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, 2023, there were 46,608,796 Units outstanding held by 779 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 and accurate 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. 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 2022, the price of natural gas Gross Proceeds for production from the Subject Interests increased from an average price for natural gas of $3.20 per Mcf in 2021 to $5.54 per Mcf in 2022. The price for oil Gross Proceeds increased from an average price of $54.72 per Bbl in 2021 to $86.73 per Bbl in 2022. The amount of Gross Proceeds 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 10 Table of Contents drilling operations or well recompletions in the near term, the Subject Interests are depleting assets; 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 cause Hilcorp to reduce drilling operations, workover, and/or recompletions, thus reducing the volume of natural gas and oil produced from the Subject Interests. Hilcorp did not conduct any new drill projects within the Subject Interests in 2022 or 2021; however, it did conduct eight recompletions and workovers in 2022. On February 17, 2023, the Trust announced that Hilcorp had provided the Trust with its 2023 capital project plan for the Subject Interests (the “2023 Plan”), and Hilcorp has estimated its 2023 capital expenditures for the Subject Interests to be $4.4 million. Hilcorp informed the Trust that its 2023 Plan will allocate approximately $3.7 million of the 2023 Plan’s budget toward 25 well recompletions and workovers scheduled to be completed in the Mesaverde, Pictured Cliffs and Fruitland Coal formations. Approximately $0.5 million of the 2023 Plan’s budget will be allocated to facilities projects related to natural gas compression, and approximately $0.2 million will be spent for permitting costs for potential future new drill projects. Hilcorp further informed the Trust that its planned project status for 2023 is subject to revision if Hilcorp revises its assumptions underlying the 2023 Plan, in which event the 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. 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, 2021 and 2022. The Trustee does not anticipate any increase or decrease to the cash reserves in 2023. 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 Production Cost Estimates . Hilcorp’s process of reconciling actual revenue and severance taxes to previously reported estimates (which the Trust refers to as “true-ups”) were still occurring and being reported in 2022. 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 may reverse and rebook revenue for certain periods. Thus, distributions to the Trust from Hilcorp in certain months during 2021 and 2022 were subject to adjustments based upon prior months’ true-ups and rebooking, plus interest. Hilcorp has informed the Trust that it completed the transition to its new accounting system and began to report actual, not estimated, revenue and expenses for operated wells beginning with the June 2021 production month (August 2021 reporting month) and that it has reversed and rebooked revenue for certain prior periods. The true-ups of revenues for non-operated properties for the 2021 distribution periods were completed in the February and March 2022 reporting months. In 2022, Hilcorp made total actualizations and other adjustments resulting in $10,951,453 additional Royalty Income paid to the Trust. Of this amount, $1,391,619 was revenue related to prior period non-operated property true-ups, revenue for granted audit exceptions, and interest, and $9,559,834 associated with Hilcorp process reviews and adjustments. Hilcorp has continued to inform the Trustee that it has implemented additional controls to enhance the reporting process to reduce the need for future corrections. As of December 31, 2022, Hilcorp has informed the Trust that it believes that all prior month actualizations have occurred, and it does not expect to need to report any further actualizations in future distribution reports. 11 Table of Contents However, 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 payments made by Hilcorp to the Trust, inclusive of sales revenues, production costs, capital expenditures, adjustments, actualizations, and recoupments. The Trust’s auditing process has also included detailed analysis of Hilcorp’s pricing and rates charged. As previously disclosed in the Trust’s filings, these revenues and costs (along with all costs) are the subject of the Trust’s ongoing comprehensive audit process by our professional consultants and outside counsel to ensure full compliance with all the underlying operative Trust agreements and evaluating all available potential remedies in the event there is evidence of non-compliance. 