PRT PermRock Royalty Trust

NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)

PermRock Royalty Trust (the “Trust”) is a Delaware statutory trust formed on November 22, 2017 under the Delaware Statutory Trust Act pursuant to a trust agreement dated November 22, 2017, as amended and restated on May 4, 2018, by and among Boaz Energy II, LLC (“Boaz Energy”), as trustor, Simmons Bank, as Trustee (the “Trustee”), and Wilmington Trust, National Association, as Delaware Trustee (the “Delaware Trustee”) (such amended and restated trust agreement, as amended to date, the “Trust Agreement”).

The Trust was created to acquire and hold the Net Profits Interest for the benefit of the Trust unitholders. In connection with the closing of the initial public offering of Trust units, on May 4, 2018, Boaz Energy conveyed the Net Profits Interest to the Trust in exchange for Trust units pursuant to a conveyance agreement between Boaz Energy, the Trustee and the Delaware Trustee (the “Conveyance”). The Net Profits Interest represents an interest in the Underlying Properties.

The Net Profits Interest entitles the Trust to receive 80% of the net profits from the sale of oil and natural gas production from the Underlying Properties. The Net Profits Interest is passive in nature and neither the Trust nor the Trustee has any control over, or responsibility for, costs relating to the operation of the Underlying Properties. The Trust has and will continue to make monthly cash distributions of all of its monthly cash receipts, after deduction of fees and expenses for the administration of the Trust and any cash reserves, to holders of its Trust units as of the applicable record date on or before the 10th business day after the record date. Distributions generally relate to sales from a one-month period.

The Trustee may deposit funds awaiting distribution in an account with an FDIC-insured or national bank, including the Trustee, if the interest paid to the Trust at least equals amounts paid by the Trustee on similar deposits, and make other short-term investments with the funds distributed to the Trust.

In May 2018, Boaz Energy completed an initial public offering of 6,250,000 of its Trust units.

The Trust uses the modified cash basis of accounting to report Trust receipts of the Net Profits Interest and payments of expenses incurred. The Net Profits Interest represents the right to receive revenues (primarily oil and natural gas sales), less direct operating expenses, lease operating expenses, severance and ad valorem taxes and development expenses of the Underlying Properties, multiplied by 80%, less any payments made or plus any payments received in connection with the settlement of certain hedge contracts. Cash distributions of the Trust are 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, liabilities, Trust corpus, earnings and distributions as follows:

5

PERMROCK ROYALTY TRUST

NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)

The financial statements of the Trust are prepared on a modified cash basis of accounting, which is considered to be the most meaningful basis of preparation for a royalty trust because monthly distributions to the Trust unitholders are based on net cash receipts. Although this basis of accounting is permitted for royalty trusts by the SEC, the financial statements of the Trust differ from financial statements prepared in accordance with GAAP because net profits income is not accrued in the month of production, expenses are not recognized when incurred and cash reserves may be established for certain contingencies that would not be recorded in GAAP financial statements. This comprehensive basis of accounting other than GAAP corresponds to the accounting permitted for royalty trusts by the SEC as specified by Staff Accounting Bulletin Topic 12:E, Financial Statements of Royalty Trusts.

The accompanying unaudited financial statements have been prepared by the Trust in accordance with the accounting policies stated in the audited financial statements and notes of the Trust thereto included in the Trust’s 2019 Annual Report and reflect all adjustments that are, in the opinion of the Trustee, necessary to state fairly the information in the Trust’s unaudited interim financial statements.

The preparation of financial statements requires the Trust to make estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

The Trust’s revenue and distributions are substantially dependent upon the prevailing and future prices for oil and natural gas, each of which depends on numerous factors beyond the Trust’s control such as economic conditions, the global political environment, regulatory developments and competition from other energy sources. Oil and natural gas prices historically have been volatile and may be subject to significant fluctuations in the future.

Revenue received by the Trust (and its ability to pay distributions) has been and will continue to be directly affected by the volatility in commodity prices, which have declined sharply since the beginning of 2020 in response to the economic effects of the COVID-19 pandemic and the dispute over production levels between Russia and the members of the Organization of Petroleum Exporting Countries. The sharp decline in commodity prices has resulted in an oversupply of crude oil, further exacerbating the decline in crude oil prices, which could remain low for an extended period of time.

