Gulf Coast Ultra Deep Royalty Trust 10-Q, filed Nov 15, 2023
Gulf Coast Ultra Deep Royalty Trust (GULTU)
About this 10-Q
Gulf Coast Ultra Deep Royalty Trust filed this 10-Q on November 15, 2023, covering the quarter ended September 30, 2023.
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2023
OR
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________ to ___________
Commission File Number: 001-36386
Gulf Coast Ultra Deep Royalty Trust
(Exact Name of Registrant as Specified in its Charter)
| Delaware | 46-6448579 | |
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) |
The Bank of New York Mellon Trust Company, N.A., as trustee 601 Travis Street, 16th Floor Houston, Texas |
77002 | |
| (Address of principal executive offices) | (Zip Code) |
Registrant’s telephone number, including area code: (512) 236-6555
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 ☐ 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 ☐ 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 | ☒ | Smaller reporting company | ☒ | |||
| 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
On November 15, 2023, there were 230,172,696 royalty trust units outstanding representing beneficial interests in the registrant.
GULF COAST ULTRA DEEP ROYALTY TRUST
TABLE OF CONTENTS
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GULF COAST ULTRA DEEP ROYALTY TRUST
STATEMENTS OF ASSETS, LIABILITIES AND TRUST CORPUS
| September 30, 2023 | December 31, 2022 | |||||||
| (unaudited) | (audited) | |||||||
| ASSETS | ||||||||
| Operating cash | $ | 43,094 | $ | 915,643 | ||||
| Reserve fund cash and short-term investments | 1,102,052 | 1,065,351 | ||||||
| Overriding royalty interests in subject interests, net | — | 329,851 | ||||||
| Total assets | $ | 1,145,146 | $ | 2,310,845 | ||||
| LIABILITIES AND TRUST CORPUS | ||||||||
| Reserve fund liability | $ | 1,102,052 | $ | 1,065,351 | ||||
| Trust corpus (230,172,696 royalty trust units authorized, issued and | ||||||||
| outstanding as of September 30, 2023 and December 31, 2022) | 43,094 | 1,245,494 | ||||||
| Total liabilities and trust corpus | $ | 1,145,146 | $ | 2,310,845 | ||||
The accompanying notes are an integral part of these financial statements.
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GULF COAST ULTRA DEEP ROYALTY TRUST
STATEMENTS OF DISTRIBUTABLE INCOME (Unaudited)
| Three Months Ended | Nine Months Ended | |||||||||||||||
| September 30, | September 30, | |||||||||||||||
| 2023 | 2022 | 2023 | 2022 | |||||||||||||
| Royalty income | $ | - | $ | 791,065 | $ | 401,278 | $ | 1,767,784 | ||||||||
| Interest income and other | 1,696 | 2,296 | 15,220 | 2,679 | ||||||||||||
| Administrative expenses | (108,432 | ) | (127,201 | ) | (469,822 | ) | (523,291 | ) | ||||||||
| Income in excess of administrative expenses (administrative expenses in excess of income) (Note 4) | $ | (106,736 | ) | $ | 666,160 | $ | (53,324 | ) | $ | 1,247,172 | ||||||
| Distributable income (Note 4) | $ | - | $ | 657,410 | $ | 197,331 | $ | 1,220,922 | ||||||||
| Distributable income per royalty trust unit | $ | - | $ | 0.002856 | $ | 0.000857 | $ | 0.005304 | ||||||||
| Royalty trust units outstanding at end of period | 230,172,696 | 230,172,696 | 230,172,696 | 230,172,696 | ||||||||||||
The accompanying notes are an integral part of these financial statements.
| 4 |
GULF COAST ULTRA DEEP ROYALTY TRUST
STATEMENTS OF CHANGES IN TRUST CORPUS (Unaudited)
| Three Months Ended | Nine Months Ended | |||||||||||||||
| September 30, | September 30, | |||||||||||||||
| 2023 | 2022 | 2023 | 2022 | |||||||||||||
| Trust corpus, beginning of period | $ | 149,830 | $ | 971,472 | $ | 1,245,494 | $ | 1,219,756 | ||||||||
| Amortization of overriding royalty interests in subject interests | - | (34,634 | ) | (21,780 | ) | (108,101 | ) | |||||||||
| Impairment of subject interests | - | - | (308,071 | ) | - | |||||||||||
| Income in excess of administrative expenses (administrative expenses in excess of income) | (106,736 | ) | 666,160 | (53,324 | ) | 1,247,172 | ||||||||||
| Distributions paid | - | (305,382 | ) | (819,225 | ) | (1,061,211 | ) | |||||||||
| Trust corpus, end of period | $ | 43,094 | $ | 1,297,616 | $ | 43,094 | $ | 1,297,616 | ||||||||
The accompanying notes are an integral part of these financial statements.
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GULF COAST ULTRA DEEP ROYALTY TRUST
NOTES TO FINANCIAL STATEMENTS (Unaudited)
1. BASIS OF ACCOUNTING AND SIGNIFICANT ACCOUNTING POLICIES
The financial statements of Gulf Coast Ultra Deep Royalty Trust (the Royalty Trust) are prepared on the modified cash basis of accounting and are not intended to present the Royalty Trust’s financial position and results of operations in conformity with United States (U.S.) generally accepted accounting principles (GAAP). This other comprehensive basis of accounting corresponds to the accounting permitted for royalty trusts by the U.S. Securities and Exchange Commission (SEC), as specified by Staff Accounting Bulletin Topic 12:E, Financial Statements of Royalty Trusts.
