Item 2. Trustees Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion of the Trusts financial condition and results of operations should be read in conjunction with the financial statements and notes thereto. The Trusts purpose is, in general, to hold the net profits interest, to distribute to the Trust unitholders cash that the Trust receives in respect of the net profits interest and to perform certain administrative functions in respect of the net profits interest and the Trust Units. The Trust derives substantially all of its income and cash flows from the net profits interest. All information regarding operations has been provided to the Trustee by VOC Brazos.
Results of Operations for the Quarters Ended September 30, 2019 and 2018
The following is a summary of income from net profits interest received by the Trust for the three months ended September 30, 2019 and 2018 consisting of the July distribution for each respective year:
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Three months ended
|
|
|
|
September 30,
|
|
|
|
2019
|
|
2018
|
|
Sales volumes:
|
|
|
|
|
|
Oil (Bbl)
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|
148,496
|
|
132,705
|
|
Natural gas (Mcf)
|
|
78,786
|
|
80,036
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|
Total (BOE)
|
|
161,627
|
|
146,044
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|
Average sales prices:
|
|
|
|
|
|
Oil (per Bbl)
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|
$
|
58.63
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|
$
|
62.84
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|
Natural gas (per Mcf)
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|
$
|
2.83
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|
$
|
3.31
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|
Gross proceeds:
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|
|
|
|
|
Oil sales
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|
$
|
8,705,923
|
|
$
|
8,338,594
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|
Natural gas sales
|
|
223,269
|
|
264,969
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|
Total gross proceeds
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|
8,929,192
|
|
8,603,563
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Costs:
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|
|
|
|
|
Production and development costs:
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|
|
|
|
|
Lease operating expenses
|
|
3,170,157
|
|
2,993,076
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|
Production and property taxes
|
|
550,970
|
|
675,789
|
|
Development expenses
|
|
518,623
|
|
338,853
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|
Total costs
|
|
4,239,750
|
|
4,007,718
|
|
|
|
|
|
|
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Excess of revenues over direct operating expenses and lease equipment and development costs
|
|
4,689,442
|
|
4,595,845
|
|
Times net profits interest over the term of the Trust
|
|
80
|
%
|
80
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%
|
Income from net profits interest before reserve adjustments
|
|
3,751,554
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|
3,676,676
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|
VOC Brazos reserve for future development, maintenance or operating expenditures
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|
0
|
|
0
|
|
Income from net profits interest
|
|
$
|
3,751,554
|
|
$
|
3,676,676
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|
The cash received by the Trust from VOC Brazos during the quarter ended September 30, 2019 substantially represents the production by VOC Brazos from March 2019 through May 2019. The cash received by the Trust from VOC Brazos during the quarter ended September 30, 2018 substantially represents the production by VOC Brazos from March 2018 through May 2018. The revenues from oil production are typically received by VOC Brazos one month after production.
Gross proceeds. Oil and natural gas sales were $8,929,192 for the three months ended September 30, 2019, an increase of $325,629 or 3.8% from $8,603,563 for the three months ended September 30, 2018. Revenues are a function of oil and natural gas sales prices and volumes sold. The increase in gross proceeds was due to increases in oil sales volumes partially offset by a decrease in natural gas sales volumes and decreases in market prices for oil and natural gas sales prices during the third quarter of 2019. Oil sales volumes were 148,496 Bbls for the three months ended September 30, 2019, an increase of 15,791 Bbls or 11.9% from 132,705 Bbls for the three months ended September 30, 2018, while natural gas sales volumes were 78,786 Mcf, a decrease of 1,250 Mcf or 1.6% from 80,036 Mcf for the same period in 2018. During the three months ended September 30, 2019, the average price for oil decreased 6.7% to $58.63 per Bbl and the average price for natural gas decreased 14.5% to $2.83 per Mcf.
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Costs. Lease operating expenses were $3,170,157 for the three months ended September 30, 2019, an increase of $177,081 or 5.9% from $2,993,076 for the three months ended September 30, 2018. Production and property taxes were $550,970 for the three months ended September 30, 2019, a decrease of $124,819 or 18.5% from $675,789 for the same period in 2018. Such decrease is primarily due to a decrease in property taxes of $176,116 or 38.6% offset by an increase of $51,297 or 23.3% in production taxes due to higher sales volumes for oil. Development expenses were $518,623 for the three months ended September 30, 2019, an increase of $179,770 or 53.1% from $338,853 for the same period in 2018. Such increase was primarily due to increased drilling activity and development expenses during the three months ended September 30, 2019, compared to the three months ended September 30, 2018.