Contingencies related to the Underlying Properties that are unfavorably resolved would generally be expected to result in reductions to cash receipts to the Trust in respect of the Net Profits Interest with corresponding reductions to cash distributions to Trust unitholders. Please see the discussion of litigation in Note 9 to condensed financial statements.

Tax counsel advised the Trust at the time of formation that for U.S. federal income tax purposes, the Trust is treated as a grantor trust and will not be subject to federal income tax at the trust level. Trust unitholders will be treated for such purposes as owning a direct interest in the assets of the Trust, and each Trust unitholder is taxed directly on its pro rata share of the income and any gain, if sold, attributable to the assets of the Trust and is entitled to claim its pro rata share of deductions and expenses attributable to the assets of the Trust. Each Trust unitholder should consult his or her own tax advisor regarding income tax requirements, if any, applicable to such unitholder’s ownership of Trust units.

6

PERMROCK ROYALTY TRUST

NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)

Pursuant to the Trust Agreement, as of May 31, 2019, the Trustee began retaining cash from the distributions the Trust receives to be used by the Trust in the event that its cash on hand (including available cash reserves) is not sufficient to pay ordinary course administrative expenses as they become due. The Trustee is authorized to retain cash reserves (i) in an amount not to exceed $1.0 million at any one time and (ii) in such amounts as the Trustee in its discretion deems appropriate to pay for future liabilities of the Trust, but not less than $25,000 per month or more than $100,000 per month. Cash reserves held by the Trustee for administrative expenses totaled $1,000,000 as of June 30, 2020.

Boaz Energy is entitled under the Conveyance to reserve up to $3 million from the net profits for certain taxes and development or operating expenses. In April 2020, Boaz Energy reserved $305,502 net to the Trust, which was applied in part to recoupment of the $80,000 net to the Trust balance of previously advanced funds, and the remaining $225,502 net to the Trust was reserved for certain taxes and future development expenses. In May 2020, Boaz Energy reserved $254,868 net to the Trust for future expenses as well. Then, in June 2020, Boaz Energy applied $287,649 net to the Trust of funds previously reserved in April and May 2020. As of June 30, 2020, the balance of funds reserved by Boaz Energy, net to the Trust, was $192,721.

The Trust makes monthly cash distributions of the net amount, if any, of its monthly cash receipts, after deduction of fees and expenses for the administration of the Trust and cash reserves to holders of its Trust units as of the applicable record date on or before the 10th business day after the record date.

Based on 12,165,732 Trust units outstanding at each date listed below, the per unit distributions during the quarter ended June 30, 2020 were as follows:

Trustee Administrative Fee. Under the terms of the Trust Agreement, the Trust pays an annual administrative fee to the Trustee and the Delaware Trustee. The Delaware Trustee’s annual fee is $4,000. For 2020, the Trustee’s annual administrative fee is $189,072. The Trustee’s annual administrative fee will increase at a rate of 3% per year for the first three years of the Trust’s existence, increase at a rate of 2% per year for the following two years, then increase at a rate of 1% per year until the 20th anniversary of the Trust’s formation and then remain flat thereafter. These costs of the Trust, which are included in administration expenses, are deducted by the Trust before distributions are made to Trust unitholders.

Agreements with Boaz Energy. On May 4, 2018, the Trust entered into a registration rights agreement for the benefit of Boaz Energy and certain of its affiliates and transferees, pursuant to which the Trust agreed to register the offering of the Trust units held by Boaz Energy and certain of its affiliates and permitted transferees upon request by Boaz Energy. As of June 30, 2020, Boaz Energy owned 5,878,332 Trust units of the 12,165,732 Trust units issued and outstanding.

