Notes to Financial Statements (Unaudited)
(Prepared on a modified basis of cash receipts and disbursements)
June 30, 2016
(1) Formation of the
Trust and Organization
BP Prudhoe Bay Royalty Trust (the Trust), a grantor trust, was created as a Delaware business trust
pursuant to a Trust Agreement dated February 28, 1989 (the Trust Agreement) among The Standard Oil Company (Standard Oil), BP Exploration (Alaska) Inc. (BP Alaska), The Bank of New York Mellon, as trustee,
and BNY Mellon Trust of Delaware (successor to The Bank of New York (Delaware)), as co-trustee. Standard Oil and BP Alaska are indirect wholly-owned subsidiaries of BP p.l.c. (BP). On December 15, 2010, The Bank of New York Mellon
resigned as trustee and was replaced by The Bank of New York Mellon Trust Company, N.A., a national banking association, as successor trustee (the Trustee).
On February 28, 1989, Standard Oil conveyed an overriding royalty interest (the Royalty Interest) to the Trust. The Trust was
formed for the sole purpose of owning and administering the Royalty Interest. The Royalty Interest represents the right to receive a per barrel royalty (the Per Barrel Royalty) of 16.4246% on the lesser of (a) the first 90,000
barrels of the average actual daily net production of oil and condensate per quarter or (b) the average actual daily net production of oil and condensate per quarter from BP Alaskas working interests as of February 28, 1989 in the
Prudhoe Bay field situated on the North Slope of Alaska (the 1989 Working Interests). Trust Unit holders are subject to the risk that production will be interrupted or discontinued or fall, on average, below 90,000 barrels per day in any
quarter. BP has guaranteed the performance of BP Alaska of its payment obligations with respect to the Royalty Interest.
Effective
January 1, 2000, BP Alaska and all other Prudhoe Bay working interest owners cross-assigned interests in the Prudhoe Bay field pursuant to the Prudhoe Bay Unit Alignment Agreement. BP Alaska retained all rights, obligations, and liabilities
associated with the Trust.
The trustees of the Trust are The Bank of New York Mellon Trust Company, N.A. and BNY Mellon Trust of Delaware,
a Delaware banking corporation. BNY Mellon Trust of Delaware serves as co-trustee in order to satisfy certain requirements of the Delaware Statutory Trust Act. The Bank of New York Mellon Trust Company, N.A. alone is able to exercise the rights and
powers granted to the Trustee in the Trust Agreement.
The Per Barrel Royalty in effect for any day is equal to the price of West Texas
Intermediate crude oil (the WTI Price) for that day less scheduled Chargeable Costs (adjusted for inflation) and Production Taxes (based on statutory rates then in effect).
The Trust is passive, with the Trustee having only such powers as are necessary for the collection and distribution of revenues, the payment of
Trust liabilities, and the protection of the Royalty Interest. The Trustee, subject to certain conditions, is obligated to establish cash reserves and borrow funds to pay liabilities of the Trust when they become due. The Trustee
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BP Prudhoe Bay Royalty Trust
Notes to Financial Statements (Unaudited)
(Prepared on a modified basis of cash receipts and disbursements)
June 30, 2016
may sell Trust properties only (a) as authorized by a vote of the Trust Unit holders, (b) when necessary to provide for the payment of specific liabilities of the Trust then due
(subject to certain conditions) or (c) upon termination of the Trust. Each Trust Unit issued and outstanding represents an equal undivided share of beneficial interest in the Trust. Royalty payments are received by the Trust and distributed to
Trust Unit holders, net of Trust expenses, in the month succeeding the end of each calendar quarter. The Trust will terminate (i) upon a vote of holders of not less than 60% of the outstanding Trust Units, or (ii) at such time the net
revenues from the Royalty Interest for two successive years are less than $1,000,000 per year (unless the net revenues during such period are materially and adversely affected by certain events).
In order to ensure that the Trust has the ability to pay future expenses, the Trust established a cash reserve account, which the Trustee
believes is sufficient to pay approximately one years current and expected liabilities and expenses of the Trust.
(2) Basis of Accounting
The financial statements of the Trust are prepared on a modified cash basis and reflect the Trusts assets, liabilities, corpus,
earnings, and distributions, as follows:
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a.
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Revenues are recorded when received (generally within 15 days of the end of the preceding quarter) and distributions to Trust Unit holders are recorded when paid.
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b.
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Trust expenses (which include accounting, engineering, legal, and other professional fees, trustees fees, and out-of-pocket expenses) are recorded on an accrual basis.
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c.
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Cash reserves may be established by the Trustee for certain contingencies that would not be recorded under generally accepted accounting principles.
