SANDRIDGE MISSISSIPPIAN TRUST II Introduction
The following discussion and analysis is intended to help the reader understand the financial condition, results of operations, liquidity and capital resources ofSandRidge Mississippian Trust II (the "Trust"). This discussion and analysis should be read in conjunction with the Trust's unaudited interim financial statements and the accompanying notes included in this Quarterly Report and the Trust's audited financial statements and the accompanying notes included in the 2019 Form 10-K. All information regarding operations has been provided to the Trustee by SandRidge. Overview The Trust is a statutory trust created under the Delaware Statutory Trust Act. The business and affairs of the Trust are administered by the Trustee and, as necessary, the Delaware Trustee. The Trust's purpose is to hold 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. Other than the foregoing activities, the Trust does not conduct any operations or activities. The Trustee has no involvement with, control or authority over, or responsibility for, any aspect of the operations on or relating to the properties in which the Trust has an interest. 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 federal income tax purposes. Commodity Price Volatility; COVID-19 Pandemic. The Trust's quarterly cash distributions are highly dependent upon the prices realized from the sale of oil, natural gas and NGL. The markets for these commodities are volatile, as demonstrated by significant price swings experienced during 2019 and have declined sharply in 2020 attributable primarily to the economic effects of the dispute over production levels betweenRussia and the members of theOrganization of Petroleum Exporting Countries ("OPEC"), includingSaudi Arabia , and the global outbreak of the novel form of coronavirus known as COVID-19. The spot price for WTI crude oil has decreased from$61.18 onJanuary 2, 2020 to$25.78 onMay 12, 2020 . COVID-19 and the responses by federal, state and local governmental authorities to the pandemic have also resulted in significant business and operational disruptions, including business closures, supply chains disruptions, travel restrictions, stay-at-home orders and limitations on the availability of workforces. The full impact of COVID-19 is unknown and is rapidly evolving. The extent to which COVID-19 negatively impacts SandRidge or any third-party operator of theUnderlying Properties will depend on the severity, location and duration of the effects and spread of COVID-19, the actions undertaken by federal, state and local governments and health officials to contain the virus or treat its effects, and how quickly and to what extent economic conditions improve and normal business and operating conditions resume. A prolonged period of low crude oil, NGL and natural gas prices will adversely affect SandRidge or third-party operators of theUnderlying Properties . As a result, there can be no assurance that prices for oil, natural gas and NGL, and therefore the Trust's quarterly cash distributions, will be maintained for any significant period of time. Continued low oil, NGL and natural gas prices will reduce revenues to the Trust, which will reduce the amount of cash available for distribution to unitholders and in certain periods could result in no distributions to unitholders, and could negatively affect the value of the Royalty Interests, which could reduce the amount of proceeds the Trust would receive from a sale of the Trust's assets in connection with the early termination of the Trust. Impairment of Investment in Royalty Interests. During the three-month period endedMarch 31, 2020 , the Trust recorded an impairment to the carrying value of the Investment in Royalty Interests of$5.1 million . The impairment resulted in a non-cash charge to trust corpus and did not affect the Trust's distributable income. There was no impairment in the carrying value of the Investment in Royalty Interests during the three-month period endedMarch 31, 2019 . Material write-downs in subsequent periods may occur if commodity prices decline or a change in circumstances causes a decline in expected future undiscounted cash flows relative to the carrying value of the investment in royalty interests. See "Impairment of Investment in Royalty Interests" in Note 2 to the unaudited interim financial statements contained in Part I, Item 1 of this Quarterly Report for further discussion of the impairments. Properties. As ofMarch 31, 2020 , the Trust's properties consisted