Trustee's Discussion and Analysis of Financial Condition and Results of
Operations.
This document contains forward-looking statements, which describe current
expectations or forecasts of future events. Please refer to "Forward-Looking
Statements" which follows the Table of Contents of this
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report for an explanation of these types of statements and their limitations.
All information regarding operations has been provided by Greylock Energy.
Overview
The Trust is a statutory trust created under the Delaware Statutory Trust Act.
The Bank of New York Mellon Trust Company, N.A. serves as Trustee. The Trust
does not conduct any operations or activities. The Trust's purpose is, in
general, to hold the Royalty Interests, to distribute to the Trust unitholders
cash that the Trust receives in respect of the Royalty Interests after payment
of Trust expenses, and to perform certain administrative functions in respect of
the Royalty Interests and the Trust units. The Trustee has no authority or
responsibility for, and no involvement with, any aspect of the oil and gas
operations on the properties to which the Royalty Interests relate. The Trust
derives all or substantially all of its income and cash flows from the Royalty
Interests. The Trust is treated as a partnership for federal and state income
tax purposes.
In November 2017, Greylock Energy, LLC and certain of its wholly owned
subsidiaries ("Greylock Energy"), including Greylock Production, LLC ("Greylock
Production"), which serves as operator of the subject wells, and Greylock
Midstream, LLC ("Greylock Midstream"), whose subsidiaries market and gather
certain of the gas, acquired substantially all of the gas production and
midstream assets of Legacy ECA, including all of Legacy ECA's interests in
certain natural gas properties that are subject to royalty interests held by the
Trust (the "Acquisition").
In connection with the Acquisition, Greylock Production assumed all of Legacy
ECA's obligations under the Trust Agreement and other instruments to which
Legacy ECA and the Trustee were parties at the time of the transaction,
including (1) the Administrative Services Agreement by and among Legacy ECA, the
Trust and the Trustee dated July 7, 2010, and (2) a letter agreement between
Legacy ECA and the Trustee regarding certain loans to be made by Legacy ECA to
the Trust as necessary to enable the Trust to pay its liabilities as they become
due (the "Letter Agreement"). In addition, Legacy ECA, Greylock Production, and
the Trustee entered into a Reaffirmation and Amendment of Mortgage, Assignment
of Leases, Security Agreement, Fixture Filing and Financing Statement (the
"Reaffirmation Agreement"), pursuant to which, among other things, Greylock
Production (1) reaffirmed the liens and the security interest granted pursuant
to the existing mortgage securing the interests in the subject properties, as
well as the mortgage and the obligations of Legacy ECA under the mortgage, and
(2) assumed the obligations of Legacy ECA under the Letter Agreement.
As part of the initial acquisition of substantially all of Legacy ECA's assets,
neither Greylock Energy nor Greylock Production acquired title ownership of
Legacy ECA's working interest in two wells in which the Trust also had an
interest, the Penneco Morrow #1MH and Penneco Morrow #2MH wells. In March 2019,
Legacy ECA sold the title ownership and working interest in these two wells to
Greylock Production.
Legacy ECA completed its drilling obligation to the Trust under the Development
Agreement as of November 30, 2011. Consequently, no additional wells will be
drilled for the Trust. All trust units share in all cash distributions on a
pro rata basis. As of December 31, 2022 the Trust owned Royalty Interests in the
14 Producing Wells and the 40 development wells (52.06 Equivalent PUD Wells
calculated in accordance with the Development Agreement) that are now completed
and in production.
