Chesapeake Granite Wash Trust 10-Q, filed Nov 12, 2021
Chesapeake Granite Wash Trust (CHKR)
10-Q
2021-11-12
For: 2021-09-30
View Original
Added on
April 06, 2026
About this 10-Q
Chesapeake Granite Wash Trust filed this 10-Q on November 12, 2021, covering the quarter ended September 30, 2021.
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the Quarterly Period Ended September 30, 2021
[ ] Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from to .
Commission File No. 001-35343
Chesapeake Granite Wash Trust
(Exact name of registrant as specified in its charter)
| Delaware | 45-6355635 | |||||||
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |||||||
| The Bank of New York Mellon Trust Company, N.A., Trustee Global Corporate Trust | ||||||||
| 601 Travis Street, Floor 16 | ||||||||
| Houston, Texas | 77002 | |||||||
| (Address of principal executive offices) | (Zip Code) | |||||||
(512) 236-6555
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer," “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
| Large accelerated filer [ ] | Accelerated filer [ ] | Non-accelerated filer [X] | Smaller reporting company [X] | Emerging growth company [ ] | ||||||||||
If an emerging growth company indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13 (a) of the Exchange Act. [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of November 2, 2021, 46,750,000 common units representing beneficial interests in Chesapeake Granite Wash Trust were outstanding.
CHESAPEAKE GRANITE WASH TRUST
INDEX TO FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2021
| PART I. FINANCIAL INFORMATION | ||||||||
| Page | ||||||||
| Item 1. | ||||||||
| Statements of Assets and Trust Corpus | ||||||||
| Item 2. | ||||||||
| Item 3. | ||||||||
| PART II. OTHER INFORMATION | ||||||||
| Item 1. | Legal Proceedings | |||||||
| Item 1A. | Risk Factors | |||||||
| Item 6. | ||||||||
All references to “we,” “us,” “our,” or the “Trust” refer to Chesapeake Granite Wash Trust. The royalty interests conveyed on November 16, 2011 by Chesapeake from its interests in certain properties in the Colony Granite Wash formation in Oklahoma and held by the Trust are referred to as the “Royalty Interests.” References to “Chesapeake” refer to Chesapeake Energy Corporation and, where the context requires, its subsidiaries. References to "Tapstone" or "Operator" refer to Tapstone Energy Holding, LLC or its wholly owned subsidiary Tapstone Energy LLC. As of December 11, 2020, Tapstone owns and operates all Underlying Properties (as defined below) held by the Trust.
DISCLOSURES REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q (“Quarterly Report”) includes “forward-looking statements” about the Trust and the Operator and other matters discussed herein that are subject to risks and uncertainties that are intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995 and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). All statements other than statements of historical fact included in this document, including, without limitation, statements under “Trustee’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 2 of Part I and elsewhere herein regarding the continuing effects of the COVID-19 pandemic and the impact thereof on our and Tapstone’s business, financial condition, results of operations and cash flows, actions by, or disputes among or between, members of the Organization of the Petroleum Exporting Countries and its allies, such as Russia, market factors, market prices, the proved oil, natural gas and natural gas liquids ("NGL") reserves associated with the properties underlying the Royalty Interests, the Trust’s or Tapstone’s future financial position, business strategy, budgets, projected costs and plans and objectives for future operations, information regarding target distributions, statements pertaining to future development activities and costs, information regarding production and reserve growth, statements regarding the Trust's continued listing on the OTC Markets Group, Inc. and statements regarding the potential acquisition of Tapstone are forward-looking statements. Actual outcomes and results may differ materially from those projected. Our forward-looking statements are generally accompanied by words such as “estimate,” “project,” “predict,” “believe,” “expect,” “anticipate,” “potential,” “could,” “may,” “foresee,” “seek,” “plan,” “goal,” “assume,” “target,” “should,” “intend,” “ability,” “will,” “would,” “forecast” or other words that convey the uncertainty of future events or outcomes. These statements are based on certain assumptions made by the Trust, and by Tapstone, in light of its experience and perception of historical trends, current conditions and expected future developments, as well as other factors we believe are appropriate under the circumstances. However, whether actual results and developments will conform with such expectations and predictions is subject to a number of risks and uncertainties, including the risk factors discussed in Item 1A of Part I of the Trust’s Annual Report on Form 10-K for the year ended December 31, 2020 (the "2020 Form 10-K") and in Item 1A of Part II of this Quarterly Report and those set forth from time to time in the Trust’s filings with the United States Securities and Exchange Commission (the "SEC"), which could affect the future results of the energy industry in general, and the Trust and Tapstone in particular, and could cause those results to differ materially from those expressed in such forward-looking statements. The actual results or developments anticipated may not be realized or, even if substantially realized, may not have the expected consequences to or effects on Tapstone’s business and the Trust. Such statements are not guarantees of future performance and actual results or developments may differ materially from those projected in such forward-looking statements. These factors should not be construed as exhaustive, and there may also be other risks that we are unable to predict at this time. The Trustee relies on Tapstone for information regarding the Royalty Interests, the Underlying Properties (as defined below) and Tapstone itself. The Trust undertakes no obligation to publicly update or revise any forward-looking statements and expressly disclaims any obligation to do so, except as required by applicable law.
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
CHESAPEAKE GRANITE WASH TRUST STATEMENTS OF ASSETS AND TRUST CORPUS (Unaudited) | ||||||||||||||
| September 30, 2021 | December 31, 2020 | |||||||||||||
| ($ in thousands) | ||||||||||||||
| ASSETS: | ||||||||||||||
| Cash and cash equivalents | $ | 1,939 | $ | 1,738 | ||||||||||
| Investment in Royalty Interests | 487,793 | 487,793 | ||||||||||||
| Less: accumulated amortization and impairment | (478,356) | (476,384) | ||||||||||||
| Net investment in Royalty Interests | 9,437 | 11,409 | ||||||||||||
Total assets | $ | 11,376 | $ | 13,147 | ||||||||||
| TRUST CORPUS: | ||||||||||||||
Trust corpus; 46,750,000 common units issued and outstanding | 11,376 | 13,147 | ||||||||||||
Total Trust corpus | $ | 11,376 | $ | 13,147 | ||||||||||
The accompanying notes are an integral part of these financial statements.
