WHITING USA TRUST II This document contains forwardlooking statements, which include expectations or forecasts of future events. Please refer to "ForwardLooking Statements" which follows the Table of Contents of this Form 10K for an explanation of these types of statements.
Overview and Trust Termination
The Trust does not conduct any operations or activities. The Trust's purpose is, in general, to hold the NPI, to distribute to unitholders cash that the Trust receives pursuant to the NPI, and to perform certain administrative functions with respect to the NPI and the Trust units. The Trust derives substantially all of its income and cash flows from the NPI. The NPI entitles the Trust to receive 90% of the net proceeds from the sale of production from the underlying properties. Oil and gas prices historically have been volatile and may fluctuate widely in the future. The table below highlights these price trends by listing quarterly average NYMEX crude oil and natural gas prices for the periods indicated throughDecember 31, 2019 . The 2019 NPI distributions are mainly affected, however, byOctober 2018 throughSeptember 2019 oil prices andSeptember 2018 throughAugust 2019 natural gas prices. 2017 2018 2019 Q1 Q2 Q3 Q4 Q1 Q2
Q3 Q4 Q1 Q2 Q3 Q4
Crude oil
Oil prices have declined sharply during the first quarter of 2020 in response to the economic effects of the recent announcement ofSaudi Arabia's abandonment of output restraints and the COVID-19 pandemic. Continued low oil and gas prices on production from the underlying properties could cause (i) a reduction in the amount of net proceeds to which the Trust is entitled, which could materially reduce or completely eliminate the amount of cash available for distribution to Trust unitholders, (ii) a reduction in the amount of oil, natural gas and natural gas liquids that are economic to produce from the underlying properties, which could extend the length of time required to produce 11.79 MMBOE (10.61 MMBOE at the 90% NPI), and (iii) the recognition of impairment charges on the NPI. All costless collar hedge contracts terminated as ofDecember 31, 2014 and no additional hedges are allowed to be placed on the Trust assets. Consequently, there are no further cash settlement gains or losses on commodity derivatives for inclusion in the Trust's computation of net proceeds (or net losses, as the case may be), and the Trust therefore has increased exposure to oil and natural gas price volatility. Additionally, in the current commodity price environment, the Trust's distributions have increased sensitivity to fluctuations in operating and capital expenditures, as was the case for the fourth quarter of 2017 and the first quarter of 2019. Trust Termination. The Trust will wind up its affairs and terminate shortly after the earlier of (a) the NPI termination date, which is the later to occur of (1)December 31, 2021 , or (2) the time when 11.79 MMBOE (10.61 MMBOE to the 90% net profits interest) have been produced from the underlying properties and sold, which is estimated to beDecember 31, 2021 based on the Trust's yearend 2019 reserve report or (b) the sale of the net profits interest. After the termination of the Trust, it will pay no further distributions. Since the assets of the Trust are depleting assets, a portion of each cash distribution paid, if any, on the Trust units is a return of capital to investors, with the remainder being considered as a return on investment or yield. As a result, the market price of the Trust units will decline to zero at the termination of the Trust. As ofDecember 31, 2019 , on a cumulative accrual basis, 9.95 MMBOE (94%) of the 10.61 MMBOE attributable to the NPI have been produced and sold or divested. The remaining minimum reserve quantities are projected to be produced prior toDecember 31, 2021 , based on the Trust's reserve report as ofDecember 31, 2019 . Accordingly, the Trust's remaining reserves attributable to the 90% NPI were estimated to be 1.52 MMBOE as ofDecember 31, 2019 , which is more than the minimum, but there is no assurance that the Trust will receive more than the minimum amount of reserves. For additional discussion relating to the assumptions underlying the estimated date when 11.79 MMBOE (10.61 MMBOE at the 90% NPI) will be produced and sold from the underlying properties, refer to "Description of the Underlying Properties" in Item 2 of this Annual Report on Form 10K. For a discussion of material changes to the Trust's proved reserves fromDecember 31, 2018 toDecember 31, 2019 , refer to "Reserves" in Item 2 of this Annual Report on Form 10K. Additionally, for a discussion of the need to use enhanced recovery techniques, refer to "Oil and Natural Gas Production" in Item 2 of this Annual Report on Form 10K. 40
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Capital Expenditure Activities
