S A N J U A N B A S I N R O Y A L T Y T R U S T
1 9 9 5 A N N U A L R E P O R T & F O R M 1 0 - K
[PICTURE OF WORK GLOVES APPEARS HERE]
The principal asset of the San Juan Basin Royalty Trust (the "Trust") consists
of a 75% net overriding royalty interest carved out of certain of Southland
Royalty Company's ("Southland Royalty") oil and gas leasehold and royalty
interests in the San Juan Basin of northwestern New Mexico.
Units of Beneficial Interest The Units of Beneficial Interest of the Trust
("Units") are traded on the New York Stock Exchange under the symbol "SJT." From
January 1, 1994, to December 31, 1995, quarterly high and low sales prices and
the aggregate amount of monthly distributions per Unit paid each quarter were as
follows:
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1995 High Low Distribution
- --------------------------------------------------------------------------------
First Quarter $7.375 $5.875 $.090595
Second Quarter 7.250 5.625 .108430
Third Quarter 7.000 5.875 .071482
Fourth Quarter 6.875 5.750 .025360
Total for 1995 $.295867
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- --------------------------------------------------------------------------------
1994 High Low Distribution
- --------------------------------------------------------------------------------
First Quarter $9.875 $8.125 $.151503
Second Quarter 9.000 8.000 .182759
Third Quarter 8.875 7.375 .081320
Fourth Quarter 7.875 5.875 .070002
Total for 1994 $.485584
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At December 31, 1995, 46,608,796 Units outstanding were held by 2,906 Unit
holders of record. The following table presents information relating to the
distribution of ownership Units:
- --------------------------------------------------------------------------------
Type of Number of
Unit Holders Unit Holders Units Held
- --------------------------------------------------------------------------------
Individuals 2,286 4,170,017
Fiduciaries 537 995,603
Institutions 65 1,230,268
Brokers, Dealers and Nominees 10 38,679,138
Corporations and Partnerships 7 1,533,700
Miscellaneous 1 70
Total 2,906 46,608,796
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2
TO UNIT HOLDERS
We are pleased to present the 1995 Annual Report of the San Juan Basin
Royalty Trust. The report includes a copy of the Trust's Annual Report on Form
10-K to the Securities and Exchange Commission for the year ended December 31,
1995, without exhibits. The Form 10-K contains important information concerning
the Trust's properties, including the oil and gas reserves attributable to the
net overriding royalty interest owned by the Trust.
The Trust was established in November 1980 by Trust Indenture between
Southland Royalty and Texas American Bank/Fort Worth, N.A. Pursuant to the
Indenture, Southland Royalty conveyed to the Trust a 75% net overriding royalty
interest carved out of Southland Royalty's oil and gas leasehold and royalty
interest in the San Juan Basin of northwestern New Mexico. This net overriding
royalty interest (the "Royalty") is the principal asset of the Trust.
Effective January 1, 1996, Southland Royalty, a wholly-owned subsidiary of
Meridian Oil Inc. ("MOI") was merged with and into MOI, by which action the
separate corporate existence of Southland Royalty ceased and MOI survived and
succeeded to the ownership of all of the assets, has the rights, powers and
privileges and assumed all of the liabilities and obligations of Southland
Royalty. Production figures provided in this letter and in the Trustee's
Discussion and Analysis are based on information provided by Southland Royalty
and MOI.
Under the Trust Indenture, Bank One, Texas, NA (successor trustee) as
Trustee, has the primary function of collecting monthly net proceeds ("Royalty
Income") attributable to the Royalty and making the monthly distributions to the
Unit holders after deducting administrative expenses and any amounts necessary
for cash reserves.
Income distributed to Unit holders for the year 1995 was $13,790,101 or
$.295867 per Unit. This distributable income consisted of Royalty Income of
$15,156,292 plus interest income of $31,978, less administrative expenses of
$1,398,169.
In September 1988, the Trust was advised by Southland Royalty and its
affiliate MOI, both of which were subsidiaries of Burlington Resources, Inc.,
that they had initiated a drilling program in the San Juan Basin of northwestern
New Mexico involving development of Fruitland Coal Seam gas reserves on
properties in which the Trust owns an interest. For more information on the coal
seam drilling program and the related Federal income tax credit associated with
gas produced from coal seam wells drilled before January 1, 1993, please see the
"Description of the Properties" section of this Annual Report.
On June 5, 1995, the Trustee announced that non-binding mediation, which had
been ongoing with regard to the lawsuit filed against Southland Royalty and MOI
in the state district court in Santa Fe County, New Mexico, was not successful
in resolving the claims asserted by the Trust. Trial has been set for July 15,
1996.
Information about the Trust's estimated proved reserves of gas, including
coal seam gas, and of oil as well as the present value of net revenues
discounted at 10% can be found in Item 2 of the accompanying Form 10-K.