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While these statements differ from financial statements prepared in accordance with accounting principles generally accepted in the United
States of America, the modified cash basis of reporting revenues and distributions is considered to be the most meaningful because quarterly distributions to the Trust Unit holders are based on net cash receipts. These modified cash basis financial
statements are unaudited but, in the opinion of the Trustee, include all adjustments necessary to present fairly the assets, liabilities and corpus of the Trust as of June 30, 2016 and December 31, 2015, and the modified cash basis of
earnings and distributions and changes in Trust corpus for the three and six-month periods ended June 30, 2016 and 2015. The adjustments are of a normal recurring nature and are, in the opinion of the Trustee, necessary to fairly present the
results of operations.
As of June 30, 2016 and December 31, 2015, cash equivalents which represent the cash reserve consist of a
Morgan Stanley ILF Treasury Fund.
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BP Prudhoe Bay Royalty Trust
Notes to Financial Statements (Unaudited)
(Prepared on a modified basis of cash receipts and disbursements)
June 30, 2016
Estimates and assumptions are required to be made regarding assets, liabilities and changes
in Trust corpus resulting from operations when financial statements are prepared. Changes in the economic environment, financial markets and any other parameters used in determining these estimates could cause actual results to differ, and the
differences could be material.
These unaudited financial statements should be read in conjunction with the financial statements and
related notes in the Trusts Annual Report on Form 10-K for the fiscal year ended December 31, 2015. The cash earnings and distributions for the interim periods presented are not necessarily indicative of the results to be expected for the
full year.
(3) Royalty Interest
At
inception in February 1989, the Royalty Interest held by the Trust had a carrying value of $535,000,000. In accordance with generally accepted accounting principles, the Trust amortized the value of the Royalty Interest based on the units of
production method. Such amortization was charged directly to the Trust corpus, and did not affect cash earnings. In addition, the Trust periodically evaluated impairment of the Royalty Interest by comparing the undiscounted cash flows expected to be
realized from the Royalty Interest to the carrying value, pursuant to the Financial Accounting Standards Board Accounting Standards Codification 360,
Property, Plant, and Equipment
. If the expected future undiscounted cash flows were less
than the carrying value, the Trust recognized impairment losses for the difference between the carrying value and the estimated fair value of the Royalty Interest. By December 31, 2010, the Trust had recognized accumulated amortization of
$359,473,000 and aggregate impairment write-downs of $175,527,000 reducing the carrying value of the Royalty Interest to zero.
(4) Income Taxes
The Trust files its federal tax return as a grantor trust subject to the provisions of subpart E of Part I of Subchapter J of the
Internal Revenue Code of 1986, as amended, rather than as an association taxable as a corporation. The Trust Unit holders are treated as the owners of Trust income and corpus, and the entire taxable income of the Trust will be reported by the Trust
Unit holders on their respective tax returns.
If the Trust were determined to be an association taxable as a corporation, it would be
treated as an entity taxable as a corporation on the taxable income from the Royalty Interest, the Trust Unit holders would be treated as shareholders, and distributions to Trust Unit holders would not be deductible in computing the Trusts tax
liability as an association.
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BP Prudhoe Bay Royalty Trust
Notes to Financial Statements (Unaudited)
(Prepared on a modified basis of cash receipts and disbursements)
June 30, 2016
(5) Alaska Oil and Gas Production Tax
The Alaska oil and gas production tax statutes were amended by a bill (the 2006 Amendments) which became effective in August 2006.
The 2006 Amendments replaced an oil production tax levied at the flat rate of 15% of the gross value at the point of production (the wellhead or field value) of taxable oil produced from a producers leases or properties
in the State of Alaska. Under the 2006 Amendments, producers were taxed on the production tax value of taxable oil (gross value at the point of production for the calendar year less the producers direct costs of exploring for,
developing, or producing oil or gas deposits located within the producers leases or properties in Alaska for the year) at a rate equal to the sum of 22.5% plus a progressivity rate determined by the average monthly production tax
value of the oil produced. The progressivity rate imposed by the 2006 Amendments was equal to 0.25% times the amount by which the simple average for each calendar month of the daily production tax values per barrel of the oil produced during the
month exceeded $40 per barrel.
In December 2007, a bill (popularly titled Alaskas Fair and Equitable Share or
ACES) took effect which further amended the Alaska oil and gas production tax statutes in certain respects. ACES changed the basic tax rate from 22.5% to 25% and increased the progressivity rate. If the producers average monthly
production tax value per barrel is greater than $30 but not more than $92.50, the progressivity tax rate is 0.4% times the amount by which the average monthly production tax value exceeds $30 per barrel. If the producers average monthly
production tax value per barrel is greater than $92.50, the progressivity tax rate is the sum of 25% and the product of 0.1% multiplied by the difference between the average monthly production tax value per barrel and $92.50, except that the sum may
not exceed 50%.
