Item 1. Business.
General
VOC Energy Trust, which we refer to as the "trust," was formed in November 2010, by VOC Brazos Energy Partners, L.P., which we refer to
as "VOC Brazos." Much of the information disclosed herein has been provided to the trust by VOC Brazos, including information associated with the underlying properties such as production and well
counts, major producing areas, customer relationships, competition, marketing and post-production services, and certain information on which reserve data is based.
The
trust is a statutory trust created under the Delaware Statutory Trust Act. The business and affairs of the trust are managed by The Bank of New York Mellon Trust Company, N.A., as
trustee. The trust maintains its offices at the office of the trustee, at 601 Travis Street, Floor 16, Houston, Texas 77002. The telephone number of the trustee is 1-855-802-1094. In addition,
Wilmington Trust Company acts as the Delaware trustee of the trust. The Delaware trustee has only minimal rights and duties as are necessary to satisfy the requirements of the Delaware Statutory Trust
Act. The trust does not have any employees and the business and affairs of the trust are managed by the trustee.
The
trustee does not maintain a website for filings by the trust with the Securities and Exchange Commission, which we refer to as the "SEC." Electronic filings by the trust with the SEC
are available free of charge through the SEC's website at www.sec.gov and at
http://voc.investorhq.businesswire.com
.
On
May 10, 2011, VOC Brazos and the trust completed an initial public offering of units of beneficial interest in the trust, which are referred to herein as the "trust units." In
connection with the closing of the initial public offering, on May 10, 2011, VOC Brazos conveyed a net profits interest to the trust, which entitles the trust to receive 80% of the net proceeds
(calculated as described below) from the sale and production of substantially all of the interests in oil and natural gas properties in the states of Kansas and Texas held by VOC Brazos as of
May 10, 2011, which is referred herein as the "net profits interests." VOC Brazos' net interests in such properties, after deduction of all royalties and other burdens on production thereon as
of May 10, 2011, is referred to herein as the "underlying properties." As of December 31, 2017, the underlying properties included interests in 801 gross (492.5 net) producing wells and
included 89,892 gross (55,736.9 net) acres. The net profits interest will terminate on the later to occur of (1) December 31, 2030, or (2) the time from and after
January 1, 2011 when 10.6 MMBoe have been produced from the underlying properties and sold (which amount is the equivalent of 8.5 MMBoe in respect of the trust's right to receive 80% of the net
proceeds from the underlying properties pursuant to the net profits interest), and the trust will soon thereafter wind up its affairs and terminate. As of December 31, 2017, cumulatively, since
inception, the trust has received payment for approximately 4.1 MMBoe of the trust's 8.5 MMBoe interest.
The
trust will make quarterly cash distributions of substantially all of its quarterly cash receipts, after deducting the trust's administrative expenses, on or about 45 days
following the completion of each quarter through (and including) the quarter ending December 31, 2030. Because payments to the trust
will be generated by depleting assets and the trust has a finite life with the production from the underlying properties diminishing over time, a portion of each distribution will represent a return
of the original investment in the trust units.
The
amount of trust revenues and cash distributions to trust unitholders will depend on, among other things:
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oil sales prices and, to a lesser extent, natural gas sales prices;
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volumes of oil and natural gas produced and sold attributable to the underlying properties;
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property and production taxes;
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development expenses;
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lease operating expenses; and
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administrative expenses of the trust.
The
trust was created to acquire and hold the net profits interest for the benefit of the trust unitholders. 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 business and affairs of the trust are managed by the trustee, and neither VOC
Brazos nor any of its affiliates has the ability to manage or influence the operations of the trust. Vess Oil Corporation, which we refer to as "Vess Oil," L.D. Drilling, Inc. and Davis
Petroleum, Inc., which are collectively referred to herein as the "VOC Operators," are currently the operator or contract operator of substantially all of the underlying properties. VOC Brazos
does not, as a matter of course, make public projections as to future sales, earnings or other results relating to the underlying properties.