The accompanying unaudited financial statements have been prepared in accordance with the instructions to Form 10-Q and do not include all required information and disclosures. Therefore, this information should be read in conjunction with the Royalty Trust’s financial statements and notes contained in its annual report on Form 10-K for the year ended December 31, 2022. The information furnished herein reflects all adjustments that are, in the opinion of The Bank of New York Mellon Trust Company, N.A. (the Trustee), necessary for a fair statement of the results for the interim periods reported. All such adjustments are, in the opinion of the Trustee, of a normal recurring nature. Operating results for the three- and nine-month periods ended September 30, 2023, are not necessarily indicative of the results that may be expected for the year ending December 31, 2023.
The Royalty Trust was created to hold a 5% gross overriding royalty interest (collectively, the overriding royalty interests) in future production from specified Inboard Lower Tertiary/Cretaceous exploration prospects, located in the shallow waters of the Gulf of Mexico and onshore in South Louisiana that existed as of December 5, 2012 (collectively, the subject interests).
Royalties are recorded in royalty income on the statements of distributable income when received under the modified cash basis of accounting. Significant accounting policies are consistent with Note 1 - Summary of Significant Accounting Policies in Part II, Item 8 of the 2022 Form 10-K.
The Royalty Trust evaluates the carrying values of the overriding royalty interests in the subject interests for impairment if conditions indicate that potential uncertainty exists regarding the Royalty Trust’s ability to recover its recorded amounts related to the overriding royalty interests. Indications of potential impairment with respect to the overriding royalty interests can include, among other things, subject interest lease expirations, reductions in estimated reserve quantities or resource potential, changes in estimated future oil and natural gas prices, exploration costs, and/or drilling plans, and other matters that arise that could negatively impact the carrying values of the overriding royalty interests. If an impairment event occurs and it is determined that the carrying value of the Royalty Trust’s overriding royalty interests in the subject interests may not be recoverable, an impairment will be recognized as measured by the amount by which the carrying amount of the overriding royalty interests in the subject interests exceeds the fair value of these assets, which would be measured by discounting projected cash flows. The related impairment amounts are recorded as a reduction to the overriding royalty interest with an offsetting reduction to the Trust Corpus in the period such impairment is determined. Impairment of the carrying values of the overriding royalty interests in the subject interests involves a significant amount of judgment and may be subject to changes over time based on drilling plans and results, geophysical evaluations, the assignment of proved natural gas reserves, availability of capital and other factors. Fair value accounting guidance includes a hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 inputs) and the lowest priority to unobservable inputs (Level 3). When indicators of impairment are present and it is determined that the carrying value of the Royalty Trust’s overriding royalty interests in the subject interests exceeds the estimated undiscounted cash flows of the subject interest, fair value estimates utilized in the impairment assessment are determined based on inputs not observable in the market and thus represent Level 3 measurements.
2. OVERRIDING ROYALTY INTERESTS
The onshore Highlander subject interest is the only subject interest in which the Royalty Trust holds an overriding royalty interest. Amortization charges related to production volumes associated with the onshore Highlander subject interest reduced the carrying value of the overriding royalty interests by $0 and $21,780 during the three- and nine-month periods ended September 30, 2023, respectively, and $34,634 and $108,101 during the three- and nine-month periods ended September 30, 2022, respectively.
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Highlander Oil & Gas Assets LLC (HOGA) has a 72 percent working interest and an approximate 48 percent net revenue interest in the onshore Highlander subject interest. The Royalty Trust holds a 3.6 percent overriding royalty interest in the onshore Highlander subject interest. HOGA is the operator of the onshore Highlander subject interest.
As previously disclosed, the sole well producing from the onshore Highlander subject interest experienced an operational issue on January 19, 2023, resulting in substantial amounts of water entering the well, which caused a shut in of the well before production resumed at significantly reduced levels. Following an evaluation by HOGA’s field operations team, HOGA determined that it would be necessary to commence operations to control the water production, in expectation of eventually initiating “kill” operations on the well. HOGA has informed the Trustee that the well was shut in effective March 31, 2023 and production from the well has ceased. Since that time the well has flowed intermittently but not on a continuous basis. HOGA has informed the Trustee that due to the underground flow of fluids into the wellbore, the well cannot be salvaged and must be plugged and abandoned. Abandoning the well will eliminate any production from the onshore Highlander subject interest, which also will eliminate any proceeds to which the Royalty Trust would be entitled pursuant to its overriding royalty interests. Unless another well is drilled on the onshore Highlander subject interest, the Royalty Trust does not expect to receive any significant income attributable to its overriding royalty interests and accordingly, does not expect to have any cash available to distribute to Royalty Trust unitholders in future periods. HOGA currently is evaluating its options regarding a future drilling of a new well on the Highlander subject interest.