of Royalty Interests in oil and natural gas wells located in northernOklahoma and southernKansas . Distributions. The Trust makes quarterly cash distributions of substantially all of its cash receipts, after deducting amounts for the Trust's administrative expenses, property tax and cash reserves withheld by the Trustee, on or about the 60th day following the completion of each quarter. Pursuant to Internal Revenue Code ("IRC") Section 1446, withholding tax on income effectively connected to aUnited 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 fromUnited States sources allocated to non-U.S. persons should be made at 30% of gross income unless the rate is reduced by treaty. This is intended to be a qualified notice to nominees and brokers as 11 -------------------------------------------------------------------------------- provided for under Treasury Regulation Section 1.1446-4(b) by the Trust, and while specific relief is not specified for IRC Section 1441 income, this disclosure is intended to suffice. Nominees and brokers should withhold at the highest marginal rate on the distribution made to non-U.S. persons. The Tax Cuts and Jobs Act (the "TCJA") enacted inDecember 2017 treats a non-U.S. holder's gain on the sale of Trust units 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 the 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. Pending the finalization of proposed regulations under IRC Section 1446, theIRS has suspended this new withholding obligation with respect to publicly traded partnerships such as the Trust, which is classified as a partnership for federal and state income tax purposes. Early Termination of the Trust. As discussed in "Early Termination of the Trust" in Note 1 to the unaudited interim financial statements contained in Part I, Item 1 of this Quarterly Report, winding up procedures for the Trust commenced at the close of business onFebruary 14, 2020 . Accordingly, the Trustee is required to sell all of the Trust's assets, either by private sale or public auction. Any net proceeds of the sale will be distributed to the Trust unitholders after payment, or reasonable provision for payment, of all Trust liabilities, which is expected to include the establishment of cash reserves deemed appropriate by the Trustee for the payment of all claims and obligations of the Trust, including any contingent, conditional or unmatured claims and obligations, in accordance with the Delaware Statutory Trust Act. The sale process will involve costs that will reduce the amounts of any distributions to unitholders during the winding up period. As required by the trust agreement, the Trustee has engaged a third-party advisor to assist with the marketing and sale of the Trust's assets. As provided in the trust agreement, SandRidge has a right of first refusal with respect to any sale of assets to a third party. The Trustee expects to complete the sale of the Trust's assets and distribute the net proceeds of the sale to the Trust unitholders by the end of 2020, and the Trust units are expected to be canceled shortly thereafter. Pending the sale or sales of the royalty interests, and subject to the effective date and other terms of such sales, the Trust anticipates that it will continue to receive income from the royalty interests and will continue to make quarterly distributions to unitholders to the extent there is available cash after payment of Trust expenses and additions to cash reserves. The Trust will remain in existence until the filing of a certificate of cancellation with the Secretary of State of theState of Delaware following the completion of the winding up process. As previously disclosed, beginning with the distribution to unitholders paid in the first quarter of 2019, the Trustee has been withholding the greater of$50,000 or 3.5%, increasing to$195,000 for the fourth quarter 2019 distribution, of the funds otherwise available for distribution each quarter to gradually increase existing cash reserves for the payment of future known, anticipated or contingent expenses or liabilities by a total of$625,000 . The targeted reserve amount has been funded and no additional cash reserve amount was withheld from the distribution for the three-month period endedMarch 31, 2020 . Any cash reserves remaining after the payment of all expenses and liabilities and any further additions to cash reserves as the Trustee in its discretion deems appropriate for the purpose of making reasonable provision for all claims and obligations of the Trust, including any contingent, conditional or unmatured claims and obligations, will be distributed to unitholders prior to the completion of the winding up process. 12 --------------------------------------------------------------------------------
