SAN JUAN BASIN ROYALTY TRUST 10-K

ITEM 5. MARKET FOR REGISTRANT ’ S UNITS, RELATED UNIT HOLDER MATTERS AND ISSUER PURCHASES OF UNITS Units of Beneficial Interest The Trust’s units of beneficial interest (the “Units”) are traded on the New York Stock Exchange under the symbol “SJT.” Dividend Policy The Trust makes monthly cash distributions to the Unit Holders. The aggregate monthly distribution amount is the excess of (i) the Royalty Income attributable to the Royalty paid to the trustee of the Trust, plus any decrease in cash reserves previously established for liabilities and contingencies of the Trust, over (ii) the expenses and payments of liabilities of the Trust, plus any net increase in cash reserves. Future payments of cash distributions are dependent on such factors as prevailing natural gas and oil prices, expenses, increases in cash reserves and the actual production from the Subject Interests. Actualizations from prior periods may also impact the ability of the Trust to pay distributions or may affect the amount of distributions payable to the Unit Holders. Unit Holders According to the records of our transfer agent, as of March 21, 2022, there were 46,608,796 Units outstanding held by 800 Unit Holders of record. The actual number of Unit Holders is greater than these numbers of Unit Holders of record and includes Unit Holders who are beneficial owners, but whose shares are held in street name by brokers and nominees. The number of Unit Holders of record also does not include Unit Holders whose Units may be held in trust by other entities. Equity Compensation Plans The Trust has no directors, executive officers or employees. Accordingly, the Trust does not maintain any equity compensation plans and there are no Units reserved for issuance under any such plans. ITEM 6. SELECTED FINANCIAL DATA Not Required. ITEM 7. TRUSTEE ’ S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS As discussed herein under Part II, Item 9A (Controls and Procedures), due to the pass-through nature of the Trust, Hilcorp is the primary source of the information disclosed in this Annual Report on Form 10-K and the other periodic reports filed by the Trust with the SEC. Although the Trustee receives periodic updates from Hilcorp regarding activities which may relate to the Trust, the Trust’s ability to timely report certain information required to be disclosed in the Trust’s periodic reports is dependent on Hilcorp’s timely delivery of the information to the Trust. Overview The principal asset of the Trust is the Royalty, which consists of a 75% net overriding royalty interest that burdens the Subject Interests located in the San Juan Basin. The primary function of the Trustee is to collect the Royalty Income, to pay all expenses and charges of the Trust and to 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. 12 Royalty Income . The Royalty functions generally as a net profits interest in the Subject Interests. The Royalty Income paid to the Trust is 75% of Net Proceeds from the Subject Interests. The term “Net Proceeds,” as used in the Conveyance, means the excess of Gross Proceeds received by Hilcorp during a particular period over production costs for such period. “Gross Proceeds” means the amount received by Hilcorp (or any subsequent owner of the Subject Interests) from the sale of the production attributable to the Subject Interests, subject to certain adjustments (e.g., fuel, gathering, and transportation). The amount of Gross Proceeds attributable to the Subject Interests depends on prevailing natural gas prices and, to a lesser extent, crude oil prices. As a result, commodity prices affect the amount of Royalty Income available for distribution to the Unit Holders. During 2021, the price of natural gas Gross Proceeds for production from the Subject Interests increased from an average price for natural gas of $1.51 per Mcf in 2020 to $3.20 per Mcf in 2021. The price for oil Gross Proceeds increased from an average price of $31.47 per Bbl in 2020 to $54.72 per Bbl in 2021. The amount of Gross Proceeds also depends on the volumes of natural gas and oil produced from the Subject Interests. Under the terms of the Indenture, the Trust cannot acquire new natural gas and oil assets, and as a result, Royalty Income is dependent on the natural gas and oil volumes attributable to the Subject Interests. Although Hilcorp and other operators of the Subject Interests may conduct drilling operations or well recompletions in the near term, the Subject Interests are depleting assets, and Hilcorp has informed the Trust that it is unable to estimate the productive life of the Subject Interests. The reduction in proved reserve quantities is a common measure of depletion. Hilcorp’s (or a future operator’s) capital investments in the Subject Interests will affect the quantity of proved reserves and can offset any reduction in proved reserves. Lower commodity prices may also reduce the volume of natural gas and oil produced from the Subject Interests by Hilcorp. Hilcorp did not conduct any new drill projects or recompletions within the Subject Interests in 2021. On February 17, 2022, the Trust announced that Hilcorp had provided the Trust with its 2022 capital project plan for the Subject Interests (the “2022 Plan”), and Hilcorp has estimated its 2022 capital expenditures for the Subject Interests to be $1.9 million. Hilcorp informed the Trust that its 2022 Plan will allocate