The Royalty Trust fully impaired the carrying value of the onshore Highlander subject interest by $308,071 on March 31, 2023. The Royalty Trust determined the fair value of the onshore Highlander subject interest to be zero using Level 3 measurements under the fair value hierarchy of ASC 820 Fair Value Measurement. Therefore, the Royalty Trust recognized the remaining carrying value of the onshore Highlander subject interest as of March 31, 2023 as an impairment loss. Accumulated amortization was $6,756,701 and $6,426,850 at September 30, 2023 and December 31, 2022, respectively.
3. RELATED PARTY TRANSACTIONS
Royalty Income. In accordance with the terms of the master conveyance, royalties are paid to the Royalty Trust on the last day of the month following the month in which production payments are received by HOGA. The Royalty Trust received royalties of $0 and $401,278 during the three- and nine-month periods ended September 30, 2023, respectively, and $791,065 and $1,767,784 during the three- and nine-month periods ended September 30, 2022, respectively. Royalties received by the Royalty Trust must first be used to (i) satisfy Royalty Trust administrative expenses and (ii) reduce Royalty Trust indebtedness. The Royalty Trust had no indebtedness outstanding as of September 30, 2023 and December 31, 2022.
Each quarter, the Trustee will determine the amount of funds available for distribution to the Royalty Trust unitholders. Available funds will equal the excess cash received by the Royalty Trust from the royalty interests and other sources during that quarter over the Royalty Trust’s liabilities for that quarter. Available funds will be reduced by any cash the Trustee reserves against future liabilities. As of September 30, 2023, the Trustee has established a minimum cash reserve of $302,500. The minimum cash reserve is not reflective of the Royalty Trust’s operating cash balance as of September 30, 2023.
Commencing with the distribution to unitholders in the first quarter of 2022, the Royalty Trust withheld $8,750 from the funds otherwise available for distribution each quarter through the first quarter of 2023, with the intent of gradually building a cash reserve of approximately $350,000. As no proceeds were available for distribution in the second and third quarters of 2023, the Royalty Trust did not withhold any funds for the cash reserve. Unless another well is drilled on the onshore Highlander subject interest as discussed in Note 2 above, the Royalty Trust does not intend to withhold funds for the cash reserve in the future, as the Royalty Trust does not expect to have any cash available to distribute to unitholders in future periods. This cash is reserved for the payment of future known, anticipated or contingent expenses or liabilities of the Royalty Trust. The Trustee may increase or decrease the targeted cash reserve amount at any time, and may increase or decrease the rate at which it withholds funds to build the cash reserve at any time, without advance notice to the unitholders. Cash held in reserve will be invested as required by the royalty 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. For additional information regarding distributions to Royalty Trust unitholders, see Note 4.
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Funding of Administrative Expenses. Pursuant to the royalty trust agreement, Freeport-McMoRan Inc. (FCX) has agreed to pay annual trust expenses up to a maximum amount of $350,000, with no right of repayment or interest due, to the extent the Royalty Trust lacks sufficient funds to pay administrative expenses. No such contributions were made during the three-month periods ended September 30, 2023 or 2022. FCX, in light of the shut-in of the sole well on the Highlander subject interest and the cessation of production from the well as described above, has confirmed to the Trustee that FCX plans to provide funds for the payment of such expenses as they become payable, in accordance with the provisions of the royalty trust agreement. In addition to such annual contributions, FCX has agreed to lend money, on an unsecured, interest-free basis, to the Royalty Trust to fund the Royalty Trust’s ordinary administrative expenses as set forth in the royalty trust agreement. No loans were outstanding at September 30, 2023 or December 31, 2022.
Pursuant to the royalty trust agreement, FCX agreed to provide and maintain a $1.0 million stand-by reserve account or an equivalent letter of credit for the benefit of the Royalty Trust to enable the Trustee to draw on such reserve account or letter of credit to pay obligations of the Royalty Trust if its funds are inadequate to pay its obligations at any time. Currently, with the consent of the Trustee, FCX may reduce the reserve account or substitute a letter of credit with a different face amount for the original letter of credit or any substitute letter of credit. In connection with this arrangement, FCX provided $1.0 million to the Royalty Trust. The $1.0 million, plus interest collected thereon, is reflected as reserve fund cash, with a corresponding reserve fund liability in the accompanying Statements of Assets, Liabilities and Trust Corpus. As of September 30, 2023, the Royalty Trust had not drawn any funds from the reserve account, and FCX had not requested a reduction of such reserve account.
Administration. HOGA performs all administrative and reporting responsibilities with respect to the Royalty Trust, including those described in Article III of the royalty trust agreement.
Compensation of the Trustee. The Trustee receives annual compensation of $200,000. Additionally, the Trustee receives reimbursement for its reasonable out-of-pocket expenses incurred in connection with the administration of the Royalty Trust. The Trustee’s compensation is paid out of the Royalty Trust’s assets. The Trustee has a lien on the Royalty Trust’s assets to secure payment of its compensation and any indemnification expenses and other amounts to which it is entitled under the royalty trust agreement.