Results of Trust Operations
The primary factors affecting the Trust's revenues and costs are the quantity of oil, natural gas and NGL production attributable to the Royalty Interests and the prices received for such production. Royalty income, post-production expenses and certain taxes are recorded on a cash basis when net revenue distributions are received by the Trust from SandRidge. Information regarding the Trust's production, pricing and costs for the three-month periods endedMarch 31, 2020 and 2019 is presented below. Three Months Ended March 31, 2020(1) 2019(2) Production Data Oil (MBbls) 9 11 NGL (MBbls) 37 44 Natural gas (MMcf) 445 512 Combined equivalent volumes (MBoe) 120 141 Average daily combined equivalent volumes (MBoe/d) 1.3 1.6 Well Data Initial and Trust Development Wells producing - average 107 129 Revenues (in thousands) Royalty income$ 1,761 $ 3,188 Total revenue 1,761 3,188 Expenses (in thousands) Post-production expenses $ 378$ 399 Production taxes 99 196 Trust administrative expenses 545 409
Cash reserves withheld for current Trust expenses, net of amounts used
56 64
Total expenses 1,078 1,068
Distributable income available to unitholders $ 683 $ 2,120
Average Prices
Oil (per Bbl) $ 54.48 $ 65.31
NGL (per Bbl) $ 16.33 $ 29.17
Combined oil and NGL (per Bbl) $ 23.48 $ 36.57
Natural gas (per Mcf) $ 1.54 $ 2.22
Combined equivalent (per Boe) $ 14.64 $ 22.50
Average Prices - including impact of post-production expenses
Natural gas (per Mcf) $ 0.69 $ 1.44
Combined equivalent (per Boe) $ 11.47 $ 19.67
Expenses (per Boe)
Post-production $ 3.16 $ 2.83
Production taxes $ 0.83 $ 1.39
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1.Production volumes and related revenues and expenses for the three-month
period ended March 31, 2020 (included in SandRidge's February 2020 net revenue
distribution to the Trust) represent production from September 1, 2019 to
November 30, 2019 .
2.Production volumes and related revenues and expenses for the three-month
period ended March 31, 2019 (included in SandRidge's February 2019 net revenue
distribution to the Trust) represent production from September 1, 2018 to
November 30, 2018 .
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Three Months Ended
Revenues Royalty Income. Royalty income is a function of production volumes sold attributable to the Royalty Interests and associated prices received. Royalty income received during the three-month period endedMarch 31, 2020 totaled$1.8 million compared to$3.2 million received during the three-month period endedMarch 31, 2019 . The approximate$1.4 million decrease in royalty income consisted of approximately$0.9 million attributable to a decrease in prices received and approximately$0.5 million attributable to a decrease in total volumes produced. The average number of producing wells in the three-month period endedMarch 31, 2020 decreased by 22 from 129 in the three-month period endedMarch 31, 2019 , because wells that could not economically produce due to continued declining production and current pricing were shut-in.
Expenses
Production Taxes. Production taxes are calculated as a percentage of oil and natural gas revenues, net of any applicable tax credits. Production taxes for the three-month period endedMarch 31, 2020 totaled approximately$0.1 million , or$0.83 per Boe, and were approximately 5.6% of royalty income. Production taxes for the three-month period endedMarch 31, 2019 totaled approximately$0.2 million , or$1.39 per Boe, and were approximately 6.1% of royalty income.
Distributable Income
Distributable income for the three-month period endedMarch 31, 2020 was$0.7 million , which included a net addition to the cash reserve for payment of future Trust expenses of approximately$56,000 , reflecting approximately$601,000 withheld from theFebruary 2020 cash distribution to unitholders partially offset by approximately$545,000 used to pay Trust expenses during the period. Distributable income for the three-month period endedMarch 31, 2019 was$2.1 million , which included a net addition to the cash reserve for payment of future Trust expenses of approximately$64,000 , reflecting approximately$473,000 withheld from theFebruary 2019 cash distribution to unitholders partially offset by approximately$409,000 used to pay Trust expenses during the period.
