . . . . . . . .   $ .052155
                  August . . . . . . . . . . . .        .036122
                  September. . . . . . . . . . .        .010789

                  Quarter Total . . . . .             $ .099066

The Royalty income distributed in the third quarter of 2012 was lower than that distributed in the third quarter of 2011 primarily due to a decrease in the average gas price from $4.94 per Mcf for the third quarter of 2011 to $2.44 per Mcf for the third quarter of 2012. Interest income was higher for the quarter ended September 30, 2012 as compared to the quarter ended September 30, 2011, due to additional interest received in September from granted audit exceptions. Administrative expenses were higher in 2012 primarily as a result of differences in timing in the receipt and payment of certain of these expenses.

The capital costs attributable to the Underlying Properties for the third quarter of 2012 and deducted by BROG in calculating Royalty income were approximately $4.1 million as compared to approximately $6.5 million of capital costs in the third quarter of 2011. However, BROG indicates that actual drilling costs were approximately $3.1 million higher in the third quarter of 2011. A miscalculation by BROG for the months of April through July 2012 caused lease operating expenses and capital expenditures to be understated by approximately 25% (the "2012 Calculation Error"). The 2012 Calculation Error caused capital costs to be understated by $333,644 in July 2012 and to be overstated by a total of $985,356 in August and September 2012 as that error was corrected.

As a result of the 2012 Calculation Error, the Royalty income due the Trust for the four months of April through July 2012 was overpaid by approximately $3,386,861. BROG has communicated to the Trust that, as permitted under the terms of the Royalty conveyance document, it intends to offset the overpayment against Royalty income payable to the Trust over four consecutive months beginning with August 2012. Based upon the additional monthly lease operating expenses and capital expenditures BROG has reported it will use in order to recover the overpayment, the Royalty income distributions to the Trust were reduced by $742,779 in August, $1,090,583 in September, $767,122 in October and an estimated reduction of $786,377 is anticipated in November 2012.


BROG has informed the Trust that its budget for capital expenditures for the Underlying Properties in 2012 is estimated at $20.8 million. Of the $20.8 million, approximately $5 million will be attributable to the capital budgets for 2011 and prior years. BROG reported in February 2012 that based on its actual capital requirements, the pace of regulatory approvals, the mix of projects and swings in the price of natural gas, the actual capital expenditures for 2012 could range from $5 million to $35 million.

BROG anticipates 383 projects in 2012. Approximately $12.4 million of the $20.8 million budget is allocable to 21 new wells, including nine wells scheduled to be dually completed in the Mesaverde and Dakota formations and 12 wells to be completed in all three of the Mesaverde, Mancos Shale and Dakota formations. BROG indicates that evaluation of the Mancos Shale formation is in the very early stages. There are plans for a horizontal Mancos well beginning in the fourth quarter of 2012. Approximately $3.4 million will be spent on workovers and facilities projects. Of the $5 million attributable to the budgets for prior years, approximately $3 million is allocable to 20 new wells and the $2 million balance will be applied to miscellaneous capital projects such as workovers and operated facility projects.

Lease operating expenses and property taxes were $9,017,423 and $139,489, respectively, for the third quarter of 2012, as compared to $8,938,611 and $150,406, respectively, for the third quarter of 2011. The 2012 Calculation Error resulted in lease operating expenses being understated by $214,859 in July 2012 and overstated in August and September 2012 by a total of $1,459,127 as that error was corrected. Adjusting lease operating expenses for the third quarter of 2012 for the 2012 Calculation Error indicates actual lease operating expenses of $8,273,155, an amount which is $665,456 lower than lease operating expenses in the third quarter of 2011. But BROG also reports the figure for 2011 included a non-recurring audit adjustment which added $612,964 in lease operating expenses from a prior period, such that actual lease operating expenses for the third quarter of 2012 were only nominally lower than for the third quarter of the prior year. Taxes for the third quarter of 2012 were lower because in April 2012, BROG reduced its accrual for taxes from $50,135 per month to $46,496 per month. BROG adjusts its accruals for taxes based upon actual property taxes paid in the prior year.

BROG has reported to the Trustee that during the third quarter of 2012, four gross (0.69 net) conventional wells were completed on the Underlying Properties. Seven gross (2.98 net) conventional wells were in progress at September 30, 2012.