The primary goal of the planned capital expenditures relative to the underlying properties is to mitigate a portion of the natural decline in production from producing properties. No assurance can be given, however, that any such expenditures will be made, or if made, will result in production in commercially paying amounts, if any, or that the characteristics of any newly developed well will match the characteristics of existing wells on the underlying properties or the operator's historical drilling success rate. The underlying properties have a capital expenditure budget per the reserve report of$3.8 million estimated to be spent over the two years estimated to remain. No assurance can be given that the actual level of capital expenditures on the underlying properties will meet this$3.8 million amount of budgeted capital expenditures over such time frame. With respect to fields for which Whiting is not the operator, Whiting has limited control over the timing and amount of capital expenditures relative to such fields. Refer to the risk factor entitled "Whiting has limited control over activities on the underlying properties that Whiting does not operate, which could reduce production from the underlying properties, increase capital expenditures and reduce cash available for distribution to Trust unitholders." The following table summarizes the underlying properties' planned capital expenditures per the reserve report for 2020 through the NPI termination date, which is currently estimated to beDecember 31, 2021 : 2020 - 2021 Planned Capital Expenditures(2) (in millions) Gross Wells Net WellsRocky Mountains Region :
Rangely field - CO2 and maintenance capital $ 2.6 - - Garland field - maintenance capital 1.2
- -
Total(1) $ 3.8 - -
____________
(1) The planned capital expenditures attributable to the Trust's 90% net profits
interest are
(2) The planned capital expenditures for each of the two remaining years of the
NPI are below the annual capital expenditure limitation, which limitation
became effective
Rocky Mountains Region . TheRangely field, operated by Chevron Corporation, is located inRio Blanco County, Colorado . This field was discovered in 1931 with development drilling commencing in 1943. The field is currently producing under the tertiary recovery process of CO2 injection. The underlying properties include a 4.6% working interest in the Rangely Weber Sand Unit. Capital is expended each year to purchase CO2 for injection in the field. According to information provided by the operator, the estimated capital expenditures allocated to the underlying properties' interest are approximately$1.3 million per year for 2020 and 2021 through the estimated termination of the NPI. Such capital costs are comprised mainly of CO2 purchases and plant and equipment expenditures. During 2017, Chevron Corporation advised Whiting of a mandatory compliancedriven inspection and maintenance project for the Rangely Weber Sand Unit, which commenced inJune 2017 and was completed duringJuly 2017 . The cost of the project attributable to the underlying properties was$1.5 million ($1.4 million to the 90% NPI), the vast majority of which were capital expenditures. Whiting is not aware of any development plans byChevron USA at this time, however,Chevron USA may propose capital expenditures in the future. Whiting owns a nonoperated working interest in the Garland field located inBig Horn County, Wyoming , which produces from the Madison and Tensleep zones. According to information provided by the operator, the estimated capital expenditures allocated to the underlying properties' interest are$0.6 million per year for 2020 and 2021, respectively, through the estimated termination of the NPI. Although Whiting is not aware of any development plans by this operator or other operators of the underlying properties in this region, these operators may propose additional capital expenditures in the future. Additionally, although Whiting has not identified any future capital expenditures for the Whitingoperated fields in theRocky Mountains region at this time, further study or offsetting drilling activity may result in capital expenditures in the future. Other Regions. Although Whiting has not identified any future capital expenditures for its operated fields in thePermian Basin ,Gulf Coast and MidContinent regions at this time, further study or offsetting development activity may result in additional capital expenditures in the future. Additionally, although Whiting is not aware of any development plans by other operators of the underlying properties in these regions, operators may propose capital expenditures in the future. Annual capital expenditure limitation. The capital expenditures included in the net proceeds attributable to the underlying properties are subject to an annual limitation which became effectiveJanuary 1, 2018 . As a result, the sum of the capital expenditures and amounts 41