4. DISTRIBUTIONS
Natural gas sales volumes (measured in thousands of cubic feet, or Mcf), average sales price and net cash proceeds available for distribution for the three- and nine-month periods ended September 30, 2023 and 2022, are set forth in the table below.
| Three Months Ended | Nine Months Ended | |||||||||||||||
| September 30, | September 30, | |||||||||||||||
| 2023 | 2022 | 2023 | 2022 | |||||||||||||
| Natural gas sales volumes (Mcf) | - | 104,953 | 101,352 | 327,850 | ||||||||||||
| Natural gas average sales price (per Mcf) | $ | - | $ | 7.97 | $ | 4.63 | $ | 5.80 | ||||||||
| Gross proceeds | - | 836,099 | 468,887 | 1,901,001 | ||||||||||||
| Post-production costs and specified taxes | - | (45,034 | ) | (67,609 | ) | (133,217 | ) | |||||||||
| Royalty income | - | 791,065 | 401,278 | 1,767,784 | ||||||||||||
| Interest and dividend income | 1,696 | 2,296 | 15,220 | 2,679 | ||||||||||||
| Administrative expenses | (108,432 | ) | (127,201 | ) | (469,822 | ) | (523,291 | ) | ||||||||
| Income in excess of administrative expenses (administrative expenses in excess of income) | (106,736 | ) | 666,160 | (53,324 | ) | 1,247,172 | ||||||||||
| Income available for distribution | - | 666,160 | 206,081 | 1,247,172 | ||||||||||||
| Adjustment to minimum cash reserve | - | (8,750 | ) | (8,750 | ) | (26,250 | ) | |||||||||
| Net cash proceeds available for distribution | $ | - | $ | 657,410 | $ | 197,331 | $ | 1,220,922 | ||||||||
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A summary of quarterly per unit distributions for the three-month periods ended March 31, 2023 and 2022, the three-month periods ended June 30, 2023 and 2022, and the three-month periods ended September 30, 2023 and 2022, is set forth in the table below.
| 2023 | 2022 | |||||||||||||||||||||
| Amount | Per Unit Amount | Record Date | Payment Date | Amount | Per Unit Amount | Record Date | Payment Date | |||||||||||||||
| $ | 197,331 | $ | 0.000857 | 4/28/2023 | 5/12/2023 | $ | 258,130 | $ | 0.001121 | 4/29/2022 | 5/13/2022 | |||||||||||
| $ | - | $ | - | 7/28/2023 | N/A | $ | 305,382 | $ | 0.001327 | 7/29/2022 | 8/12/2022 | |||||||||||
| $ | - | $ | - | 10/30/2023 | N/A | $ | 657,410 | $ | 0.002856 | 10/28/2022 | 11/14/2022 | |||||||||||
These distributions are not necessarily indicative of future distributions.
5. CONTINGENCIES AND OTHER COMMITMENTS
Litigation. There are currently no pending legal proceedings to which the Royalty Trust is a party.
6. SUBSEQUENT EVENTS
The Royalty Trust evaluated all other events subsequent to September 30, 2023, and through the date the Royalty Trust’s financial statements were issued, and determined that all events or transactions occurring during this period requiring recognition or disclosure were appropriately addressed in these financial statements.
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Item 2. Trustee’s Discussion and Analysis of Financial Condition and Results of Operations.
OVERVIEW
You should read the following discussion in conjunction with the financial statements of Gulf Coast Ultra Deep Royalty Trust (the Royalty Trust) and the related Trustee’s Discussion and Analysis of Financial Condition and Results of Operations and the discussion of its Business and Properties in the Royalty Trust’s Annual Report on Form 10-K for the year ended December 31, 2022 (2022 Form 10-K), filed with the United States (U.S.) Securities and Exchange Commission (SEC). The results of operations reported and summarized below are not necessarily indicative of future operating results. Unless otherwise specified, all references to “Notes” refer to the Notes to Financial Statements located in Part I, Item 1. “Financial Statements” of this Form 10-Q. Also see the 2022 Form 10-K for a glossary of definitions for some of the oil and gas industry terms used in this Form 10-Q. Additionally, please refer to the section entitled “Cautionary Statement” on page 13 of this Form 10-Q. The information below has been furnished to the Trustee by Highlander Oil & Gas Assets LLC (HOGA).
Business Overview
On June 3, 2013, Freeport-McMoRan Inc. (FCX) and McMoRan Exploration Co. (MMR) completed the transactions contemplated by the Agreement and Plan of Merger, dated as of December 5, 2012 (the merger agreement), by and among MMR, FCX, and INAVN Corp., a Delaware corporation and indirect wholly owned subsidiary of FCX (Merger Sub). Pursuant to the merger agreement, Merger Sub merged with and into MMR, with MMR surviving the merger as an indirect wholly owned subsidiary of FCX (the merger).
FCX’s oil and gas assets are held through its wholly owned subsidiary, FCX Oil & Gas LLC (FM O&G). As a result of the merger, MMR and McMoRan Oil & Gas LLC (McMoRan) are both indirect wholly owned subsidiaries of FM O&G.
The Royalty Trust is a statutory trust created as contemplated by the merger agreement by FCX under the Delaware Statutory Trust Act pursuant to a trust agreement entered into on December 18, 2012 (inception), by and among FCX, as depositor, Wilmington Trust, National Association, as Delaware trustee, and certain officers of FCX, as regular trustees. On May 29, 2013, Wilmington Trust, National Association, was replaced by BNY Trust of Delaware, as Delaware trustee (the Delaware Trustee), through an action of the depositor. Effective June 3, 2013, the regular trustees were replaced by The Bank of New York Mellon Trust Company, N.A., a national banking association, as trustee (the Trustee).
