SAN JUAN BASIN ROYALTY TRUST Overview
The Trust is an express trust created under the laws of the state ofTexas by theSan Juan Basin Royalty Trust Indenture entered into onNovember 1, 1980 betweenSouthland Royalty Company ("Southland") andThe Fort Worth National Bank (the "Original Indenture"). The Original Indenture was amended and restated onSeptember 30, 2002 , and further amended and restated onDecember 12, 2007 , which the Trust refers to as the "Indenture" in this Quarterly Report on Form 10-Q. OnJune 1, 2021 , PNC completed its acquisition ofBBVA USA Bancshares, Inc. , including itsU.S. banking subsidiary,BBVA USA . The Trustee continued to operate asBBVA USA , an indirect wholly owned subsidiary of PNC, until the conversion of bank systems and merger ofBBVA USA with and into PNC Bank, an indirect wholly owned subsidiary of PNC, which was completed inOctober 2021 . As a result, PNC Bank succeededBBVA USA as Trustee under the terms of the Indenture.
The Conveyance and the Royalty
Pursuant to the Net Overriding Royalty Conveyance (the "Conveyance") effectiveNovember 1, 1980 , Southland conveyed the Royalty that burdens the Subject Interests in properties located in theSan Juan Basin of northwesternNew Mexico to the Trust. Subsequent to the Conveyance of the Royalty, through a series of sales, assignments and mergers, Southland's successor became Hilcorp, which acquired the Subject Interests fromBurlington Resources Oil & Gas Company LP ("Burlington"), an indirect wholly owned subsidiary of ConocoPhillips, onJuly 31, 2017 . The Royalty constitutes the principal asset of the Trust. The beneficial interest in the Royalty is divided into 46,608,796 units (the "Units") representing undivided fractional interests in the beneficial interest of the Trust equal to the number of shares of the common stock of Southland outstanding as of the close of business onNovember 3, 1980 . Each stockholder of Southland of record at the close of business onNovember 3, 1980 received one freely tradable Unit for each share of the common stock of Southland then held. Holders of Units in the Trust are referred to herein as "Unit Holders." 7
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The Trustee
The primary function of the Trustee is to collect Royalty Income, to pay all expenses and charges of the Trust and distribute the remaining available income to the Unit Holders. The amount of income distributable to Unit Holders, which we refer to as "Distributable Income," depends on the amount of Royalty Income and interest received by the Trust, as well as the amount of expenses paid by the Trust and any change in cash reserves. The Trust has no employees, officers or directors. The Trustee performs all administrative functions of the Trust.
Hilcorp
Hilcorp is the principal operator of the majority of the Subject Interests and is responsible, subject to the terms of a prior agreement with the Trust, for marketing the oil and natural gas production from such properties, either under existing sales contracts or under future arrangements, at the best prices and on the best terms it shall deem reasonably obtainable under the circumstances. A very high percentage of the Royalty Income is attributable to the production and sale by Hilcorp of natural gas from the Subject Interests. Accordingly, the market price and demand for natural gas produced and sold from theSan Juan Basin heavily influences the amount of Royalty Income distributed by the Trust and, by extension, the price of the Units.