Excess of revenues over direct operating expenses and lease equipment and development costs. The excess of revenues over direct operating expenses and lease equipment and development costs from the underlying properties was $4,689,442 for the three months ended September 30, 2019, an increase of $93,597 or 2.0% from $4,595,845 for the three months ended September 30, 2018. The Trusts 80% net profits interest of these totals was $3,751,554 and $3,676,676, respectively. During the three months ended September 30, 2019 and 2018, VOC Brazos did not withhold or release any dollar amounts due to the Trust from the previously established cash reserve for future development, maintenance or operating expenditures, which resulted in income from the net profits interest of $3,751,554 and $3,676,676 for such periods, respectively. These amounts were reduced by a Trust holdback for future expenses of $266,554 and $276,676 for the three months ended September 30, 2019 and 2018, respectively. The Trustee paid general and administrative expenses of $200,922 for the three months ended September 30, 2019, an increase of $79,357 from $121,565 for the three months ended September 30, 2018. This increase was primarily due to the differences in timing of receipt and payment of recurring general and administrative expenses. These factors resulted in distributable income for the three months ended September 30, 2019 of $3,485,000, an increase of $85,000 from $3,400,000 for the three months ended September 30, 2018.
Results of Operations for the Nine Months Ended September 30, 2019 and 2018
The following is a summary of income from net profits interest received by the Trust for the nine months ended September 30, 2019 and 2018 consisting of the January, April and July distributions for each respective year:
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Nine months ended
September 30,
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|
|
|
2019
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2018
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|
Sales volumes:
|
|
|
|
|
|
Oil (Bbl)
|
|
417,601
|
|
395,668
|
|
Natural gas (Mcf)
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|
232,498
|
|
247,597
|
|
Total (BOE)
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|
456,351
|
|
436,934
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|
Average sales prices:
|
|
|
|
|
|
Oil (per Bbl)
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|
$
|
56.87
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|
$
|
57.00
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|
Natural gas (per Mcf)
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|
$
|
3.21
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|
$
|
3.25
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|
Gross proceeds:
|
|
|
|
|
|
Oil sales
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|
$
|
23,750,531
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|
$
|
22,554,788
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|
Natural gas sales
|
|
746,711
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|
804,898
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|
Total gross proceeds
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|
24,497,242
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23,359,686
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Costs:
|
|
|
|
|
|
Production and development costs:
|
|
|
|
|
|
Lease operating expenses
|
|
9,391,214
|
|
9,280,249
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|
Production and property taxes
|
|
1,517,824
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|
1,849,139
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|
Development expenses
|
|
1,936,834
|
|
991,188
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|
Total costs
|
|
12,845,872
|
|
12,120,576
|
|
|
|
|
|
|
|
Excess of revenues over direct operating expenses and lease equipment and development costs
|
|
11,651,370
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|
11,239,110
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|
Times net profits interest over the term of the Trust
|
|
80
|
%
|
80
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%
|
Income from net profits interest before reserve adjustments
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|
9,321,096
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|
8,991,288
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VOC Brazos reserve for future development, maintenance or operating expenditures
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0
|
|
0
|
|
Income from net profits interest
|
|
$
|
9,321,096
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|
$
|
8,991,288
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|
The cash received by the Trust from VOC Brazos during the nine months ended September 30, 2019 substantially represents the production by VOC Brazos from September 2018 through May 2019. The cash received by the Trust from VOC Brazos during the nine months ended September 30, 2018 substantially represents the production by VOC Brazos from September 2017 through May 2018. The revenues from oil production are typically received by VOC Brazos one month after production.
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Gross proceeds. Oil and natural gas sales were $24,497,242 for the nine months ended September 30, 2019, an increase of $1,137,556 or 4.9% from $23,359,686 for the nine months ended September 30, 2018. Revenues are a function of oil and natural gas sales prices and volumes sold. The increase in gross proceeds was due to an increase in oil sales volumes offset by a decease in natural gas sales volumes and slight decreases in market prices for oil and natural gas during the first nine months of 2019. Oil sales volumes were 417,601 Bbls for the nine months ended September 30, 2019, an increase of 21,933 Bbls or 5.5% from 395,668 Bbls for the nine months ended September 30, 2018, while natural gas sales volumes were 232,498 Mcf, a decrease of 15,099 Mcf or 6.1% from 247,597 Mcf for the same period in 2018. During the nine months ended September 30, 2019, the average price for oil decreased 0.2% to $56.87 per Bbl and the average price for natural gas decreased 1.2% to $3.21 per Mcf.