The Royalty Interests were conveyed from Legacy ECA's working interest in the
Producing Wells and the PUD Wells limited to the Underlying Properties. The PDP
Royalty Interest entitles the Trust to receive 90% of the proceeds (exclusive of
any production or development costs but after deducting post-production costs
and any applicable taxes) from the sale of production of natural gas
attributable to the Sponsor's interest in the Producing Wells for a period of
20 years commencing on April 1, 2010 and 45% thereafter. The PUD Royalty
Interest entitles the Trust to receive 50% of the proceeds (exclusive of any
production or development costs but after deducting post-production costs and
any applicable taxes) from the sale of production of natural gas attributable to
the Sponsor's interest in the PUD Wells for a period of 20 years commencing on
April 1, 2010 and 25% thereafter. Approximately 50% of the originally estimated
natural gas production attributable to the Royalty Interests was hedged through
March 31, 2014.
The Trust's cash receipts in respect of the Royalty Interests are determined
after deducting post-production costs and any applicable taxes associated with
the Royalty Interests, and the Trust's cash
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available for distribution is reduced by Trust administrative expenses.
Post-production costs generally consist of costs incurred to gather, compress,
transport, process, treat, dehydrate and market the natural gas produced.
Charges payable to Legacy ECA for such post-production costs on the related GCGS
were limited to $0.52 per MMBtu gathered until Legacy ECA fulfilled its drilling
obligation in 2011; since then the Sponsor has been permitted to increase the
Post-Production Services Fee to the extent necessary to recover certain capital
expenditures in the GCGS.
Generally, the percentage of production proceeds to be received by the Trust
with respect to a well equals the product of (i) the percentage of proceeds to
which the Trust is entitled under the terms of the conveyances (90% for the
Producing Wells and 50% for the PUD Wells) multiplied by (ii) Greylock
Production's net revenue interest in the well. Greylock Production on average
owns an 81.53% net revenue interest in the Producing Wells. Therefore, the Trust
is entitled to receive on average 73.37% of the proceeds of production from the
Producing Wells. With respect to the PUD Wells, the conveyance related to the
PUD Royalty Interest provides that the proceeds from the PUD Wells will be
calculated on the basis that the underlying PUD Wells are burdened only by
interests that in total would not exceed 12.5% of the revenues from such
properties, regardless of whether the royalty interest owners are actually
entitled to a greater percentage of revenues from such properties. As an
example, assuming Greylock Production owns a 100% working interest in a PUD
Well, the applicable net revenue interest is calculated by multiplying Greylock
Production's percentage working interest in the 100% working interest well by
the unburdened interest percentage (87.5%), and such well would have a minimum
87.5% net revenue interest. Accordingly, the Trust is entitled to a minimum of
43.75% of the production proceeds from the well provided in this example. To the
extent Greylock Production's working interest in a PUD Well is less than 100%,
the Trust's share of proceeds would be proportionately reduced.
The Trust makes quarterly cash distributions of substantially all of its cash
receipts, after deducting Trust administrative expenses and costs and reserves
therefor, on or about 60 days following the completion of each quarter. Unless
sooner terminated, the Trust will begin to liquidate in March 2030 and will soon
thereafter wind up its affairs and terminate.
The amount of Trust revenues and cash distributions to Trust unitholders depends
on, among other things:
•
natural gas prices received;
•
the volume and Btu rating of natural gas produced and sold;
•
post-production costs and any applicable taxes; and
•
administrative expenses of the Trust including expenses incurred as a result of
being a publicly traded entity, and any changes in amounts reserved for such
expenses.
The markets for natural gas are volatile, as demonstrated by significant price
swings experienced during 2020 and 2021 attributable primarily to the economic
effects of the COVID-19 pandemic, followed by the gradual return of demand for
natural gas as economies reopened. COVID-19 and the responses by federal, state
and local governmental authorities to the pandemic also resulted in significant
business and operational disruptions, including business closures, supply chain
disruptions, travel restrictions, stay-at-home orders and limitations on the
availability of workforces. Meanwhile, the outbreak of armed conflict between
Russia and Ukraine in February 2022 and the subsequent sanctions imposed on
Russia and other actions have created significant market uncertainties,
including uncertainties around potential supply disruptions for oil and natural
gas, which has further enhanced the volatility in natural gas prices over the
last year. Given the dynamic nature of these events, neither Greylock Energy nor
the Trust can reasonably estimate the period of time that these market
conditions will persist. As a result of these and other factors, prices for
natural gas, and therefore the Trust's quarterly cash distributions, might not
be maintained for any significant period of time.