1
CHESAPEAKE GRANITE WASH TRUST STATEMENTS OF DISTRIBUTABLE INCOME (Unaudited) | ||||||||||||||||||||||||||||||||
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||||||||||
| 2021 | 2020 | 2021 | 2020 | |||||||||||||||||||||||||||||
| ($ in thousands, except unit and per unit data) | ($ in thousands, except unit and per unit data) | |||||||||||||||||||||||||||||||
| REVENUES: | ||||||||||||||||||||||||||||||||
| Royalty income | $ | 2,299 | $ | 377 | $ | 5,799 | $ | 4,181 | ||||||||||||||||||||||||
| EXPENSES: | ||||||||||||||||||||||||||||||||
| Production tax (expenses)/income | (146) | (27) | (388) | 91 | ||||||||||||||||||||||||||||
| Trust administrative expenses | (364) | (33) | (993) | (722) | ||||||||||||||||||||||||||||
| Cash reserves withheld | (45) | (70) | (198) | (210) | ||||||||||||||||||||||||||||
| Total expenses | (555) | (130) | (1,579) | (841) | ||||||||||||||||||||||||||||
| Distributable income available to unitholders | $ | 1,744 | $ | 247 | $ | 4,220 | $ | 3,340 | ||||||||||||||||||||||||
Distributable income per common unit (46,750,000 common units) | $ | 0.0373 | $ | 0.0053 | $ | 0.0903 | $ | 0.0715 | ||||||||||||||||||||||||
CHESAPEAKE GRANITE WASH TRUST STATEMENTS OF CHANGES IN TRUST CORPUS (Unaudited) | ||||||||||||||||||||||||||||||||
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||||||||||
| 2021 | 2020 | 2021 | 2020 | |||||||||||||||||||||||||||||
| ($ in thousands) | ($ in thousands) | |||||||||||||||||||||||||||||||
TRUST CORPUS: Beginning of period | $ | 11,808 | $ | 17,762 | $ | 13,147 | $ | 21,805 | ||||||||||||||||||||||||
| Increase in cash and cash equivalents | (123) | (237) | 200 | 16 | ||||||||||||||||||||||||||||
| Amortization of Investment in Royalty Interests | (309) | (531) | (1,134) | (1,781) | ||||||||||||||||||||||||||||
| Impairment of Investment in Royalty Interests | — | (640) | (837) | (3,686) | ||||||||||||||||||||||||||||
| Distributable income available to unitholders | 1,744 | 247 | 4,220 | 3,340 | ||||||||||||||||||||||||||||
| Distributions paid to unitholders | (1,744) | (247) | (4,220) | (3,340) | ||||||||||||||||||||||||||||
TRUST CORPUS: End of period | $ | 11,376 | $ | 16,354 | $ | 11,376 | $ | 16,354 | ||||||||||||||||||||||||
The accompanying notes are an integral part of these financial statements.
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CHESAPEAKE GRANITE WASH TRUST
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
1.Organization of the Trust
Chesapeake Granite Wash Trust (the “Trust”) is a statutory trust formed in June 2011 under the Delaware Statutory Trust Act pursuant to an initial trust agreement by and among Chesapeake Energy Corporation ("Chesapeake"), as Trustor, The Bank of New York Mellon Trust Company, N.A., as Trustee (the “Trustee”), and The Corporation Trust Company, as Delaware Trustee (the “Delaware Trustee” and, together with the Trustee, the "Trustees").
On December 11, 2020, Tapstone Energy LLC ("Tapstone") acquired 23,750,000 common units and the Underlying Properties (as defined below) from Chesapeake in a transaction under Section 363 of the Bankruptcy Code. Pursuant to an Assignment and Assumption Agreement, dated as of December 11, 2020 (the “Assignment Agreement”), by and among Chesapeake Energy Corporation, Chesapeake Exploration, L.L.C., Chesapeake E&P Holding, L.L.C., and Tapstone Energy, LLC, Tapstone agreed to assume all duties and obligations of Chesapeake and its subsidiaries under each of the Trust Agreement, the Administrative Services Agreement, the royalty conveyances and the Registration Rights Agreement following the divestiture by Chesapeake of the Underlying Properties (as defined below) and 23,750,000 common units. As such, duties previously performed by Chesapeake with respect to the Trust will now be performed by Tapstone and all agreements between Chesapeake and the Trust transferred from Chesapeake to Tapstone.
The Trust was created to own royalty interests (the “Royalty Interests”) for the benefit of Trust unitholders pursuant to a trust agreement dated as of June 29, 2011, and subsequently amended and restated as of November 16, 2011, by and among Tapstone (as successor to Chesapeake and Chesapeake Exploration, L.L.C., a wholly owned subsidiary of Chesapeake), the Trustee and the Delaware Trustee (the “Trust Agreement”). The Royalty Interests are derived from Tapstone’s interests in the specified oil and natural gas properties located within an area of mutual interest (the "AMI") in the Colony Granite Wash play in Washita County in the Anadarko Basin of western Oklahoma (the "Underlying Properties"). Chesapeake conveyed the Royalty Interests to the Trust from (a) Chesapeake’s interests in 69 existing horizontal wells (the “Producing Wells”) and (b) Chesapeake’s interests in 118 horizontal development wells (the "Development Wells") that have since been drilled on properties held by Chesapeake within the AMI. Pursuant to a development agreement with the Trust, Chesapeake was obligated to drill, cause to be drilled or participate as a non-operator in the drilling of the Development Wells by June 30, 2016. Additionally, based on Chesapeake's assessment of the ability of a Development Well to produce in paying quantities, Chesapeake was obligated to either complete and tie into production or plug and abandon each Development Well. As of June 30, 2016, Chesapeake fulfilled its drilling obligation under the development agreement.
The business and affairs of the Trust are managed by the Trustee. The Trust Agreement limits the Trust’s business activities generally to owning the Royalty Interests and any activity reasonably related to such ownership, including activities required or permitted by the terms of the conveyances related to the Royalty Interests. The royalty interests in the Producing Wells entitle the Trust to receive 90% of the proceeds (exclusive of any production or development costs but after deducting certain post-production expenses and any applicable taxes) from the sales of oil, natural gas and NGL production attributable to Tapstone’s net revenue interest in the Producing Wells. The royalty interests in the Development Wells entitle the Trust to receive 50% of the proceeds (exclusive of any production or development costs but after deducting certain post-production expenses and any applicable taxes) from the sales of oil, natural gas and NGL production attributable to Tapstone’s net revenue interest in the Development Wells.
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CHESAPEAKE GRANITE WASH TRUST
NOTES TO FINANCIAL STATEMENTS - (Continued)
(Unaudited)
The Trust will dissolve and begin to liquidate on June 30, 2031, or earlier upon the below events (the "Termination Date"):
•the Trust sells all of the Royalty Interests;
•the aggregate quarterly cash distribution amounts for any four consecutive quarters is less than $1.0 million;
•the holders of the majority of the Trust units and a majority of the common units (excluding common units owned by Tapstone and its affiliates), in each case voting in person or by proxy at a meeting of such holders at which a quorum is present, vote in favor of dissolution; except that at any time during which Tapstone and its affiliates collectively own less than 10% of the outstanding Trust units, the standard for approval will be a majority of the Trust units, including Trust units owned by Tapstone and its affiliates voting in person or by proxy at a meeting of such holders at which a quorum is present; or
•the Trust is judicially dissolved.
At the Termination Date, (a) 50% of the total Royalty Interests conveyed by Chesapeake will revert automatically to Tapstone and (b) 50% of the total Royalty Interests conveyed by Chesapeake (the “Perpetual Royalties”) will be retained by the Trust and thereafter sold. The net proceeds of the sale of the Perpetual Royalties, as well as any remaining Trust cash reserves, will be distributed to the unitholders on a pro rata basis. Tapstone will have a right of first refusal to purchase the Perpetual Royalties retained by the Trust at the Termination Date.
The Trust's common units now trade under the symbol "CHKR" on the OTC Markets Group, Inc. (the "OTC Pink"). The OTC Pink is a significantly more limited market than the New York Stock Exchange (the "NYSE") and the quotation of the Trust's common units on the OTC Pink may result in less demand compared to the NYSE and could diminish interest in the Trust from investors, analysts and other market participants.
2.Basis of Presentation and Significant Accounting Policies
Basis of Accounting. The accompanying Statements of Assets and Trust Corpus as of September 30, 2021 and December 31, 2020 and the unaudited interim financial statements of the Trust as of and for the three and nine months ended September 30, 2021 (the “Current Quarter” and the “Current Period”, respectively) and the three and nine months ended September 30, 2020 (the “Prior Quarter” and the “Prior Period”, respectively) have been presented in accordance with the rules and regulations of the SEC and include all adjustments which are, in the opinion of the Trustee, necessary to fairly state the Trust's financial position and results of operations for the periods presented. The accompanying unaudited interim financial statements should be read in conjunction with the December 31, 2020 audited financial statements and notes of the Trust, included in the Trust’s Annual Report on Form 10-K for the year ended December 31, 2020. These financial statements have been prepared in accordance with the SEC instructions to Form 10-Q and, therefore, do not include all disclosures required for financial statements prepared in conformity with accounting principles generally accepted in the United States of America ("GAAP").