The Royalty Trust was created to hold a 5% gross overriding royalty interest (collectively, the overriding royalty interests) in future production from specified Inboard Lower Tertiary/Cretaceous exploration prospects located in the shallow waters of the Gulf of Mexico and onshore in South Louisiana that existed as of December 5, 2012, the date of the merger agreement (collectively, the subject interests). The subject interests were “carved out” of the mineral interests that were acquired by FCX pursuant to the merger and were not considered part of FCX’s purchase consideration of MMR. McMoRan has informed the Trustee that it has no plans to pursue, has relinquished, has allowed to expire or has sold all of its subject interests.
In connection with the merger, on June 3, 2013, (1) FCX, as depositor, McMoRan, as grantor, the Trustee and the Delaware Trustee entered into the amended and restated royalty trust agreement to govern the Royalty Trust and the respective rights and obligations of FCX, the Trustee, the Delaware Trustee, and the Royalty Trust unitholders with respect to the Royalty Trust (the royalty trust agreement); and (2) McMoRan, as grantor, and the Royalty Trust, as grantee, entered into the master conveyance of overriding royalty interests (the master conveyance) pursuant to which McMoRan conveyed to the Royalty Trust the overriding royalty interests in future production from the subject interests. Other than (a) its formation, (b) its receipt of contributions and loans from FCX for administrative and other expenses as provided for in the royalty trust agreement, (c) its payment of such administrative and other expenses, (d) its repayment of loans from FCX, (e) its receipt of the conveyance of the overriding royalty interests from McMoRan pursuant to the master conveyance, (f) its receipt of royalties from McMoRan and HOGA, and (g) its cash distributions to Royalty Trust unitholders, if any, the Royalty Trust has not conducted any activities. The Trustee has no involvement with, control over, or responsibility for, any aspect of any operations on or relating to the subject interests.
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The Trustee receives annual compensation of $200,000. Additionally, the Trustee receives reimbursement for its reasonable out-of-pocket expenses incurred in connection with the administration of the Royalty Trust. The Trustee’s compensation is paid out of the Royalty Trust’s assets. The Trustee has a lien on the Royalty Trust’s assets to secure payment of its compensation and any indemnification expenses and other amounts to which it is entitled under the royalty trust agreement.
On February 5, 2019, McMoRan completed the sale of all of its rights, title and interest in and to the onshore Highlander subject interest pursuant to a purchase and sale agreement with HOGA (the Highlander Sale). The onshore Highlander subject interest was sold subject to the overriding royalty interest in future production held by the Royalty Trust. As a result of the Highlander Sale, HOGA has a 72 percent working interest and an approximate 48 percent net revenue interest in the onshore Highlander subject interest. The Royalty Trust continues to hold a 3.6 percent overriding royalty interest in the onshore Highlander subject interest. HOGA is the operator of the onshore Highlander subject interest. McMoRan has informed the Trustee that it has no plans to pursue, has relinquished, has allowed to expire or has sold all of its subject interests.
In connection with the Highlander Sale, McMoRan sold its interests in substantially all of its oil and gas leases associated with the Highlander subject interest to HOGA. At September 30, 2023, HOGA owned interests in approximately 131 gas leases onshore in South Louisiana, covering approximately 9,000 gross acres (6,476 acres net to HOGA’s interest) associated with the onshore Highlander subject interest. Whether or not HOGA maintains the acreage associated with the onshore Highlander subject interest is determined by HOGA’s current and future plans, over which the Royalty Trust has no control. As of September 30, 2023, the onshore Highlander subject interest had minimal production, prompting HOGA to shut-in the well.
Status of the Onshore Highlander Subject Interest
As previously disclosed, the sole well producing from the onshore Highlander subject interest experienced an operational issue on January 19, 2023, resulting in substantial amounts of water entering the well, which caused a shut in of the well before production resumed at significantly reduced levels. Following an evaluation by HOGA’s field operations team, HOGA determined that it would be necessary to commence operations to control the water production, in expectation of eventually initiating “kill” operations on the well. HOGA has informed the Trustee that the well was shut in effective March 31, 2023 and production from the well has ceased. Since that time the well has flowed intermittently but not on a continuous basis. HOGA has informed the Trustee that due to the underground flow of fluids into the wellbore, the well cannot be salvaged and must be plugged and abandoned. Abandoning the well will eliminate any production from the onshore Highlander subject interest, which also will eliminate any proceeds to which the Royalty Trust would be entitled pursuant to its overriding royalty interests. Unless another well is drilled on the onshore Highlander subject interest, the Royalty Trust does not expect to receive any significant income attributable to its overriding royalty interests and accordingly, does not expect to have any cash available to distribute to Royalty Trust unitholders in future periods. HOGA currently is evaluating its options regarding the drilling of a new well on the Highlander subject interest.