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reserved for approved capital expenditure projects for each year beginning in 2018 may not exceed the average annual capital expenditure amount. The "average annual capital expenditure amount" means the quotient of (x) the sum of the capital expenditures and amounts reserved for approved capital expenditure projects with respect to the three years endedDecember 31, 2017 , divided by (y) three, which amount equals$3.9 million and will be increased annually by 2.5% to account for expected increased costs due to inflation. The capital expenditures incurred during 2019 and 2018 did not exceed this annual limitation, and capital expenditures included in the net proceeds attributable to the underlying properties cannot exceed$4.2 million during the year endingDecember 31, 2020 . Farmout agreements. In an effort to develop the underlying properties while limiting additional capital expenditures for the Trust (other than those capital expenditures already contemplated in the reserve report),Whiting Oil and Gas entered into three farmout agreements with a thirdparty partner covering (i) 5,127 gross acres in eight leasehold sections within the Keystone South field inWinkler, Texas inApril 2016 (the "Keystone South farmout"), (ii) 9,740 gross acres in approximately 15 units (which unit size is determined by the lateral well length) within the Signal Peak field inHoward County, Texas inFebruary 2017 , as amended inMay 2018 ,September 2019 andFebruary 2020 (the "Signal Peak farmout") and (iii) 640 gross acres in one leasehold section within the Flying W, SE field inWinkler County, Texas inMarch 2017 (the "Flying W farmout"). These farmout agreements provide the thirdparty partner with the option, but not the obligation, to drill one well in each of the leasehold sections or units, as the case may be, subject to the applicable farmout agreement, whereby the partner will pay 100% of the related drilling and well completion costs to earn a 75% working interest. As a result, the applicable underlying properties will consist of (i) 25% of the original working interest in these properties and (ii) an overriding royalty interest equal to the difference between 25% and the lease burdens of record. Upon completion of one well in each section or unit, as the case may be, pursuant to the terms of the applicable agreements, the partner has the option to drill (i) up to 15 additional wells under the Keystone South farmout, (ii) up to 12 additional wells under the Signal Peak farmout and (iii) one additional well under the Flying W farmout. For each of these additional optional wells, the partner is required to pay 85% of the drilling and well completion costs otherwise ascribed to the underlying properties for a 75% working interest. Given the Trust's interest in the NPI, the Trust would be responsible for 13.5% of the underlying properties' remaining drilling and well completion costs at the 90% NPI, subject to the average annual capital expenditure amount limitation discussed above. The third-party partner drilled and completed the first three wells pursuant to the terms of the Keystone South farm-out agreement during 2017, a fourth well was drilled and completed during the second quarter of 2018, and a fifth well was drilled and completed during the fourth quarter of 2019, whereby the partner earned a 75% working interest in each of the underlying properties' respective leasehold sections. The partner has no obligation to drill and complete any additional wells, and the Keystone South farm-out agreement will terminate during the third quarter of 2020 if no additional drilling has commenced by that time. During the fourth quarter of 2019, the third-party partner drilled and completed the first well under the Signal Peak farm-out, whereby the partner earned a 75% working interest in the underlying properties' respective leasehold section. The partner has no obligation to drill and complete any additional wells, and the Signal Peak farmout will terminate during the second quarter of 2020 if no additional drilling has commenced by that time. In addition, the partner drilled and completed the first well under the Flying W farm-out during the second quarter of 2018, whereby the partner earned a 75% working interest in the underlying properties' respective leasehold section. 42 Table of Contents Results of Trust Operations The following is a summary of income from net profits interest and distributable income received by the Trust for each respective period (dollars in thousands, except per Bbl, per Mcf and per BOE amounts): Trust Results Year Ended December 31, 2019 2018 2017 Sales volumes: Oil from underlying properties (MBbl)(1) 917 (4) 955 (5) 965 (6) Natural gas from underlying properties (MMcf) 1,111 (4) 1,307 (5) 1,220 (6) Total production (MBOE) 1,103 1,173 1,168 Average sales prices: Oil (per Bbl)(1)$ 48.40 $ 54.28 $ 42.42 Natural gas (per Mcf)(2)$ 2.30 $ 3.29 $ 3.18 Cost metrics: Lease operating expenses (per BOE)$ 29.52 $ 24.64 $ 26.19 Production tax rate (percent of total revenues) 5.0 % 5.1 % 4.8 %
Revenues:
Oil sales(1)$ 44,407 (4)$ 51,827 (5)$ 40,931 (6) Natural gas sales 2,558 (4) 4,296 (5) 3,883 (6) Total revenues 46,965 56,123 44,814 Costs: Lease operating expenses 32,555 28,900 30,595 Production taxes 2,328 2,887 2,132 Development costs 1,950 3,309 4,613
Cash settlements on commodity derivatives(3) -
- - Total costs 36,833 35,096 37,340 Net proceeds 10,132 21,027 7,474 Net profits percentage 90 % 90 % 90 % Income from net profits interest 9,119 18,924 6,727 Provision for estimated Trust expenses (800) (800) (900) Montana state income tax withheld (15) (15) (13) Distributable income$ 8,304 $ 18,109 $ 5,814 ____________
(1) Oil includes natural gas liquids.