Description of the Trust Units
Each trust unit is a unit of beneficial interest in the trust and is entitled to receive cash distributions from the trust on a pro rata basis.
Each trust unitholder has the same rights regarding each of his trust units as every other trust unitholder has regarding his units. The trust units are in book-entry form only and are not represented
by certificates. The trust had 17,000,000 trust units outstanding as of March 14, 2018.
Distributions and Income Computations
Each quarter, the trustee determines the amount of funds available for distribution to the trust unitholders. Available funds are the excess
cash, if any, received by the trust from the net profits interest and other sources (such as interest earned on any amounts reserved by the trustee) in that quarter, over the trust's expenses for that
quarter. Available funds are reduced by any cash the trustee decides to hold as a reserve against future expenses. Quarterly cash distributions during the term of the trust are made by the trustee on
or before the 45th day following the end of each quarter to the trust unitholders of record on the 30th day following the end of each quarter (or the next succeeding business day).
Unless
otherwise advised by counsel or the Internal Revenue Service, which we refer to herein as the "IRS," the trustee will treat the income and expenses of the trust for each quarter
as belonging to the trust unitholders of record on the quarterly record date. For federal income tax purposes, trust unitholders must take into account items of income, gain, loss, deduction and
credit consistent with their methods of accounting and without regard to the taxable year or accounting method employed by the trust and without regard to the quarter in which the trust makes
distributions related to those items to the trust unitholders. Variances between taxable income and cash distributions may occur. For
example, the trustee could establish a reserve in one quarter using funds that would be included in income in the quarter in which the reserve is created but may not result in a tax deduction or a
distribution until a later quarter or possibly in a later taxable year. Similarly, the trustee could also make a payment in one quarter that would be amortized for income tax purposes over several
quarters. See "Federal Income Tax Matters."
Periodic Reports
The trustee files all required trust federal and state income tax and information returns. The trustee prepares and provides the tax information
that trust unitholders need to correctly report their share of the income and deductions of the trust. The trustee also causes to be prepared and filed
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reports
required to be filed under the Exchange Act and by the rules of any securities exchange or quotation system on which the trust units are listed or admitted to trading, and also causes the
trust to comply with the provisions of The Sarbanes-Oxley Act of 2002, including but not limited to, by establishing, evaluating and maintaining a system of internal controls over financial reporting
in compliance with the requirements of Section 404 thereof.
Each
trust unitholder and his representatives may examine, for any proper purpose, during reasonable business hours, the records of the trust and the trustee.
Liability of Trust Unitholders
Under the Delaware Statutory Trust Act, trust unitholders are entitled to the same limitation of personal liability extended to stockholders of
private corporations for profit under the General Corporation Law of the State of Delaware. No assurance can be given, however, that the courts in jurisdictions outside of Delaware will give effect to
such limitation.
Voting Rights of Trust Unitholders
The trustee or trust unitholders owning at least 10% of the outstanding trust units may call meetings of trust unitholders. The trust is
responsible for all costs associated with calling a meeting of trust unitholders unless such meeting is called by the trust unitholders, in which case the trust unitholders are responsible for all
costs associated with calling such meeting of trust unitholders. Meetings must be held in such location as is designated by the trustee in the notice of such meeting. The trustee must send written
notice of the time and place of the meeting and the matters to be acted upon to all of the trust unitholders at least 20 days and not more than 60 days before the meeting. Trust
unitholders representing a majority of trust units outstanding must be present or represented to have a quorum. Each trust unitholder is entitled to one vote for each trust unit owned.
Unless
otherwise required by the trust agreement, a matter may be approved or disapproved by the vote of a majority of the trust units held by the trust unitholders at a meeting where
there is a quorum. This is true even if a majority of the total trust units did not approve it. The affirmative vote of the holders of a majority of the outstanding trust units is required
to:
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dissolve the trust;
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remove the trustee or the Delaware trustee;
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amend the trust agreement (except with respect to certain matters that do not adversely affect the rights of trust unitholders in any material
respect);
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merge or consolidate the trust with or into another entity; or
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approve the sale of all or any material part of the assets of the trust.