approximately $1.5 million of the 2022 Plan’s budget towards 24 well recompletions and workovers scheduled to be completed in the Mesaverde, Pictured Cliffs and Fruitland Coal formations. Approximately $300,000 of the 2022 Plan’s budget will be allocated to facilities projects related to natural gas compression, and approximately $100,000 will be spent for permitting and surveying costs for future new drill projects that are being considered for 2023 and 2024. Hilcorp further informed the Trust that its planned project status for 2022 is subject to revision if Hilcorp revises its assumptions underlying the 2022 Plan, and that actual capital costs may vary from these estimates. Under the terms of the Conveyance, production costs are deducted from Gross Proceeds in calculating Royalty Income. “Production costs” generally means costs incurred on an accrual basis by Hilcorp in operating the Subject Interests, including both capital and non-capital costs. For example, these costs include development drilling, production and processing costs, applicable taxes and operating charges. However, Hilcorp informed the Trust that, for wells operated by Hilcorp, it generally did not intend to accrue lease operating expenses to the Trust. If production costs exceed Gross Proceeds in any month, the excess is recovered out of future Gross Proceeds prior to the making of further payment to the Trust, but the Trust is not otherwise liable for any production costs or other costs or liabilities attributable to the Subject Interests or the minerals produced therefrom. 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. The Trust and the Trustee has very limited authority to control the amount and timing of production costs. Distributable Income . In addition to Royalty Income, the Trust receives interest income, typically from interest paid on cash deposits. General and administrative expenses constitute the Trust’s primary expense and include, among other items, the Trustee’s fees, audit, consulting and legal fees and reporting costs. 13 The Trustee is authorized to determine in its discretion the amount of cash reserves needed to pay liabilities and contingencies of the Trust. Total cash reserves were $1.0 million as of December 31, 2020 and 2021. In August 2021, the Trust utilized cash reserves of $150,148 to pay Trust administrative expenses. The Trust replenished its cash reserves by $150,148 in September 2021 to bring the cash reserve balance back to the previously established amount of $1.0 million. The Trustee does not anticipate any increase or decrease to the cash reserves in 2022. Hilcorp The sale of San Juan Basin assets, including the Subject Interests, from Burlington to Hilcorp closed on July 31, 2017. 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. Gross Proceeds and Severance Tax Estimates. Hilcorp’s process of reconciling actual revenue and severance taxes to previously reported estimates (which the Trust refers to as “true-ups”) during fiscal years 2018 and 2020 were still occurring and being reported in 2021. At the beginning of 2021, Hilcorp informed the Trust that it planned to refine further its estimating and reporting processes, and that Hilcorp would review prior periods to ensure greater accuracy and consistency, both for prior periods as well as future reporting periods. As part of that review process, Hilcorp informed the Trust that it would reverse and rebook revenue for certain prior periods. Thus, distributions to the Trust from Hilcorp in certain months during 2021 were subject to adjustments based upon prior months’ true-ups and rebooking, plus interest. Hilcorp has informed the Trust that it has completed its transition to its new accounting system that began in March 2021. Therefore, revenue and expenses for the production months of January through May 2021 were based on estimates, but Hilcorp began reporting actual revenue and expenses for operated wells beginning with the June 2021 production month. As of December 31, 2021, Hilcorp believes that all prior month actualizations have occurred, and does not expect to need to report any further actualizations in future distribution reports. In 2021, Hilcorp made total actualizations and other adjustments resulting in an additional $4,650,061 Royalty Income paid to the Trust based on the production months of June 2018 through December 2018, July 2020 through October 2020, and January 2021 through May 2021. 14 Results of Operations Royalty Income consists of 75% of the monthly Net Proceeds attributable to the Royalty. Royalty Income for the two years ended December 31, 2021 was determined as shown in the following table: For the years ended December 31, 2021 2020 Gross Proceeds from the Subject Interests: Natural Gas $ 77,443,286 $ 38,937,359 Oil 2,575,053 1,608,922 Other 2,110,676 (1) (467,053 ) (2) Total 82,129,015 40,079,228 Capital Expenditures 313,440 259,746 Severance Tax – Natural Gas 8,934,773 4,239,797 Severance Tax – Oil 265,340 240,302 Other - 16,064 (3) Lease Operating Expenses and Property Taxes 22,450,645 23,530,957 Total 31,964,198 28,286,866 Net Proceeds 50,164,817 11,792,362 Net Overriding Royalty Interest 75 % 75 % Royalty Income $ 37,623,612 $ 8,844,272 (1) Estimated revenue from non-operated properties and granted audit exceptions with interest as a result of the 2019 audit, offset by Hilcorp’s true-ups and adjustments of non-operated revenue for the production months of June through