Liquidity and Capital Resources
The Trust has no source of liquidity or capital resources other than cash flow generated from the Royalty Interests and borrowings to fund administrative expenses, including any amounts borrowed under SandRidge's loan commitment described in Note 5 to the unaudited interim financial statements contained in Part I, Item 1 of this Quarterly Report. The Trust's primary uses of cash are distributions to Trust unitholders, including, if applicable, payment of Trust administrative expenses, including any reserves established by the Trustee for future liabilities, payment of applicable taxes and payment of expense reimbursements to SandRidge for out-of-pocket expenses incurred on behalf of the Trust. The Trust does not have any capital requirements related to drilling wells or any other operating or capital costs related to the wells. Administrative expenses include payments to the Trustee and the Delaware Trustee as well as a quarterly fee of$75,000 to SandRidge 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 sale of production attributable to the Royalty Interests that quarter over the Trust's expenses for the quarter. If at any time the Trust's cash on hand (including available cash reserves) is not sufficient to pay the Trust's ordinary course administrative expenses as they become due, the Trust may borrow funds from the Trustee or other lenders, including SandRidge, to pay such expenses. The Trustee does not intend to lend funds to the Trust. If such funds are borrowed, no further distributions will be made to unitholders (except in respect of any previously determined quarterly distribution amount) until the borrowed funds have been repaid. No such loan was outstanding atMarch 31, 2020 orDecember 31, 2019 . Commencing with the distribution to unitholders paid in the first quarter of 2019, the Trustee has been withholding, the greater of$50,000 or 3.5%, increasing to$195,000 for the fourth quarter 2019 distribution, of the funds otherwise available for distribution each quarter to gradually increase cash reserves for the payment of future known, anticipated or contingent expenses or liabilities by a total of$625,000 . The targeted reserve amount has been funded and no additional cash reserve amount was withheld from the distribution for the three-month period endedMarch 31, 2020 . Any cash reserves remaining after the payment of all expenses and liabilities and any further additions to cash reserves as the Trustee in its discretion deems appropriate for the purpose of making reasonable provision for all claims and obligations of the Trust, including any contingent, conditional or unmatured claims and obligations, will be distributed to unitholders prior to the completion of the winding up process. These cash reserves, if needed, are expected to be sufficient to fund the Trust's expenses for the next 12 months. 14 -------------------------------------------------------------------------------- The Trust is highly dependent on its Trustor, SandRidge, for multiple services, including the operation of the Trust wells, remittance of net proceeds from the sale of associated production to the Trust, administrative services such as accounting, tax preparation, bookkeeping and informational services performed on behalf of the Trust, and potentially for loans to pay Trust administrative expenses. The ability to operate the properties depends on the Trustor's future financial condition and economic performance, access to capital, and other factors, many of which are out of the control of the Trustor. The reduced demand for crude oil in the global market resulting from the economic effects of the COVID-19 pandemic and the oversupply in crude oil attributable to the dispute over production levels betweenRussia and the members ofOPEC , includingSaudi Arabia , have had, and are likely to continue to have, negative impact on the Trustor's financial condition. This negative impact could affect the Trustor's ability to operate the wells and provide services to the Trust. 2020 Trust Distributions to Unitholders. During the three-month period endedMarch 31, 2020 , the Trust's distribution to unitholders totaled$0.7 million or 0.014 per unit. See "Distributions to Unitholders" in Note 3 to the unaudited interim financial statements contained in Part I, Item 1 of this Quarterly Report for additional discussion of this distribution. Future Trust Distributions to Unitholders. During the three-month production period fromDecember 1, 2019 toFebruary 29, 2020 , average oil prices increased slightly and average natural gas and NGL prices decreased compared to the three-month period endedNovember 30, 2019 . Combined sales volumes were lower than the previous period. OnApril 23, 2020 , the Trust declared a cash distribution of$0.015 per unit covering production for the period. The distribution will be paid on or aboutMay 29, 2019 to record unitholders as ofMay 15, 2020 . See "Distribution to Unitholders" in Note 6 to the unaudited interim financial statements contained in Part I, Item 1 of this Quarterly Report for additional discussion of this future distribution. See also "Overview-Commodity Price Volatility; COVID-19 Pandemic" for discussion of the effects of continued low oil, NGL and natural gas prices on cash available for distribution to unitholders in future periods.
As the Trust cannot acquire or cause additional wells to be drilled on its behalf, the Trust's production is expected to decline each quarter during the remainder of its life.
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