Royalty Income is generally considered portfolio income under the passive
loss rules enacted by the Tax Reform Act of 1986. Therefore, it appears that
Unit holders should not consider the taxable income from the Trust to be passive
income in determining net passive income or loss. Unit holders should consult
their tax advisors for further information.
Unit holders of record will continue to receive an individualized tax
information letter for each of the quarters ending March 31, June 30 and
September 30, 1996, and for the year ending December 31, 1996. Unit holders
owning Units in nominee name may obtain monthly tax information from the Trustee
upon request.
Bank One, Texas, NA, Trustee
By: /s/ Lee Ann Anderson
Lee Ann Anderson
Vice President
3
DESCRIPTION OF THE PROPERTIES
The San Juan Basin properties from which the Trust's net overriding royalty
interest was carved are located in San Juan, Rio Arriba and Sandoval counties of
northwestern New Mexico (the "Trust properties"). The Trust properties contain
151,900 (119,000 net) producing acres.
The Trust properties have historically produced gas primarily from
conventional wells drilled to three major formations: the Pictured Cliffs, the
Mesa Verde and the Dakota, ranging in depth from 1,500 to 8,000 feet. The
characteristics of these reservoirs result in the wells having very long
productive lives. A production index for oil and gas properties is the number of
years derived by dividing remaining reserves by current production. Based upon
the reserve report prepared by independent petroleum engineers as of December
31, 1995, the production index for the San Juan Basin properties is estimated to
be approximately 10.2 years.
During 1988, a drilling program was initiated involving development of
Fruitland Coal Seam gas reserves. Wells drilled in the Fruitland Coal Seam range
in depth from 2,500 to 3,500 feet on 320-acre spacing.
The process of removing coal seam gas is often referred to as degasification
or desorption. Millions of years ago, natural gas was generated in the process
of coal formation and adsorbed into the coal. Water later filled the natural
fracture system. When the water is removed from the natural fracture system,
reservoir pressure is lowered and the gas desorbs from the coal. The desorbed
gas then flows through the fracture system and is produced at the well bore. The
volume of formation water production typically declines with time and the gas
production may increase for a period of time before starting to decline. In
order to dispose of the formation water, surface facilities including pumping
units are required, which results in the cost of a completed well being as much
as $500,000.
From 1988 through December 31, 1995, Southland Royalty has participated in
the completion of 111 gross (74.46 net) and recompletions of 106 gross (65.80
net) coal seam wells on Trust properties. At December 31, 1995, 145 coal seam
wells had been connected to pipeline facilities. During 1995, these coal seam
wells produced a total of approximately 12,147,483 MMBtu (or 13,485,881 Mcf) of
gas from the Trust properties, which was sold at an average price of $.85 per
MMBtu.
Production from coal seam wells drilled prior to January 1, 1993, qualifies
for Federal income tax credits through 2002. For 1995 the credit was
approximately $1.01 per MMBtu. During 1995, potential Section 29 tax credits of
approximately $.103 per Unit were generated for Trust Unit holders from
production from coal seam wells.
During 1995, Southland Royalty incurred approximately $6,560,276 of capital
expenditures for the drilling and completion of 24 gross (11.41 net)
conventional wells, drilling and completion of 5 gross (2.54 net) coal seam
wells, recompleting 24 gross (11.41 net) coal seam wells, recompleting 38 gross
(8.61 net) conventional wells and other maintenance activities. There were 4
gross (1.89 net) coal seam wells and 7 gross (2.24 net) conventional wells in
progress at December 31, 1995. During 1994, Southland Royalty participated in
the completion of 13 gross (1.96 net) conventional wells, drilling and
completion of 8 gross (4.80 net) conventional wells as coal seam wells,
recompleting 44 gross (12.96 net) conventional wells and maintenance activities
and facilities costs at a cost of $9,409,000.
Due to the size of the coal seam drilling program in the San Juan Basin
during the last several years by various operators, there has been more gas
deliverability than available pipeline capacity. Consequently, these properties
produced only 20.4 Bcf during 1991. As a result, several natural gas
transportation companies commenced pipeline expansion projects which almost
doubled the available transportation capacity out of the San Juan Basin. These
projects were completed during 1992 and production increased to 26.6 Bcf for
1992 and to 34.4 Bcf for 1995. MOI has informed the Trustee that mainline
capacity out of the San Juan Basin is approximately 2.93 Bcf per day for El Paso
Natural Gas Pipeline Company and approximately .52 Bcf per day for Transwestern
Pipeline Company.
Based on existing geological and pricing information, there are
approximately 25 net conventional gas wells remaining to be drilled on the Trust
properties. Proved undeveloped reserves have been assigned to these wells. MOI
has advised the Trust that its 1996 capital projections for Trust working
interests are estimated to be in the range of the amount spent in 1995.