The sale of
Gross Proceeds and Severance Tax Estimates. Hilcorp has advised the Trust that for certain months (since the closing of its purchase of the assets), it has reported estimates of cash revenues and expenses based on the best information available to it at the time, instead of reporting actual amounts. Hilcorp further has informed the Trust that it believes that its estimates have been prepared in accordance with the Conveyance, and the Trust and its advisors continue to review such estimates for compliance with the Conveyance. Hilcorp's process of reconciling actual revenue and severance taxes to previously reported estimates (which the Trust refers to as "true-ups") are still occurring and being reported in 2021. In addition, Hilcorp informed the Trust that due to Hilcorp's transition to a new accounting system beginning inMarch 2021 , revenue and severance tax categories for the February throughMay 2021 production months were based on estimates utilizing historical trends. Revenue and severance tax for the May, June and July production months were trued-up in August andSeptember 2021 . During theNovember 2021 Meeting, Hilcorp informed the Trust that it had completed its actualization and validation of January, February, andMarch 2021 with respect to the gross proceeds and severance tax estimates attributable to the Royalty Interests owned by the Trust. Based on such review, Hilcorp informed the Trust that it had determined that it owes the Trust an additional$448,780 for these time periods, along with$63,496 in interest in accordance with the terms of the Conveyance. Hilcorp intends to include the payments for these actualizations and adjustments, together with the related interest, in the November reporting and distribution to the Trust. Lease operating expenses and capital costs for the January throughApril 2021 production months were based on estimates, but the lease operating expenses and capital costs forMay 2021 were based on actual costs. Both Lease operating expense and capital costs for the January throughMay 2021 production months were trued-up inJuly 2021 . However, due to excess production costs for the June production month (which corresponds with the Trust's August distribution month), there was no cash distribution made inAugust 2021 . These true-up corrections resulted in no distribution payment declared for theAugust 2021 reporting month. Hilcorp also confirmed that it continues to work on its actualization and accounting of the operated revenue and severance tax computations for the production month ofApril 2021 (the remaining 2021 production month that was based on estimates) and will notify the Trust promptly upon completion of such actualization and accounting by the end of 2021. Hilcorp further informed the Trust that it believes that theApril 2021 true-up and adjustment may result in changes to future distributions of net proceeds to the Trust that reflect such rebooking and true-ups plus interest on such amounts (as required by the Conveyance) to the extent an underpayment to the Trust has occurred. Hilcorp has confirmed that it will continue to waive interest to the extent there were any overpayments to the Trust based on true-ups in 2021. The Trustee continues to engage with Hilcorp regarding its ongoing accounting and reporting to the Trust, and the Trust's third-party compliance auditors continue to audit all payments made by Hilcorp to the Trust, including adjustments, true-ups, and recoupments. The Trustee continues to consult with outside counsel to review the rights of the Trust with respect to these matters and to evaluate any available potential legal remedies. Commodity Prices. The Trust's income and monthly distributions from the Subject Interests are heavily influenced by the price of oil and natural gas. These prices may fluctuate widely in response to relatively minor changes in the supply of and demand for oil and natural gas based on market uncertainty or a variety of additional factors that are beyond the Trustee's control. 8
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OnJanuary 20, 2021 ,President Biden signed an executive order that reversedthe United States withdrawal from the Paris Agreement, andthe United States formally rejoined the Paris Agreement onFebruary 19, 2021 . At the federal regulatory level, both theEnvironmental Protection Agency ("EPA") and theBureau of Land Management ("BLM") have adopted regulations for the control of methane emissions, which also include leak detection and repair requirements, from the oil and gas industry.President Biden's executive orders require the adoption of new regulations and policies to address climate change and suspend, revise or rescind prior agency actions that are identified as conflicting with theBiden Administration's climate policies. In addition, federal government efforts to limit or prohibit hydraulic fracturing and additional prohibitions on new leases for production of minerals on federal properties, including onshore lands could affect the Subject Interests and the Trust in several ways. For example, Hilcorp could be required to increase its capital expenditures for the Subject Interests, the market could suffer a decreased demand for natural gas and oil production, or various agencies could limit the Subject Interests' ability to produce natural gas or oil. The Trust is unable to determine what, if any, the effects of such actions will have on the Subject Interests' ability to produce natural gas and oil, and Hilcorp's ability to pay royalty income to the Trust. Hilcorp previously informed the Trust that it does not believe that recent actions undertaken by the Biden's administration to curtail future leases for natural gas and oil drilling on federally owned land will affect the Subject Interests because as currently enacted, they do not affect current leases.