7

PERMROCK ROYALTY TRUST

NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)

Income from the Net Profits Interest is exposed to fluctuations in energy prices in the normal scope of business. To mitigate the negative effects of a possible decline in oil prices on distributable income to the Trust, Boaz Energy entered into derivative put option contracts with respect to approximately 100% of expected oil production attributable to the Net Profits Interest during 2018 and 76% of such production during 2019. These derivative contracts consisted of put option contracts with strike prices of $60 per barrel in 2018 and $50 per barrel in 2019. Boaz Energy believed that these put option contracts provided downside protection to the Trust in the event spot prices for crude oil declined below the applicable strike price, while still allowing the Trust to benefit from increasing crude oil prices. If prices for crude oil as quoted on NYMEX declined below the applicable strike prices, Boaz Energy could exercise its put option and receive payment generally equal to the difference between the applicable strike price and the market price for crude oil at the time of exercise, multiplied by the notional quantity of crude oil hedged under the applicable put option contract being exercised. These contracts expired as of December 31, 2019, and after December 31, 2019 none of the production attributable to the Underlying Properties is hedged.

For the six months ended June 30, 2019, there was $688,562 ($550,850 net to the Trust) in cash proceeds from the settlement of derivative contracts. Because the derivative contracts have since expired, there were no cash proceeds from settlement of derivative contracts during the three or six months ended June 30, 2020.

Boaz Energy has advised the Trustee that the estimate for Boaz Energy’s 2020 capital budget has been increased from $2.0 million to $2.5 million, based principally upon capital projects being implemented by outside operators, of which $1,800,00 has been expended as of June 30, 2020. Based on current oil and gas prices, Boaz Energy has informed the Trustee that it is not planning any new Boaz Energy-operated wells or other significant capital projects for the remainder of 2020, other than waterflood projects and workovers principally in the Permian Platform area, the costs of which are included in the $2.5 million estimate. The estimated 2020 capital budget is subject to change based on, among other things, changes in the price of oil and natural gas, the impact of the COVID-19 pandemic on prices and economic activity, Boaz Energy’s actual capital requirements, capital expenditure requirements of third-party operators, the pace of regulatory approvals and the mix of projects.

On October 1, 2018, a lawsuit styled Thaleia L. Marston, Trustee of the Marston Trust v. Blackbeard Operating, LLC, et.al, No. 18-10-24761 – CVW in the 143rd District Court in Ward County, Texas (the “2018 Litigation”) was filed, naming, among others, Boaz Energy and the Trust as defendants. The plaintiff is a lessor under two leases operated by Blackbeard Operating LLC. The Underlying Properties include the interests of Boaz Energy in some of the minerals covered by those leases. The litigation seeks surface use damages and alleges violations of the terms of the leases, among other things. While it is not yet possible to estimate any potential loss or range of loss, Boaz Energy has advised the Trustee that it does not anticipate the litigation will materially affect the Trust. On January 3, 2020, Lawrence M. Marston joined the lawsuit as a plaintiff alleging surface damage claims against Blackbeard and Goodnight Midstream Permian, L.L.C., but not against the Trust. On January 17, 2020, the Trust and the other defendants filed a motion for summary judgment, which would dispose of the claims against the Trust if granted. Mediation set for April 2020 did not occur and a hearing on the summary judgment motion was delayed due to closures related to COVID-19. However, all parties have served their expert reports, there have been a series of depositions of parties and experts, and a summary judgment hearing is tentatively scheduled for August 27, 2020.

8

PERMROCK ROYALTY TRUST

NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)

On July 21, 2020, the Trust declared there would be no cash distribution to record unit holders as of July 31, 2020 based upon production during the month of May 2020.

In July 2020, Boaz Energy applied $192,721 net to the Trust of funds Boaz Energy previously reserved to cover certain taxes and future development expenses, and also advanced $140,606 net to the Trust to cover expenses, including Trust administrative expenses. Boaz Energy reports it anticipates recouping the $140,606 net to the Trust advancement in calculating the Trust’s Net Profits Interest in August 2020.

In July and August of 2020, the unfavorable oil and natural gas price environment continued. The Trustee cannot predict the long-term impact on the Trust, however there may be additional months in 2020 when the Trust will not declare distributions to unitholders.

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ITEM 2.

