VOC ENERGY TRUST The following review of the trust's financial condition and results of operations should be read in conjunction with the financial statements and notes thereto. The trust's purpose is, in general, to hold the net profits interest, to distribute to the trust unitholders cash that the trust receives in respect of the net profits interest, and to perform certain administrative functions in respect of the net profits interest and the trust units. The trust derives substantially all of its income and cash flows from the net profits interest.
Critical Accounting Policies
The trust uses the modified cash basis of accounting to report receipts by the trust of the net profits interest and payments of expenses incurred. The net profits interest represents the right to receive revenues (oil and natural gas sales), less direct operating expenses (lease operating expenses and production and property taxes) and development expenses (which are capitalized in financial statements prepared in accordance with accounting principles generally accepted inthe United States of America ("U.S. GAAP")) of the underlying properties, times 80%. Cash distributions of the trust will be made based on the amount of cash received by the trust pursuant to terms of the conveyance creating the net profits interest.
The financial statements of the trust, as prepared on a modified cash basis, reflect the trust's assets, trust corpus, earnings and distributions as follows:
(a)
Income from the net profits interest is recorded when distributions are received by the trust;
(b)
Distributions to trust unitholders are recorded when paid by the trust;
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TABLE OF CONTENTS (c) Trust general and administrative expenses (which include the trustee's fees as well as accounting, engineering, legal and other professional fees) are recorded when paid; (d) Cash reserves for trust expenses may be established by the trustee for certain expenditures that would not be recorded as contingent liabilities underU.S. GAAP; (e)
Amortization of the investment in net profits interest, calculated using the units-of-production method based upon total estimated proved reserves, is charged directly to trust corpus and does not affect distributable income; and
(f)
The trust evaluates its investment in the net profits interest periodically to determine whether its aggregate value has been impaired below its total capitalized cost based on the underlying properties. The trust will provide a write-down to its investment in the net profits interest if and when total capitalized costs, less accumulated amortization, exceed undiscounted future net cash flows attributable to the trust's interests in the proved oil and gas reserves of the underlying properties. While these statements differ from financial statements prepared in accordance withU.S. GAAP, the modified cash basis of reporting revenues and distributions is considered most meaningful because quarterly distributions to the trust unitholders are based on net cash receipts received from VOC Brazos.
This comprehensive basis of accounting other than
The following is a summary of income from net profits interest received by the trust for the years endedDecember 31, 2019 , 2020 and 2021, consisting of the February, May, August and November distributions for each respective year. Year Ended December 31, 2019 2020 2021 Sales volumes: Oil (Bbl) 570,216(1) 577,838(2) 528,166(3) Natural gas (Mcf) 330,906(1) 358,455(2) 352,159(3) Total (BOE) 625,367 637,581 586,859 Average sales prices: Oil (per Bbl) $ 56.11 $ 43.22 $ 53.09 Natural gas (per Mcf) $ 2.90 $ 1.80 $ 2.98 Gross proceeds: Oil sales$ 31,992,019 (1)$ 24,976,564 (2)$ 28,040,262 (3) Natural gas sales 959,126(1) 645,569(2) 1,048,349(3) Total gross proceeds 32,951,145 25,622,133 29,088,611 Costs: Production and development costs: Lease operating expenses 12,688,464 11,094,881 11,645,363 Production and property taxes 1,755,076 1,774,462 1,753.929 Development expenses 2,680,356 6,495,006 4,061,450 Total costs 17,123,896 19,364,349 17,460,742 45
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Year Ended December 31,
2019 2020 2021
Excess of revenues over direct operating expenses
and lease equipment and development costs 15,827,249 6,257,784 11,627,869
Times net profits interest over the term of the Trust 80% 80% 80%
Income from net profits interest before reserve adjustments 12,661,799
5,006,227 9,302,296
Cash reserve 0 0 0
Income from net profits interest $ 12,661,799 $ 5,006,227 $ 9,302,296
(1)
Oil and gas sales volumes and related revenues for the year ended December 31,
2019 (consisting of VOC Brazos' February, May, August and November 2019 net
profits interest distributions to the trust) generally represent the production
by VOC Brazos from September 2018 through August 2019 .