Financial statements of the Trust differ from financial statements prepared in accordance with GAAP, as the Trust records revenues when received and expenses when paid and may also establish certain cash reserves for contingencies which would not be accrued in financial statements prepared in accordance with GAAP. This non-GAAP comprehensive basis of accounting corresponds to the accounting principles permitted for royalty trusts by the SEC as specified by Staff Accounting Bulletin Topic 12:E, Financial Statements of Royalty Trusts.
Most accounting pronouncements apply to entities whose financial statements are prepared in accordance with GAAP, directing such entities to accrue or defer revenues and expenses in a period other than when such revenues were received or expenses were paid. Because the Trust’s financial statements are prepared on the modified cash basis, most accounting pronouncements are not applicable to the Trust’s financial statements.
Use of Estimates. The preparation of financial statements requires the Trust to make estimates and assumptions that affect the reported amounts of assets, liabilities and Trust corpus during the reporting period. Significant estimates that impact the Trust’s financial statements include estimates of proved oil, natural gas and NGL reserves, which are used to compute the Trust’s amortization of the Investment in Royalty Interests (as defined
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NOTES TO FINANCIAL STATEMENTS - (Continued)
(Unaudited)
in Investment in Royalty Interests below) and, as necessary, to evaluate potential impairments of Investment in Royalty Interests. Actual results could differ from those estimates.
Risks and Uncertainties. The global spread of COVID-19 created significant volatility, uncertainty, and economic disruption during 2020. The pandemic has reached more than 200 countries and territories and has resulted in widespread adverse impacts on the global economy and on Tapstone and Tapstone’s customers and other parties with whom it has business relations. To date, Tapstone has experienced limited operational impacts as a result of COVID-19 or the related governmental restrictions. While we cannot predict the full impact that COVID-19 or the current signification disruption and volatility in the oil and natural gas markets will have on Tapstone's business, cash flows, liquidity, financial condition and results of operations. For additional discussion regarding risks associated with the COVID-19 pandemic, see Part II, Item 7. Trustee's Discussion and Analysis of Financial Condition and Results of Operations in our 2020 Form 10-K and Item 1A "Risk Factors" in our 2020 Form 10-K.
The Trust's reserves and quarterly cash distributions depend primarily upon the prices realized by Tapstone from the sales of oil, natural gas and NGL. Low oil, natural gas and NGL prices negatively affect the amount of cash available for capital expenditures and debt repayment and the ability to borrow money or raise additional capital and, as a result, could have a material adverse effect on Tapstone’s financial condition, results of operations, cash flows and reserves and the Trust’s reserves and quarterly cash distributions. There is no guarantee that any actions taken by Tapstone in light of COVID-19 will be effective in preventing future disruptions to its business. Moreover, future operations of Tapstone could be negatively affected if a significant number of its employees are quarantined as a result of exposure to the virus, which in turn could negatively affect proceeds to the Trust and the Trust’s reserves and quarterly cash distributions to unitholders.
The Trust's revenues and distributable income available to unitholders were adversely affected in 2020 and early 2021 due to depressed commodity prices as a result of COVID-19. The Trust expects natural production decline to continue and expects distributable income to continue to be affected by commodity price volatility. On November 3, 2021, the Trust declared a cash distribution of $0.0496 per common unit (the "November 2021 Distribution"), consisting of proceeds attributable to production from June 1, 2021 to August 31, 2021. The distribution will be paid on November 29, 2021 to common unitholders of record as of November 19, 2021. See Note 5 for information regarding prior distributions paid, and Note 6 on the November 2021 Distribution.
Tapstone's ability to perform its obligations to the Trust depends on its future results of operations, financial condition and liquidity, which in turn depend upon the supply and demand for oil, natural gas and NGL, prevailing economic conditions, and financial, business and other factors, many of which are beyond Tapstone's control. The Trust is highly dependent on Tapstone for multiple services, including the operation of wells, remittance of net proceeds generated by the interests in specified oil and natural gas properties located within the AMI and administrative services performed on behalf of the Trust. The ability to operate the properties depends on Tapstone’s future financial condition and economic performance, access to capital, and other factors, many of which are out of the control of Tapstone.
Cash and Cash Equivalents. Cash equivalents include all highly-liquid instruments with maturities of three months or less at the time of acquisition. The Trustee maintains a minimum cash reserve of $1.0 million and may, at the Trustee’s discretion, reserve funds for future expected administrative expenses. Cash maintained at financial institutions may at times exceed federally insured amounts, but the Trust does not expect to be exposed to any significant risks related thereto.
Investment in Royalty Interests. The conveyance of the Royalty Interests to the Trust was accounted for as a transfer of properties between entities under common control and recorded at the historical cost. The Investment in Royalty Interests is amortized as a single cost center on a units-of-production basis over total proved reserves. Such amortization does not reduce distributable income, rather it is charged directly to Trust corpus. Revisions to estimated future units-of-production are treated on a prospective basis beginning on the date such revisions are known. The carrying value of the Trust’s Investment in Royalty Interests will not necessarily be indicative of the fair value of such Royalty Interests. The Trust is not burdened by development costs of the Royalty Interests.
On a quarterly basis, the Trust evaluates the carrying value of the Investment in Royalty Interests under the full cost accounting rules of the SEC. This quarterly review is referred to as a ceiling test. Under the ceiling test, the
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NOTES TO FINANCIAL STATEMENTS - (Continued)
(Unaudited)
carrying value of the Investment in Royalty Interests may not exceed an amount equal to the sum of the present value (using a 10% discount rate) of the estimated future net revenues from proved reserves. The Trust's Investment in Royalty Interests is subject to a quarterly full cost ceiling test. The Trust recognized a $0.84 million impairment of the Royalty Interests in the Current Period with no impairment of the Royalty Interests in the Current Quarter. The Trust recognized a $3.69 million impairment of the Royalty Interests in the Prior Period and a $0.64 million impairment of the Royalty Interests in the Prior Quarter. Impairments do not impact royalty income or the cash distribution to unitholders.
Loan Commitment. Pursuant to the Trust Agreement, if at any time the Trust’s cash on hand (including available cash reserves, if any) is not sufficient to pay the Trust’s ordinary course expenses as they become due, Tapstone will loan funds to the Trust necessary to pay such expenses. Such loans will be recorded as a liability on the Statements of Assets, Liabilities and Trust Corpus until repaid. A loan neither increases nor decreases distributions to unitholders; however, no further distributions will be made to unitholders (except in respect of any previously determined quarterly cash distribution amount and unless Tapstone otherwise consents in writing) until the loan is repaid. There were no loans outstanding as of September 30, 2021 and December 31, 2020.
Revenues and Expenses. Neither the Trust nor the Trustee is responsible for, or has any control over, any costs related to the drilling of the Development Wells or any other operating or capital costs of the Underlying Properties. The Trust’s revenues with respect to the Royalty Interests in the Underlying Properties are net of existing royalties and overriding royalties associated with Tapstone's interests and are determined after deducting certain post-production expenses and any applicable taxes associated with the Royalty Interests. Royalty Income (and associated Production Taxes and post-production costs) for the three and nine months ended September 30, 2021 generally includes royalties attributable to sales of oil, natural gas and NGL related to production from March 1, 2021 to May 31, 2021 and September 1, 2020 to May 31, 2021, respectively. Post-production expenses generally consist of costs incurred to gather, store, compress, transport, process, treat, dehydrate and market the oil, natural gas and NGL produced. However, the Trust is not responsible for costs of marketing services provided by Tapstone or Tapstone affiliates.