Results of Operations - for the Three and Nine Months Ended
Royalty Income Royalty Income consists of monthly net proceeds attributable to the Royalty. Royalty Income for the three and nine months endedSeptember 30, 2021 and 2020 was determined as shown in the following table: Three Months Ended Nine Months Ended September 30, September 30, 2021 2020 2021 2020 Gross proceeds from the Subject Interests: Natural Gas$ 17,558,353 $ 8,474,484 $ 53,434,587 $ 28,640,859 Oil 821,082 398,805 1,677,536 1,043,043 Other 769,567 (1) (773,604 )(2) 1,316,214 )(1)(3) (877,651 )(2)(4) Total 19,149,002 (5) 8,099,685 56,428,337 (5)(6) 28,806,251 Production Costs: Severance tax - gas 2,459,722 1,332,878 6,979,245 2,748,720 Severance tax - oil 94,468 95,451 241,333 151,368 Lease operating expense and property tax 8,620,746 5,113,994 19,811,848 17,809,264 Capital expenditures (105,409 ) 60,486 279,267 120,665 Other - 16,065 (7) - 16,065 (7) Total 11,069,527 6,618,874 27,311,693 20,846,082 Production costs in excess of gross proceeds - (1,480,811 )(8) - 92,003 Net profits 8,079,475 - 29,116,644 8,052,172 Net overriding royalty interest 75 % 75 % 75 % 75 % Royalty Income 6,059,606 -$ 21,837,483 $ 6,039,129
1. Estimated revenue from non-operated properties, granted audit exceptions with
interest as a result of the audit, and interest owed from the true-up of
January through April 2021 production costs.
2. Estimated revenue from non-operated properties and true-ups and adjustments
of non-operated revenue for the production months of
2018,
included in the estimated gross proceeds in the
2018 distribution months.
3. Estimated revenue from non-operated properties offset by Hilcorp's true-ups
and adjustments of non-operated revenue for the production months of June
through
4. Estimated revenue from non-operated properties and granted audit exceptions
with interest as a result of the 2018 audit, negatively offset by Hilcorp's
true-ups and adjustments of non-operated revenue from the
through
5. Due to Hilcorp's transition to a new accounting system, the
production month), was based on estimated revenue and severance tax. The May
production month corresponds to the Trust's July distribution month.
6. Due to Hilcorp's transition to a new accounting system, the
production month was based on estimated production, actual realized prices
and estimated costs. The February, March and April production months were
based on estimated production, estimated prices and estimated costs.
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-------------------------------------------------------------------------------- Table of Contents 7. Interest charges on excess production costs.
8. Net proceeds (gross proceeds less production costs) for the three months
ended
eliminate, the prior excess production costs of
months ended
Subject Interests were
(net), allocated to the Trust.
The Royalty Income distributed to the Trust for both the three and nine months endedSeptember 30, 2021 was higher than that distributed during the same period of 2020 due primarily to higher natural gas prices. There was no Royalty Income distributed to the Trust in the three months endedSeptember 30, 2020 due to excess production costs from theApril 2020 production month. The average natural gas price increased from$1.46 per Mcf for the three months endedSeptember 30, 2020 to$2.74 per Mcf for the three months endedSeptember 30, 2021 , and the average natural gas price increased from$1.47 Mcf for the nine months endedSeptember 30, 2020 to$2.72 per Mcf for the nine months endedSeptember 30, 2021 . Production of natural gas from the Subject Interests increased from 5,786,304 Mcf for the three months endedSeptember 30, 2020 to 6,410,955 Mcf for the three months endedSeptember 30, 2021 , and increased slightly from 19,521,825 Mcf for the nine months endedSeptember 30, 2020 to 19,631,861 Mcf for the nine months endedSeptember 30, 2021 . Gross Proceeds from Subject Interests. Total Gross proceeds increased approximately$11 million , or 136%, for the three months endedSeptember 30, 2021 compared to the three months endedSeptember 30, 2020 , and increased approximately$27.6 