Fruitland Coal is estimated to be approximately 15% of the total and the
remainder would be conventional projects. Development plans are dependent upon
numerous factors, including, but not limited to, drilling results of gas wells,
anticipated demand for gas, the sales price of gas, cost to drill the wells and
other factors that MOI may deem appropriate. Gas production from the Trust
properties is sold in both interstate and intrastate commerce under the Natural
Gas Policy Act of 1978 ("NGPA"). For a further discussion of gas pricing, gas
purchasers, gas production and regulatory matters affecting gas production see
"Item 2. Properties," in the accompanying Form 10-K.
4
[PICTURE OF PICK AX APPEARS HERE]
TRUSTEE'S DISCUSSION AND ANALYSIS
Distributable income consists of Royalty Income plus interest, less the
general and administrative expenses of the Trust and any changes in cash
reserves established by the Trustee. For the year ended December 31, 1995,
distributable income was $13,790,101, which was less than the $22,632,493
distributed in 1994. The net decrease was primarily attributable to
significantly lower gas prices. Interest income decreased from $38,129 in 1994
to $31,978 in 1995 primarily due to decreased funds available for investment.
Royalty Income for the calendar year is associated with actual gas and oil
production during the period from November of the preceding year through
October. Gas and oil sales attributable to the Royalty for the past five years,
excluding portions attributable to litigation settlement proceeds (see Note 6 to
accompanying Financial Statements), are summarized in the following table:
- ------------------------------------------------------------------------------------------------------------------------------------
1995 1994 1993 1992 1991
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Gas - Mcf 13,331,758 15,459,542 23,895,506 13,984,645 6,892,757
Average Price (per Mcf) $1.25 $1.66 $1.70 $1.57 $1.66
Oil - Bbls 29,424 36,769 51,921 41,087 21,878
Average Price (per Bbl) $14.43 $13.09 $15.58 $17.65 $20.50
- ------------------------------------------------------------------------------------------------------------------------------------
The average gas price declined in 1992 primarily as a result of lower spot
market prices in the second and third quarters of 1992. Due to the increase in
the average price of gas in the first quarter of 1993, the average price for the
year increased. Gas and oil prices declined in 1994. Gas prices plummeted in the
San Juan Basin in 1995 due to a surplus of gas supplies. Since the oil and gas
sales attributable to the Royalty are based on an allocation formula that is
dependent on such factors as price and cost, the production amounts do not
provide a meaningful comparison.
Total gas and oil production from the properties from which the Royalty was
carved for the five years ended December 31, 1995, were as follows:
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1995 1994 1993 1992 1991
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Gas - Mcf 34,387,190 34,222,189 40,736,391 26,642,265 20,390,665
Mcf per day 94,211 93,759 111,607 72,993 55,865
Oil - Bbls 75,014 84,648 88,466 79,600 74,005
Bbls per day 206 232 242 218 203
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The fluctuations in annual gas production that have occurred during these
five years generally resulted from changes in the demand for gas during that
time, marketing conditions and production from new wells. Production from the
properties from which the Royalty was carved is influenced by the line pressures
of the gas gathering systems in the San Juan Basin. Expansion during 1992 of the
gas transmission systems that transport gas out of the San Juan Basin resulted
in increased production beginning in 1992. Higher volumes in 1993 can be
partially attributed to gas balancing in the San Juan 30-6 Federal Unit which
occurred in the third and fourth quarters of 1993. Production from the 30-6 Unit
was more normalized in 1994 and 1995.
6
Royalty Income for the five years ended December 31,
1995, was determined as shown in the following table:
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1995 1994 1993 1992 1991
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Gross Proceeds from the
Southland Royalty Properties
from which the Trust's Overriding
Royalty was carved:
Gas $41,483,305 $54,357,586 $69,266,623 $41,961,599 $29,399,897
Oil 1,084,262 1,140,738 1,384,468 1,409,179 1,453,798
Other 2,592 -0- -0- -0- -0-
Litigation Settlement -0- -0- -0- 16,118,174 14,726,971
----------- ----------- ----------- ----------- -----------
Total 42,570,159 55,498,324 70,651,091 59,488,952 45,580,666
----------- ----------- ----------- ----------- -----------
Less Production Costs:
Capital Costs 6,560,277 9,409,462 3,988,136 2,530,833 3,164,737
Severance Tax - Gas 4,694,750 5,864,834 6,543,615 3,696,172 2,569,476
Severance Tax - Oil 115,474 117,028 153,072 155,663 164,280
Severance Tax - Other 117 -0- -0- -0- -0-
Severance Tax - Litigation -0- -0- -0- 356,944 370,522
Lease Operating Expenses 10,991,152 9,066,750 9,864,773 9,423,403 10,459,171
----------- ----------- ----------- ----------- -----------
Total 22,361,770 24,458,074 20,549,596 16,163,015 16,728,186
----------- ----------- ----------- ----------- -----------
Net Profits 20,208,389 31,040,250 50,101,495 43,325,937 28,852,480
Royalty Percentage 75% 75% 75% 75% 75%
Royalty Income $15,156,292 $23,280,188 $37,576,121 $32,494,453 $21,639,360
=========== =========== =========== =========== ===========
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The capital costs incurred by Southland Royalty on the properties from which
the Royalty was carved for the year ended December 31, 1995, amounted to
$6,560,277 versus $9,409,462 for 1994. The decrease was primarily attributable
to fewer recompletions. The litigation settlement and the related severance
taxes pertain to The Public Service Company of New Mexico litigation which was
settled during 1990. (See Note 6 to accompanying Financial Statements.) Monthly
operating costs in 1995 averaged approximately $876,000, which is higher than
the $755,000 average in 1994 due to a variety of factors that included braden
head repairs, recompletions and numerous wells that were shut-in during 1994 and
began flowing in 1995. Non-operated lease operating expense is subject to
significant fluctuations due to invoice timing issues. There are a large number
of non-operated properties that are burdened by the Trust.