Trust administrative expenses for each of the three and nine months ended September 30, 2021 generally include administrative expense related to invoices paid between the periods of May 1, 2021 to July 31, 2021 and November 1, 2020 to July 31, 2021, respectively. Trust administrative expenses also includes a change in cash advance that estimates three months of subsequent Trust administration expense payments each quarter.
3.Income Taxes
The Trust is a Delaware statutory trust that is treated as a partnership for U.S. federal income tax purposes. The Trust is not required to pay federal or state income taxes. Accordingly, no provision for federal or state income tax has been made.
Trust unitholders are treated as partners of the Trust for U.S. federal income tax purposes. The Trust Agreement contains tax provisions that generally allocate the Trust’s income, deductions and credits among the Trust unitholders in accordance with their percentage interests in the Trust. The Trust Agreement also sets forth the tax accounting principles to be applied by the Trust.
4.Related Party Transactions
Sale of Underlying Properties. On December 11, 2020, Tapstone acquired 23,750,000 common units and the Underlying Properties of the Trust from Chesapeake in a transaction under Section 363 of the Bankruptcy Code. All of Chesapeake’s responsibilities and obligations with respect to the Trust transferred to Tapstone in connection with such transaction, pursuant to the Assignment Agreement. As such, duties previously performed by Chesapeake with respect to the Trust will now be performed by Tapstone and all agreements between Chesapeake and the Trust transferred from Chesapeake to Tapstone. As of December 11, 2020, Tapstone is the Operator and assumes all agreements entered between the Chesapeake and the Trust.
Trustee Administrative Fee. Under the terms of the Trust Agreement, the Trust is required to pay an annual administrative fee of $175,000 to the Trustee, paid in equal quarterly installments. The administrative fee may be adjusted for inflation by no more than 3% in any calendar year beginning in 2015. To date, the Trustee's annual
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CHESAPEAKE GRANITE WASH TRUST
NOTES TO FINANCIAL STATEMENTS - (Continued)
(Unaudited)
administrative fees have been adjusted upward by a total of 10.2% from the original fee including 2020 and 2021 increases of 2.3% and 1.4%, respectively, to the current annual amount of $192,831.
Agreements with Tapstone. In connection with the initial public offering and the conveyance of the Royalty Interests to the Trust, the Trust entered into an administrative services agreement, a development agreement and a registration rights agreement with Chesapeake. Pursuant to the Assignment Agreement, Tapstone agreed to assume all duties and obligations of Chesapeake and its subsidiaries under each such agreement.
Pursuant to the administrative services agreement, Tapstone provides the Trust with certain accounting, tax preparation, bookkeeping and information services related to the Royalty Interests and the registration rights agreement. In return for the services provided by Tapstone under the administrative services agreement, the Trust pays Tapstone, in equal quarterly installments, an annual fee of $200,000, which will remain fixed for the life of the Trust. Tapstone is also entitled to receive reimbursement for its actual out-of-pocket fees, costs and expenses incurred in connection with the provision of any of the services under the administrative services agreement.
The administrative services agreement will terminate upon the earliest to occur of (a) the date the Trust shall have dissolved and wound up its business and affairs in accordance with the Trust Agreement, (b) the date that all of the Royalty Interests have been terminated or are no longer held by the Trust, (c) with respect to services to be provided with respect to any Underlying Properties transferred by Tapstone to a third party, the date that either Tapstone or the Trustee may designate by delivering 90-days prior written notice, provided that the drilling obligation has been completed and the transferee of such Underlying Properties assumes responsibility to perform the services in place of Tapstone, or (d) a date mutually agreed upon by Tapstone and the Trustee.
The Trust also entered into a registration rights agreement for the benefit of Tapstone (a “holder”). Pursuant to the registration rights agreement, the Trust agreed to register the Trust units held by such holder for resale under the Securities Act of 1933, as amended, under certain circumstances. In connection with the preparation and filing of any registration statement, Tapstone will bear all costs and expenses incidental to such registration statement, excluding certain internal expenses of the Trust, which will be borne by the Trust, and any underwriting discounts and commissions, which will be borne by the seller of the Trust units.
Loan Commitment. Pursuant to the Trust Agreement, if at any time the Trust’s cash on hand (including available cash reserves, if any) is not sufficient to pay the Trust’s ordinary course expenses as they become due, Tapstone will loan funds to the Trust necessary to pay such expenses. Any funds loaned by Tapstone pursuant to this commitment will be limited to the payment of current accounts payable or other obligations to trade creditors in connection with obtaining goods or services or the payment of other current liabilities arising in the ordinary course of the Trust’s business, and may not be used to satisfy Trust indebtedness for borrowed money of the Trust. If Tapstone loans funds pursuant to this commitment, no further distributions will be made to unitholders (except in respect of any previously determined quarterly cash distribution amount and unless Tapstone otherwise consents in writing) until such loan is repaid. There were no loans outstanding as of September 30, 2021 and December 31, 2020.
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CHESAPEAKE GRANITE WASH TRUST
NOTES TO FINANCIAL STATEMENTS - (Continued)
(Unaudited)
5.Distributions to Unitholders
The Trust makes quarterly cash distributions of substantially all of its cash receipts, after deducting the Trust’s expenses, approximately 60 days following the completion of each quarter through (and including) the quarter ending June 30, 2031.
For the nine months ended September 30, 2021 and 2020, the Trust declared and paid the following cash distributions:
Production Period | Distribution Date | Cash Distribution per Common Unit | ||||||||||||||||||
| September 2020 - November 2020 | March 1, 2021 | $0.0063 | ||||||||||||||||||
| December 2020 - February 2021 | June 1, 2021 | $0.0467 | ||||||||||||||||||
| March 2021 - May 2021 | August 30, 2021 | $0.0373 | ||||||||||||||||||
| September 2019 - November 2019 | March 2, 2020 | $0.0371 | ||||||||||||||||||
| December 2019 - February 2020 | June 1, 2020 | $0.0291 | ||||||||||||||||||
| March 2020 - May 2020 | August 31, 2020 | $0.0053 | ||||||||||||||||||
8
CHESAPEAKE GRANITE WASH TRUST
NOTES TO FINANCIAL STATEMENTS - (Continued)
(Unaudited)
6. Subsequent Events
The Trust's quarterly income available for distribution was $0.0496 per common unit for the production period from June 1, 2021 to August 31, 2021 (net of administrative expenses incurred between August 1, 2021 to October 31, 2021). On November 3, 2021, the Trust declared the November 2021 Distribution attributable to such production period. The distribution will be paid on November 29, 2021 to common unitholders of record as of November 19, 2021. All Trust unitholders share on a pro rata basis in the Trust's distributable income.
Distributable income attributable to production from June 1, 2021 to August 31, 2021 was calculated as follows (in thousands, except for unit and per unit amounts):
| REVENUES: | |||||
Royalty income(a) | $ | 2,899 | |||
| EXPENSES: | |||||
| Production taxes | (202) | ||||
Trust administrative expenses(b) | (377) | ||||
| Total expenses | (579) | ||||
Cash withheld to increase cash reserves(c) | — | ||||
| Distributable income available to common unitholders | $ | 2,320 | |||
Distributable income per common unit(d) | $ | 0.0496 | |||
___________________________________________________
(a)Net of certain post-production expenses.