(2)
Oil and gas sales volumes and related revenues for the year endedDecember 31, 2020 (consisting of VOC Brazos' February, May, August andNovember 2020 net profits interest distributions to the trust) generally represent the production by VOC Brazos fromSeptember 2019 throughAugust 2020 .
(3)
Oil and gas sales volumes and related revenues for the year endedDecember 31, 2021 (consisting of VOC Brazos' February, May, August andNovember 2021 net profits interest distributions to the trust) generally represent the production by VOC Brazos fromSeptember 2020 throughAugust 2021 .
Comparison of Results of the
The following represents a discussion of the Comparison of Results of theTrust for the Years endedDecember 31, 2021 and 2020. Refer to "Item 7. Trustee's Discussion and Analysis of Financial Condition and Results of Operations" in the Annual Report on Form 10-K for the year endedDecember 31, 2020 , filed with theSEC onMarch 16, 2021 for a discussion of the Comparison of Results of theTrust for the Years endedDecember 31, 2020 and 2019. Income from Net Profits Interest. Income from net profits interest is recorded on a modified cash basis when the trust receives net profits interest proceeds from VOC Brazos. Net profits interest proceeds that VOC Brazos remits to the trust are based on the oil and gas production VOC Brazos has received payment for within one month following the end of the most recent fiscal quarter. VOC Brazos receives payment for its crude oil sales generally within 30 days following the month in which it is produced. Income from net profits interest is generally a function of oil and gas gross proceeds, lease operating expenses, production and property taxes and development expenses as follows: Total oil and natural gas sales. Oil and natural gas sales were$29,088,611 for the year endedDecember 31, 2021 , an increase of$3,466,478 or 13.5% from$25,622,133 for the year endedDecember 31, 2020 . Revenues are a function of oil and natural gas sales prices and volumes sold. The increase in gross proceeds was due to a increase in market prices for oil and natural gas sales during 2021 compared to 2020 offset by an decrease in oil and gas sales volumes compared to 2020. Oil sales volumes were 528,166 Bbls for the year endedDecember 31, 2021 , a decrease of 49,672 Bbls or 8.6% from 577,838 Bbls for the year endedDecember 31, 2020 , while natural gas sales volumes were 352,159 Mcf, a decrease of 6,296 Mcf from 358,455 Mcf for the year endedDecember 31, 2020 . During the year endedDecember 31, 2021 , the average price for oil increased 22.8% to$53.09 per Bbl and the average price for natural gas increased 65.6% to$2.98 per Mcf. Costs. Lease operating expenses were$11,645,363 for the year endedDecember 31, 2021 , an increase of$550,482 or 5.0% from$11,094,881 for the year endedDecember 31, 2020 . The increase was primarily due to increases in the costs of oilfield goods and services as well as increased costs as a result of bringing back online wells that were shut-in during periods of low prices for oil sales in 2020. Production and property taxes were$1,753,929 for the year endedDecember 31, 2021 , a decrease of$20,533 or 1.2% from 46
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$1,774,462 for the year endedDecember 31, 2020 . The decrease is primarily due to a decrease in severance taxes of$12,543 or 1.7% and a decrease in property taxes of$7,990 or 0.8%. The decrease in severance taxes was primarly due to a severance tax refund of approximately$119,000 received in 2021from the low-producing oil well exemption that was triggered by the low oil prices in mid 2020 partially offset by higher sales prices for oil and natural gas in 2021. Development expenses were$4,061,450 for the year endedDecember 31, 2021 , a decrease of$2,433,556 or 37.5% from$6,495,006 for 2020. The decrease was primarily due to only having expenses from completing one drilled but uncompleted horizontal well in 2021, the former MD Earning Well, for$1,695,593 compared to payments made to the operator in 2020 for previously unpaid costs associated with the drilling and completion of two horizontal wells, theHawkwood Development wells, for$5,356,749 . Excess of revenues over direct operating expenses and lease equipment and development costs. The excess of revenues over direct operating expenses and lease equipment and development costs from the underlying properties was$11,627,869 for the year endedDecember 31, 2021 , an increase of$5,370,085 or 85.8% from$6,257,784 for the year endedDecember 31, 2020 . The trust's 80% net profits interest of these totals were$9,302,296 and$5,006,227 , respectively. During the year endedDecember 31, 2021 , VOC Brazos did not withhold or release any dollar amounts due to the Trust and during the year endedDecember 31, 2020 , VOC Brazos released$7,045 during the third quarter and withheld$7,045 during the fourth quarter due to the Trust from previously