The effective date of the Trust was April 1, 2010, meaning the Trust has
received the proceeds of production attributable to the PDP Royalty Interest
from that date even though the PDP Royalty Interest was not conveyed to the
Trust until July 7, 2010. The amount of the quarterly distributions fluctuates
from quarter to quarter, depending on the proceeds received by the Trust, among
other factors. There is no minimum required distribution.
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Pursuant to IRC Section 1446, withholding tax on income effectively connected to
a United States trade or business allocated to non-U.S. persons ("ECI") should
be made at the highest marginal rate. Under IRC Section 1441, withholding tax on
fixed, determinable, annual, periodic income from United States sources
allocated to non-U.S. persons should be made at a 30% rate unless the rate is
reduced by treaty. Nominees and brokers should withhold at the highest marginal
rate on distributions made to non-U.S. persons. As a result of the TCJA enacted
in December 2017, a non-U.S. holder's gain on the sale of Trust units is now
treated as ECI to the extent such holder would have had ECI if the Trust had
sold all of its assets at fair market value on the date of the exchange. The
TCJA also requires a transferee of units to withhold 10% of the amount realized
on the sale of exchange of units (generally, the purchase price) unless the
transferor certifies that it is not a nonresident alien individual or foreign
corporation or other exception is available. Pursuant to final Treasury
Regulations issued in 2020, this withholding obligation applies to transfers
of units in publicly traded partnerships such as the Trust (which is classified
as a partnership for United States federal and state income tax purposes)
occurring on or after January 1, 2022.
Results of Trust Operations
For the twelve months ended December 31, 2022 compared to the twelve months
ended December 31, 2021
Distributable income for the year ended December 31, 2022 increased to
$10.1 million from $4.8 million for the year ended December 31, 2021. Compared
to the year ended December 31, 2021, royalty income increased $5.3 million while
general and administrative expenses remained relatively flat.
Royalty income increased from $6.3 million for the year ended December 31, 2021
to $11.6 million for the year ended December 31, 2022, an increase of
$5.3 million. This was due to an increase in the average realized price
partially offset by a decrease in production.
The average price realized for the year ended December 31, 2022 increased $2.58
per Mcf to $4.96 per Mcf as compared to $2.38 for the year ended December 31,
2021. The increase in the average sales price for gas production was due
primarily to an increase in the weighted average monthly closing NYMEX price
partially offset by a decrease to the average Basis. The average sales price,
before post-production costs, increased from $3.32 per Mcf for the year ended
December 31, 2021 to $5.83 per Mcf for the year ended December 31, 2022. This
increase in price was primarily the result of an increase in the weighted
average monthly closing NYMEX price for the current period to $6.60 per MMBtu
compared to the year ended December 31, 2021 weighted average monthly closing
NYMEX price of $3.83 per MMBtu, and to a lesser extent to a $0.34 per MMBtu
decrease in the average Basis to $(0.95) per MMBtu in the current period
compared to the prior period Basis of $(0.61) per MMBtu.
Post-production costs consist of a post-production services fee together with a
charge for electricity used in lieu of gas for compression on the gathering
system and firm transportation charges on interstate gas pipelines. Overall,
average post-production costs decreased to $0.87 per Mcf for the year ended
December 31, 2022 as compared to $0.94 per Mcf for the year ended December 31,
2021 primarily due to a refund received from Columbia during the year ended
December 31, 2022.
Production decreased 11.5% from 2,648 MMcf for the year ended December 31, 2021
to 2,343 MMcf for the year ended December 31, 2021.