LIQUIDITY AND CAPITAL RESOURCES
Pursuant to the royalty trust agreement, FCX has agreed to pay annual trust expenses up to a maximum amount of $350,000, with no right of repayment or interest due, to the extent the Royalty Trust lacks sufficient funds to pay administrative expenses. No such contributions by FCX were made during the nine-month periods ended September 30, 2023 or 2022. FCX, in light of the shut-in of the sole well on the Highlander subject interest and the cessation of production from the well as described above, has confirmed to the Trustee that FCX plans to provide funds for the payment of such expenses as they become payable, in accordance with the provisions of the royalty trust agreement. In addition to such annual contributions, FCX has agreed to lend money, on an unsecured, interest-free basis, to the Royalty Trust to fund the Royalty Trust’s ordinary administrative expenses as set forth in the royalty trust agreement. No loans were outstanding as of September 30, 2023, or December 31, 2022. All funds the Trustee borrows to cover expenses or liabilities, whether from FCX or from any other source, must be repaid before the Royalty Trust unitholders receive any distributions.
Pursuant to the royalty trust agreement, FCX agreed to provide and maintain a $1.0 million stand-by reserve account or an equivalent letter of credit for the benefit of the Royalty Trust to enable the Trustee to draw on such reserve account or letter of credit to pay obligations of the Royalty Trust if its funds are inadequate to pay its obligations at any time. Currently, with the consent of the Trustee, FCX may reduce the reserve account or substitute a letter of credit with a different face amount for the original letter of credit or any substitute letter of credit. In connection with this arrangement, FCX provided $1.0 million to the Royalty Trust. The $1.0 million, plus interest collected thereon, is held in reserve fund cash. As of September 30, 2023, the Royalty Trust had not drawn any funds from the reserve account, and FCX had not requested a reduction of such reserve account.
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In connection with the completion of the Highlander Sale, HOGA assumed all administrative and reporting responsibilities with respect to the Royalty Trust, including those described in Article III of the royalty trust agreement.
In accordance with the terms of the master conveyance, royalties are paid to the Royalty Trust on the last day of the month following the month in which production payments are received by HOGA. The Royalty Trust received royalties of $0 and $401,278 during the three- and nine-month periods ended September 30, 2023, respectively, and $791,065 and $1,767,784 during the three- and nine-month periods ended September 30, 2022, respectively.
Royalties received by the Royalty Trust must first be used to (i) satisfy Royalty Trust administrative expenses and (ii) reduce Royalty Trust indebtedness. The Royalty Trust had no indebtedness outstanding as of September 30, 2023 and December 31, 2022.
Each quarter, the Trustee will determine the amount of funds available for distribution to the Royalty Trust unitholders. Available funds will equal the excess cash received by the Royalty Trust from the royalty interests and other sources during that quarter over the Royalty Trust’s liabilities for that quarter. Available funds will be reduced by any cash the Trustee decides to hold as a reserve against future liabilities. As of September 30, 2023, the Trustee has established a minimum cash reserve of $302,500. The minimum cash reserve is not reflective of the Royalty Trust’s operating cash balance as of September 30, 2023.
Commencing with the distribution to unitholders in the first quarter of 2022, the Royalty Trust withheld $8,750 from the funds otherwise available for distribution each quarter through the first quarter of 2023, with the intent of gradually building a cash reserve of approximately $350,000. As no proceeds were available for distribution in the second or third quarters of 2023, the Royalty Trust did not withhold any funds for the cash reserve. Unless another well is drilled on the onshore Highlander subject interest as discussion “Overview – Status of the Onshore Highlander Subject Interest” above, the Royalty Trust does not intend to withhold funds for the cash reserve as the Royalty Trust does not expect to have any cash available to distribute to unitholders in future periods. This cash is reserved for the payment of future known, anticipated or contingent expenses or liabilities of the Royalty Trust. The Trustee may increase or decrease the targeted cash reserve amount 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. Cash held in reserve will be invested as required by the royalty 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.
Distributable income totaled $0 and $197,331 during the three- and nine-month periods ended September 30, 2023, respectively, and $657,410 and $1,220,922 during the three- and nine-month periods ended September 30, 2022, respectively. These distributions are not necessarily indicative of future distributions, particularly in light of the shutting in of the sole well producing from the Highlander subject interest, as discussed above, and the cessation of production from the well, effective March 31, 2023. HOGA has informed the Trustee that due to the underground flow of fluids into the wellbore that the well cannot be salvaged and needs to be plugged and abandoned. Abandoning the well will eliminate any production from the onshore Highlander subject interest, which also will eliminate any proceeds to which the Royalty Trust would be entitled pursuant to its overriding royalty interest. Unless another well is drilled on the onshore Highlander subject interest, the Royalty Trust does not expect to receive any significant income attributable to its overriding royalty interests and accordingly, does not expect to have any cash available to distribute to Royalty Trust unitholders in future periods. The Royalty Trust’s only other sources of liquidity are mandatory annual contributions, any loans and the required standby reserve account or letter of credit from FCX. As a result, any material adverse change in FCX’s, McMoRan’s or HOGA’s financial condition or results of operations could materially and adversely affect the Royalty Trust and the underlying royalty trust units.
