Investing

Mesa Royalty Trust was formed in 1979 by Boone Pickens. In 1985 he reacquired 88.6% of the trust leaving the small 1.86M shares remaining.

About 75% of their royalties come from US Natural gas, the remainder from Natural Gas liquids and Oil.

A simple model based on Natural Gas prices shows that MTR should be worth closer to $37 from today’s price of $24.85. Instead the trust is being priced off short term cash flow, which will be around $1.90 this year for a yield of around 8% .

Simple valuation model based on NG

It is quite hard to develop a full financial model for MTR because they don’t have detailed financials on the wells that pay the royalties. Therefore both the NG only and the crude models are based on correlations to historic distributions. The correlation is quite good for just Natural Gas but as you would expect it’s slightly better once Crude is included.

Valuation model based on NG and Crude

The $6.50 NG & $75 crude cases closely reflect current long term strip prices. It’s therefore quite easy to make the case that MTR has 50%-60% price appreciation potential. If you believe that Natural Gas is going to move closer to it’s longer term average. My target Crude price is $112 per bbl based on my long term crude forecast and updated long term crude forecast. I have not developed a long term natural gas forecast. McDep is now using $8, $1.50 above the strip. Using $6.50 gas and $112 crude values MTR at $48 for appreciation of 95%.

There have been some problems with Mesa’s calculation of reserve life. They have previously based their calculations on the calculations by the operators that pay royalties. I don’t see a problem with this. However before their 2007 annual report they sought out an independent review of their reserve life. To quote from the 2007 10k

“The December 31, 2007 reserve estimates for the San Juan Basin properties were prepared by a third party reservoir engineering firm, whereas the December 31, 2006 and 2005 reserve estimates were prepared by the Working Interest Owner. Revisions to previous estimate in 2007 are primarily due to professional differences in judgment regarding estimate of San Juan Basin reserves.”

The difference is not small! They cut their natural gas reserves in half and their liquids by more than half. On that basis the trust has reserves until about 2020 which is my baseline case. However, if the professional differences are in fact in favour of the operators then there could be substantially more reserves and a higher value for MTR.

Valuation Sensitivity to reserve life

MTR is a trust and as such has no management (and no management expenses) only a trustee. SEC filings are sparse and currently quite late (due to the reserve issue mentioned above).

The value of MTR increases in direct proportion to the price of natural gas. A 10% rise in long term natural gas prices causes a 10% rise in Mesa’s value. Therefore you get to participate on a long call on Natural Gas prices while you are paid 8% to wait. Compared to UNG (MTR has a correlation of about 80% to UNG) where you have a cost of carry and management costs MTR is a fantastic deal.

I have no idea when natural gas will recover. The beauty of an idea like this is you get paid to wait and then you get paid once the waiting is over. The main risk is these sorts of ideas is truncation risk and that isn’t going to happen when there is no debt.

Mesa Royalty Trust has no debt and no management risk. There is 60% price appreciation to very conservative energy price assumptions. There is substantial leverage to additional reserves and higher long term energy prices with little risk and actual reward while you wait.

posted by Neil  # 5:12 AM