TRUSTEE’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Introduction

The following discussion and analysis is intended to help the reader understand the Trust’s financial condition, results of operations, liquidity and capital resources. This discussion and analysis should be read in conjunction with the Trust’s unaudited condensed financial statements and the accompanying notes included in this Quarterly Report on Form 10-Q (“Quarterly Report”) and the Trust’s audited financial statements and the accompanying notes included in the Trust’s 2019 Annual Report.

Cautionary Statement Regarding Forward Looking Statements

Certain information included in this Quarterly Report contains, and other materials filed or to be filed by the Trust with the SEC (as well as information included in oral statements or other written statements made or to be made by the Trust) may contain or include, forward-looking statements within the meaning of Section 21E of the Exchange Act and Section 27A of the Securities Act of 1933, as amended (the “Securities Act”). Such forward-looking statements generally are accompanied by words such as “may,” “will,” “estimate,” “expect,” “predict,” “project,” “anticipate,” “goal,” “should,” “assume,” “believe,” “plan,” “intend,” or other words that convey the uncertainty of future events or outcomes. All statements other than statements of historical fact included in this Quarterly Report are forward-looking statements, including without limitation statements under this “Trustee’s Discussion and Analysis of Financial Conditions and Results of Operations” and all statements regarding Boaz Energy and Simmons Bank’s (as Trustee of the Trust) expectations, beliefs and plans regarding the following: (i) Boaz Energy’s capital projects, timing and estimated costs, and the resulting impact of those activities on the computation of the Net Profits Interest; (ii) outside operators’ capital projects and the resulting impact of those activities on the Net Profits Interest; (iii) implementation or continued use of waterflood projects and workovers and the location of waterflood projects and workovers; (iv) Boaz Energy’s estimated capital expenditures; (v) the timing of capital expenditures and capital reserve amounts; (vi) the expected timing of litigation proceedings; (vii) the impact of current litigation matters on the Trust; (viii) Boaz Energy’s staffing levels or future reductions in staffing on the Underlying Properties; (ix) shut in of wells on the Underlying Properties; (x) the effects of COVID-19; and (xi) distributions to Trust unitholders. Such statements are based on certain assumptions of the Trustee, and certain assumptions of information provided to the Trust by Boaz Energy, the owner of the Underlying Properties; are based on an assessment of, and are subject to, a variety of factors deemed relevant by the Trustee and Boaz Energy; and involve risks and uncertainties. Certain factors could affect the future results of the energy industry in general, and Boaz Energy and the Trust in particular, and could cause actual results to differ materially from those projected in such forward-looking statements. Those factors include, without limitation, the following:

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You should not place undue reliance on any forward-looking statements. All forward-looking statements speak as of the date of this Quarterly Report. The Trust does not undertake any obligation to release publicly any revisions to the forward-looking statements to reflect events or circumstances after the date of this Quarterly Report or to reflect the occurrence of unanticipated events, unless required by applicable law.

Boaz Energy Information

As a holder of a net profits interest, the Trust relies on Boaz Energy for information regarding Boaz Energy and its affiliates; the Underlying Properties, including the operations, acreage, well and completion count, working interests, production volumes, sales revenues, capital expenditures, operating expenses, reserves, drilling plans, drilling results and leasehold terms related to the Underlying Properties; and factors and circumstances that have or may affect the foregoing.

Overview

PermRock Royalty Trust, a Delaware statutory trust formed in November 2017 by Boaz Energy, completed its initial public offering in May 2018. The Trust’s main asset and source of income is the Net Profits Interest, which entitles the Trust to receive 80% of the net profits from oil and natural gas production from the Underlying Properties. The Net Profits Interest is passive in nature and neither the Trust nor the Trustee has any management control over or responsibility for costs relating to the operation of the Underlying Properties.

Although the Trust was formed on November 22, 2017, the conveyance of the Net Profits Interest did not occur until May 4, 2018, with an effective date of January 1, 2018, and no proceeds were received by the Trust from Boaz Energy during the three-month period ended June 30, 2018. As a result, the Trust did not recognize any income or make any distributions during the three-month period ended June 30, 2018.