OFF-BALANCE SHEET ARRANGEMENTS
The Royalty Trust has no off-balance sheet arrangements. The Royalty Trust has not guaranteed the debt of any other party, nor does the Royalty Trust have any other arrangements or relationships with other entities that could potentially result in unconsolidated debt, losses or contingent obligations.
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RESULTS OF OPERATIONS
Royalty Income. In accordance with the terms of the master conveyance, during the three-month period ended September 30, 2023, the Royalty Trust did not receive royalty income. During the three-month period ended September 30, 2022, the Royalty Trust received royalties of $791,065 related to 104,953 Mcf of natural gas production attributable to the onshore Highlander subject interest with average post-production costs of $0.43 per Mcf and an average sales price of $7.97 per Mcf.
During the nine-month period ended September 30, 2023, the Royalty Trust received royalties of $401,278 related to 101,352 Mcf of natural gas production attributable to the onshore Highlander subject interest with average post-production costs of $0.67 per Mcf and an average sales price of $4.63 per Mcf. During the nine-month period ended September 30, 2022, the Royalty Trust received royalties of $1,767,784 related to 327,580 Mcf of natural gas production attributable to the onshore Highlander subject interest with average post-production costs of $0.41 per Mcf and an average sales price of $5.80 per Mcf.
Royalty income was lower during the three- and nine-month periods ended September 30, 2023, as compared to the corresponding 2022 periods, primarily due to lower production resulting from the operational issues relating to the sole well producing from the Highlander subject interest and ultimately the shutting in of the well.
Administrative Expenses. Administrative expenses consist primarily of audit, legal and trustee expenses incurred in connection with the administration of the Royalty Trust. During the three-month periods ended September 30, 2023 and 2022, the Royalty Trust paid administrative expenses of $108,432 and $127,201, respectively. During the nine-month periods ended September 30, 2023 and 2022, the Royalty Trust paid administrative expenses of $469,822 and $523,291, respectively. Administrative expenses were lower for the three- and nine-month periods ended September 30, 2023, as compared to the corresponding 2022 periods, primarily due to the timing of payments for professional services.
NEW ACCOUNTING STANDARDS
None.
CAUTIONARY STATEMENT
This Quarterly Report on Form 10-Q contains 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 (the Exchange Act). Forward-looking statements are all statements other than statements of historical facts, such as any statements regarding the future financial condition of the Royalty Trust or the trading market for the royalty trust units, all statements regarding the respective plans of McMoRan or HOGA for the subject interests, the potential results of any drilling on the subject interests by the applicable operator, anticipated interests of McMoRan or HOGA and the Royalty Trust in any of the subject interests, HOGA’s geologic models and the nature of the geologic trend onshore in South Louisiana discussed in this Form 10-Q, the amount and date of quarterly distributions to Royalty Trust unitholders, expectations regarding any drilling of another well on the Highlander subject interest, and statements regarding the Royalty Trust’s future income from the overriding royalty interests and future distributions to Royalty Trust unitholders and all statements regarding any belief or understanding of the nature or potential of the subject interests. The words “anticipates,” “may,” “can,” “plans,” “believes,” “estimates,” “expects,” “projects,” “intends,” “likely,” “will,” “should,” “to be,” “potential,” and any similar expressions and/or statements that are not historical facts are intended to identify those assertions as forward-looking statements.
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Forward-looking statements are not guarantees or assurances of future performance and actual results may differ materially from those anticipated, projected or assumed in the forward-looking statements. Important factors that may cause actual results to differ materially from those anticipated by the forward-looking statements include, but are not limited to, the future plans of FCX and HOGA for their remaining oil and gas properties; the risk that the subject interests will not produce additional hydrocarbons; general economic and business conditions; variations in the market demand for, and prices of, oil and natural gas; drilling results; changes in oil and natural gas reserve expectations; the potential adoption of new governmental regulations; decisions by FCX, McMoRan or HOGA not to develop and/or transfer the subject interests; any inability of FCX, McMoRan or HOGA to develop the subject interests; damages to facilities resulting from natural disasters or accidents; fluctuations in the market price, volume and frequency of the trading market for the royalty trust units; the amount of cash received or expected to be received by the Trustee from the underlying subject interests on or prior to a record date for a quarterly cash distributions; the cost and timing of drilling a new well on the Highlander subject interest; and other factors described in Part I, Item 1A. “Risk Factors” in the 2022 Form 10-K, as updated by the Royalty Trust’s subsequent filings with the SEC. Any differences in actual cash receipts by the Royalty Trust could affect the amount of quarterly cash distributions.
Investors are cautioned that current production rates may not be indicative of future production rates or of the amounts of hydrocarbons that a well may produce, and that many of the assumptions upon which forward-looking statements are based are likely to change after such forward-looking statements are made, which the Royalty Trust cannot control. The Royalty Trust cautions investors that it does not intend to update its forward-looking statements, notwithstanding any changes in assumptions, changes in business plans, actual experience, or other changes, and the Royalty Trust undertakes no obligation to update any forward-looking statements except as required by law.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
As a smaller reporting company, the Royalty Trust is not required to provide the information required by this Item.
Item 4. Controls and Procedures.