million , or 96%, for the nine months endedSeptember 30, 2021 compared to the nine months endedSeptember 30, 2020 . The increase was due primarily to higher natural gas prices. Capital Expenditures. Capital expenditures by Hilcorp decreased approximately$166,000 for the three months endedSeptember 30, 2021 compared to the three months endedSeptember 30, 2020 . The decrease is due primarily to a credit as a result of true-ups for the January throughApril 2021 production months. Hilcorp's capital expenditures increased approximately$159,000 for the nine months endedSeptember 30, 2021 compared to the nine months endedSeptember 30, 2020 . The increase was primarily due to differences in timing in the payment of these expenditures along with capital expenditures attributable to the prior year's budget. Severance Taxes. Aggregate severance taxes increased approximately$1.1 million for the three months endedSeptember 30, 2021 compared to the three months endedSeptember 30, 2020 , and increased approximately$4.3 million for the nine months endedSeptember 30, 2021 compared to the nine months endedSeptember 30, 2020 . The increase in severance taxes was primarily attributable to higher gross proceeds during those periods. Severance taxes represented approximately 13% of gross proceeds for the three months endedSeptember 30, 2021 , compared to approximately 18% for the same period of 2020. Severance taxes represented approximately 13% of gross proceeds for the nine months endedSeptember 30, 2021 , compared to approximately 10% for the same period of 2020. The distributions in 2020 included true ups of previous production months which resulted in fluctuations of severance taxes. Lease Operating Expenses and Property Taxes. Lease operating expenses and property taxes increased$3.5 million , or 69%, for the three months endedSeptember 30, 2021 compared to the three months endedSeptember 30, 2020 , and increased$2 million , or 11%, for the nine months endedSeptember 30, 2021 compared to the nine months endedSeptember 30, 2020 . The increase is primarily due to true-ups and corrections for the January throughMay 2021 production months, as well as to increased activity at the Subject Interests by Hilcorp. Monthly lease operating expenses of the Subject Interests, including property taxes, for the three months endedSeptember 30, 2021 averaged approximately$2.9 million , compared to$1.7 million for the three months endedSeptember 30, 2020 . Monthly lease operating expenses of the Subject Interests, including property taxes, for the nine months endedSeptember 30, 2021 averaged$2.2 million , compared to an average of$2 million for the nine months endedSeptember 30, 2020 . Distributable Income Three Months Ended Nine Months Ended September 30, September 30, 2021 2020 2021 2020 Royalty income$ 6,059,606 $ -$ 21,837,483 $ 6,039,129 Interest income 237 396 1,006 6,010 Total income 6,059,843 396 21,838,489 6,045,139 General and administrative expenses (385,910 ) (290,344 ) (1,247,306 ) (1,238,724 ) Decrease in cash reserves - 289,948 - 397,090 Distributable income$ 5,673,933 $ - $
20,591,183
Distributable income per Unit (46,608,796 Units)$ 0.121735 $ 0.000000 $ 0.441787 $ 0.111642 10
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Distributable Income. Distributable Income for the three months endedSeptember 30, 2021 was$5.7 million ($0.121735 per Unit). There was no Distributable Income during the three months endedSeptember 30, 2020 . Distributable Income increased by approximately$15.4 million , or 296%, to$20.6 million ($0.441787 per Unit) for the nine months endedSeptember 30, 2021 from$5.2 million ($0.111642 per Unit) for the nine months endedSeptember 30, 2020 . The increase in Distributable Income was primarily attributable to higher natural gas prices.
Based on 46,608,796 Units outstanding, the per-Unit distributions during the third quarter of 2021 were as follows:
July $ 0.084740
August 0.000000
September 0.036995
Quarter Total $ 0.121735
Due to excess production costs for the June production month (which corresponds
with the Trust's August distribution month), there was no cash distribution made
in August.