7
RESULTS OF THE 4TH QUARTERS OF 1995 AND 1994
Distributable income for the quarter ended December 31, 1995, totaled
$1,182,038 ($.025361 per Unit) as compared to $3,262,714 ($.070002 per Unit) for
the quarter ended December 31, 1994. The amount distributed in the fourth
quarter of 1995 was lower than that of 1994 primarily because of the lower
average price of gas sold.
Royalty Income of the Trust for the fourth quarter is associated with actual
gas and oil production during August through October of each year. Gas and oil
sales for the quarters ended December 31, 1995 and 1994 were as follows:
- --------------------------------------------------------------------------------
1995 1994
- --------------------------------------------------------------------------------
Properties From Which the Royalty Was Carved
Gas - Mcf 8,929,852 8,490,235
Average Price (per Mcf) $.98 $1.27
Oil - Bbls 17,681 20,230
Average Price (per Bbl) $14.72 $14.46
Attributable to the Royalty
Gas - Mcf 1,864,559 2,811,893
Oil - Bbls 3,663 6,543
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[PICTURE OF MAP SHOWING THE SAN JUAN BASIN AREA, LEASEHOLD ACREAGE, MINERAL
ACERAGE, GAS FIELDS AND OIL FIELDS OF THE TRUST APPEARS HERE]
The average price of gas decreased in the fourth quarter of 1995 primarily
due to decreases in prices paid by Meridian Oil Trading, Inc. ("MOTI"), a
subsidiary of MOI that markets a substantial portion of the Trust's gas. The
average price of oil increased compared to the prior year because of increases
in the posted prices. Gas production increased primarily due to increased demand
from gas purchasers. During the fourth quarter of 1995, coal seam production
from the properties from which the Royalty was carved averaged 1,173,000 Mcf per
month compared to 1,213,000 Mcf per month during the fourth quarter of 1994.
Capital costs for the fourth quarter of 1995 totaled $2,413,744 compared to
$3,242,330 during the same period of 1994. The decrease was due to decreased
drilling activity. Lease operating costs for the fourth quarter of 1995 averaged
$1,025,000 per month compared to $721,000 per month in the fourth quarter of
1994. The increase relates to various recompletions, valve repairs and
compressor rental expense. Non-operated properties are subject to invoice timing
issues.
8
[PICTURE OF PIPE WRENCH APPEARS HERE]
SAN JUAN BASIN ROYALTY TRUST
Statements of Assets, Liabilities and Trust Corpus
December 31, 1995 and 1994
- -------------------------------------------------------------------------------
1995 1994
- -------------------------------------------------------------------------------
Assets
Cash and Short-term Investments $ 421,446 $ 589,365
Net Overriding Royalty Interest in
Producing Oil and
Gas Properties - Net (Notes 2 and 3) 70,133,536 74,942,040
----------- -----------
$70,554,982 $75,531,405
=========== ===========
Liabilities and Trust Corpus
Distribution Payable to Unit Holders $ 421,446 $ 589,365
Contingencies (Note 5) -- --
Trust Corpus - 46,608,796 Units of
Beneficial Interest
Authorized and Outstanding 70,133,536 74,942,040
----------- -----------
$70,554,982 $75,531,405
=========== ===========
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Statements of Distributable Income
for the Three Years Ended December 31, 1995
- -------------------------------------------------------------------------------
1995 1994 1993
- -------------------------------------------------------------------------------
Royalty Income (Notes 2, 3 and 6) $15,156,292 $23,280,188 $37,576,121
Interest Income 31,978 38,129 45,491
----------- ----------- -----------
15,188,270 23,318,317 37,621,612
Expenditures - General and
Administrative 1,398,169 685,824 860,815
----------- ----------- -----------
Distributable Income $13,790,101 $22,632,493 $36,760,797
----------- ----------- -----------
Distributable Income per Unit
(46,608,796 units) $ .295867 $ .485584 $ .788710
=========== =========== ===========
- -------------------------------------------------------------------------------
Statements of Changes in Trust Corpus for the
Three Years Ended December 31, 1995
- -------------------------------------------------------------------------------
1995 1994 1993
- -------------------------------------------------------------------------------
Trust Corpus, Beginning of Period $74,942,040 $79,898,032 $88,215,333
Amortization of Net Overriding
Royalty Interest (Notes 2 and 3) (4,808,504) (4,955,992) (8,317,301)
Distributable Income 13,790,101 22,632,493 36,760,797
Distributions Declared (13,790,101) (22,632,493) (36,760,797)
----------- ----------- -----------
Trust Corpus, End of Period $70,133,536 $74,942,040 $79,898,032
=========== =========== ===========
- -------------------------------------------------------------------------------
The accompanying Notes to Financial Statements are an integral part of this
statement.