December 2018 and July through October 2020. (2) Estimated revenue from non-operated properties and granted audit exceptions with interest as a result of the 2018 audit, negatively offset by a reduction of $2.0 million in “Other” Gross Proceeds included in the December 2017 and January 2018 distribution months, and further offset by Hilcorp’s true-ups and adjustments of non-operated revenue for the production months of August through December 2017, January through May 2018, February through July 2019, October through November 2019, and March through June 2020. (3) Interest charges on excess production costs. Gross Proceeds from Subject Interests. Gross Proceeds increased $42 million, or 105%, to $82.1 million for the year ended December 31, 2021 as compared to $40.1 million for the year ended December 31, 2020. The increase was due primarily to increased natural gas prices. Capital Expenditures . The capital expenditures reported by Hilcorp for 2021 included amounts attributable to the capital budgets for prior years because capital expenditures are deducted in calculating Net Proceeds in the month they accrue, and projects within a given year’s budget often extend into subsequent years. With respect to any wells operated by third parties other than Hilcorp, Hilcorp’s share, if any, of capital expenditures for the year ended December 31, 2021 may not be paid until 2022 or later. For a summary of Hilcorp’s planned 2022 capital expenditures, see Liquidity and Capital Resources— 2022 Capital Expenditure Budget . Capital expenditures increased approximately $54,000, or 21%, to $0.31 million for the year ended December 31, 2021, as compared to $0.26 million for the year ended December 31, 2020. Hilcorp allocated its 2021 capital spending primarily towards facilities projects related to natural gas compression. Hilcorp did not conduct any new drill projects or recompletions within the Subject Interests in 2021. 15 Severance Taxes. Aggregate severance taxes increased $4.7 million, or 105%, to $9.2 million for the year ended December 31, 2021, as compared to $4.5 million for the year ended December 31, 2020. The increase was primarily attributable to higher revenue in 2021. Lease Operating Expenses and Property Taxes. Lease operating expenses and property taxes decreased $1.0 million, or 4.6%, to $22.5 million for the year ended December 31, 2021, as compared to $23.5 million for the year ended December 31, 2020. Monthly operating expenses of the Subject Interests, including property taxes, in 2021 averaged approximately $1.9 million, compared to $2.0 million in 2020. The decrease is primarily attributable to lower compression, contract pumper and well servicing expenses in addition to decreases across other cost categories as Hilcorp was able to reduce operating costs in the current price environment. Distributable Income For the years ended December 31, 2021 2020 Royalty Income $ 37,623,612 $ 8,844,272 Interest Income 1,150 6,248 Total Income 37,624,762 8,850,520 Expenditures – General and Administrative 1,654,674 1,432,038 Distributable Income $ 35,970,088 $ 7,418,482 Distributable Income per Unit (46,608,796 Units) $ 0.771744 $ 0.159164 Distributable Income increased $28.6 million, or 385%, to $36 million ($0.771744 per Unit) for the year ended December 31, 2021, as compared to $7.4 million ($0.159164 per Unit) for the year ended December 31, 2020. The increase in Distributable Income from 2020 to 2021 was primarily attributable to higher natural gas prices and to lower Royalty Income in 2020. The Trust did not receive Royalty Income from Hilcorp for August 2021 due primarily to the true-ups of the January 2021 through May 2021 lease operating and capital expenditures and the May 2021 revenues. The true-ups resulted in excess production costs for the June 2021 production month, which led to no Distributable Income in August 2021. Per the Trust’s internal policies and procedures, the Trust applied the Royalty Income that it received in September 2021, after the payment of the excess production costs, to the Trust’s accumulated administrative expense that replenished cash reserves, with remaining funds distributed to Unit Holders. Interest Income. Interest Income in 2021 decreased as compared to 2020 due to lower yields on short-term investments. General & Administrative Expenses. General and administrative expenses increased $0.2 million, or 16%, to $1.65 million for the year ended December 31, 2021, as compared to $1.4 million for the year ended December 31, 2020. The increase was primarily attributable to higher third-party compliance auditor costs and increased legal expenses during the period of transition from BBVA USA to PNC Bank as the Trustee. Cash Reserves. Total cash reserves were $1.0 million as of December 31, 2020 and 2021. 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 16 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 its 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 the Unit Holders 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. 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 for the following twelve-month period. 