The Trustee and BP Alaska entered into a letter agreement in October 2006 and an amendment thereto in January 2008 (the
Letter Agreement) to resolve issues associated with the 2006 Amendments and ACES. The Letter Agreement modified the calculation of Production Taxes in the daily Per Barrel Royalty calculation effective as of August 20, 2006, in the
case of the 2006 Amendments, and effective December 20, 2007, in the case of ACES. It also provides that the retroactivity provisions of the respective tax bills are not applicable to the Per Barrel Royalty calculation for periods prior to the
effective dates of the 2006 Amendments and ACES.
On April 14, 2013, Alaskas legislature passed an oil-tax reform bill aimed at
encouraging oil production and investment in Alaskas oil industry. On May 21, 2013, Alaska Governor Sean Parnell signed the bill into law as chapter 10 of the 2013 Session Laws of Alaska (the Act). Among significant changes,
the Act eliminated the monthly progressivity tax rate implemented by 2006 Amendments and ACES, increased the base rate from 25% to 35% and added a stair-step per-barrel tax credit for oil production. This tax credit is based on the gross
value at the point of production per barrel of taxable oil and may not reduce a producers tax
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BP Prudhoe Bay Royalty Trust
Notes to Financial Statements (Unaudited)
(Prepared on a modified basis of cash receipts and disbursements)
June 30, 2016
liability below the minimum tax (which is a percentage, ranging from zero to 4%, of the gross value at the point of production of a producers taxable production during the
calendar year based on the average price per barrel for Alaska North Slope crude oil for sale on the United States West Coast for the year) under the Production Tax Statutes. These changes became effective on January 1, 2014.
On January 15, 2014, the Trustee executed a letter agreement with BP Alaska dated January 15, 2014 (the 2014 Letter
Agreement) regarding the implementation of the Act with respect to the Trust. Pursuant to the 2014 Letter Agreement, Production Taxes for the Trusts Royalty Production will equal the tax for the relevant quarter, minus the allowable
monthly stair-step per-barrel tax credits for the Royalty Production during that quarter. If there is a minimum tax-related limitation on the amount of the stair-step per-barrel tax credits that could otherwise be claimed for any quarter
during the year, any difference between that limitation as preliminarily determined on a quarterly basis and the actual limitation for the entire year will be reflected in the payment to the Trust for the first quarter Royalty Production in the
following year.
On July 6, 2015, BP Alaska and the Trustee signed a letter agreement (the 2014 Letter Agreement
Amendment) amending the 2014 Letter Agreement to provide that if there is a minimum tax-related limitation on the amount of the stair-step per-barrel tax credits that could otherwise be claimed for any quarter during the year, any
difference between that limitation as preliminarily determined on a quarterly basis and the actual limitation for the entire year will be reflected in the payment to the Trust for the fourth quarter Royalty Production payment for such year rather
than in the payment to the Trust for the first quarter Royalty Production in the following year. The 2014 Letter Agreement Amendment became effective immediately.
(6) Royalty Revenue Adjustments
Certain
of the royalty payments received by the Trust in 2016 and 2015 were adjusted by BP Alaska to compensate for underpayments or overpayment of the royalties due with respect to the quarters ended prior to the dates of such payments. Average net
production of crude oil and condensate from the proved reserves allocated to the Trust was less than 90,000 barrels per day during certain quarters. Royalty payments by BP Alaska with respect to those quarters were based on estimates by BP Alaska of
production levels because actual data was not available by the date on which payments were required to be made to the Trust. Subsequent recalculation by BP Alaska of the royalty payments due based on actual production data resulted in the payment
adjustments shown in the table below (in thousands). In addition, the payment received in January 2015 included an adjustment of the royalty payment due with respect to the quarters ended June 30, 2014 and September 30, 2014. The
underpayment was a result of the BP Operating unit reaching the cumulative condensate limit of 1,175,000,000 barrels as of June 8, 2014. Once the cumulative condensate limit had been reached the production associated with condensate was subject
to the Oil Rim Initial
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BP Prudhoe Bay Royalty Trust
Notes to Financial Statements (Unaudited)
(Prepared on a modified basis of cash receipts and disbursements)
June 30, 2016
Participating Area royalty interest of 50.6848339% instead of the Gas Cap Participating Area Royalty Interest of 13.8398950%. This allocation of the condensate production to the Oil Rim Initial
Participating Interest remains in effect.
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Payments Received
(In Thousands)
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Jan. 2016
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Apr. 2015
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Jan. 2015
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Royalty payment as calculated
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$
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13,168
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$
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21,832
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$
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48,150
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Adjustment for previous quarters underpayment (overpayment), plus accrued interest
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(47
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59
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9,539
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Total payment received
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$
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13,121
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$
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21,891
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$
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57,689
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(7) Subsequent Event
In July 2016 the Trust received a payment of $15,110,437 from BP Alaska, representing the royalty payment due with respect to the Trusts
Royalty Interest for the quarter ended June 30, 2016. On July 20, 2016, after deducting Trust administrative expenses, the Trustee distributed $14,659,918 to Unit holders of record on July 16, 2016.
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