The Trust is required to make monthly cash distributions of substantially all of its monthly cash receipts, after deduction of fees and expenses for the administration of the Trust and any cash reserves, to holders of its Trust units as of the applicable record date on or before the 10th business day after the record date. The Net Profits Interest is entitled to a share of the profits from and after January 1, 2018 attributable to production occurring on or after such date. The Trust is not subject to any pre-set termination provisions based on a maximum volume of oil or natural gas to be produced or the passage of time. The amount of Trust revenues and cash distributions to Trust unitholders depends on, among other things:

Boaz Energy typically receives payment for oil production 30 to 60 days after it is produced and for natural gas production 60 to 90 days after it is produced.

Properties. The Underlying Properties consist of four operating areas in the Permian Basin in Texas, aggregating 35,390 gross (22,997 net) acres. The Permian Clearfork area consists of 2,434 net acres on the Central Basin Platform of the Permian Basin in Hockley and Terry Counties, Texas. The Permian Abo area consists of 1,667 net acres on the Central Basin Platform of the Permian Basin in Terry and Cochran Counties, Texas. The Permian Shelf area consists of 14,727 net acres on the Eastern Shelf of the Permian Basin in Glasscock, Schleicher, Stonewall and Coke Counties, Texas. The Permian Platform area consists of 4,169 net acres on the Central Basin Platform of the Permian Basin in Ward, Crane, Terry and Ector Counties, Texas.

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2019 Recap and 2020 Outlook

In 2019, Boaz Energy optimized waterflood operations, converted additional wells to injection wells where prudent and continued to participate in Permian Platform drilling proposed by non-operating partners. Boaz Energy completed two new wells operated by Boaz Energy in the Permian Clearfork area in 2019. The first was completed in August 2019 and came on-line in September 2019. The second new well reached total depth and came on-line in December 2019.

In 2020, Boaz Energy has informed the Trustee that due to current oil and natural gas pricing it is not planning any new Boaz Energy-operated wells or other significant capital projects for the remainder of 2020, other than waterflood projects and workovers, principally in the Permian Platform area. Boaz Energy has implemented reduced staffing measures on the Underlying Properties and anticipates reacting on a monthly basis to the need to shut in wells on the Underlying Property to reduce the risk of a realization of negative oil prices in a production month. Boaz Energy has indicated it currently intends to continue to build a reserve for capital costs and other expenses, as permitted under the Conveyance, which reserves will reduce distributions to the Trust.

RESULTS OF OPERATIONS

Distributable Income

Three Months Ended June 30, 2020

For the three months ended June 30, 2020, net profits income received by the Trust was $376,992 compared to $3,140,783 for the same period of the prior year. This decrease in net profits income was primarily due to decreased oil production and sales, as well as decreased oil prices and oversupply resulting from economic effects of the COVID-19 pandemic and the dispute over production levels between Russia and the members of the Organization of Petroleum Exporting Countries. See “Computation of Income from the Net Profits Interest Received by the Trust” below.

After considering interest income of $1,245, general and administrative expenditures of $278,237 and cash reserves retained by the Trustee of $100,000, distributable income for the three months ended June 30, 2020 was $0, or $0.000000 per Trust unit. For the three months ended June 30, 2019, total distributable income was $2,645,711, or $0.217472 per unit.

Interest income was essentially the same for the three months ended June 30, 2020 as compared to the prior year, due to less investable cash received attributable to the Net Profits Interest and lower interest rates. General and administrative expenditures decreased by $78,334 for the three months ended June 30, 2020 as compared to the prior year, primarily due to timing of payments.

Pursuant to the Trust Agreement, as of May 31, 2019, the Trustee was authorized to begin retaining cash reserves for administrative expenses. The Trustee retained $100,000 in cash reserves during the three months ended June 30, 2020 compared to $140,000 in cash reserves retained in the same period of the prior year. Total cash reserves were $1,000,000 as of June 30, 2020 compared to $140,000 as of June 30, 2019.