(2) The average sales price of natural gas for the gas production months within
the years ended
prices for those same months within the period due to the "liquids rich"
content of a portion of the natural gas volumes produced by the underlying
properties. While the gas volumes produced by the underlying properties
during the year ended 2019 are still "liquids rich," such liquids content did
not result in a premium to the NYMEX natural gas price due to depressed
liquids prices during that period.
(3) As discussed in "Quantitative and Qualitative Disclosures About Market Risk"
in Item 7A of this Annual Report on Form 10K, all costless collar hedge
contracts terminated as of
allowed to be placed on Trust assets. Consequently, there are no further cash
settlements on commodity hedges, and the Trust will have increased exposure
to oil and natural gas price volatility.
(4) Oil and gas sales volumes and related revenues for the year ended
represent crude oil production from
natural gas production from
(5) Oil and gas sales volumes and related revenues for the year ended
represent crude oil production from
natural gas production from
(6) Oil and gas sales volumes and related revenues for the year ended December
31, 2017 (consisting of Whiting's
production from October 2016 through September 2017 and natural gas
production from September 2016 through August 2017 .
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Comparison of Results of the
Income from Net Profits Interest. Income from net profits interest is recorded on a cash basis when NPI proceeds are received by the Trust from Whiting. NPI proceeds are based on the oil and gas production for which Whiting has received payment within one month following the end of the most recent fiscal quarter. Whiting receives payment for its crude oil sales generally within 30 days following the month in which it is produced, and Whiting receives payment for its natural gas sales generally within 60 days following the month in which it is produced. Income from net profits interest is generally a function of oil and gas revenues, lease operating expenses, production taxes and development costs as follows: Revenues. Oil and natural gas revenues were$9.2 million (or 16%) lower in 2019 compared to 2018. Sales revenue is a function of average commodity prices realized and oil and gas volumes sold. The decrease in revenue between periods was primarily due to lower realized oil prices and a decline in oil production volumes. The average sales price realized decreased for crude oil and natural gas by 11% and 30%, respectively, between periods primarily as a result of lower NYMEX oil prices and rising natural gas differentials, which were partially offset by improved oil differentials. Crude oil production volumes decreased by 38 MBbls (or 4%) between periods and natural gas volumes decreased by 196 MMcf (or 15%) in 2019 compared to 2018. The slight oil volume decrease between periods was primarily related to normal field production decline, which was partially offset by two new wells that came online as a result of the Keystone South farmout agreement. The decrease in gas volumes between periods was primarily due to (i) normal field production decline and (ii) one unit in the Warmsly South field and one well in the Keystone South field that were shut-in for all or a portion of 2019. The decrease in gas volumes was partially offset by one new well that came online as a result of the Keystone South farm-out agreement. Based on theDecember 31, 2019 reserve report, overall production attributable to the underlying properties is expected to decline at an average yearoveryear rate of approximately 8.5% for oil and 13.6% for gas from 2020 through the estimatedDecember 31, 2021 NPI termination date. Lease Operating Expenses. LOE increased$3.7 million (or 13%) during the year endedDecember 31, 2019 compared to the same 2018 period primarily due to a$4.2 million increase in oilfield goods and services, which includes an increase of$1.2 million in workover costs between periods. This increase was partially offset by (i)$0.5 million of lower labor and other operating costs on Whiting-operated properties and (ii) a$0.2 million decrease in ad valorem taxes between periods. The increase in overall LOE coupled with the decline in overall production volumes resulted in an increase in LOE on a per BOE basis of 20%
from
Production Taxes. Production taxes are typically calculated as a percentage of oil and gas revenues. Production taxes as a percentage of revenues decreased from 5.1% during 2018 to 5.0% during 2019. Additionally, overall production taxes in 2019 decreased$0.6 million (or 19%) as compared to 2018 primarily due to lower oil and natural gas revenues between periods. Development Costs. Development costs were$1.4 million (or 41%) lower in 2019 as compared to 2018. Development costs decreased primarily due to reduced drilling and capital workover costs between periods of$1.6 million in the Garland, Keystone South,Rangely , Deb andWest Dickinson fields, which was partially offset by increased drilling and capital workover costs of$0.2 million in the Justis field.
Comparison of Results of the
For a discussion of the Trust's financial performance in the year endedDecember 31, 2018 compared to the year endedDecember 31, 2017 , refer to Part II, Item 7 "Trustee's Discussion and Analysis of Financial Condition and Results of Operations" of the 2018 Annual Report on Form 10-K filed with theSEC onMarch 22, 2019 under the subheading "Results of Trust Operations - Comparison of Results of theTrust for the Years Ended December 31, 2018 and 2017."