General and administrative expenses paid by the Trust remained relatively flat
at $1.1 million for each of the years ended December 31, 2022 and 2021. In each
of the years ended December 31, 2022 and 2021, the Trustee withheld
approximately $0.4 million towards the cash reserve that the Trustee has
established for the payment of future liabilities of the Trust as they become
due. The addition to the cash reserve decreased distributable income in each of
the years ended December 31, 2022 and 2021.
Liquidity and Capital Resources
The Trust has no source of liquidity or capital resources other than cash flows
from the Royalty Interests. Other than Trust administrative expenses, including,
if applicable, expense reimbursements to Greylock Production and any reserves
established by the Trustee for future liabilities, the Trust's only use of cash
is for distributions to Trust unitholders. Administrative expenses include
payments to the Trustee
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and the Delaware Trustee as well as a quarterly fee of $15,000 to Greylock
Production pursuant to the ASA. 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 Royalty Interests and other sources (such as
interest earned on any amounts reserved by the Trustee) that quarter, over the
Trust's expenses for that quarter. Available funds are reduced by any cash the
Trustee determines to hold as a reserve against future expenses or liabilities.
The Trustee may borrow funds required to pay expenses or liabilities if the
Trustee determines that the cash on hand and the cash to be received are
insufficient to cover the Trust's expenses or liabilities. If the Trustee
borrows funds, the Trust unitholders will not receive distributions until the
borrowed funds are repaid.
Since the first quarter of 2019, the Trustee has been gradually building a cash
reserve for the payment of future expenses and liabilities of the Trust to
approximately $1.8 million by withholding cash reserve amounts from each
quarterly distribution equal to the greater of $90,000 or 10% of the amount
distributable to unitholders. In November 2021, the Trustee notified the Sponsor
that the Trustee had determined to increase the targeted cash reserve to
approximately $3.8 million. The Trustee achieved its initial target of
$1.8 million in the quarter ended December 2022 and currently plans to withhold
$66,175 per quarter until a total of approximately $3.8 million in cash reserves
is withheld. These withholdings are in addition to the existing cash reserve of
$0.5 million, which is determined prior to the payments of quarterly expenses.
The Trustee may increase or decrease the targeted 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 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. In 2022
and 2021, the Trustee withheld $404,389 and $419,061, respectively, from the
funds otherwise available for distribution. As of December 31, 2022, the Trustee
has withheld from the funds otherwise available for distribution a total amount
of $1,800,000, plus $22,420 of interest, toward the building of the $3.8 million
cash reserve.
Payments to the Trust in respect of the Royalty Interests are based on the
complex provisions of the various conveyances held by the Trust, copies of which
are filed as exhibits to this report, and reference is hereby made to the text
of the conveyances for the actual calculations of amounts due to the Trust.
The Trust does not have any transactions, arrangements or other relationships
with unconsolidated entities or persons that could materially affect the Trust's
liquidity or the availability of capital resources.
Pursuant to the terms of the ASA, the Trust is obligated to pay Greylock
Production an annual administrative services fee of $60,000 for accounting,
bookkeeping and informational services relating to the Royalty Interests to be
performed by Greylock Production on behalf of the Trust throughout the term of
the Trust. Pursuant to the Trust Agreement, the Trustee is to be paid an annual
administrative fee, which may be adjusted annually, up or down, by the amount of
the change in the All Urban Consumers (CPI-U) - US City Average for the
immediately preceding calendar year, not to exceed +/- 3% in any one year. This
fee was $161,325 and $167,027 in 2021 and 2022, respectively. The Trust is also
obligated to pay the Delaware Trustee a fee of $2,500 per year, throughout the
term of the Trust.
Greylock Production and the Trustee each may terminate the provisions of the ASA
relating to Greylock Production's provision of administrative services at any
time following delivery of notice no less than 90 days prior to the date of
termination; provided, however, that Greylock Production may not terminate the
ASA except in connection with Greylock Production's transfer of some or all of
the Subject Interests, as defined in the Conveyances, and then only with respect
to the services to be provided with respect to the Subject Interests being
transferred, and only upon the delivery to the Trustee of an agreement of the
transferee of such Subject Interests reasonably satisfactory to the Trustee in
which such transferee assumes the responsibility to perform the services
relating to the Subject Interests being transferred.