In
addition, certain amendments to the trust agreement may be made by the trustee without approval of the trust unitholders. The trustee must consent before all or any part of the trust
assets can be sold except in connection with the dissolution of the trust or limited sales directed by VOC Brazos in conjunction with its sale of underlying properties.
Duration of the Trust; Sale of the Net Profits Interest
The trust will remain in existence until the later to occur of (1) December 31, 2030 or (2) the time when 10.6 MMBoe (which
is the equivalent of 8.5 MMBoe in respect of the trust's right to receive 80% of the net proceeds from the underlying properties pursuant to the net profits interest) have been produced and sold. The
trust will dissolve prior to its termination if:
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the trust sells the net profits interest;
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annual gross proceeds attributable to the net profits interest are less than $1 million for each of two consecutive years;
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the holders of a majority of the outstanding trust units vote in favor of dissolution; or
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there is a judicial dissolution of the trust.
Upon
dissolution, the trustee would sell all of the trust's assets, either by private sale or public auction, and distribute the net proceeds of the sale to the trust unitholders.
Computation of Net Proceeds
The provisions of the conveyance governing the computation of the net proceeds are detailed and extensive. The following information summarizes
the material information contained in the conveyance related to the computation of the net proceeds. For more detailed provisions concerning the net profits interest, please see the conveyance, which
is referenced as an exhibit to this Form 10-K.
Net Profits Interest
The net profits interest was conveyed to the trust by VOC Brazos on May 10, 2011 by means of a conveyance instrument that has been
recorded in the appropriate real property records in each of Kansas and Texas where the oil and natural gas properties to which the underlying properties relate are located. The net profits interest
burdens the net interest owned by VOC Brazos in the underlying properties in existence as of May 10, 2011.
The
amounts paid to the trust for the net profits interest are based on the definitions of "gross proceeds" and "net proceeds" contained in the conveyance and described below. Under the
conveyance, net proceeds are computed quarterly, and 80% of the aggregate net proceeds attributable to a computation period will be paid to the trust on or before the 30th day of the month
following the computation period. VOC Brazos will not pay to the trust any interest on the net proceeds held by VOC Brazos prior to payment to the trust. The trustee will make distributions to trust
unitholders quarterly, if sufficient funds are available. See "Description of the Trust UnitsDistributions and Income Computations."
"Gross
proceeds" means the aggregate amount received by VOC Brazos from sales of oil and natural gas produced from the underlying properties (other than amounts received for certain
future non-consent operations). However, gross proceeds does not include consideration for the transfer or sale of any underlying property by VOC Brazos or any subsequent owner to any new owner. Gross
proceeds also does not include any amount for oil or natural gas lost in production or marketing or used by the owner of the underlying properties in drilling, production and plant operations. Gross
proceeds includes payments for future production if they are not subject to repayment in the event of insufficient subsequent production.
"Net
proceeds" means gross proceeds less the following:
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all payments to mineral owners or landowners, such as royalties, overriding royalties or other burdens against production, delay rentals,
shut-in oil and natural gas payments, minimum royalty or other payments for drilling or deferring drilling;
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any taxes paid by the owner of an underlying property to the extent not deducted in calculating gross proceeds, including estimated and accrued
general property (ad valorem), production, severance, sales, gathering, excise and other taxes;
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any extraordinary taxes or windfall profits taxes that may be assessed in the future that are based on profits realized or prices received for
production from the underlying properties;
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costs paid by an owner of a property comprising the underlying properties under any joint operating agreement pursuant to the terms of the
conveyance;
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all other costs and expenses, development costs and liabilities of drilling, recompleting, workovers, operating and producing oil and natural
gas, including allocated expenses such as labor, vehicle and travel costs and materials and any plugging and abandonment liabilities (net of any capital costs for which a reserve had already been made
to the extent such development costs are incurred during the computation period) other than costs and expenses for certain future non-consent operations;
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costs or charges associated with gathering, treating and processing oil and natural gas (provided, however, that any proceeds attributable to
treatment or processing will offset such costs or changes, if any);
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any overhead charge incurred pursuant to any operating agreement relating to an underlying property;
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costs for recording the conveyance and costs estimated to record the termination and for the release of the conveyance;
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amounts previously included in gross proceeds but subsequently paid as a refund, interest or penalty;
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costs and expenses for renewals or extensions of leases; and
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at the option of VOC Brazos (or any subsequent owner of the underlying properties), amounts reserved for approved development, maintenance or
operating expenditures, including well drilling, recompletion and workover costs, which amounts will at no time exceed $1.0 million in the aggregate, and will be subject to the limitations
described below (provided that such costs shall not be debited from gross proceeds when actually incurred).