10
SAN JUAN BASIN ROYALTY TRUST NOTES TO FINANCIAL STATEMENTS
1. Trust Organization and Provisions
The San Juan Basin Royalty Trust ("Trust") was established as of November 1,
1980. Bank One, Texas, NA ("Trustee") is Trustee for the Trust. Southland
Royalty Company ("Southland") conveyed to the Trust a 75% net overriding royalty
interest ("Royalty") in Southland's working interests and royalty interests in
the San Juan Basin in northwestern New Mexico.
On November 3, 1980, units of beneficial interest ("Units") in the Trust
were distributed to the Trustee for the benefit of Southland shareholders of
record as of November 3, 1980, who received one Unit in the Trust for each share
of Southland common stock held. The Units are traded on the New York Stock
Exchange.
The terms of the Trust Indenture provide, among other things, that:
. The Trust shall not engage in any business or commercial activity of any
kind or acquire any assets other than those initially conveyed to the Trust;
. the Trustee may not sell all or any part of the Royalty unless approved by
holders of 75% of all Units outstanding, in which case the sale must be for
cash and the proceeds promptly distributed;
. the Trustee may establish a cash reserve for the payment of any liability
which is contingent or uncertain in amount;
. the Trustee is authorized to borrow funds to pay liabilities of the Trust;
and
. the Trustee will make monthly cash distributions to Unit holders (see
Note 2).
2. Net Overriding Royalty Interest and Distribution to Unit Holders
The amounts to be distributed to Unit holders ("Monthly Distribution Amounts")
are determined on a monthly basis. The Monthly Distribution Amount is an amount
equal to the sum of cash received by the Trustee during a calendar month
attributable to the Royalty, any reduction in cash reserves and any other cash
receipts of the Trust, including interest, reduced by the sum of liabilities
paid and any increase in cash reserves. If the Monthly Distribution Amount for
any monthly period is a negative number, then the distribution will be zero for
such month. To the extent the distribution amount is a negative number, the
amount will be carried forward and deducted from future monthly distributions
until the cumulative distribution calculation becomes a positive number, at
which time a distribution will be made. Unit holders of record will be entitled
to receive the calculated Monthly Distribution Amount for each month on or
before ten business days after the monthly record date, which is generally the
last business day of each calendar month.
The cash received by the Trustee consists of the amounts received by the
owner of the interest burdened by the Royalty from the sale of production less
the sum of applicable taxes, accrued production costs, development and drilling
costs, operating charges and other costs and deductions, multiplied by 75%.
The initial carrying value of the Royalty ($133,275,528) represented
Southland's historical net book value at the date of the transfer to the Trust.
Accumulated amortization as of December 31, 1995 and 1994 aggregated $63,141,992
and $58,333,488, respectively.
3. Basis of Accounting
The financial statements of the Trust are prepared on the following basis:
. Royalty income recorded for a month is the amount computed and paid by the
working interest owner, Southland, to the Trustee on behalf of the Trust.
Royalty income consists of the amounts received by the owner of the interest
burdened by the net overriding royalty interest from the sale of production
less accrued production costs, development and drilling costs, applicable
taxes, operating charges, and other costs and deductions, multiplied by 75%.
. 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 overriding royalty interests to the
Trust provides that any excess of production costs over gross proceeds must
be recovered from future net profits.
The financial statements of the Trust differ from financial statements
prepared in accordance with generally accepted accounting principles ("GAAP")
because revenues are not accrued in the month of production and certain cash
reserves may be established for contingencies which would not be
11
accrued in financial statements prepared in accordance with GAAP. Amortization
of the Royalty calculated on a unit-of-production basis is charged directly to
trust corpus.
4. Federal Income Taxes
For Federal income tax purposes, the Trust constitutes a fixed investment trust
which is taxed as a grantor trust. A grantor trust is not subject to tax at the
trust level. The Unit holders are considered to own the Trust's income and
principal as though no trust were in existence. The income of the Trust is
deemed to have been received or accrued by each Unit holder at the time such
income is received or accrued by the Trust rather than when distributed by the
Trust.