Costs. Lease operating expenses were $9,391,214 for the nine months ended September 30, 2019, an increase of $110,965 or 1.2% from $9,280,249 for the nine months ended September 30, 2018. Production and property taxes were $1,517,824 for the nine months ended September 30, 2019, a decrease of $331,315 or 17.9% from $1,849,139 for the nine months ended September 30, 2018. Such decrease is primarily due to a decrease of $416,510 or 33.5% in property taxes partially offset by an increase of $85,195 or 14.1% in production taxes due to higher sales volumes and prices for oil. Development expenses were $1,936,834 for the nine months ended September 30, 2019, an increase of $945,646 or 95.4% from $991,188 for the same period in 2018. Such increase was primarily due to increased drilling activity and corresponding increased development expenses during the nine months ended September 30, 2019 compared to the nine months ended September 30, 2018.
Excess of revenues over direct operating expenses and lease equipment and development costs. The excess of revenues over direct operating expenses and lease equipment and development costs from the underlying properties was $11,651,370 for the nine months ended September 30, 2019, an increase of $412,260 or 3.7% from $11,239,110 for the nine months ended September 30, 2018. The Trusts 80% net profits interest of these totals were $9,321,096 and $8,991,288, respectively. During the nine months ended September 30, 2019 and 2018, VOC Brazos did not withhold or release any dollar amounts due to the Trust from the previously established cash reserve for future development, maintenance or operating expenditures, which resulted in income from the net profits interest of $9,321,096 and $8,991,288 for such periods, respectively. These amounts were further reduced by a Trust holdback for future expenses of $651,096 and $661,288 for the nine months ended September 30, 2019 and 2018, respectively. The Trustee paid general and administrative expenses of $738,665 for the nine months ended September 30, 2019, an increase of $152,644 from $586,021 for the nine months ended September 30, 2018. This increase was primarily due to the differences in timing of receipt and payment of recurring general and administrative expenses. These factors resulted in distributable income of $8,670,000 for the nine months ended September 30, 2019 and $8,330,000 for the nine months ended September 30, 2018.
Liquidity and Capital Resources
Other than Trust administrative expenses, including any reserves established by the Trustee for future liabilities, the Trusts only use of cash is for distributions to Trust unitholders. Administrative expenses include payments to the Trustee as well as a quarterly administrative fee to VOC Brazos pursuant to an administrative services agreement. Each quarter, the Trustee determines the amount of funds available for distribution. Available funds are the excess cash, if any, received by the Trust from the net profits interest and other sources (such as interest earned on any amounts reserved by the Trustee) in that quarter, over the Trusts expenses paid for that quarter. Available funds are reduced by any cash that the Trustee decides to reserve for future development, maintenance or operating expenses. As of September 30, 2019, $272,596 was held by the Trustee as such a reserve.
The Trustee may cause the Trust to borrow funds required to pay expenses if the Trustee determines that the cash on hand and the cash to be received are insufficient to cover the Trusts expenses. If the Trust borrows funds, the Trust unitholders will not receive distributions until the borrowed funds are repaid. During the three and nine months ended September 30, 2019 and 2018, there were no such borrowings. VOC Brazos has provided a letter of credit in the amount of $1,700,000 to the Trustee to protect the Trust against the risk that it does not have sufficient cash to pay future expenses.
Income to the Trust from the net profits interest is based on the calculation and definitions of gross proceeds and net proceeds contained in the conveyance.
As substantially all of the underlying properties are located in mature fields, VOC Brazos does not expect future costs for the underlying properties to change significantly compared to recent historical costs, other than changes due to fluctuations in the general cost of oilfield services. VOC Brazos may establish a cash reserve of up to $1.0 million in the aggregate at any given time from the dollar amount otherwise distributable to the Trust to reduce the impact on distributions of uneven capital expenditure timing. The cash reserve balance was $1,000,000 at September 30, 2019 and 2018, respectively.
In 2018, VOC Brazos entered into a new joint venture agreement with Hawkwood Energy East Texas, LLC (Hawkwood Energy) to develop the lower EagleBine interval, also referred to as the Lower Woodbine Organic Shale (LWOS), within the south half of the Kurten Woodbine Unit (the Contract Area). Under the terms of the new joint venture agreement, Hawkwood Energy could carry VOC Brazos for its share of drilling and completion costs for up to four LWOS wells (the Hawkwood Earning Wells), with the first Hawkwood Earning Well to be spud by August 31, 2018 and the fourth Hawkwood Earning Well to be spud by June 30, 2019. In exchange, Hawkwood Energy would earn a working interest representing 50% of VOC Brazos interest in each Hawkwood Earning Well and a 50% interest in VOC Brazos acreage in the Contract Area. After the Hawkwood Earning Wells are completed, Hawkwood Energy also has the right to propose and drill up to eight LWOS wells in 2019 and twelve LWOS wells in 2020. There is no contractual limitation of the number of wells per year to propose and drill after 2020.