(b)Includes the quarterly change in cash advance resulting in a decrease in administrative expenses totaling $0.05 million
(c)The Trustee may increase or decrease the targeted amount of the cash reserve at any time, and may increase or decrease the rate at which it is withholding funds to build the cash reserve at any time, without advance notice to the unitholders. Without limiting the foregoing, the Trustee has reviewed the adequacy and sufficiency of the existing cash reserve and determined that, commencing with the distribution to unitholders for the fourth quarter 2021 (payable in 2022), the Trustee shall begin withholding the funds otherwise available for distribution to the unitholders each quarter to increase existing cash reserves by a total of approximately $3,200,000 over a period of several quarters. Cash held in reserve will be invested as required by the trust agreement. Any cash reserved in excess of the amount necessary to pay or provide for the payment of future known, anticipated or contingent expenses or liabilities eventually will be distributed to unitholders, together with interest earned on the funds.
(d)Calculation of distributable income per common unit is based on 46,750,000 common units issued and outstanding as of November 2, 2021.
Tapstone’s Agreement to be acquired by Diversified Energy
On October 6, 2021, Tapstone Energy Holdings, LLC entered into a conditional Agreement and Plan of Merger with Diversified Energy Company PLC (“Diversified Energy”) to acquire all upstream assets, field infrastructure, equipment and facilities owned by Tapstone, which includes the Underlying Properties of the Trust (the “Acquisition”). The Acquisition has not yet been consummated and is subject to certain closing conditions. Additional information about Diversified Energy, including its presentation of the Acquisition is available on Diversified Energy's website at www.div.energy. No information regarding Diversified Energy, including any information on its website, is incorporated into this filing.
9
ITEM 2. Trustee's Discussion and Analysis of Financial Condition and Results of Operations
Introduction
The following discussion and analysis is intended to help the reader understand the Trust’s financial condition and results of operations. This discussion and analysis should be read in conjunction with the Trust’s unaudited interim financial statements and the accompanying notes relating to the Trust and the Underlying Properties included in Item 1 of Part I of this Quarterly Report as well as the Trust’s Annual Report on Form 10-K for the year ended December 31, 2020.
Recent Developments
Tapstone’s Agreement to be acquired by Diversified Energy
On October 6, 2021, Tapstone Energy Holdings, LLC entered into a conditional Agreement and Plan of Merger with Diversified Energy to acquire all upstream assets, field infrastructure, equipment and facilities owned by Tapstone, which includes the Underlying Properties of the Trust. The Acquisition has not yet been consummated and is subject to certain closing conditions. Additional information about Diversified Energy, including its presentation of the Acquisition is available on Diversified Energy's website at www.div.energy. No information regarding Diversified Energy, including any information on its website, is incorporated into this filing.
COVID-19 Pandemic and Impact on Global Demand for Oil and Natural Gas
The global spread of COVID-19 created significant volatility, uncertainty, and economic disruption during 2020. The pandemic has reached more than 200 countries and territories and has resulted in widespread adverse impacts on the global economy and on Tapstone and Tapstone’s customers and other parties with whom it has business relations. To date, Tapstone has experienced limited operational impacts as a result of COVID-19 or the related governmental restrictions.
While we cannot predict the full impact that COVID-19 or the current significant disruption and volatility in the oil and natural gas markets will have on Tapstone’s business, cash flows, liquidity, financial condition and results of operations. For additional discussion regarding risks associated with the COVID-19 pandemic, see Part II, Item 7. Trustee's Discussion and Analysis of Financial Condition and Results of Operations in our 2020 Form 10-K and Item 1A “Risk Factors” in our 2020 Form 10-K.
Winter Weather Event
In June 2021, Tapstone, pursuant to certain royalty trust conveyances between Tapstone and the Trust, deposited $0.5 million of proceeds received by Tapstone associated with the February 2021 production period in a separate escrow account. Significant demand, coupled with freeze related natural gas production curtailment resulted in supply shortages prompting natural gas prices to spike in mid-February in the central United States (the “Winter Weather Event”). Natural gas produced from the Underlying Properties and other Tapstone assets in February 2021 realized a significant increase in prices for natural gas during such period, causing the related natural gas production revenues generated from the Underlying Properties (the "Winter Weather Event Proceeds") to significantly increase, which is not expected to be a normal or recurring event. To ensure the proper allocation of the Winter Weather Event Proceeds to Tapstone’s mineral interest owners, including the Trust, from this event, Tapstone deposited $0.5 million, an estimate of the amount at issue, in an escrow account (the “Escrowed Funds”) to avoid possible allocation controversy while it reviewed the allocation between mineral ownership of the Underlying Properties. Interest on the Escrowed Funds attributable to the Royalty Interests was paid to the Trust in November 2021. Tapstone concluded its allocation review process in July 2021 and submitted the Winter Weather Event Proceeds attributable to the Royalty Interests in the amount of $0.4 million net of production tax to the Trust for distribution to Trust unitholders as a part of the August 2021 Distribution.
Overview
The Trust is a statutory trust formed in June 2011 under the Delaware Statutory Trust Act. The business and affairs of the Trust are managed by the Trustee and, as necessary, the Delaware Trustee. The Trust does not
10
conduct any operations or activities other than owning the Royalty Interests and activities related to such ownership. The Trust’s purpose is generally to own the Royalty Interests, to distribute to the Trust unitholders cash that the Trust receives in respect of the Royalty Interests and to perform certain administrative functions in respect of the Royalty Interests and the Trust units. The Trust derives all or substantially all of its income and cash flow from the Royalty Interests. The Trust is treated as a partnership for U.S. federal income tax purposes.
Concurrent with the Trust's initial public offering in November 2011, Chesapeake conveyed the Royalty Interests to the Trust effective July 1, 2011, which included interests in (a) 69 Producing Wells in the Colony Granite Wash play and (b) 118 Development Wells that Chesapeake was obligated to drill, cause to be drilled or participate as a non-operator in the drilling of, from drill sites in the AMI, on or prior to June 30, 2016. As of June 30, 2016, Chesapeake fulfilled its drilling obligation under the development agreement. Chesapeake retained an interest in each of the Producing Wells and Development Wells, which were acquired by Tapstone pursuant to the Assignment Agreement, and Tapstone currently operates 96% of the Producing Wells and the completed Development Wells.
The Trust was not responsible for any costs related to the drilling of the Development Wells and is not responsible for any other operating or capital costs of the Underlying Properties, and Chesapeake was not permitted to drill and complete any well in the Colony Granite Wash formation on acreage included within the AMI for its own account until it had satisfied its drilling obligation to the Trust.
The Royalty Interests entitle the Trust to receive 90% of the proceeds (after deducting certain post-production expenses and any applicable taxes) from the sales of production of oil, natural gas and NGL attributable to Tapstone’s net revenue interest in the Producing Wells and 50% of the proceeds (after deducting certain post-production expenses and any applicable taxes) from the sales of oil, natural gas and NGL production attributable to Tapstone’s net revenue interest in the Development Wells. Post-production expenses generally consist of costs incurred to gather, store, compress, transport, process, treat, dehydrate and market the oil, natural gas and NGL produced. However, the Trust is not responsible for costs of marketing services provided by Tapstone or Tapstone affiliates.
The Trust is required to make quarterly cash distributions of substantially all of its cash receipts, after deducting the Trust’s administrative expenses, on or about 60 days following the completion of each calendar quarter through (and including) the quarter ending June 30, 2031. During the nine months ended September 30, 2021, a distribution was paid on March 1, 2021, June 1, 2021 and August 30, 2021. See Liquidity and Capital Resources below and Note 5 to the financial statements contained in Item 1 of Part I of this Quarterly Report for more information regarding these distributions.