(a) Evaluation of disclosure controls and procedures. The Royalty Trust has no employees, and, therefore, does not have a principal executive officer or principal financial officer. Accordingly, the Trustee is responsible for making the evaluations, assessments and conclusions required pursuant to this Item 4. The Trustee has evaluated the effectiveness of the Royalty Trust’s “disclosure controls and procedures” (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Form 10-Q. Based on this evaluation, the Trustee has concluded that the Royalty Trust’s disclosure controls and procedures are effective as of the end of the period covered by this Form 10-Q.
Due to the nature of the Royalty Trust as a passive entity and in light of the contractual arrangements pursuant to which the Royalty Trust was created, including the provisions of (i) the amended and restated royalty trust agreement and (ii) the master conveyance, the Royalty Trust’s disclosure controls and procedures necessarily rely on (A) information provided by FCX or HOGA, including information relating to results of operations, the costs and revenues attributable to the subject interests 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 subject interests and the overriding royalty interests, and (B) conclusions and reports regarding reserves by the Royalty Trust’s independent reserve engineers.
(b) Changes in internal control over financial reporting. During the quarter ended September 30, 2023, there has been no change in the Royalty Trust’s internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the Royalty Trust’s 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 FCX or HOGA.
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There are currently no pending legal proceedings to which the Royalty Trust is a party.
Please refer to Part I, Item 1A. “Risk Factors” in the 2022 Form 10-K. Any of these factors could result in a significant or material adverse effect on the Royalty Trust’s results of operations or financial condition. There have been no material changes to the Royalty Trust’s risk factors since the 2022 Form 10-K.
On October 16, 2023, the Royalty Trust issued a press release that was furnished as an exhibit to the Current Report on Form 8-K filed with the SEC on the same date, announcing that the Royalty Trust would not be making a distribution for the quarter ended September 30, 2023, as post-production costs exceeded royalty income. Presented below is a corrected version of the table that was included in the press release, showing the corrected natural gas (Mcf) sales volumes, average sales price and net cash proceeds available for distribution, reflecting the absence of any royalty income to the Royalty Trust for the quarter ended September 30, 2023:
| Natural gas (Mcf) sales volumes (a) | - | |||
| Natural gas (per Mcf) average sales price | $ | - | ||
| Gross proceeds | $ | - | ||
| Post-production costs and specified taxes | - | |||
| Royalty income | - | |||
| Interest and dividend income | 1,696 | |||
| Administrative expenses | (108,432 | ) | ||
| Administrative expenses in excess of income (b) | (106,736 | ) | ||
| Increase in minimum cash reserve (c) | - | |||
| Cash proceeds available for distribution | $ | - |
The following exhibits are filed or furnished as part of this quarterly report on Form 10-Q:
| Exhibit | Filed or Furnished with this | Incorporated by Reference | ||||||||
| Number | Exhibit Title | Form 10-Q | Form | File No. | Date Filed | |||||
| 3.1 | Composite Certificate of Trust of Gulf Coast Ultra Deep Royalty Trust | 10-Q | 333-185742 | August 14, 2013 | ||||||
| 31 | Certification pursuant to Rule 13a-14(a)/15d-14(a) | X | ||||||||
| 32 | Certification pursuant to 18 U.S.C. Section 1350 | X | ||||||||
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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.
| Gulf Coast Ultra Deep Royalty Trust | ||
| By: | The Bank of New York Mellon | |
| Trust Company, N.A., as Trustee | ||
| By: | /s/ Sarah C. Newell | ||
| Sarah C. Newell | |||
| Vice President | |||
| Date: | November 15, 2023 |
The Registrant, Gulf Coast Ultra Deep Royalty Trust, has no principal executive officer, principal financial officer, controller or chief accounting 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 any such function exists pursuant to the terms of the amended and restated royalty trust agreement, dated June 3, 2013, under which it serves.
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Exhibit 31
Certification
I, Sarah C. Newell, certify that:
| 1. | I have reviewed this quarterly report on Form 10-Q of Gulf Coast Ultra Deep Royalty 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)), or for causing such controls and procedures to be established and maintained for the registrant, and 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, including its consolidated subsidiaries, 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 accounting described in Note 1 to the financial statements; | |
| (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 Highlander Oil & Gas Assets LLC.
Date: November 15, 2023
| /s/ Sarah C. Newell | |
| Sarah C. Newell | |
| Vice President | |
| The Bank of New York Mellon Trust Company, | |
| N.A., as Trustee of Gulf Coast Ultra Deep Royalty Trust |
Exhibit 32
Certification Pursuant to 18 U.S.C. Section 1350
(Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002)
Securities and Exchange Commission
100 F Street, N.E.
Washington, D.C. 20549
In connection with the Quarterly Report on Form 10-Q of Gulf Coast Ultra Deep Royalty Trust (the “Trust”) for the quarter ended September 30, 2023, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), the undersigned, not in its individual capacity but solely as the trustee of the Trust, hereby certifies, pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, that, to the best of its knowledge:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition, distributable income and changes in trust corpus of the Trust.
Date: November 15, 2023
| /s/ Sarah C. Newell | |
| Sarah C. Newell | |
| Vice President | |
| The Bank of New York Mellon Trust Company, N.A., as Trustee of Gulf Coast Ultra Deep Royalty 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 Form 10-Q or as a separate disclosure document.