Distribution Drop May Spell Trouble for San Juan Royalty Trust

Let's take a look at San Juan Royalty Trust (SJT), which currently trades at $30.26

I’ll be brief. From time to time, I play this with puts or calls depending on the direction I think natural gas prices are headed -- so I thought I’d write it up. SJT has a pretty high correlation to natural gas. I won’t short it, because it pays a monthly dividend, and I find it disturbing if I have to pay those while I wait out the fall (although I may reconsider my stance if the monthlies continue to ebb). I wouldn’t buy and hold the stock either, as the production that underlies the trust is slipping, so I don’t think the yield will hold.

A Quick Description

• The San Juan Basin royalty trust holds a 75% net overriding royalty interest carved out of certain oil and gas leasehold and royalty interests in properties owned by Burlington Resources. The underlying reserves are located in the long-reserve-life San Juan Basin of New Mexico. After expenses, the trust pays a monthly dividend to unit holders. Simple enough.
• The production underlying SJT’s interest is 99% natural gas.
• Underlying production is operated by Burlington Resources, which is now owned by ConocoPhillips (COP) (more on COP’s gas history in a subsequent post). Essentially SJT has no control over or ability to increase production. They’re just along for the ride.
• Burlington has indicated it plans to carry out 416 projects in San Juan in 2007, down from 476 in 2006.

Annual Distribution Statement

Two important takeaways:

• Unit distribution is highly sensitive to gas price. Even as production fell nearly 3% from 2004 to 2005, a 34% jump in realized gas equivalent prices yielded a stout distribution for the year.
• In the following year, higher capital spending on the underlying properties severely dented the trust’s distribution, despite continued strength in gas prices.

Long-term production from the San Juan basin underlying assets is declining...

The monthly chart going back to 2005 shows the most recent two months aren’t an anomaly, but the continuation of a trend:

A look at the two most recently announced distributions further demonstrates the great sensitivity that production and gas prices exert on monthly distributions:

Monthly distributions are highly correlated to SJT’s share price. I generally don’t try to forecast the monthly numbers as, 1) the realized price can stray pretty far from the San Juan posted price, and 2) the stock moves more closely with natural gas prices and is less volatile on the monthly distribution posting day than it once was.

Comments

[Georealist]

The author wouldn't buy and he won't short (Why anyone would even consider shorting a natural gas equity rather than simply shorting natural gas if one is considered a proxy for the other is beyond sense)...So? It should be enough to know that SJT is a "captive" entity..they have no effective control over future development or the timing or expene of reserve replacement. End of story. Much ado about less than nothing..since there are any number of alternatives. Canadian Trusts like PrimeWest and Shiningbank are also gas oriented..they have very aggressive developmental structures they are in charge. They've already been hammered below any reason because of tax issues that may never take place in several years. BGR..a closed end fund... sells at over a 9% discont to NAV and yields over 5.5%..and gives excellent diversity in the natural gas domestic market.

[jiveyjr]

Zman's comments are very thought provoking. Many income investors simply buy these trusts, maybe look at McDep for reassurance and give it no more thought. A cursory look at the SEC filings shows that Zman's concerns have merit given that disclosed reserves are in a downtrend.

As to the reduced projects to be implemented in 2007, the SEC filings say that the trust is in transition from unconventional to more conventional development, perhaps that is why fewer projects or on slate. It may also be true that the uptrend in exploration costs together with the downtrend in pricing has affected the appetite for additional development in 2007.

In relationship to my holdings SJT is large. Appreciate the heads up!