established cash reserves for future development, maintenance or operating expenditures, which resulted in income from the net profits interest of$9,302,296 and$5,006,227 for such years, respectively. These amounts were further reduced by a trust holdback for future expenses of$632,296 and$1,181,227 for the years endedDecember 31, 2021 and 2020, respectively. The decrease between 2021 and 2020 is primarily the result in 2020 of including an amount estimated to be sufficient to pay estimated Trust expenses throughApril 2021 . The trustee paid general and administrative expenses of$948,096 for the year endedDecember 31, 2021 , an increase of$43,741 from$904,355 for the year endedDecember 31, 2020 . These factors resulted in distributable income for the year endedDecember 31, 2021 of$8,670,000 , an increase of$4,845,000 from$3,825,000 for the year endedDecember 31, 2020 .
Liquidity and Capital Resources
Other than trust administrative expenses, including any reserves established by the trustee for future liabilities, the trust's only use of cash is for distributions to trust unitholders. Available funds are the excess cash, if any, received by the trust from the net profits interest and payments from other sources (such as interest earned on any amounts reserved by the trustee) in that quarter, over the trust's expenses paid for that quarter. Available funds are reduced by any cash the trustee decides to hold as a reserve against future expenses. As ofDecember 31, 2021 , the trustee held$287,203 as such a reserve. The trust paid, out of the first cash payment received by the trust, the trustee's andDelaware trustee's legal expenses incurred in forming the trust, in connection with the initial public offering (that were not otherwise paid by VOC Brazos) and related matters, as well as theDelaware trustee's acceptance fee in the amount of$5,000 . InNovember 2021 , the Trustee notified VOC Brazos that the Trustee intends to build a reserve for the payment of future known, anticipated or contingent expenses or liabilities, commencing with the distribution payable in the first quarter of 2022. The Trustee intends to withhold a portion of the proceeds otherwise available for distribution each quarter to gradually build a cash reserve to approximately$1.175 million . This amount is in addition to the letter of credit in the amount of$1.7 million provided to the Trustee by VOC Brazos to protect the Trust against the risk that it does not have sufficient cash to pay future 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. The trustee can authorize the trust to borrow money to pay trust administrative or incidental expenses that exceed cash held by the trust. The trustee may authorize the trust to borrow from the trustee as lender provided the terms of the loan are fair to the trust unitholders. The trustee may also deposit funds awaiting distribution in an account with itself, if the interest paid to the trust at least equals amounts paid by the trustee on similar deposits, and make no other short-term investments with the funds distributed to the trust. 47
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The trustee has no current plans to authorize the trust to borrow money. If the trust borrows funds, the trust unitholders will not receive distributions until the borrowed funds are repaid. During the year endedDecember 31, 2021 , the trust made no borrowings. As substantially all of the underlying properties are located in mature fields, VOC Brazos does not expect future costs for the underlying properties to change significantly as compared to recent historical costs other than changes due to fluctuations in the cost of oilfield services generally. However, see "Item 7. Trustee's Discussion and Analysis of Financial Condition and Results of Operations -Planned Development and Workover Program" below. VOC Brazos has agreed to post a letter of credit in the amount of$1.7 million in favor of the trustee to protect the trustee against the risk that the trust does not have sufficient cash to pay its expenses. The trust pays the trustee an administrative fee of$150,000 per year. The trust pays theDelaware trustee a fee of$2,500 per year. The trust also incurs, either directly or as a reimbursement to the trustee, legal, accounting, tax and engineering fees, printing costs and other expenses that are deducted by the trust before distributions are made to trust unitholders, including the$18,750 administrative services fee payable quarterly to VOC Brazos pursuant to an administrative services agreement. The trust is also responsible for paying other expenses incurred as a result of being a publicly traded entity, including costs associated with annual and quarterly reports to trust unitholders, tax return and Form 1099 preparation and distribution, NYSE listing fees, independent auditor fees and registrar and transfer agent fees. 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.
