Notes to Financial Statements (Unaudited)
(Prepared on a modified basis of cash receipts and disbursements)
June 30, 2017
(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 may sell Trust properties
only (a) as authorized by a vote of the Trust Unit holders, (b) when
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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, 2017
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:
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, 2017 and December 31, 2016, and the modified cash basis of earnings and
distributions and changes in Trust corpus for the three and
six-month
periods ended June 30, 2017 and 2016. 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, 2017 and December 31, 2016, cash equivalents which represent the cash
reserve consist of a Morgan Stanley ILF Treasury Fund.
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.
5
BP Prudhoe Bay Royalty Trust
Notes to Financial Statements (Unaudited)
(Prepared on a modified basis of cash receipts and disbursements)
June 30, 2017
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, 2016. 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.
(5) Alaska Oil and Gas Production Tax
On April 14, 2013, Alaskas legislature passed an
oil-tax
reform bill amending Alaskas oil and
gas production tax statutes, AS 43.55.10 et seq. (the Production Tax Statutes) with the aim of encouraging oil production and investment in Alaskas oil industry. On May 21, 2013, the Governor of Alaska 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
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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, 2017
progressivity tax rate implemented by certain amendments to the Production Tax Statutes in 2006 and 2007, 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 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.
(6) Royalty Revenue Adjustments
Certain of the royalty payments received by the Trust in 2017 and 2016 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).
7
BP Prudhoe Bay Royalty Trust
Notes to Financial Statements (Unaudited)
(Prepared on a modified basis of cash receipts and disbursements)
June 30, 2017
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Jan. 2017
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Jan. 2016
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Royalty payment as calculated
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$
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21,475
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$
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13,168
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Adjustment for previous quarters underpayment (overpayment), plus accrued interest
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7
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(47
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)
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Total payment received
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$
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21,482
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$
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57,689
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(7) Subsequent Event
In
July 2017 the Trust received a payment of $18,229,689 from BP Alaska, representing the royalty payment due with respect to the Trusts Royalty Interest for the quarter ended June 30, 2017. On July 20, 2017, after deducting Trust
administrative expenses, the Trustee distributed $17,824,693 to Unit holders of record on July 16, 2017.
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