Liquidity and Capital Resources
Overview. The Trust has no source of liquidity or capital resources other than
cash flows from the NPI. 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. Administrative expenses
include payments to the Trustee and the Delaware Trustee, a quarterly fee paid
to Whiting pursuant to an administrative services agreement, and expenses in
connection with the discharge of the Trustee's duties, including third party
engineering, audit, accounting and legal fees. Each quarter, the Trustee
determines the amount of funds available for distribution to unitholders.
Available funds are the excess cash, if any, received by the Trust from the NPI
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 (i) any cash the Trustee decides to hold as a reserve
against future liabilities and (ii) any accumulated net losses to be recovered
by Whiting, plus accrued interest. If the NPI generates net losses or limited
net proceeds (which was the case during the fourth quarter of 2017 and
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first quarter of 2019), the net profits interest may not provide sufficient funds to the Trustee to enable it to pay all of the Trust's administrative expenses. The Trust may borrow the amount of funds required to pay its liabilities if the Trustee determines that the cash on hand and the cash to be received, which is dependent on future net proceeds, are insufficient to cover the Trust's liabilities. If the Trust borrows funds, the Trust unitholders will not receive distributions until the borrowed funds together with any accumulated net losses and accrued interest are repaid. As ofFebruary 29, 2020 , the Trust had cash reserves of$0.2 million for the payment of its administrative expenses. If the Trustee determines that the Trust's cash reserves are insufficient to cover the general and administrative expenses of the Trust during periods when the NPI generates net losses or minimal net proceeds, Whiting intends to loan to the Trust the amount of funds necessary to satisfy payment of its liabilities. Additionally, 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. Letter of Credit. InJune 2012 , Whiting established a$1.0 million letter of credit for the Trust in order to provide a mechanism for the Trustee to pay the operating expenses of the Trust, in the event that Whiting should fail to lend funds to the Trust, if requested to do so by the Trustee. This letter of credit will not be used to fund NPI distributions to unitholders, and if the Trustee were to draw on the letter of credit or were to borrow funds from Whiting or other entities, no further distributions would be made to unitholders until all such amounts have been repaid by the Trust. Such letter of credit is renewed annually during December for a one year term. As ofDecember 31, 2019 and 2018, the Trust had no borrowings under the letter of credit. Reserve for Expenditures. Whiting may reserve from the gross proceeds amounts up to a total of$2.0 million at any time for future development, maintenance or operating expenses. However, Whiting has not funded such a reserve since the inception of the Trust, including during the years endedDecember 31, 2019 , 2018 and 2017. Instead, Whiting has deducted from the Trust's gross proceeds only actual costs paid for development, maintenance and operating expenses. Plugging and Abandonment. Plugging and abandonment costs related to the underlying properties, net of any proceeds received from the salvage of equipment, cannot be included as a deduction in the calculation of net proceeds pursuant to the terms of the conveyance agreement. During the year endedDecember 31, 2019 , Whiting incurred$0.9 million of plugging and abandonment charges on the underlying properties, and these costs were not charged to the unitholders of the Trust.
OffBalance Sheet Arrangements
The Trust has no offbalance sheet arrangements. The Trust has not guaranteed the debt of any other party, nor does the Trust have any other arrangements or relationships with other entities that could potentially result in unconsolidated debt, losses or contingent obligations.
Contractual Obligations
The following table summarizes the Trust's obligations and commitments as ofDecember 31, 2019 to make future payments during the specified time periods
(in
thousands):
Payments Due by Period(4)
Less than
Contractual Obligations Total 1 year 1-3 years 3-5 years(4)
Delaware Trustee fees(1) $ 8 $ 4 $ 4 $ -
Trustee administrative service
fees(2) 391 193 198 -
Whiting administrative service
fees(3) 400 200 200 -
Total $ 799 $ 397 $ 402 $ -
____________
(1) Pursuant to the terms of the Trust agreement, the Trust is obligated to pay
the Delaware Trustee a fee of
(2) Pursuant to the terms of the Trust agreement, the Trust is obligated to pay
the Trustee an annual administrative fee of
quarterly installments and is billed in arrears. Starting in 2017, such fee
escalates by 2.5% each year.
