San Juan Royalty Trust - Current Natural Gas Prices Will Slash Dividend

| About: San Juan (SJT)
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The recent dive in prices of natural gas has caused many producers' stocks to come under pressure. Investors who are bearish natural gas may be using companies like Chesapeake (NYSE:CHK) and Southwestern Energy (NYSE:SWN) to short the gas market. One should use caution when doing this, as many of these producers have already undergone enormous haircuts and are able to hedge gas prices and mitigate losses via other resource production. However, there are still pure play natural gas stocks that have not fully priced in the recent drop in the commodity. One in particular is San Juan Royalty Trust (NYSE:SJT).

SJT has a 75% net overriding royalty interest carved out of Burlington Resources Oil & Gas Company LPs oil and gas leasehold, and royalty interests located in the San Juan Basin in northwestern New Mexico. Burlington Resources Oil & Gas Company LP (a subsidiary of Conoco Phillips, COP) operates the drilling and sale of natural gas and distributes the net profit of the royalty interest every month. The trust is almost a pure play on natural gas production as oil makes up only about 3% of total revenues. Despite an almost 50% drop in natural gas price since July, SJT has only sold off about 20%. Using monthly price and production information from SJT, I have created a model to predict the future distributions as the stock begins to realize the lower gas prices.

The model below is a simple Excel spreadsheet in which I have inputted past price and production of SJT along with their reported capital costs, lease expenses, and taxes. Using this information and guidance from the operator, I can estimate production, capital costs, lease expenses, and taxes going forward. The only missing component to complete my model is the price of natural gas at the San Juan hub, which can be found at Note that the trust distribution lags two months, so the most recent distribution announced in January is for natural gas sales from November. Prices used in the model for December and January are the average selling price at the San Juan hub during those months. For February the model assumes current spot market prices over the course of the month.

You can see above, the model predicts a large decrease in the monthly distribution for SJT if gas prices remain low. Many SJT owners are long the stock for fixed income and a prolonged decrease may force them to sell. Back in 2009 natural gas prices briefly dropped below $3 and caused a large decrease in SJT distributions and stock price. During that four month period, distributions averaged only about $.02 per month and the stock price dipped below $14. Based on the model, current gas prices will only allow a distribution to SJT holders of about $.02 - $.03 per month, and a drop to $14 or lower certainly seems possible.

It must be noted that the above model has several inherent limitations that may skew future distribution predictions. First, I am assuming no hedging activity by the operator. Burlington Resources Oil and Gas Company LP (Conoco Phillips) can and does use derivatives to hedge natural gas prices. According to their latest 10Q filing for Conoco Phillips, the company is short the equivalent of 128 billion cubic feet of natural gas using basis and fixed price hedges. However, this is about one month of production for the company and likely only slightly improves average sales price. Additionally, Conoco could be forward selling or contract selling some or all of the natural gas at a premium. Although the gas prices SJT reported closely matched the prices at the San Juan hub for the first half of 2011, the second half of 2011 shows SJT is getting a premium on their sales (about 10% - 15%). If this premium continues, the model above will underestimate the distribution. Finally, the cost and tax assumptions made above are based on prior month data and 2011 guidance by the operator. If gas prices stay low, the operator could decide to lower capital spending or negotiate a more favorable lease which would increase the distribution.

Despite the potential limitations listed above, SJT still looks overvalued at current natural gas prices. Even if I give SJT a 20% premium on current prices they are still only selling their gas for $2.70, which equates to a distribution of about $.045 per month. With the current stock price at $19.20, it would yield a paltry 2.8% annually. Additionally, cutting capital costs may help the distribution in the short term, but it requires investing less in land development which will lead to lower production over time. Look for SJT distributions and shares to fall in the coming months as the trust begins to realize the recent drop in gas prices.

Disclosure: I am short SJT.