Certain
non-production revenues, including salvage value for equipment related to plugged and abandoned wells, as detailed in the conveyance, offset the costs outlined above in
calculating the net proceeds. If any excess amounts have not been used to offset costs at the time when the later to occur of (1) December 31, 2030 or (2) the time when 10.6 MMBoe
(which is the equivalent of 8.5 MMBoe in respect of the net profits interest) have been produced from the underlying properties and sold, then trust unitholders will not be entitled to receive the
benefit of such excess amounts.
During
each twelve-month period beginning on the later to occur of (1) December 31, 2027 and (2) the time when 9.8 MMBoe have been produced from the underlying
properties and sold (which is the equivalent of 7.8 MMBoe in respect of the net profits interest), which we refer to, in either case, as the "Capital Expenditure Limitation Date," the sum of the
development expenditures and amounts reserved for approved development expenditure projects for such twelve-month period may not exceed the Average Annual Capital Expenditure Amount. The "Average
Annual Capital Expenditure Amount" means the quotient of (x) the sum of the development expenditures and amounts reserved for approved development expenditure projects with respect to the three
twelve- month periods ending on the Capital Expenditure Limitation Date, divided by (y) three. Commencing on the Capital Expenditure Limitation Date, and each anniversary of the Capital
Expenditure Limitation Date thereafter, the Average Annual Capital Expenditure Amount will be increased by 2.5% to account for expected increased costs due to inflation.
As
is customary in the oil and natural gas industry, VOC Brazos pays an overhead fee to the VOC Operators to operate the underlying properties on behalf of VOC Brazos. The operating
activities include various engineering, accounting and administrative functions. The fee is based on a monthly charge per active operated well, which totaled $1.7 million paid to the VOC
Operators in 2015, 2016 and 2017, respectively, for all of the underlying properties for which VOC Brazos was designated as the
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operator.
The fee is adjusted annually and will increase or decrease each year based on changes in the Overhead Adjustment Index ("OAI") published by the Council of Petroleum Accountants Society
("COPAS") for that year.
In
the event that the net proceeds for any computation period is a negative amount, the trust will receive no payment for that period, and any such negative amount plus accrued interest
at the prime rate will be deducted from gross proceeds in the following computation period for purposes of determining the net proceeds for that following computation period.
Gross
proceeds and net proceeds are calculated on a cash receipts and cash disbursements basis except that certain costs, primarily ad valorem taxes and expenditures of a material
amount, may be determined on an accrual basis.
Additional Provisions
If a controversy arises as to the sales price of any production, then for purposes of determining gross
proceeds:
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amounts withheld or placed in escrow by a purchaser are not considered to be received by the owner of the underlying property until actually
collected;
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amounts received by the owner of the underlying property and promptly deposited with a nonaffiliated escrow agent will not be considered to
have been received until disbursed to it by the escrow agent; and
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amounts received by the owner of the underlying property and not deposited with an escrow agent will be considered to have been received.
The
trustee is not obligated to return any cash received from the net profits interest. Any overpayments made to the trust by VOC Brazos due to adjustments to prior calculations of net
proceeds or otherwise will reduce future amounts payable to the trust until VOC Brazos recovers the overpayments plus interest at the prime rate.