Based on 12,165,732 Trust units outstanding at each date listed below, the per unit distributions during the three months ended June 30, 2020 were as follows:

Six Months Ended June 30, 2020

For the six months ended June 30, 2020, net profits income received by the Trust was $2,131,247 compared to $5,463,992 for the same period of the prior year. This decrease in net profits income was primarily due to decreased oil production and sales, as well as decreased oil prices and oversupply resulting from economic effects of the COVID-19 pandemic and the dispute over production levels between Russia and the members of the Organization of Petroleum Exporting Countries. See “Computation of Income from the Net Profits Interest Received by the Trust” below.

12

After considering interest income of $4,318, general and administrative expenditures of $540,501 and cash reserves retained by the Trustee of $400,000, distributable income for the six months ended June 30, 2020 was $1,195,064, or $0.098232 per Trust unit. For the six months ended June 30, 2019, total distributable income was $4,716,513, or $0.387688 per unit.

Interest income decreased for the six months ended June 30, 2020 as compared to the prior year, due to less investable cash received attributable to the Net Profits Interest in 2020 and lower interest rates. General and administrative expenditures decreased by $71,634 for the six months ended June 30, 2020 as compared to the prior year, primarily due to timing of payments and lower legal fees.

The Trustee retained $400,000 in cash reserves during the six months ended June 30, 2020 compared to $140,000 in cash reserves retained in the prior year period. Pursuant the terms of the Trust Agreement, the Trustee was authorized to begin retaining cash reserves for administrative expenses in May of 2019, and therefore, no cash reserves were withheld in the first four months of 2019.

Computation of Income from the Net Profits Interest Received by the Trust

The Net Profits Interest entitles the Trust to receive 80% of the net profits attributable to Boaz Energy’s interest from the sale of oil and natural gas production from the Underlying Properties. The Trust’s income from the Net Profits Interest consists of monthly net profits attributable to income from the Underlying Properties. Because of the interval between the time of production and receipt of net profits income by the Trust, the Trust recognizes production during the month in which the related net profits income is paid to the Trust. Net profits income for the three months ended June 30, 2020, was based on production during the months of February 2020 through April 2020. The table below outlines the computation of income from the Net Profits Interest received by the Trust for the three and six months ended June 30, 2020 and June 30, 2019:

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Important factors used in calculating the Trust’s net profits income include the volumes of oil and natural gas produced from the Underlying Properties and the realized prices received for the sale of those minerals, including oil and natural gas liquids, as well as direct operating expenses, lease operating expenses, severance and ad valorem taxes, development and other expenses and capital reserves.

Sales Volumes

Oil

Oil sales volumes decreased by 6,753 Bbls (5%) and 15,084 Bbls (5%), respectively, for the three and six months ended June 30, 2020 as compared to the same periods in the prior year. Boaz Energy reports this decrease was primarily due to decreased oil demand as a result of oversupply and economic effects of COVID-19, as well as Boaz Energy’s shut in of a material amount of production in May 2020 due to price uncertainties.

Natural Gas

Natural gas sales volumes decreased by 9,808 Mcf (7%) for the three months ended June 30, 2020 as compared to the prior year period. Boaz Energy reports this decrease was primarily because of decreased natural gas demand as a result of oversupply and economic effects of COVID-19, as well as Boaz Energy’s shut in of a material amount of production in May 2020 due to price uncertainties. Natural gas sales volumes decreased by 19,246 Mcf (6%) for the six months ended June 30, 2020 as compared to the prior year period. Boaz Energy reports this decrease was primarily because of the effects of a shut in at a natural gas processing plant in Crane County during the first quarter of 2020 and Boaz Energy’s shut in of a material amount of production in May 2020 due to price uncertainties, but was also impacted by decreased natural gas demand and sales as a result of oversupply and economic effects of COVID-19.

Sales Prices

Oil

The average realized oil price per Bbl decreased for the three months ended June 30, 2020 as compared to the prior year period primarily related to oversupply, decreased demand and economic effects of COVID-19. The average realized oil price per Bbl for the three months ended June 30, 2020 is primarily related to production from February 2020 through April 2020, when the average NYMEX price was $32.56 per Bbl.  The average realized oil price per Bbl also decreased for the six months ended June 30, 2020 due to oversupply, decreased demand and economic effects of COVID-19. The average realized oil price per Bbl for the six months ended June 30, 2020 is primarily related to production from November 2019 through April 2020, when the average NYMEX price was $45.37 per Bbl.