There were 14 gross (1.61 net) conventional wells and one gross (0.22 net) coal seam well completed on the Underlying Properties during the third quarter of 2011. Six gross (0.08 net) conventional wells and one gross (0.66 net) coal seam well were in progress at September 30, 2011.

There were 4,049 gross (1,180.50 net) producing wells being operated subject to the Royalty as of December 31, 2011, calculated on a well bore basis and not including multiple completions as separate wells. Of those wells, seven gross (5.50 net) are oil wells and the balance are gas wells. BROG reports that approximately 828 gross (324.5 net) of the wells are multiple completion wells resulting in a total of 4,877 gross (1,505 net) completions.

"Gross" acres or wells, for purposes of this discussion, means the entire ownership interest of all parties in such properties, and BROG's interest therein is referred to as the "net" acres or wells. In calculating the number of net wells, where a well is completed to multiple formations, BROG indicates it
(a) multiplies the working interest for each zone by a fraction equal to one divided by the total number of completions in that well bore, and (b) adds the interests so calculated for each zone to obtain the net ownership interest in that well. A "payadd" is the completion of an additional productive interval in an existing completed zone in a well.


Royalty income for the quarter ended September 30, 2012 is associated with actual gas and oil production during May 2012 through July 2012 from the Underlying Properties. Gas and oil sales from the Underlying Properties for the three months ended September 30, 2012 and 2011 were as follows:

                                              Three Months Ended
                                                 September 30,
                                            2012               2011
             Gas:
             Total sales (Mcf)            8,503,327          8,565,498
             Mcf per day                     92,427             93,103
             Average price (per Mcf)    $      2.44        $      4.94

             Oil:
             Total sales (Bbls)              14,290             14,701
             Bbls per day                       155                160
             Average price (per Bbl)    $     76.52        $     84.89

During the third quarter of 2012, average gas prices were $2.50 per Mcf lower than the average prices reported during the third quarter of 2011. The average price per barrel of oil during the third quarter of 2012 was $8.37 per barrel lower than that received for the third quarter of 2011.

BROG previously entered into four contracts effective April 1, 2009, for the sale of all gas produced from the Underlying Properties other than the gas covered by a pre-existing contract with New Mexico Gas Company, Inc. ("NMGC"). The then current purchasers were Chevron Natural Gas, a division of Chevron USA, Inc. ("Chevron"), Pacific Gas and Electric Company ("PG&E"), BP Energy Company, Macquarie Cook Energy LLC, and NMGC. In March 2010, notice of termination of each of the Chevron, BP Energy Company and Macquarie Cook Energy LLC contracts was given such that they terminated effective March 31, 2011. Requests for proposal were circulated to potential purchasers of those packages of gas covered by the expiring contracts with a view toward obtaining new contracts to be effective April 1, 2011. Because none of BROG, PG&E, or NMGC gave notice of termination of their contracts, the terms of those two contracts have been automatically extended through at least March 31, 2013.

BROG entered into three new contracts effective April 1, 2011, for the sale of the gas produced from the Underlying Properties but not sold under the two pre-existing contracts. The purchasers under such new contracts are Chevron, PG&E and Salt River Project Agricultural Improvement and Power District ("SRP"). All five of the current contracts provide for (i) the delivery of such gas at various delivery points through March 31, 2013 and from year-to-year thereafter, until terminated by either party upon notice of between six and twelve months (except for the SRP contract which terminated March 31, 2012); and (ii) the sale of such gas at prices which fluctuate in accordance with the published indices for gas sold in the San Juan Basin of northwestern New Mexico. Requests for proposals were circulated soliciting bids for the purchase of those volumes sold under the SRP contract which expired March 31, 2012. Contracts are now in place for the sale of those volumes to PG&E, Shell Energy North America (US), LP and SRP on delivery and pricing terms substantially the same as the other contracts described in this paragraph and also for terms expiring March 31, 2013.

On or about January 4, 2012, the operator of the Lybrook gas processing plant took that facility out of service and rerouted gas formerly treated there to its Ignacio plant. Because the NMGC system is not interconnected with the Ignacio plant, it became impossible for BROG to sell gas to NMGC under the contract described above such that BROG declared a force majeure event and terminated the NMGC contract. BROG negotiated a contract to sell the NMGC volumes to Chevron at prices and terms acceptable to the Trust's consultants for the period through the March 31, 2013 termination date of the prior NMGC contract.