The primary goals of VOC Brazos' development and workover program have been to develop proved undeveloped reserves, manage workovers and minimize the natural decline in production in areas in which it operates. However, VOC Brazos is not obligated to undertake any development activities, so any drilling and completing activities will be subject to the reasonable discretion of VOC Brazos. No assurance can be given, however, that any development well will produce in commercially paying quantities or that the characteristics of any development well will match the characteristics of VOC Brazos' existing wells or VOC Brazos' historical drilling success rate. With respect to the underlying properties, VOC Brazos expects, but is not obligated, to implement the following development strategies specific to each of its primary operating areas:
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Kansas . VOC Brazos' historical development and workover program for theKansas Underlying Properties has included recompleting certain existing wells, drilling infill development wells, conducting3-D seismic surveys, completing workovers and applying new production technologies. VOC Brazos expects to incur future development expenditures for these properties throughDecember 31, 2024 of approximately$1.0 million , of which VOC Brazos contemplates spending approximately$0.9 million to drill and complete four vertical wells. The remaining approximately$0.1 million is expected to be used for recompletions and workovers of three wells.
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Texas . VOC Brazos' historical development and workover program for theTexas underlying properties has included recompleting certain existing wells, drilling infill development wells, completing workovers and applying new production technologies. In particular, since 2003, through its ownership in theKurten Woodbine Unit, VOC Brazos has pursued operational, strategic and technological initiatives to economically produce and sell hydrocarbons from the Woodbine Interval, also commonly referred to as the Eaglebine formation, which is the correlative interval defined as encompassing all depths from the base of the Austin Chalk to the top of theBuda formation. VOC Brazos has: (a) operated approximately 100 primary and secondary recovery vertical wells in various Woodbine sands, (b) drilled, completed and operated 13 horizontal wells primarily from, but not limited to, the Woodbine C sand, (c) conducted geologic evaluations, including3-D seismic data acquisition and analysis, of the source shale present throughout the Woodbine Interval, and (d) most recently, pursued development of the lower depths of the source shale present throughout the Woodbine Interval, defined as theLower Woodbine Organic Shale ("LWOS"). 48
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In 2018, VOC Brazos entered into a new joint venture agreement withHawkwood Energy East Texas, LLC ("Hawkwood"). Under the terms of the new joint venture agreement, Hawkwood carried VOC Brazos for its share of drilling and completion costs for four LWOS wells (the "Hawkwood Earning Wells"). In exchange, Hawkwood earned a working interest representing 50% of VOC Brazos' interest in each Hawkwood Earning Well and up to a 50% interest in VOC Brazos' acreage in the south half of the Kurten Woodbine Unit. After the Hawkwood Earning Wells were completed, Hawkwood had the right to propose and drill up to eight wells in the LWOS in 2019 and twelve LWOS wells in 2020, with no contractual limitation of the number of wells per year to propose and drill after 2020 (collectively, the "Hawkwood Development Wells"). In 2019, Hawkwood drilled and completed four Hawkwood Development Wells. VOC Brazos was paying Vess Oil, as the operator, for its share of costs and related interest in the Hawkwood Development Wells, as net revenue from each of the wells is received, thereby having no current effect on Trust distributions. OnMarch 27, 2020 , in addition to paying its costs from revenues received on these wells, VOC Brazos paid an additional$2.5 million of its share of costs to Vess Oil. The remaining balance was paid in full onDecember 31, 2020 . No new Hawkwood Development Wells were drilled in 2020 or 2021. In 2018, VOC Brazos also entered into a joint venture agreement withMD America Energy, LLC ("MD America") to develop the LWOS, within the north half of the Kurten Woodbine Unit (the "North Contract Area"). Under the terms of the joint venture agreement, MD America was to carry VOC Brazos for its share of drilling and completion costs for up to four LWOS wells (the "MD Earning Wells"), with the first MD Earning Well to be spud byDecember 31, 2018 and the fourth MD Earning Well to be spud byNovember 20, 2020 . In exchange, MD America had the opportunity to earn a working interest representing 50% of VOC Brazos' interest in each MD Earning Well and up to a 50% interest in VOC Brazos' acreage in the North Contract Area. After the MD Earning Wells were to be completed, MD America had the right to