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, 2022, was determined as shown in the following table: For the years ended December 31, 2022 2021 Gross Proceeds from the Subject Interests: Natural Gas $ 135,603,914 $ 77,443,286 Oil 3,069,153 2,575,053 Other 10,951,453 (1) 2,110,676 (2) Total 149,624,520 82,129,015 Production Costs: Severance tax – natural gas 16,712,086 8,934,773 Severance tax – oil 353,559 265,340 Lease operating expense and property tax 26,229,213 22,450,645 Capital expenditures 984,349 313,440 Total 44,279,207 31,964,198 Net profits 105,345,313 50,164,817 Net overriding royalty interest 75 % 75 % Royalty Income $ 79,008,985 $ 37,623,612 (1) Revenue and estimated revenue related to audit exceptions with interest, revenue from prior period non-operated revenue true-ups and related interest, revenue from non-operated properties offset by Hilcorp’s true-ups, adjustments of non-operated revenue for the production months November 2020 through October 2021, and revenue and interest related to a corrections associated with Hilcorp’s process reviews. (2) 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. Gross Proceeds from Subject Interests. Gross Proceeds increased $67.5 million, or 82%, to $149.6 million for the year ended December 31, 2022, as compared to $82.1 million for the year ended December 31, 2021. The increase was due primarily to increased natural gas prices. Capital Expenditures . The capital expenditures reported by Hilcorp for 2022 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, 2022, may not be paid until 2023 or later. For a summary of Hilcorp’s planned 2023 capital expenditures, see Liquidity and Capital Resources. Capital expenditures increased approximately $0.7 million, or 214%, to $1.0 million for the year ended December 31, 2022, as compared to $0.3 million for the year ended December 31, 2021. Hilcorp allocated its 2022 capital spending primarily toward well recompletions and workovers, facilities projects related to natural gas compression, and for permitting and surveying costs for future news drill projects. Hilcorp did not conduct any new drill projects within the Subject Interests in 2022. Severance Taxes. Aggregate severance taxes increased $7.9 million, or 86%, to $17.1 million for the year ended December 31, 2022, as compared to $9.2 million for the year ended December 31, 2021. The increase was primarily attributable to higher revenue in 2022. Lease Operating Expenses and Property Taxes. Lease operating expenses and property taxes increased $3.8 million, or 17%, to $26.2 million for the year ended December 31, 2022, as compared to $22.5 million for the year ended December 31, 2021. Monthly operating expenses of the Subject Interests, including property taxes, in 2022 averaged approximately $2.2 million, compared to $1.9 million in 2021. The increase is primarily due to increased expenses in the first quarter of 2022, which included approximately $0.5 12 Table of Contents million in non-operated lease operating expense true-ups, the payment of approximately $1.0 million for year-end salaries and bonuses for Hilcorp employees, and differences in the timing in the receipt and payment of these The Trust and its consultants are conducting a detailed analysis of these expenses associated with the 2021 year-end salaries and bonuses for Hilcorp employees to determine if they comport with the Conveyance and other operative agreements. Distributable Income For the years ended December 31, 2022 2021 Royalty Income $ 79,008,985 $ 37,623,612 Interest Income 57,186 1,150 Total Income 79,066,171 37,624,762 Expenditures – General and Administrative 1,466,718 1,654,674 Distributable Income $ 77,599,453 $ 35,970,088 Distributable Income per Unit (46,608,796 Units) $ 1.664908 $ 0.771744 Distributable Income increased $41.6 million, or 116%, to $77.6 million ($1.664908 per Unit) for the year ended December 31, 2022, as compared to $36 million ($0.771744 per Unit) for the year ended December 31, 2021. The increase in Distributable Income from 2021 to 2022 was primarily attributable to higher natural gas prices, which resulted in increased Royalty Income in 2022. Interest Income. Interest Income in 2022 increased as compared to 2021 due to an increase in funds available for investment and to higher yields on short-term investments. General & Administrative Expenses. General and administrative expenses decreased $0.2 million, or 11%, to $1.5 million for the year ended December 31, 2022, as compared to $1.7 million for the year ended December 31, 2021. The decrease was primarily attributable to differences in timing in the receipt and payment of certain expenses by the Trust. 