The Royalty constitutes an "economic interest" in oil and gas properties for
Federal income tax purposes. Unit holders must report their share of the
revenues of the Trust as ordinary income from oil and gas royalties, and are
entitled to claim depletion with respect to such income. The Royalty is treated
as a single property for depletion purposes.
The Trust has on file technical advice memoranda confirming the tax
treatment described above.
The Trust began receiving royalty income from coal seam wells beginning in
1989. Under Section 29 of the Internal Revenue Code, production from coal seam
gas wells drilled prior to January 1, 1993, qualifies for the Federal income tax
credit for producing non-conventional fuels. This tax credit was approximately
$1.02 per MMBtu for the year 1995 and is adjusted for inflation annually. The
credit currently applies to production through the year 2002. Each Unit holder
must determine his pro rata share of such production based upon the number of
Units owned during each month of the year and apply the tax credit against his
own income tax liability, but such credit may not reduce his regular tax
liability (after the foreign tax credit and certain other nonrefundable credits)
below his tentative minimum tax. Section 29 also provides that any amount of
Section 29 credit disallowed for the tax year solely because of this limitation
will increase his credit for prior year minimum tax liability, which may be
carried forward indefinitely as a credit against the taxpayer's regular tax
liability, subject, however, to the limitations described in the preceding
sentence. There is no provision for the carryback or carryforward of the Section
29 credit in any other circumstances.
The classification of the Trust's income for purposes of the passive loss
rules may be important to a Unit holder. As a result of the Tax Reform Act of
1986, royalty income will generally be treated as portfolio income and will not
reduce passive losses.
5. Commitments and Contingencies
On June 4, 1992, the Trustee filed suit against Meridian Oil Inc. ("MOI")
and Southland in the state district court in Rio Arriba County, New Mexico,
Cause No. RA 92-1211(C). In a decision filed August 8, 1994, the Supreme Court
of New Mexico ruled that venue was not proper in Rio Arriba County and remanded
the case for dismissal without prejudice to its refiling. In its ruling, the
Supreme Court of New Mexico also ruled that venue was proper in Santa Fe County,
New Mexico. Such decision did not relate to merits of the Trust's claims. The
Trustee refiled the lawsuit in Santa Fe County, New Mexico on August 31, 1994,
in Cause No. SF 94-1982(C).
The principal asset of the Trust consists of a 75% net overriding royalty
interest carved out of certain of Southland's oil and gas leasehold and royalty
interests in the San Juan Basin located in San Juan, Rio Arriba and Sandoval
counties of northwestern New Mexico (the "Trust Properties"). MOI and Southland
are the operators of the Trust Properties.
The claims asserted on behalf of the Trust in the Santa Fe County, New
Mexico, lawsuit now include breach of contract, breach of the covenant of good
faith and fair dealing, breach of express good faith duty, constructive fraud,
unjust enrichment, prima facie tort, intentional interference with contract and
conspiracy. The relief sought includes compensatory and punitive damages, an
accounting and a permanent injunction relating to the operation of the Trust
Properties.
In response to the Trustee's lawsuit, Southland filed suit on August 7, 1992
against the Trustee in Probate Court in Tarrant County, Texas, Cause
No. 92-1927-2. The lawsuit seeks declaratory relief that: (i) the rights and
duties of the Trustee be governed in accordance with and by the terms and
provisions of the Trust instruments which establish the Trust as well as the
Texas Trust Code, (ii) the Trustee cannot object to Southland's reports or
audits after 180 days, (iii) the interests held by the Trust are not subject to
partition, and (iv) the Trust is without standing to remove Southland as
operator of the Trust Properties. The lawsuit also seeks to remove Bank One,
Texas, NA, as Trustee.
Southland has filed a counter-claim in the Santa Fe County
12
[PICTURE OF DRILL BIT APPEARS HERE]
lawsuit seeking declaratory relief as follows:
A. That Southland's policy and practice of remitting payments to the Trustee
for the net overriding royalty interest ("NORI") based on the proceeds actually
received by Southland at prevailing prices in the area of production constitutes
good faith compliance with its duties and obligations under the net overriding
royalty conveyance filed of record in San Juan County, New Mexico, on November
21, 1980 ("Conveyance");
B. That the revenue or profits realized by MOTI and Meridian Oil
Hydrocarbons Inc. ("MOHI") on subsequent downstream resale or treatment of the
gas is immaterial to the calculation and payment of the NORI;
C. That Meridian Oil Gathering Inc. ("MOGI") is not compelled or required to
grant the Trustee a discounted fee or rate (different and less than that charged
by MOGI to the owners of other interests) for gathering and processing services
provided by MOGI;
D. That the Trustee has no power or authority under the Conveyance or the
San Juan Basin Royalty Trust Indenture dated November 3, 1980 ("Indenture") to
take exception to the quarterly and annual reports and audits by Southland
relating to the NORI that were not timely excepted to in writing by the Trustee
as required by Section 2.04 of the Conveyance, and that the reports and audits
are deemed to be correct as rendered;
E. That Southland is entitled to its costs, attorneys' fees and for such
other relief as the Court deems just and proper.