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Natural Gas

The average realized natural gas price per Mcf decreased for the three and six months ended June 30, 2020 as compared to the prior year period because of oversupply of ethane and other natural gas liquids, decreased demand, depressed pricing and costs to dispose of excess natural gas liquids. The average realized natural gas price per Mcf for the three months ended June 30, 2020 is primarily related to production from February 2020 through April 2020 when the average NYMEX price was $2.13 per Mcf. The decrease in the average realized natural gas price per Mcf for the six months ended June 30, 2020 is primarily related to production from November 2019 through April 2020, when the average NYMEX price was $1.85 per Mcf.

Costs

Direct Operating Expenses

Direct operating expenses decreased for the three and six months ended June 30, 2020 as compared to the prior year periods primarily because of a slowdown in operations in light of current prices for oil and natural gas and economic conditions during the COVID-19 pandemic.

Lease Operating Expenses

Lease operating expenses decreased slightly for the three and six months ended June 30, 2020 as compared to the prior year periods as a result of less operating activity and a decrease in staffing.

Severance and ad Valorem Taxes

Severance and ad valorem taxes increased for the three months ended June 30, 2020 as compared to the prior year period primarily because of a one-time severance tax refund of $0.29 million on Boaz Energy’s Terry County Clearfork waterflood during the three-month period ended June 30, 2019. Severance and ad valorem taxes decreased for the six months ended June 30, 2020 compared to the same period in the prior year as a result of economic uncertainty and decreased sales due to COVID-19 and also because of a credit to the Trust in the first quarter of 2020 when actual ad valorem taxes were less than the accrual amounts.

Development Expenses Related to the Underlying Properties

Development expenses related to the Underlying Properties increased for the three months ended June 30, 2020 as compared to the prior year period because of capital costs relating to properties not operated by Boaz Energy. Development expenses related to the Underlying Properties also increased for the six months ended June 30, 2020 as compared to the prior year period as a result of capital costs relating to properties not operated by Boaz Energy.

Other Expenses

Other expenses increased by $40,380 for the three months ended June 30, 2020 as compared to the prior year period, primarily because of an adjustment to overhead in April 2020 and the timing of the payment for the annual net profits audit. Other expenses increased by $50,674 for the six months ended June 30, 2020 as compared to the prior year period, primarily because of the annual adjustment to overhead in April 2020 and well as the timing of the payment for the annual net profits audit.

Capital Reserve

In April 2020, Boaz Energy reserved $305,502 net to the Trust, which was applied in part to recoupment of the $80,000 net to the Trust balance of previously advanced funds, and the remaining $225,502 net to the Trust was reserved for certain taxes and future development expenses. In May 2020, Boaz Energy reserved $254,868 net to the Trust for future expenses as well. Then, in June 2020, Boaz Energy applied $287,649 net to the Trust of funds previously reserved in April and May 2020. As of June 30, 2020, the balance of funds reserved by Boaz Energy, net to the Trust, was $192,721.

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Derivative Contracts

Income from the Net Profits Interest is exposed to fluctuations in energy prices in the normal scope of business. To mitigate the negative effects of a possible decline in oil prices on distributable income to the Trust, Boaz Energy entered into derivative put option contracts with respect to approximately 100% of expected oil production attributable to the Net Profits Interest during 2018 and 76% of such production during 2019. These derivative contracts consisted of put option contracts with strike prices of $60 per barrel in 2018 and $50 per barrel in 2019. Boaz Energy believed that these put option contracts provided downside protection to the Trust in the event spot prices for crude oil decline below the applicable strike price, while still allowing the Trust to benefit from increasing crude oil prices. If prices for crude oil as quoted on NYMEX declined below the applicable strike prices, Boaz Energy could exercise its put option and receive payment generally equal to the difference between the applicable strike price and the market price for crude oil at the time of exercise, multiplied by the notional quantity of crude oil hedged under the applicable put option contract being exercised. These contracts expired as of December 31, 2019, and after December 31, 2019, none of the production attributable to the Underlying Properties is hedged.