Interest Income. Interest income was lower for the three months ended
General & Administrative Expenses. General and administrative expenses increased approximately 33%, for the three months endedSeptember 30, 2021 compared to the three months endedSeptember 30, 2020 , and increased 0.7%, for the nine months endedSeptember 30, 2021 compared to the nine months endedSeptember 30, 2020 . The increase in general and administrative expenses was primarily attributable to differences in timing in the receipt and payment of certain expenses by the Trust, and increased legal expenses during the transition from BBVA to PNC Bank as the Trustee. Cash Reserves. Total cash reserves were$1.0 million as ofSeptember 30, 2021 . The primary purpose of the cash reserves is to have sufficient funds to cover monthly general and administrative expenses in the event that there is insufficient Royalty Income to cover such expenses. The Trustee does not anticipate any increases to the cash reserve above a level of$1.0 million in 2021, although it cannot guarantee that the Trustee will not increase such cash reserves in the future.
Liquidity and Capital Resources
The Trust's principal source of liquidity and capital is Royalty Income. The Trust's distribution of income to Unit Holders is funded by Royalty Income after payment of Trust expenses. The Trust is not liable for any production costs or liabilities attributable to the Royalty. If at any time the Trust receives more than the amount due under the Royalty, it is not obligated to return such overpayment, but the amounts payable to it for any subsequent period are reduced by such amount, plus interest, at a rate specified in the Conveyance. If the Trustee determines that the Trust does not have sufficient funds to pay the Trust's liabilities, the Trustee may borrow funds on behalf of the Trust, in which case no distributions will be made to Unit Holders until such borrowings are repaid in full. The Trustee may not sell or dispose of any part of the assets of the Trust without the affirmative vote of 75% of all of the Units outstanding; however, the Trustee may sell up to 1% of the value of the Royalty (as determined pursuant to the Indenture) during any 12-month period without the consent of the Unit Holders. Due to excess production costs inJune 2021 , the Trust did not declare a distribution inAugust 2021 . The cash required for monthly expenses was funded by the cash reserve. The amount taken from the cash reserve was replenished inSeptember 2021 .
In the event the Trust does not receive sufficient net cash payments from Hilcorp, the Trust believes it has sufficient capacity to draw upon the cash reserve amount or borrow funds against the Royalty to cover the Trust's operating expenses until its cash reserve can be replenished from net cash payments from Hilcorp.
Oil and Natural Gas Production
The natural gas volumes reported to the Trust by Hilcorp are based on plant residue gas volumes plus equivalent volumes for natural gas liquids. Hilcorp converts one barrel of natural gas liquids to six Mcf of natural gas using industry standards.
Royalty Income for the three months endedSeptember 30, 2021 is associated with oil and natural gas production during May throughJuly 2021 from the Subject Interests. Production of oil and natural gas and related average sales prices attributable to each of the Subject Interests and the Royalty for the three months endedSeptember 30, 2021 and 2020 were as follows: 11
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For the Three Months Ended September 30,
2021 2020
Oil and Oil and
Natural Gas Condensate Natural Gas Condensate
(Mcf) (Bbls) (Mcf) (Bbls)
Production
Subject Interests 6,410,955 13,935 5,786,304 14,195
Royalty 2,643,866 9,266 946,233 6,245
Average Price (per Mcf/Bbl) $ 2.74 $ 58.92 $ 1.46 $ 28.09 Production of oil and natural gas and related average sales prices attributable
to each of the Subject Interests and the Royalty for the nine months ended
For the Nine Months Ended September 30,
2021 2020
Oil and Oil and
Natural Gas Condensate Natural Gas Condensate
(Mcf) (Bbls) (Mcf) (Bbls)
Production
Subject Interests 19,631,861 33,396 19,521,825 33,517
Royalty 8,518,986 21,485 1,951,351 16,408
Average Price (per Mcf/Bbl) $ 2.72 $ 50.23 $ 1.47 $ 31.12
The Trust recognizes production during the month in which the related net
proceeds attributable to the Royalty are paid to the Trust. Royalty Income for a
calendar year is based on the actual natural gas and oil production during the
period beginning with November of the preceding calendar year through October of
the current calendar year. However, for 2021, non-operated revenue has been
based on estimated natural gas and oil production. Sales volumes attributable to
the Royalty are determined by dividing the net profits by the Trust from the
sale of oil and natural gas, respectively, by the prices received by Hilcorp for
sales of such volumes from the Subject Interests, taking into consideration
production taxes attributable to the Subject Interests. Because the oil and
natural gas sales attributable to the Royalty are based upon an allocation
formula dependent on such factors as price and cost, including Hilcorp's capital
expenditures and the timing of Hilcorp's true-ups of prior reported estimated
oil and natural gas production data, the aggregate sales amounts from the
Subject Interests may not provide a meaningful comparison to sales attributable
to the Royalty. Future true-ups will impact future royalty proceeds, but will
not change the reported amounts due to the accounting basis used.