The amount of Trust revenues and cash distributions to Trust unitholders fluctuates from quarter to quarter depending on several factors, including, but not limited to:
•timing and amount of production and sales from the Development and Producing Wells;
•oil, natural gas and NGL prices received;
•volumes of oil, natural gas and NGL produced and sold;
•certain post-production expenses and any applicable taxes; and
•the Trust’s expenses.
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Results of Trust Operations
The quarterly payments to the Trust with respect to the Royalty Interests are based on the amount of proceeds actually received by Tapstone during the preceding calendar quarter. Proceeds from production are typically received by Tapstone in the month following the month of production. Due to the timing of the payment of production proceeds, quarterly distributions made by Tapstone to the Trust generally include royalties attributable to sales of oil, natural gas and NGL for three months, comprised of the first two months of the quarter just ended and the last month of the quarter prior to that one. Tapstone is required to make the Royalty Interest payments to the Trust within 35 days after the end of each calendar quarter. During the nine months ended September 30, 2021, the Trust received payments on the Royalty Interests representing royalties attributable to proceeds from sales of oil, natural gas and NGL for September 1, 2020 to May 31, 2021.
The Trust's revenues and distributable income available to unitholders were affected throughout 2020 and to date in 2021 by natural declines in production and commodity price volatility including, with respect to the Current Quarter, as a result of COVID-19. The Trust expects production to decline further and expects distributable income to continue to be adversely affected.
The Trust's distributable income available to unitholders declared in August 2021 totaled $1.7 million and was inclusive of proceeds attributable to the Escrowed Funds related to the February 2021 Winter Weather Event totaling $0.4 million. The average price received for natural gas production as a part of this distribution was $2.38 ($/MCF), however adjusting for the Escrowed Funds, the average price received was $1.02 ($/MCF). The average realized natural gas price received by the Trust is burdened by post-production expenses, including gathering, storage, compression, transportation, processing, treating, dehydration, and non-affiliated marketing expenses. The distributable income available to unitholders declared in November 2021 totaled $2.3 million. The average price received for natural gas production as a part of this distribution totaled $1.73 ($/MCF), an increase as compared to the $1.02 ($/MCF) realized price included in the distribution declared in August 2021 after adjusting for the Escrowed Funds. This increase is primarily a result of an improvement in NYMEX commodity pricing.
The Trust's Investment in Royalty Interests is subject to a quarterly full cost ceiling test. The Trust recognized a $0.84 million impairment of the Royalty Interests in the Current Period with no impairment of the Royalty Interests in the Current Quarter. The Trust recognized a $3.69 million impairment of the Royalty Interests in the Prior Period and a $0.64 million impairment of the Royalty Interests in the Prior Quarter. See Investment in Royalty Interests in Note 2 to the financial statements contained in Item 1 of Part I of this Quarterly Report for further discussion.
Distributable Income
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||||||||||||||
| 2021 | 2020 | Change | 2021 | 2020 | Change | ||||||||||||||||||||||||||||||
| ($ in thousands, except per unit data) | |||||||||||||||||||||||||||||||||||
| Distributable income available to unitholders | $ | 1,744 | $ | 247 | 606 | % | $ | 4,220 | $ | 3,340 | 26 | % | |||||||||||||||||||||||
Distributable income per common unit | $ | 0.0373 | $ | 0.0053 | 604 | % | $ | 0.0903 | $ | 0.0715 | 26 | % | |||||||||||||||||||||||
The $1.50 million increase in distributable income during the Current Quarter was primarily due to an increase in the average realized price per boe in the production period from March 1, 2021 to May 31, 2021 (the "Current Production Quarter") inclusive of the Winter Weather Event Escrowed Funds as compared to the production period from March 1, 2020 to May 31, 2020 (the "Prior Production Quarter"), combined with an increase in total sales volumes in the Current Production Quarter. The $0.88 million increase in distributable income during the Current Period was due to an increase in average realized price per boe inclusive of the Winter Weather Event, offset by both the natural decline in production volumes and increase in production tax expense (tax refunds received in the Prior Period) in comparing to the Prior Period.
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Royalty Income
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||||||||||||||
| 2021 | 2020 | Change | 2021 | 2020 | Change | ||||||||||||||||||||||||||||||
| ($ in thousands, except per unit data) | |||||||||||||||||||||||||||||||||||
Royalty income(a) | $ | 2,299 | $ | 377 | 510 | % | $ | 5,799 | $ | 4,181 | 39 | % | |||||||||||||||||||||||
| Estimated production from trust properties: | |||||||||||||||||||||||||||||||||||
| Oil sales volumes (MBbl) | 14 | 13 | 8 | % | 33 | 52 | (37) | % | |||||||||||||||||||||||||||
| Natural gas sales volumes (MMcf) | 323 | 357 | (10) | % | 949 | 1,353 | (30) | % | |||||||||||||||||||||||||||
| Natural gas liquids sales volumes (MBbl) | 40 | 30 | 33 | % | 102 | 114 | (11) | % | |||||||||||||||||||||||||||
| Total sales volumes (Mboe) | 108 | 102 | 6 | % | 293 | 392 | (25) | % | |||||||||||||||||||||||||||
Average prices received for production(b): | |||||||||||||||||||||||||||||||||||
| Oil ($/Bbl) | $ | 58.33 | $ | 17.91 | 226 | % | $ | 47.27 | $ | 43.21 | 9 | % | |||||||||||||||||||||||
Natural gas ($/Mcf)(c) | $ | 2.38 | $ | 0.05 | 4,660 | % | $ | 2.63 | $ | 0.47 | 460 | % | |||||||||||||||||||||||
| Natural gas liquids ($/Bbl) | $ | 18.27 | $ | 4.48 | 308 | % | $ | 16.98 | $ | 11.39 | 49 | % | |||||||||||||||||||||||
| Total average price received ($/boe) | $ | 21.34 | $ | 3.70 | 477 | % | $ | 19.76 | $ | 10.67 | 85 | % | |||||||||||||||||||||||
_____________________________________________________
(a)Net of certain post-production expenses.
(b)Includes the impact of certain post-production expenses but excludes production taxes.
(c)The Trust was adversely affected by depressed commodity prices throughout 2020 as a result of the impact of COVID-19
The increase in the average price received per barrel of oil equivalent (boe) in the Current Production Quarter compared to the Prior Production Quarter resulted in an increase of approximately $1.90 million in royalty income. The increase in royalty income is primarily attributable to an increase in commodity pricing, inclusive of the Winter Weather Event Escrowed Funds. Additionally, higher sales volumes in the Current Production Quarter increased royalty income by approximately $0.02 million, for a total increase in royalty income of approximately $1.92 million in the Current Production Quarter compared to the Prior Production Quarter. The 6 mboe increase in total sales attributable to the Royalty Interests for the Current Production Quarter compared to the Prior Production Quarter is primarily the result of improved operational performance, offset by natural declines in production from the Producing Wells and Development Wells.
The increase in the average price received per boe in the Current Period compared to the Prior Period resulted in an increase of approximately $2.67 million in royalty income. The increase in royalty income is primarily attributable to an increase in commodity pricing, inclusive of the Winter Weather Event. Additionally, lower sales volumes in the Current Period decreased royalty income by approximately $1.05 million, for a total increase in royalty income of approximately $1.62 million in the Current Period compared to the Prior Period. The 99 mboe decrease in total sales attributable to the Royalty Interests for the Current Period compared to the Prior Period is due to weather related curtailments and natural declines in production from the Producing Wells and Development Wells.