The
conveyance generally permits VOC Brazos to transfer without the consent or approval of the trust unitholders all or any part of its interest in the underlying properties, subject to
the net profits interest. The trust unitholders are not entitled to any proceeds of a sale or transfer of VOC Brazos' interest unless certain conditions set forth in the following paragraph are
satisfied. Except in certain cases where the net profits interest is released, following a sale or transfer, the underlying properties will continue to be subject to the net profits interest, and the
net proceeds attributable to the transferred property will be calculated as part of the computation of net proceeds described in this Form 10-K.
In
addition, VOC Brazos may, without the consent of the trust unitholders, require the trust to release the net profits interest associated with any lease that accounts for less than or
equal to 0.25% of the total production from the underlying properties in the prior 12 months and provided that the net profits interest covered by such releases cannot exceed, during any
12-month period, an aggregate fair market value to the trust of $500,000. These releases will be made only in connection with a sale by VOC Brazos to a non-affiliate of the relevant underlying
properties and are conditioned upon the trust receiving an amount equal to the fair value to the trust of such net profits interest. Any net sales proceeds paid to the trust are distributable to trust
unitholders for the quarter in which they are received.
As
the designated operator of a property comprising the underlying properties, VOC Brazos may enter into farm-out, operating, participation and other similar agreements to develop the
property. VOC Brazos may enter into any of these agreements without the consent or approval of the trustee or any trust unitholder.
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VOC
Brazos and any transferee of an underlying property will have the right to abandon its interest in any well or property if it reasonably believes the well or property ceases to
produce or is not capable of producing in commercially paying quantities. In making such decisions, VOC Brazos or any transferee of an underlying property is required under the applicable conveyance
to operate, or to use commercially reasonable efforts to cause the operators of the underlying properties to operate these properties as would a reasonably prudent operator in the State of Kansas or
Texas under the same or similar circumstances would act if it were acting with respect to its own properties, disregarding the existence of the net profits interest as a burden on such property. Upon
termination of the lease, the portion of the net profits interest relating to the abandoned property will be extinguished.
VOC
Brazos must maintain books and records sufficient to determine the amounts payable for the net profits interest to the trust. Quarterly and annually, VOC Brazos must deliver to the
trustee a statement of the computation of the net proceeds for each computation period. The trustee has the right to inspect and copy the books and records maintained by VOC Brazos during normal
business hours and upon reasonable notice.
Federal Income Tax Matters
The following is a summary of certain U.S. federal income tax matters that may be relevant to trust unitholders. This summary is based upon
current provisions of the Internal Revenue Code of 1986, as amended, which we refer to as the "Code," existing and proposed Treasury regulations thereunder and current administrative rulings and court
decisions, all of which are subject to changes that may or may not be retroactively applied. No attempt has been made in the following summary to comment on all U.S. federal income tax matters
affecting the trust or the trust unitholders.
The
summary is limited to trust unitholders who are individual citizens or residents of the United States. Accordingly, the following summary has limited application to domestic
corporations and persons subject to specialized federal income tax treatment.
Each trust unitholder should consult his own tax advisor with respect to his particular
circumstances.
Classification and Taxation of the Trust
Tax counsel to the trust advised the trust at the time of formation that, for federal income tax purposes, in its opinion the trust will be
treated as a grantor trust and not as an unincorporated business entity. No ruling has been or will be requested from the IRS with respect to the federal income tax treatment of the trust, including
as to the status of the trust as a grantor trust for such purposes. Thus, no assurance can be provided that the tax treatment of the trust would be sustained by a court if contested by the IRS or
another taxing authority. The remainder of the discussion below is based on tax counsel's opinion, at the time of formation, that the trust will be classified as a grantor trust for federal income tax
purposes. As a grantor trust, the trust will not be subject to federal income tax at the trust level. Rather, each trust unitholder will be considered for federal income tax purposes to own its
proportionate share of the trust's assets directly as though no trust were in existence. The income of the trust is deemed to be received or accrued by the trust unitholder at the time such income is
received or accrued by the trust, rather than when distributed by the trust. Each trust unitholder will be subject to tax on its proportionate share of the income and gain attributable to the assets
of the trust and will be entitled to claim its proportionate share of the deductions and expenses attributable to the assets of the trust, subject to applicable limitations, in accordance with the
trust unitholder's tax method of accounting and without regard to the taxable year or accounting method employed by the trust.