(3) Pursuant to the terms of the administrative services agreement with Whiting,
the Trust is obligated throughout the term of the Trust to pay Whiting an
administrative services fee of
engineering, legal and other professional services performed by Whiting on
behalf of the Trust. The administrative services agreement will expire upon
the termination of the NPI unless terminated early by mutual agreement of the
Trustee and Whiting.
(4) The contractual obligation payments due are presented through the NPI
termination date, which is currently estimated to be
on the reserve report as of
represents obligations after the estimated
date. Actual amounts paid may differ from these estimates.
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New Accounting Pronouncements
There were no accounting pronouncements issued during the year ended
Critical Accounting Policies and Estimates
The financial statements of the Trust are significantly affected by its basis of accounting and estimates related to its oil and gas properties and proved reserves, as summarized below.
Basis of Accounting. The Trust's financial statements are prepared on a modified cash basis, which is a comprehensive basis of accounting other than GAAP. This method of accounting is consistent with reporting of taxable income to the Trust unitholders. The most significant differences between the Trust's financial statements and those prepared in accordance with GAAP are:
a. Income from net profits interest is recognized when NPI distributions are
received by the Trust rather than accrued in the month of production that they
are earned;
b. Distributions to Trust unitholders are recorded when paid by the Trust rather
than accrued when owed;
c. Trust general and administrative expenses (which include the Trustee's fees as
well as administrative, accounting, engineering, legal, and other professional
fees) are recorded when paid by the Trust rather than when incurred; and
d. Cash reserves for Trust expenses may be established by the Trustee for certain
expenditures that would not be recorded as contingent liabilities under GAAP.
While these statements differ from financial statements prepared in accordance with GAAP, the modified cash basis of reporting revenues and distributions is considered to be the most meaningful for the Trust and its results because quarterly distributions to the Trust unitholders are based on net cash receipts. This comprehensive basis of accounting other than GAAP corresponds to the accounting permitted for royalty trusts by theSEC , as specified by FASB ASC Topic 932, Extractive Activities - Oil and Gas: Financial Statements of Royalty Trusts. For additional information regarding the Trust's basis of accounting, refer to Note 2 to the Financial Statements included in this Annual Report on Form 10K. All amounts included in the Trust's financial statements are based on cash amounts received or disbursed, or on the carrying value of the net profits interests, which was derived from the historical cost of the interests at the date of their transfer from Whiting less accumulated amortization and impairment charges to date. Oil and Gas Reserves. The proved oil and gas reserves for the underlying properties are estimated by independent petroleum engineers. Reserve engineering is a subjective process that is dependent upon the quality of available data and the interpretation thereof. Estimates by different engineers often vary, sometimes significantly. In addition, physical factors such as the results of drilling, testing and production subsequent to the date of an estimate, as well as economic factors such as changes in product prices and production costs, may justify revision of such estimates. Accordingly, oil and gas quantities ultimately recovered and the timing of production may be substantially different from estimates, and the Trust is unable to predict changes in reserve quantity estimates as such quantities are dependent on future economic and operational conditions. The standardized measure of discounted future net cash flows is prepared using assumptions made pursuant to FASB andSEC guidelines. Such assumptions include using average fiscalyear oil and gas prices (calculated as the unweighted arithmetic average of the firstdayofthemonth price for each month within the 12month reporting period) and yearend costs for estimated future production and development expenditures. Discounted future net cash flows are calculated using a 10% discount rate. Changes in any of these assumptions could have a significant impact on the standardized measure. The standardized measure does not necessarily result in an estimate of the current fair market value of proved reserves. Amortization of Net Profits Interest. The investment in net profits interest is amortized using the unitsofproduction method. The rate of recording amortization is dependent upon the Trust's estimates of total proved reserves, which incorporates various assumptions and future projections. If the estimates of total proved reserves decline significantly, the rate at which amortization expense is recorded would increase, reducing Trust corpus. Impairment of Investment in Net Profits Interest. The value of the investment in net profits interest is reviewed whenever the Trustee judges that events and circumstances indicate that the recorded carrying value of the investment in net profits interest may not be recoverable. Potential impairments of the investment in net profits interest are determined by comparing future net undiscounted cash flows based on the oil and gas reserves attributable to the underlying properties to the net book value at the end of each period. If the 46
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net capitalized cost exceeds undiscounted future cash flows, the cost of the investment in net profits interest is written down to "fair value," which is determined using net discounted future cash flows from the net profits interest. Different pricing assumptions, discount rates, or oil and gas reserve estimates could result in a different calculated impairment.
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