In 2018, VOC Brazos also entered into a joint venture agreement with MD America Energy, LLC (MD America) to develop the LWOS, within the north half of the Kurten Woodbine Unit (the North Contract Area). Under the terms of the joint venture agreement, MD America may carry VOC Brazos for its share of drilling and completion costs for up to four LWOS wells (the MD Earning Wells), with the first MD Earning Well to be spud by December 31, 2018 and the fourth MD Earning Well to be spud by November 20, 2020. In exchange, MD America has the opportunity to earn a working interest representing 50% of VOC Brazos interest in each MD Earning Well and up to a 50% interest in VOC Brazos acreage in the North Contract Area. After the MD Earning Wells are completed, MD America also has the right to propose and drill up to three LWOS wells per year.
To date, Hawkwood has drilled and completed all four Hawkwood Earning Wells earning 50% of VOC Brazos interest in each Hawkwood Earning Well and a 50% interest in VOC Brazos acreage in the Contract Area and MD America has drilled and set production casing for the first MD Earning Well. Additionally, Hawkwood has drilled and completed four additional LWOS wells with production commencing in October 2019. VOC Brazos elected to take an overriding royalty interest in two LWOS wells and a working interest in the other two LWOS wells.
VOC Brazos is evaluating the potential economic benefits associated with development of the LWOS. If these activities are pursued, with the exception of the Hawkwood Earning Wells and MD Earning Wells in which Hawkwood Energy and MD America, respectively, would carry VOC Brazos for its share of drilling and completion costs, such activities would result in increased development costs burdening the net profits interest of the trust relative to historical development costs. As a result of such increased development costs, cash available for distribution by the trust would be temporarily reduced until anticipated production from the various development efforts in the Kurten Woodbine Unit can be brought on-line. To address these emerging opportunities, VOC Brazos will continue to evaluate the appropriate strategy and capital plan to fund development for the trust.
9
Note Regarding Forward-Looking Statements
This Form 10-Q includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements other than statements of historical fact included in this Form 10-Q, including without limitation the statements under Trustees Discussion and Analysis of Financial Condition and Results of Operations, are forward-looking statements. Although VOC Brazos advised the Trust that it believes that the expectations reflected in the forward-looking statements contained herein are reasonable, no assurance can be given that such expectations will prove to have been correct. Important factors that could cause actual results to differ materially from expectations (Cautionary Statements) are disclosed in this Form 10-Q and in the Trusts Annual Report on Form 10-K for the year ended December 31, 2018 (the Form 10-K), including under the section Item 1A. Risk Factors. All subsequent written and oral forward-looking statements attributable to the Trust or persons acting on its behalf are expressly qualified in their entirety by the Cautionary Statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
The Trust is a smaller reporting company as defined by Rule 12b-2 of the Securities Exchange Act of 1934, as amended and is not required to provide the information under this Item.
Item 4. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures. The Trustee maintains disclosure controls and procedures designed to ensure that information required to be disclosed by the Trust in the reports that it files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the rules and regulations promulgated by the SEC. Disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed by the Trust is accumulated and communicated by VOC Brazos to the Trustee, as trustee of the Trust, and its employees who participate in the preparation of the Trusts periodic reports as appropriate to allow timely decisions regarding required disclosure.
As of the end of the period covered by this report, the Trustee carried out an evaluation of the Trusts disclosure controls and procedures. A Trust Officer of the Trustee has concluded that the disclosure controls and procedures of the Trust are effective.
Due to the contractual arrangements of (i) the Trust Agreement and (ii) the conveyance of the net profits interest, the Trustee relies on (A) information provided by VOC Brazos, including historical operating data, plans for future operating and capital expenditures, reserve information and information relating to projected production and (B) conclusions and reports regarding reserves by the Trusts independent reserve engineers. See Risk FactorsNeither the Trust nor the Trusts unitholders have the ability to influence VOC Brazos or control the operations or development of the underlying properties in the Form 10-K.
Changes in Internal Control over Financial Reporting. During the quarter ended September 30, 2019, there was no change in the Trusts internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the Trusts internal control over financial reporting. The Trustee notes for purposes of clarification that it has no authority over, and makes no statement concerning, the internal control over financial reporting of VOC Brazos.
10