13
Production Taxes
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||||||||||||||
| 2021 | 2020 | Change | 2021 | 2020 | Change | ||||||||||||||||||||||||||||||
| ($ in thousands, except per unit data) | |||||||||||||||||||||||||||||||||||
| Production tax expenses(income) | $ | 146 | $ | 27 | (441) | % | $ | 388 | $ | (91) | (526) | % | |||||||||||||||||||||||
Production taxes per boe | $ | 1.35 | $ | 0.26 | (419) | % | $ | 1.32 | $ | (0.23) | (674) | % | |||||||||||||||||||||||
Production taxes are calculated as a percentage of oil, natural gas and NGL revenues, net of any applicable tax credits. The increase in production taxes in the Current Quarter and Current Period compared to the Prior Quarter and Prior Period relates primarily to an increase in royalty income and to tax refunds received related to taxes paid from 2010 to 2017.
Trust Administrative Expenses
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||||||||||||||
| 2021 | 2020 | Change | 2021 | 2020 | Change | ||||||||||||||||||||||||||||||
| ($ in thousands) | |||||||||||||||||||||||||||||||||||
Trust administrative expenses(a) | $ | 364 | $ | 33 | 1,003 | % | $ | 993 | $ | 722 | 38 | % | |||||||||||||||||||||||
_____________________________________________________
(a)Includes a change in cash advances resulting in a $0.20 million increase and a $0.10 million decrease in administrative expenses for the three and nine months ended September 30, 2021, respectively.
Trust administrative expenses primarily consist of the administrative fees paid to the Trustees and Tapstone, as well as costs for accounting and legal services. The increase in expenses in the Current Quarter is primarily due to the timing and amount of the change in the cash advance. The increase in expenses in the Current Period is due to an increase in administrative expense activity primarily related to accounting, tax preparation, and regulatory compliance expenses.
14
Liquidity and Capital Resources
The Trust’s principal sources of liquidity and capital are cash flows generated from the Royalty Interests and the loan commitment as described below. The Trust’s primary uses of cash are distributions to Trust unitholders, payments of production taxes, payments of Trust administrative expenses, including any reserves established by the Trustee for future liabilities and repayment of loans and payments of expense reimbursements to Tapstone for out-of-pocket expenses incurred on behalf of the Trust. Administrative expenses include payments to the Trustees, as well as a quarterly fee of $50,000 to Tapstone 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 sales of oil, natural gas and NGL production attributable to the Royalty Interests during the quarter, over the Trust’s expenses for the quarter and any cash reserve for the payment of liabilities of the Trust. The Trust does not undertake or control any capital projects or capital expenditures. These capital expenditures, if any, are controlled and paid by Tapstone.
The Trust’s revenue and distributions are substantially dependent upon the prevailing and future prices for oil, natural gas and NGL, each of which depends on numerous factors beyond the Trust’s control such as economic conditions, regulatory developments and competition from other energy sources. Oil, natural gas and NGL prices historically have been volatile and may be subject to significant fluctuations in the future; however, the volatility in the prices for these commodities has substantially increased as a result of COVID-19. We expect to see continued volatility in oil and natural gas prices for the foreseeable future, and such volatility has impacted and is expected to continue to impact Tapstone’s business, financial condition and results of operations and proceeds to the Trust and the Trust’s reserves and quarterly cash distributions to unitholders. The Trust does not have the ability to enter into derivative contracts to mitigate the effect of this price volatility.
The Trustee may increase or decrease the targeted amount of the cash reserve at any time, and may increase or decrease the rate at which it is withholding funds to build the cash reserve at any time, without advance notice to the unitholders. Without limiting the foregoing, the Trustee has reviewed the adequacy and sufficiency of the existing cash reserve and determined that, commencing with the distribution to unitholders for the fourth quarter 2021 (payable in 2022), the Trustee shall begin withholding the funds otherwise available for distribution to the unitholders each quarter to increase existing cash reserves by a total of approximately $3,200,000 over a period of several quarters. Cash held in reserve will be invested as required by the trust agreement. Any cash reserved in excess of the amount necessary to pay or provide for the payment of future known, anticipated or contingent expenses or liabilities eventually will be distributed to unitholders, together with interest earned on the funds. As of September 30, 2021, $794,578 has been withheld to increase cash reserves.
The Trust is required to make quarterly cash distributions of substantially all of its cash receipts, after deducting the Trust’s administrative expenses, on or about 60 days following the completion of each calendar quarter through (and including) the quarter ending June 30, 2031. The 2021 third quarter distribution of $0.0373 per common unit, consisting of proceeds attributable to production from March 1, 2021 through May 31, 2021, (net of administrative expenses) was made on August 30, 2021 to record unitholders as of August 19, 2021.
15
On November 3, 2021, the Trust declared the November 2021 Distribution. The Trust's quarterly income available for distribution was $0.0496 per common unit consisting of proceeds attributable to production from June 1, 2021 to August 31, 2021 (net of administrative expenses). The distribution will be paid on November 29, 2021 to common unitholders of record as of November 19, 2021. All Trust unitholders share on a pro rata basis in the Trust's distributable income. Distributable income attributable to production from June 1, 2021 to August 31, 2021 was calculated as follows (in thousands, except for unit and per unit amounts):
| REVENUES: | |||||
Royalty income(a) | $ | 2,899 | |||
| EXPENSES: | |||||
| Production taxes | (202) | ||||
Trust administrative expenses(b) | (377) | ||||
| Total expenses | (579) | ||||
| Cash withheld to increase cash reserves | — | ||||
| Distributable income available to common unitholders | $ | 2,320 | |||
Distributable income per common unit(c) | $ | 0.0496 | |||
___________________________________________________
(a)Net of certain post-production expenses.
(b)Includes the quarterly change in cash advance resulting in a decrease in administrative expenses totaling $0.05 million
(c)Calculation of distributable income per common unit is based on 46,750,000 commons units issued and outstanding as of November 2, 2021
The Trustee can authorize the Trust to borrow money to pay Trust expenses that exceed cash held by the Trust. The Trustee may authorize the Trust to borrow from the Trustee as a lender provided the terms of the loan are fair to the Trust unitholders. The Trustee may also deposit funds awaiting distribution in an account with itself, if the interest paid to the Trust at least equals amounts paid by the Trustee on similar deposits, and make other short-term investments with the funds distributed to the Trust. The Trustee may also hold funds awaiting distribution in a non-interest-bearing account.
Pursuant to the Trust Agreement, if at any time the Trust’s cash on hand (including cash reserves, if any) is not sufficient to pay the Trust’s ordinary course expenses as they become due, Tapstone will loan funds to the Trust necessary to pay such expenses. Any funds loaned by Tapstone pursuant to this commitment will be limited to the payment of current accounts payable or other obligations to trade creditors in connection with obtaining goods or services or the payment of other current liabilities arising in the ordinary course of the Trust’s business and may not be used to satisfy Trust indebtedness for borrowed money of the Trust. If Tapstone loans funds pursuant to this commitment, unless Tapstone agrees otherwise in writing, no further distributions may be made to unitholders (except in respect of any previously determined quarterly cash distribution amount) until such loan is repaid. There were no loans outstanding as of September 30, 2021 and December 31, 2020.
Off-Balance Sheet Arrangements
The Trust has no off-balance sheet arrangements. The Trust has not guaranteed the debt of any other party, nor does the Trust have any other arrangements or relationships with other entities that could potentially result in unconsolidated debt, losses or contingent obligations.