Critical Accounting Policies and Estimates
The financial statements of the Trust differ from financial statements prepared
in accordance with generally accepted accounting principles in the United States
of America ("GAAP") because certain cash reserves may be established for
contingencies, which would not be accrued in financial statements prepared
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in accordance with GAAP. Amortization of the investment in overriding royalty
interests calculated on a unit-of-production basis is charged directly to Trust
Corpus. This comprehensive basis of accounting other than GAAP corresponds to
the accounting permitted for royalty trusts by the SEC as specified by FASB ASC
Topic 932 Extractive Activities - Oil and Gas: Financial Statements of Royalty
Trusts.
Income determined on the basis of GAAP would include all expenses incurred for
the period presented. However, the Trust serves as a pass-through entity, with
expenses for depreciation, depletion, and amortization, interest and income
taxes being based on the status and elections of the Trust unitholders. General
and administrative expenses, production taxes or any other allowable costs are
charged to the Trust only when cash has been paid for those expenses. In
addition, the Royalty Interests are not burdened by field and lease operating
expenses. Thus, the statement shows distributable income, defined as income of
the Trust available for distribution to the Trust unitholders before application
of those unitholders' additional expenses, if any, for depreciation, depletion,
and amortization, interest and income taxes. The revenues are reflected net of
existing royalties and overriding royalties and have been reduced by
gathering/post-production expenses.
Revenue and Expenses:
The Trust serves as a pass-through entity, with items of depletion, interest
income and expense, and income tax attributes being based upon the status and
election of the unitholders. Thus, the Statements of Distributable Income show
Income available for distribution before application of those unitholders'
additional expenses, if any, for depletion, interest income and expense, and
income taxes.
The Trust uses the accrual basis to recognize revenue, with royalty income
recorded as reserves are extracted from the Underlying Properties and sold.
Expenses are recognized when paid.
Royalty Interest in Gas Properties:
The Royalty interests in gas properties is assessed to determine whether the net
capitalized cost is impaired, whenever events or changes in circumstances
indicate that its carrying amount may not be recoverable, pursuant to Accounting
Standards Codification 360, Property, Plant and Equipment ("ASC 360"). The Trust
determines whether an impairment charge is necessary to its investment in the
Royalty Interests in gas properties if total capitalized costs, less accumulated
amortization, exceed undiscounted future net revenues attributable to proved gas
reserves of the Underlying Properties. Determination as to whether and how much
an asset is impaired may involve estimates of highly uncertain matters such as
future commodity prices, the effects of inflation, weighted average cost of
capital, and technology improvements on post-production costs and the outlook
for national or regional market supply and demand conditions. Estimates of
undiscounted future net revenues attributable to proved gas reserves utilize
forward pricing curves. No impairment indicators were identified during either
of the years ended December 31, 2022 or 2021, and accordingly no impairments
were present. Significant dispositions or abandonment of the Underlying
Properties, if necessary, are charged to Royalty Interests and the Trust Corpus.
Amortization of the Royalty interest in gas properties is calculated on
a units-of-production basis, whereby the Trust's cost basis in the properties is
divided by Trust total proved reserves to derive an amortization rate per
reserve unit. 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 significant revisions are known.
The conveyance of the Royalty Interests to the Trust was accounted for as a
purchase transaction. The $352,100,000 reflected in the Statements of Assets,
Liabilities and Trust Corpus as Royalty interest in gas properties represents
17,605,000 Trust units valued at $20.00 per unit. The carrying value of the
Trust's investment in the Royalty Interests is not necessarily indicative of the
fair value of such Royalty Interests.
Item 7A.
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