For the three and six months ended June 30, 2019, there was $688,562 ($550,850 net to the Trust) in cash proceeds from the settlement of derivative contracts. Because the derivative contracts have since expired, there were no cash proceeds from settlement of derivative contracts during the three or six months ended June 30, 2020.

LIQUIDITY AND CAPITAL RESOURCES

The Trust’s principal sources of liquidity and capital are cash flow generated from the Net Profits Interest, the amounts held by the Trustee as cash reserves to pay future liabilities, and borrowings, if any to fund administrative expenses. The Trust’s primary uses of cash are distributions to Trust unitholders, payment of Trust administrative expenses, including, if applicable, any reserves established by the Trustee for future liabilities.

Administrative expenses include the Trustee and Delaware Trustee fees, accounting, engineering, legal, tax advisory and other professional fees, and tax reporting and distribution expenses. The Trust is also responsible for paying other expenses incurred as a result of being a publicly traded entity, including costs associated with annual, quarterly and current reports to the SEC, New York Stock Exchange listing fees, independent auditor fees and registrar and transfer agent fees. If the Trustee determines that cash on hand and cash to be received in respect of the Net Profits Interest are, or will be, insufficient to cover the Trust’s liabilities and expenses, the Trustee may cause the Trust to borrow funds to pay liabilities of the Trust.

As authorized under the Trust Agreement, beginning May 31, 2019, the Trustee began retaining cash from the distributions the Trust received (i) in an amount not to exceed $1.0 million at any one time to be used by the Trust in the event that its cash on hand (including available cash reserves) is not sufficient to pay ordinary course administrative expenses as they become due and (ii) in such amounts as the Trustee in its discretion deems appropriate to pay for future liabilities of the Trust, but not less than $25,000 or more than $100,000 per month. Cash reserves held by the Trustee for administrative expenses totaled $1,000,000 as of June 30, 2020.

Boaz Energy Capital Expenditure Budget

Boaz Energy has advised the Trustee that the estimate for Boaz Energy’s 2020 capital budget has been increased from $2.0 million to $2.5 million, based principally upon capital projects being implemented by outside operators, of which $1,800,000 has been expended as of June 30, 2020. Based on current oil and gas prices, Boaz Energy has informed the Trustee that it is not planning any new Boaz Energy-operated wells or other significant capital projects for the remainder of 2020, other than waterflood projects and workovers principally in the Permian Platform area, the costs of which are included in the $2.5 million estimate.  The estimated 2020 capital budget is subject to change based on, among other things, changes in the price of oil and natural gas, the impact of the COVID-19 pandemic on prices and economic activity, Boaz Energy’s actual capital requirements, capital expenditure requirements of third-party operators, the pace of regulatory approvals and the mix of projects.

In April 2020, Boaz Energy reserved $305,502 net to the Trust, which was applied in part to recoupment of the $80,000 net to the Trust balance of previously advanced funds, and the remaining $225,502 net to the Trust was reserved for certain taxes and future development expenses. In May 2020, Boaz Energy reserved $254,868 net to the Trust for future expenses as well. Then, in June 2020, Boaz Energy applied $287,649 net to the Trust of funds previously reserved in April and May 2020. As of June 30, 2020, the balance of funds reserved by Boaz Energy, net to the Trust, was $192,721.

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Distributions Declared After Quarter End

On July 21, 2020, the Trust declared there would be no cash distribution to record unit holders as of July 31, 2020 based upon production during the month of May 2020.

Off-Balance Sheet Arrangements

As of June 30, 2020, the Trust had no off-balance sheet arrangements.

New Accounting Pronouncements

As the Trust’s financial statements are prepared on the modified cash basis, most accounting pronouncements are not applicable to the Trust’s financial statements. No new accounting pronouncements have been adopted or issued that would impact the financial statements of the Trust.

Critical Accounting Policies and Estimates

Refer to Note 2 to the unaudited condensed financial statements contained in this Quarterly Report and the Trust’s 2019 Annual Report on Form 10-K, including the audited financial statements of the Trust and notes thereto included therein, for a description of the Trust’s accounting policies and use of estimates.

ITEM 3.