On June 5, 1995, the Trustee announced that non-binding mediation, which had
been ongoing with regard to the lawsuit filed in Santa Fe County, New Mexico,
was not successful in resolving the claims asserted by the Trust. Trial is
currently set in the Santa Fe County, New Mexico, lawsuit for July 15, 1996.
A resolution of the Santa Fe County, New Mexico, lawsuit favorable to the
Trust could possibly have a material effect on distributable income depending on
the nature and terms of the resolution.
6. Litigation Settlement Distribution
Southland entered into five-year gas, gas processing and gas gathering
agreements with Sunterra Gas Gathering Company (a subsidiary of Public Service
Company of New Mexico) ("Sunterra") and Gas Company of New Mexico (a division of
Public Service Company of New Mexico) ("Gas Company") that were effective as of
July 1, 1990. The new contracts applied to all lands previously dedicated to
Sunterra and Gas Company for first sales of natural gas sold into interstate or
intrastate markets, except that the new gas purchase contracts excluded all gas
produced and sold from coal seam wells. The new gas purchase contracts provided
for purchases by Sunterra and Gas Company for winter heating season only. During
the remainder of the year, Southland could market the gas through any
arrangements it deemed advisable. Under the new gas purchase contracts,
Southland received prices, inclusive of severance taxes, ranging from
approximately $2.35 per MMBtu to $3.37 per MMBtu over the life of the contracts.
The contracts also provided for certain "take-or-pay obligations" if certain
minimum levels of natural gas sales are not reached.
In 1991, due to the low level of natural gas prices, Sunterra informed
Southland that it would not take any significant volume of gas during the
1991-1992 winter heating season and would simply pay the "take-or-pay
obligation" amount. Consequently, the majority of the wells subject to the
contracts would have remained shut-in during the winter heating season. In an
attempt to maximize production and revenues from Trust properties, Southland
informed the Trustee that it entered into an agreement with Sunterra and Gas
Company that amended the terms of the contracts discussed above for only the
1991-1992 winter heating season. The amendment provided that Sunterra and Gas
Company could purchase approximately 35% of the contract provided take levels at
a wellhead price slightly higher than the spot market wellhead index price for
the San Juan Basin. Any gas purchased by Sunterra and Gas Company above this
level averaged $2.63 per MMBtu. Southland was free to market the remaining
deliverable gas to other purchasers. During 1992, Sunterra and Gas Company
purchased 3,241,550 Mcf and 702,629 Mcf, respectively, at average prices of
$1.98 and $2.25 per Mcf, respectively, from the properties from which the
Royalty was carved.
To continue to maximize production and revenues from Trust properties,
Southland again informed the Trustee that it negotiated an agreement with
Sunterra and Gas Company that amended the terms of the original contracts
discussed above for only the 1992-1993 winter heating season. The amendment
provided that Gas Company and Sunterra were required to purchase a minimum of
11,500 MMBtu per day at $2.695 per MMBtu under the intrastate and a minimum of
16,550 MMBtu per day at $2.94 per MMBtu under the interstate contracts. A
portion of the excess gas was released for spot sales, with a recall provision
at an average contract price.
Southland informed the Trust that a similar amendment was
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entered into for the 1993-1994 winter heating season. Gas Company and Sunterra
paid the contract specified prices of $2.88 and $3.15 per MMBtu, respectively,
on a minimum purchase of 1.4 Bcf and 1.2 Bcf, respectively. All remaining gas
was released for spot sales with a recall provision at an average contract
price. Southland waived any claims for deficiency payment under the reservation
fee.
Southland informed the Trust an amendment had also been entered into for the
1994-1995 winter heating season. Gas Company and Sunterra were required to
purchase, at the wellhead, an average volume of 10,529 MMBtu per day at $2.884
per MMBtu for the period beginning November 1, 1994, and ending March 31, 1995,
and an additional 14,900 MMBtu per day at $3.146 per MMBtu for the period
beginning December 1, 1994, and ending February 28, 1995. Gas Company and
Sunterra were granted a make-up period of four months beginning April 1, 1995,
to fulfill this purchase obligation.
Gas Company and Sunterra were also granted recall rights on volumes up to
15,000 MMBtu per day at the tailgate of the Kutz and Lybrook plants, provided
they nominated the full contract volume specified above. The price for recall
gas was the average of the first and second issues of the Inside FERC EPNG SJ
Index.