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 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 12-month period. Cash Reserves. Total cash reserves have not changed year over year as total cash reserves were $1.0 million as of December 31, 2021 and 2022. The Trustee is authorized to determine in its discretion the amount of cash reserves needed to pay liabilities and contingencies of the Trust. The Trustee does not anticipate increasing or decreasing the established amount of cash reserves in 2023, although it cannot predict whether it will need to utilize some portion of those cash reserves during 2023. 2023 Capital Expenditure Budget On February 17, 2023, the Trust announced that Hilcorp had provided the Trust with its 2023 capital project plan for the Subject Interests (the “2023 Plan”), and Hilcorp has estimated its 2023 capital expenditures for the Subject Interests to be $4.4 million. Hilcorp informed the Trust that its 2023 Plan will allocate approximately $3.7 million of the 2023 Plan’s budget toward 25 well recompletions and workovers scheduled to be completed in the Mesaverde, Pictured Cliffs and Fruitland Coal formations. Approximately $0.5 million of the 2023 Plan’s budget will be allocated to facilities projects related to natural gas compression, and approximately $0.2 million will be spent for permitting costs for potential future new drill projects. Hilcorp further informed the Trust that its planned project status for 2023 is subject to revision if Hilcorp revises its assumptions underlying the 2023 Plan, and that actual capital costs may vary from these estimates. 13 Table of Contents Contractual Obligations As of December 31, 2022, 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 $100.0 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 $90,815 and $127,000 for the years ended December 31, 2022 and 2021, 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 2022 and 2021 For the three months ended December 31, 2022, Distributable Income increased to $28.8 million ($0.617388 per Unit), or 87%, as compared to $15.4 million ($0.329957 per Unit) for the three months ended December 31, 2021. The increase in Distributable Income in the fourth quarter of 2022 compared to the fourth quarter of 2021 was primarily attributed to increased revenue from sales of natural gas and oil and certain adjustment payments received from Hilcorp as discussed below. In the October 2022 reporting month, the Trust received $ $10,078,805 in other revenues and interest related to adjustments associated with Hilcorp process reviews. In the December 2022 reporting month, other revenue was reduced by $497,181 to correct the prior month’s settlement differences and related interest. Hilcorp has informed the Trustee that it has implemented additional controls to enhance the reporting process and reduce the need for future corrections. 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, 2022 and 2021 were as follows: Three months ended December 31, 2022 2021 Subject Interests Gas — Mcf 6,145,461 4,578,028 Mcf per Day 66,798 49,761 Average Gross Proceeds Price (per Mcf) $ 6.52 $ 5.24 Oil — Bbls 8,125 13,661 Bbls per Day 88 148 Average Gross Proceeds Price (per Bbl) $ 78.32 $ 65.70 Attributable to the Royalty Gas — Mcf 3,687,334 2,510,507 Oil — Bbls 5,345 9,838 The average price of gas increased in the fourth quarter of 2022 compared to the same period of 2021 by $1.28 per Mcf. The average price per barrel of oil during the fourth quarter of 2022 was $12.62 higher than the price during the fourth quarter of 2021. Capital costs for the fourth quarter of 2022 totaled approximately $0.7 million as compared to approximately $300,000 in the fourth quarter of 2021. The increased capital costs in the fourth quarter of 2022 were primarily due to increased spending due to increased production. Lease operating expenses and property taxes for the fourth quarter of 2022 averaged $2.1 million per month compared to $0.9 million per month in the fourth quarter of 2021. Lease operating expenses and property taxes were higher in the fourth quarter of 2022 than for the fourth quarter of 2021 due primarily to the 2021 receipt from and application by Hilcorp of an approximately $2.0 million credit toward prior operating costs. 14 Table of Contents Based on 46,608,796 Units outstanding, the per-Unit distributions during the fourth quarters of 2022 and 2021 were as follows: Three months ended December 31, 2022 2021 October 0.349121 0.067705 November 0.171971 0.149811 December 0.096295 0.112441