2022 Capital Expenditure Budget On February 17, 2022, the Trust announced that Hilcorp had provided the Trust with its 2022 capital project plan for the Subject Interests (the “2022 Plan”), and Hilcorp has estimated its 2022 capital expenditures for the Subject Interests to be $1.9 million. Hilcorp informed the Trust that its 2022 Plan will allocate approximately $1.5 million of the 2022 Plan’s budget towards 24 well recompletions and workovers scheduled to be completed in the Mesaverde, Pictured Cliffs and Fruitland Coal formations. Approximately $300,000 of the 2022 Plan’s budget will be allocated to facilities projects related to natural gas compression, and approximately $100,000 will be spent for permitting and surveying costs for future new drill projects that are being considered for 2023 and 2024. Hilcorp further informed the Trust that its planned project status for 2022 is subject to revision if Hilcorp revises its assumptions underlying the 2022 Plan, and that actual capital costs may vary from these estimates. Contractual Obligations As of December 31, 2021, the Trust had no obligations or commitments to make future contractual payments other than the trustee fee payable to the Trustee. Under the Indenture, the Trustee is entitled to an administrative fee for its administrative services and the preparation of quarterly and annual statements, computed as (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. The minimum administrative fee due under items (i) and (ii) is $36,000 per year. Administrative fees paid to the Trustee were $127,000 and $159,000 for the years ended December 31, 2021 and 2020, respectively. Off-Balance Sheet Arrangements None. Critical Accounting Policies and Estimates For a description of critical accounting policies and estimates, see Item 8. Financial Statements and Supplementary Data, Note 3. Results of the 4th Quarters of 2021 and 2020 For the three months ended December 31, 2021, Distributable Income increased to $15.4 million ($0.329957 per Unit), or 594%, as compared to $2.2 million ($0.047522 per Unit) for the three months ended December 31, 2020. 17 The increase in Distributable Income in the fourth quarter of 2021 compared to the fourth quarter of 2020 resulted primarily from increased revenue from sales of natural gas and oil, decreased production costs, and non-recurring additional revenue received in November 2021. In the November 2021 reporting month, the Trust received other revenues of $0.5 million for the September production month related to granted audit exceptions and interest, estimated non-operated revenue, and interest due to the Trust from prior actualizations and adjustments. Hilcorp also reported a credit of $2.0 million of production costs for the production month of September for severance tax true-ups, and credits for corrections to lease operating expenses for the January through July 2021 production months. Hilcorp informed the Trust that it had discovered errors made in the setup of a few of its general ledger accounts during its SAP conversion process. Specifically, Hilcorp stated that these accounts had been mislabeled as billable, including three of the Trust’s general ledger accounts. Hilcorp believes that its accounting internal control systems have been corrected. The Trustee is authorized to determine in its discretion the amount of cash reserves needed to pay liabilities and contingencies of the Trust. Total cash reserves were $1.0 million as of December 31, 2020 and 2021. In August 2021 the Trust utilized cash reserves of $150,148 to pay Trust administrative expenses. The Trustee replenished the cash reserves by $150,148 in September 2021 to bring the cash reserve balance to the previously established amount of $1.0 million. The Trustee does not anticipate increasing or decreasing the established amount of cash reserves in 2022, although it cannot predict whether it will need to utilize some portion of those cash reserves during 2022. Royalty Income of the Trust for the fourth quarter is based on actual gas and oil production during August through October of each year. Gas and oil sales for the quarters ended December 31, 2021 and 2020 were as follows: Three months ended December 31, 2021 2020 Subject Interests Gas — Mcf 4,578,028 6,257,089 Mcf per Day 49,761 68,012 Average Gross Proceeds Price (per Mcf) $ 5.24 $ 1.65 Oil — Bbls 13,661 17,606 Bbls per Day 148 191 Average Gross Proceeds Price (per Bbl) $ 65.70 $ 32.14 Attributable to the Royalty Gas — Mcf 2,510,507 1,606,733 Oil — Bbls 9,838 11,543 The average price of gas increased in the fourth quarter of 2021 compared to the same period of 2020 by $3.59 per Mcf. The average price per barrel of oil during the fourth quarter of 2021 was $33.56 higher than the price during the fourth quarter of 2020. Capital costs for the fourth quarter of 2021 totaled approximately $300,000 as compared to approximately $0.1 million in the fourth quarter of 2020. The reduced capital costs in the fourth quarter of 2021 primarily was due to a reduction in spending due to reduced production. Lease operating expenses and property taxes for the fourth quarter of 2021 averaged $0.88 million per month compared to $1.9 million per month in the fourth quarter of 2020. Lease operating expenses and property taxes were lower in the fourth quarter of 2021 than for the fourth quarter of 2020 due primarily to the receipt from and application by Hilcorp of an approximately $2 million credit towards prior operating costs. 18 Based on 46,608,796 Units outstanding, the per-Unit distributions during the fourth quarters of 2021 and 2020 were as follows: Three months ended December 31, 2021 2020 October 0.067705 0.013969 November 0.149811 0.027407 December 0.112441 0.006146