The fluctuations in natural gas production that have occurred during the
three-month period ended September 30, 2021 and 2020, respectively, generally
resulted from changes in the demand for natural gas during that time, market
conditions, and variances in capital spending to generate production from new
and existing wells, as offset by the natural production decline curve. Also,
production from the Subject Interests is influenced by the line pressure of the
natural gas gathering systems in the San Juan Basin . As noted above, oil and
natural gas sales attributable to the Royalty are based on an allocation formula
dependent on many factors, including oil and natural gas prices and capital
expenditures.
Marketing
There were no changes to the contracts pursuant to which Hilcorp sells
production from the Subject Interests and for the gathering and processing of
production during the three months ended
Off-Balance Sheet Arrangements
None.
Critical Accounting Policies and Estimates
For a discussion of significant accounting policies and estimates that impact the Trust's financial statements, see Part I, Item 1. Unaudited Financial Statements, Note 1 Basis of Presentation and Part II, Item 8. Financial Statements and Supplemental Data contained in the Trust's Annual Report on Form 10-K for the year endedDecember 31, 2020 . 12
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Information Regarding 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 SEC (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 within
the meaning of Section 21E of the Securities Exchange Act of 1934, as amended
(the "Exchange Act") and Section 27A of the Securities Act of 1933, as amended.
Such forward-looking statements may involve or may concern, among other things,
the amount and variability in capital expenditures by Hilcorp, drilling
activity, development activities, production efforts and volumes, hydrocarbon
prices, estimated future net revenues, estimates of reserves, the results of the
Trust's activities, the differences between Hilcorp's estimated revenue and
actual revenue, and regulatory matters. Such forward-looking statements
generally are accompanied by words such as "may," "will," "based," "estimate,"
"expect," "predict," "project," "anticipate," "believe," "plan," "intend," or
other words that convey the uncertainty of future events or outcomes. Such
statements are based on certain assumptions of the Trustee and by Hilcorp, 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 Hilcorp; and involve risks
and uncertainties. However, whether actual results and developments will conform
with such expectations and predictions is subject to a number of risks and
uncertainties which could affect the future results of the energy industry in
general, and the Trust and Hilcorp in particular, and could cause those results
to differ materially from those expressed in such forward-looking statements.
The actual results or developments anticipated may not be realized or, even if
substantially realized, they may not have the expected consequences to or
effects on Hilcorp's business and the Trust. Such statements are not guarantees
of future performance and actual results or developments may differ materially
from those projected in such forward-looking statements. The Trust undertakes no
obligation to publicly update or revise any forward-looking statements, except
as required by applicable law.
Hilcorp Information
As a holder of a net overriding royalty interest, the Trust's reporting of
financial information 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. See Part I, Item 4. Controls and Procedures.
For information on the Trust's exposure to market risk, please see Part II, Item
7A, "Quantitative and Qualitative Disclosures About Market Risk" contained in
the Trust's Annual Report on Form 10-K for the year ended December 31, 2020 .
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