BROG contracts with Williams Four Corners, LLC ("WFC") and Enterprise Field Services, LLC ("EFS") for the gathering and processing of virtually all of the gas produced from the Underlying Properties. Four new contracts were entered into with WFC to be effective for terms of 15 years commencing April 1, 2010. BROG has also signed a new agreement with EFS effective November 1, 2011 for a term of 15 years. BROG has disclosed to the Trust a summary of that agreement which the Trust has reviewed with its consultants, subject to conditions of confidentiality. The Trustee will continue to monitor this matter as it may relate to the Trust.

Confidentiality agreements with gatherers and purchasers of gas produced from the Underlying Properties prohibit public disclosure of certain terms and conditions of gas sales contracts with those entities, including specific pricing terms and gas receipt points. Such disclosure could compromise the ability to compete effectively in the marketplace for the sale of gas produced from the Underlying Properties.

Nine Months Ended September 30, 2012 and 2011

For the nine months ended September 30, 2012, the Trust received Royalty income of $30,359,217 and interest income of $569,686. There was no change in cash reserves. After deducting administrative expenses of $1,308,187, distributable income was $29,620,716 ($0.635520 per Unit) for the nine months ended September 30, 2012. For the nine months ended September 30, 2011, the Trust received Royalty income of $48,843,626 and interest income of $685,855. There was no change in cash reserves. After deducting administrative expenses of $1,276,041, distributable income was $48,253,440 ($1.035285 per Unit) for the nine months ended September 30, 2011.

The decrease in distributable income from 2011 to 2012 resulted primarily from lower gas prices during the first nine months of 2012. Interest earnings were lower for the nine months ended September 30, 2012 as compared to the nine months ended September 30, 2011, due primarily to a decrease in funds available for investment and a reduction in the amount of interest due as the result of late payment of gross proceeds.

General and administrative expenses were higher for the nine months ended September 30, 2012, as compared to the same period in 2011, primarily as a result of differences in timing in the receipt and payment of certain of the expenses.

Capital expenditures incurred by BROG, attributable to the Underlying Properties, for the first nine months of 2012 amounted to approximately $13.9 million. Capital expenditures were approximately $15.8 million for the first nine months of 2011. Lease operating expenses and property taxes for the first nine months of 2012 totaled $24,184,351 and $145,896, respectively, as compared to $26,149,294 and $571,025, respectively, for 2011. In April 2012, BROG reduced its accrual for taxes from $50,135 per month to $46,496 per month.

BROG has reported to the Trustee that during the nine months ended September 30, 2012, 20 gross (5.13 net) conventional wells were completed on the Underlying Properties.

There were 42 gross (6.64 net) conventional wells and five gross (1.04 net) coal seam wells completed on the Underlying Properties during the nine months ended September 30, 2011.


Royalty income for the nine months ended September 30, 2012 is associated with actual gas and oil production during November 2011 through July 2012 from the Underlying Properties. Gas and oil sales from the Underlying Properties for the nine months ended September 30, 2012 and 2011 were as follows:

                                               Nine Months Ended
                                                 September 30,
                                           2012                2011
            Gas:
            Total sales (Mcf)            24,846,092          24,388,870
            Mcf per day                      90,679              89,337
            Average price (per Mcf)    $       3.35        $       4.72

            Oil:
            Total Sales (Bbls)               38,330              43,318
            Bbls per day                        140                 159
            Average price (per Bbl)    $      83.54        $      83.12

Calculation of Royalty Income

Royalty income received by the Trust for the three months and nine months ended September 30, 2012 and 2011, respectively, was computed as shown in the following table:

 CALCULATION OF ROYALTY INCOME

                                        Three Months Ended                         Nine Months Ended
                                          September 30,                              September 30,
                                    2012                 2011                  2012                  2011
Gross proceeds of sales
from the Underlying
Properties
Gas proceeds                    $ 20,716,421         $ 42,209,984         $  83,538,936         $ 114,961,156
Oil proceeds                       1,093,450            1,248,036             3,202,212             3,600,453
Other                                ------               ------            (246,332)(1)             ------