propose and drill up to three LWOS wells per year. MD America spudded the first MD Earning Well onNovember 20, 2018 and drilled and set production casing for the well; however, the well was not completed by MD America. No additional MD Earning Wells were drilled and the joint venture agreement expired. As a result, MD America did not earn any interest in the MD Earning Well or an interest in VOC Brazos' acreage in the North Contract Area. VOC Brazos completed this well in 2021. VOC Brazos is evaluating the potential economic benefits associated with development of the LWOS. If these activities are pursued, such activities would result in increased development costs burdening the net profits interest of the trust relative to historical development costs. As a result of such increased development costs, cash available for distribution by the trust would be temporarily reduced, and in certain periods there may be no distributions to unitholders, until anticipated production from the various development efforts in the Kurten Woodbine Unit can be brought on-line. To address these emerging opportunities, VOC Brazos will continue to evaluate the appropriate strategy and capital plan to fund development for the trust. VOC Brazos expects to incur future development expenditures for theTexas underlying properties throughDecember 31, 2026 of approximately$28.8 million to drill and complete four Hawkwood Development Wells and six non-joint venture agreement wells, all within the Woodbine Interval of the Kurten Woodbine Unit. Additionally, VOC Brazos expects to incur approximately$0.9 million to convert 19 horizontal wells from gas lift to rod pump. The trust will indirectly bear an 80% share of these development expenditures as described below. The trust is not directly obligated to pay any portion of the capital expenditures made with respect to the underlying properties; however, capital expenditures made by VOC Brazos with respect to the underlying properties will be deducted from the gross proceeds in calculating the net proceeds from which cash will be paid to the trust. As a result, the trust will indirectly bear an 80% (subject to certain limitations during the final three years of the trust, as described above under "Item 1. Business - Computation of Net Proceeds - Net Profits Interest") share of any capital expenditures made with respect to the underlying properties. Accordingly, higher or lower capital expenditures will, in general, directly decrease or increase, respectively, the cash received by the trust in respect of its net profits interest, which will have a corresponding effect on cash available for distribution to unitholders. As the cash received by the trust in respect of the net profits interest will be reduced by the trust's pro rata share of these capital expenditures, VOC Brazos expects that it will incur capital expenditures with respect to the underlying properties throughout the term of the trust on a basis that balances the impact of the capital expenditures on current cash distributions to the 49
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trust unitholders with the longer term benefits of increased oil and natural gas production expected to result from the capital expenditures. In addition, VOC Brazos may establish a capital reserve of up to$1.0 million in the aggregate at any given time to reduce the impact on distributions of uneven capital expenditure timing. However, if annual cash proceeds attributable to the net profits interest are less than$1 million for each of two consecutive years, then under the terms of the trust agreement, the trust would be required to dissolve. VOC Brazos, as the designated operator of the underlying properties, is entitled to make all determinations related to capital expenditures with respect to the underlying properties, and there are no limitations on the amount of capital expenditures that VOC Brazos may incur with respect to the underlying properties. VOC Brazos is required under the conveyance to use commercially reasonable efforts to cause the operators of the underlying properties to operate these properties as would a reasonably prudent operator acting with respect to its own properties (without regard to the existence of the net profits interest). As the trust unitholders would not be expected to fully realize the benefits of capital expenditures made with respect to the underlying properties towards the end of the term of the trust, during each twelve-month period beginning on the later to occur of (1)December 31, 2027 and (2) the time when 9.8 MMBoe have been produced from the underlying properties and sold (which is the equivalent of 7.8 MMBoe in respect of the net profits interest), capital expenditures that may be taken into account in calculating net proceeds attributable to the net profits interest will be limited to the average annual capital expenditures during the preceding three years, as increased by 2.5% to account for expected increased costs due to inflation.
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