Critical Accounting Policies and Estimates
Refer to Note 2 to the financial statements contained in Item 1 of Part I of this Quarterly Report for a discussion of significant accounting policies and estimates that impact the Trust's financial statements. Critical accounting policies and estimates relating to the Trust are contained in Item 7 of Part II of the 2020 Form 10-K.
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ITEM 3. Controls and Procedures
Evaluation of Disclosure Controls and Procedures.
The Trust’s disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act are designed to ensure that the information required to be disclosed by the Trust in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. 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 Tapstone to the Trustee, and its employees who participate in the preparation of the Trust’s periodic reports as appropriate to allow timely decisions regarding required disclosures. The Vice President of the Trustee has evaluated the effectiveness of the Trust’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(b) as of the end of the period covered by this Quarterly Report. Based on her evaluation, as of September 30, 2021, she has concluded that the Trust’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) were effective.
Due to the nature of the Trust as a passive entity and in light of the contractual arrangements pursuant to which the Trust was created, including the provisions of (a) the Trust Agreement, (b) the administrative services agreement, (c) the development agreement and (d) the conveyances granting the Royalty Interests, the Trust’s disclosure controls and procedures necessarily rely on (i) information provided by Tapstone, including information relating to results of operations, the costs and revenues attributable to the Trust’s interests under the conveyance and other operating and historical data, plans for future operating and capital expenditures, reserve information, information relating to projected production, and other information relating to the status and results of operations of the underlying properties and the Royalty Interests, and (ii) conclusions and reports regarding reserves by the Trust’s independent reserve engineers. Although the Trustee does rely on Tapstone to perform certain functions and to provide certain information that impact the Trust’s financial statements, the Trustee remains responsible for evaluating, as appropriate, the Trust’s disclosure controls and procedures as well as its internal control over financial reporting.
Changes in Internal Control over Financial Reporting.
There were no changes in the Trust's internal control over financial reporting during the three months ended September 30, 2021 that materially affected, or were reasonably likely to materially affect, the Trust's internal control over financial reporting.
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PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
There are no legal proceedings to which the Trust is a named party. However, the Trustee has been advised by Tapstone that the Trust may from time to time be subject to litigation in the ordinary course of business for certain matters that include the Royalty Interests. While Tapstone has advised the Trustee that it does not presently believe any pending litigation will have a material adverse effect net to the Trust, in the event such matters are adjudicated or settled in a material amount and charges are made against royalty income, such charges could have a material impact on the Trust's future royalty income.
ITEM 1A. Risk Factors
Factors that could materially affect our business, financial condition, operating results or liquidity and the trading price of the Trust’s common units are discussed in Item 1A. “Risk Factors” in our 2020 Form 10-K and below.
The sale of the Underlying Properties of the Trust may result in the ownership and management of the
Trust by a party that is unfamiliar with the operation of the Trust or the Underlying Properties.
On October 6, 2021, Tapstone Energy Holdings, LLC entered into a conditional Agreement and Plan of Merger with Diversified Energy to acquire all upstream assets, field infrastructure, equipment and facilities owned by Tapstone, which includes the Underlying Properties of the Trust. The Acquisition has not yet been consummated and is subject to certain closing conditions. If the Acquisition is consummated, duties currently performed by Tapstone with respect to the Trust will be performed by another party. The purchaser of the Underlying Properties may have less experience with the operation of the Trust or the Underlying Properties, or may interpret or perform its responsibilities with respect to the Trust and the Underlying Properties in a different manner than Tapstone. Additional information about Diversified Energy, including its presentation of the Acquisition is available on Diversified Energy's website at www.div.energy. No information regarding Diversified Energy, including any information on its website, is incorporated into this filing.
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ITEM 6. Exhibits
The exhibits listed below in the Index of Exhibits are filed, furnished or incorporated by reference pursuant to the requirements of Item 601 of Regulation S-K.
INDEX OF EXHIBITS
| Incorporated by Reference | ||||||||||||||||||||||||||||||||||||||
| Exhibit Number | Exhibit Description | Form | SEC File Number | Exhibit | Filing Date | Filed or Furnished Herewith | ||||||||||||||||||||||||||||||||
| 3.1 | S-1 | 333-175395 | 3.1 | 7/7/2011 | ||||||||||||||||||||||||||||||||||
| 3.2 | 8-K | 001-35343 | 3.1 | 11/21/2011 | ||||||||||||||||||||||||||||||||||
| 31.1 | X | |||||||||||||||||||||||||||||||||||||
| 32.1 | X | |||||||||||||||||||||||||||||||||||||
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: November 12, 2021
| CHESAPEAKE GRANITE WASH TRUST | ||||||||
| By: | THE BANK OF NEW YORK MELLON TRUST COMPANY, N.A, Trustee | |||||||
| By: | /s/ Sarah Newell | |||||||
| Sarah Newell | ||||||||
| Vice President | ||||||||
The registrant, Chesapeake Granite Wash Trust, has no principal executive officer, principal financial officer, board of directors or persons performing similar functions. Accordingly, no additional signatures are available, and none have been provided. In signing the report above, the Trustee does not imply that it has performed any such function or that such function exists pursuant to the terms of the Trust Agreement under which it serves.
Exhibit 31.1
Certification
I, Sarah Newell, certify that:
1.I have reviewed this quarterly report on Form 10-Q of Chesapeake Granite Wash Trust (the "Trust"), for which The Bank of New York Mellon Trust Company, N.A., acts as Trustee;
2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, distributable income and changes in Trust corpus of the registrant as of, and for, the periods presented in this report;
4.I am responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and I have:
a)Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under my supervision, to ensure that material information relating to the registrant, is made known to me by others within those entities, particularly during the period in which this report is being prepared;
b)Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under my supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with the basis of generally accepted accounting principles;
c)Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report my conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d)Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.I have disclosed, based on my most recent evaluation of internal control over financial reporting, to the registrant’s auditors:
a)All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b)Any fraud, whether or not material, that involves any persons who have a significant role in the registrant’s internal control over financial reporting.
In giving the foregoing certifications in paragraphs 4 and 5, I have relied to the extent I consider reasonable on information provided to me by Tapstone Energy, LLC.
| Date: | November 12, 2021 | /s/ Sarah Newell | |||||||||
Sarah Newell Vice President The Bank of New York Mellon Trust Company, N.A., Trustee of Chesapeake Granite Wash Trust | |||||||||||
Exhibit 32.1
November 12, 2021
Via EDGAR
Securities and Exchange Commission
100 F. Street, N.E.
Washington, D.C. 20549
| Re: | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | ||||
Ladies and Gentlemen:
In connection with the Quarterly Report on Form 10-Q for the period ended September 30, 2021 (the "Report") of Chesapeake Granite Wash Trust (the “Trust”), as filed with the Securities and Exchange Commission on the date hereof, the undersigned, not in her individual capacity but solely as the trustee of the Trust, certifies pursuant to 18 U.S.C. § 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to her knowledge:
(1)The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and
(2)The information contained in the Report fairly presents, in all material respects, the financial condition and results of operation of the Trust.
The above certification is furnished solely pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. § 1350) and is not being filed as part of the Report or as a separate disclosure document. In giving the foregoing certifications, the undersigned has relied to the extent she considers reasonable on information provided to her by Tapstone Energy, LLC.
| The Bank of New York Mellon Trust Company, N.A. Trustee for Chesapeake Granite Wash Trust | |||||
| By: | /s/ Sarah Newell | ||||
Sarah Newell Vice President | |||||