Total                             21,809,871           43,458,020            86,494,816           118,561,609

Less production costs:
Severance tax - gas                1,909,830            3,872,807             7,487,678            10,559,177
Severance tax - oil                  109,232              115,679               310,920               359,139
Lease operating expense and
property tax                       9,156,912            9,089,017            24,330,247            26,720,319
Capital expenditures               4,065,870            6,532,136            13,887,015            15,798,139


Total                             15,241,844           19,609,639            46,015,860            53,436,774


Net profits                        6,568,027           23,848,381            40,478,956            65,124,835
Net overriding royalty
interest                                  75%                  75%                   75%                   75%


Royalty Income                  $  4,926,020         $ 17,886,286         $  30,359,217         $  48,843,626

(1) Reduction of April revenue as part of the ongoing negotiation of compliance audit exceptions.


Contractual Obligations

Under the Indenture governing the Trust, the Trustee is entitled to an administrative fee for its administrative services and the preparation of quarterly and annual statements of: (i) 1/20 of 1% of the first $100 million of the annual gross revenue of the Trust, and 1/30 of 1% of the annual gross revenue of the Trust in excess of $100 million and (ii) the Trustee's standard hourly rates for time in excess of 300 hours annually, provided that the administrative fee due under items (i) and (ii) above will not be less than $36,000 per year (as adjusted annually to reflect the increase (if any) in the Producers Price Index as published by the U.S. Department of Labor, Bureau of Labor Statistics, since December 31, 2003).

Effects of Securities Regulation

As a publicly-traded trust listed on the New York Stock Exchange (the "NYSE"), the Trust is and will continue to be subject to extensive regulation under, among others, the Securities Act of 1933, the Securities Exchange Act of 1934 (which contains many of the provisions of the Sarbanes-Oxley Act of 2002), and the rules and regulations of the NYSE. Issuers failing to comply with such authorities risk serious consequences, including criminal as well as civil and administrative penalties. In most instances, these laws, rules, and regulations do not specifically address their applicability to publicly-traded trusts, such as the Trust. In particular, the Sarbanes-Oxley Act of 2002 provides for the adoption by the Securities and Exchange Commission (the "Commission") and NYSE of certain rules and regulations that may be impossible for the Trust to literally satisfy because of its nature as a pass-through trust. It is the Trustee's intention to follow the Commission's and NYSE's rulemaking closely, attempt to comply with such rules and regulations and, where appropriate, request relief from these rules and regulations. However, if the Trust is unable to comply with such rules and regulations or to obtain appropriate relief, the Trust may be required to expend presently unknown but potentially material costs to amend the Indenture that governs the Trust to allow for compliance with such rules and regulations. To date, the rules implementing the Sarbanes-Oxley Act of 2002 have generally made appropriate accommodation for passive entities such as the Trust.

Critical Accounting Policies

In accordance with the Commission's rules and regulations and consistent with other royalty trusts, the financial statements of the Trust are prepared on the following basis:

Royalty Income recorded for a month is the amount computed and paid pursuant to the Conveyance by BROG to the Trustee for the Trust. Royalty Income consists of the proceeds received by BROG from the sale of production from the Underlying Properties less accrued production costs, development and drilling costs, applicable taxes, operating charges, and other costs and deductions, multiplied by 75%. The calculation of net proceeds by BROG for any month includes adjustments to proceeds and costs for prior months and impacts the Royalty Income paid to the Trust and the distribution to Unit Holders for that month.

Trust expenses recorded are based on liabilities paid and cash reserves established from Royalty Income for liabilities and contingencies.

Distributions to Unit Holders are recorded when declared by the Trustee.

The Conveyance which transferred the Royalty to the Trust provides that any excess of development and production costs applicable to the Underlying Properties over gross proceeds from such properties must be recovered from future net proceeds before Royalty Income is again paid to the Trust.

The financial statements of the Trust differ from financial statements prepared in accordance with GAAP because revenues are not accrued in the month of production; certain cash reserves may be


established for contingencies which would not be accrued in financial statements prepared in accordance with GAAP; expenses are recorded when paid instead of when incurred; and amortization of the Royalty calculated on a unit-of-production basis is charged directly to the Trust corpus instead of as an expense.

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