Southland has also advised the Trust that effective July 1, 1995, Williams
Field Services ("Williams") purchased the Kutz and Lybrook processing plants and
the gathering systems behind these plants which were owned by Sunterra, Gas
Company and Sunterra Gas Processing Company ("SGPC") and that new gathering and
processing agreements with Williams have been entered into which contain
acceptable rates, terms and conditions. The new agreements replaced the then
current gathering and processing agreements with Gas Company, Sunterra and SGPC
effective on the closing date of the sale of these facilities to Williams.
The Trust has further been advised by Southland that MOTI negotiated an
agreement with Gas Company providing for transportation service on Gas Company's
Albuquerque mainline. This agreement was effective on the closing date of the
sale of Gas Company's gathering and processing facilities to Williams. This
transportation agreement will be necessary to deliver volumes of gas behind the
Lybrook processing plant to mainline delivery points.
Southland has further advised the Trust that on September 13, 1994, MOTI,
one of the first purchasers of MOI producing affiliates' gas, entered into a gas
sales agreement with Gas Company for the next five winter periods beginning
November 1, 1995, and ending March 31, 2000. MOTI will be purchasing the gas
supplied for this sale from MOI producing affiliates and other third party
sellers. Sales will be based on a monthly published index. Valid delivery points
under the agreement will be the tailgate of the Lybrook Plant, the tailgate of
the Kutz Plant, the Blanco Hub, or Rio Puerco.
It is the understanding of the Trustee that Gas Company is now known as PNM
Gas Services.
While it is impossible to determine the exact economic value to be derived
under these agreements, Southland has advised the Trust that it considers the
terms of these agreements to be favorable, and of substantial additional value.
7. Significant Customers
Information as to significant purchasers of oil and gas production attributable
to the Trust's economic interests is included in Item 2 of the Trust's annual
report on Form 10-K which is included in this report.
8. Proved Oil and Gas Reserves (Unaudited)
Proved oil and gas reserve information is included in Item 2 of the Trust's
annual report on Form 10-K which is included in this report.
9. Quarterly Schedule of Distributable Income (Unaudited)
The following is a summary of the unaudited quarterly schedule of distributable
income for the two years ended December 31, 1995 (in thousands, except unit
amounts):
- --------------------------------------------------------------------------------
Distributable
Income and
Royalty Distributable Distribution
1995 Income Income Per Unit
- --------------------------------------------------------------------------------
First Quarter $ 4,476 $ 4,222 $.090595
Second Quarter 5,458 5,054 .108430
Third Quarter 3,542 3,332 .071482
Fourth Quarter 1,680 1,182 .025360
------- ------- --------
Total $15,156 $13,790 $.295867
======= ======= ========
1994
- --------------------------------------------------------------------------------
First Quarter $ 7,232 $ 7,061 $.151503
Second Quarter 8,762 8,518 .182759
Third Quarter 3,924 3,790 .081320
Fourth Quarter 3,362 3,263 .070002
------- ------- --------
Total $23,280 $22,632 $.485584
======= ======= ========
- --------------------------------------------------------------------------------
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INDEPENDENT AUDITORS' REPORT
Bank One, Texas, NA as Trustee for the
San Juan Basin Royalty Trust:
We have audited the accompanying statements of assets, liabilities and trust
corpus of the San Juan Basin Royalty Trust ("Trust") as of December 31, 1995 and
1994, and the related statements of distributable income and changes in trust
corpus for each of the three years in the period ended December 31, 1995. These
financial statements are the responsibility of the Trustee. Our responsibility
is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by the
Trustee, as well as evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
As described in Note 3 to the financial statements, these financial
statements were prepared on a modified cash basis, which is a comprehensive
basis of accounting other than generally accepted accounting principles.
In our opinion, such financial statements present fairly, in all material
respects, the assets, liabilities and trust corpus of the San Juan Basin Royalty
Trust as of December 31, 1995 and 1994 and the distributable income and changes
in trust corpus for each of the three years in the period ended December 31,
1995 on the basis of accounting described in Note 3.
/s/ Deloitte & Touche LLP
Deloitte & Touche LLP
Fort Worth, Texas
April 11, 1996
- --------------------------------------------------------------------------------
San Juan Basin Royalty Trust Legal Counsel
Bank One, Texas, NA, Trustee Shannon, Gracey, Ratliff & Miller, L.L.P.
Post Office Box 2604 Fort Worth, Texas
Fort Worth, Texas 76113
Tax Counsel
Auditors Butler & Binion, L.L.P.
Deloitte & Touche LLP Houston, Texas
Fort Worth, Texas
Transfer Agent
Harris Trust & Savings Bank
Chicago, Illinois
Design: Witherspoon & Associates
Photography: Studio 44 Photography
Oil field supplies courtesy of East Texas Oil Museum,
Kilgore College, Kilgore, Texas
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