The
trust will allocate items of income, gain, loss, deductions and credits to trust unitholders based on record ownership at each quarterly record date. It is possible that the IRS or
another taxing authority could disagree with this allocation method and could assert that income and deductions of the
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trust
should be determined and allocated on a daily, prorated or other basis, which could require adjustments to the tax returns of the trust unitholders affected by this issue and result in an
increase in the administrative expense of the trust in subsequent periods.
Classification of the Net Profits Interest
Tax counsel to the trust also advised the trust at the time of formation that, for federal income tax purposes, based upon representations made
by VOC Brazos regarding the expected economic life of the underlying properties and the expected duration of the net profits interest, in its opinion the net profits interest should be treated as a
"production payment" under Section 636 of the Code or otherwise as a debt instrument. On the basis of that advice, the trust will treat the net profits interest as indebtedness subject to
Treasury regulations applicable to contingent payment debt instruments, and by purchasing trust units, a trust unitholder will agree to be bound by the trust's application of those regulations,
including the trust's determination of the rate at which interest will be deemed to accrue on the net profits interest. No assurance can be given that the IRS or another taxing authority will not
assert that the net profits interest should be treated differently. Any such different treatment could affect the amount, timing and character of income, gain or loss in respect of an investment in
trust units and could require a trust unitholder to accrue income at a rate different than that determined by the trust.
Widely Held Fixed Investment Trust Reporting Information
The trustee assumes that some trust units are held by middlemen, as such term is broadly defined in Treasury regulations (and includes
custodians, nominees, certain joint owners, and brokers holding an interest for a custodian in street name). Therefore, the trustee considers the trust to be a non-mortgage widely held fixed
investment trust ("WHFIT") for U.S. federal income tax purposes. The Bank of New York Mellon Trust Company, N.A., 601 Travis Street, Floor 16, Houston, Texas 77002, telephone
number 1-855-802-1094, is the representative of the trust that will provide tax information in accordance with applicable Treasury regulations governing the information reporting requirements
of the trust as a WHFIT. Notwithstanding the foregoing, the middlemen holding trust units on behalf of trust unitholders, and not the trustee of the trust, are solely responsible for complying with
the information reporting requirements under the Treasury regulations with respect to
such trust units, including the issuance of IRS Forms 1099 and certain written tax statements. Trust unitholders whose trust units are held by middlemen should consult with such middlemen
regarding the information that will be reported to them by the middlemen with respect to the trust units. Any generic tax information provided by the trustee of the trust is intended to be used only
to assist trust unitholders in the preparation of their federal and state income tax returns.
Available Trust Tax Information
In compliance with the reporting requirements for WHFITs and the dissemination of trust tax reporting information, the trustee provides a
generic tax information reporting booklet that is intended to be used only to assist unitholders in the preparation of their 2017 federal and state income tax returns. The projected payment schedule
for the net profits interest is included with the tax information booklet. This tax information booklet can be obtained at
http://voc.investorhq.businesswire.com
.
Description of the Underlying Properties
The underlying properties consist of VOC Brazos' net interests in substantially all of its oil and natural gas properties after deduction of all
royalties and other burdens on production thereon as of May 10, 2011, which properties are located in the states of Kansas and Texas. The VOC Operators are currently the operators or contract
operators of substantially all of the underlying properties.
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VOC
Brazos' interests in the properties comprising the underlying properties require VOC Brazos to bear its proportionate share along with the other working interest owners of the costs
of development and operation of such properties. The underlying properties are burdened by non-working interests owned by third parties consisting primarily of overriding royalty and royalty interests
retained by the owners of the land subject to the working interests. These landowners' royalty interests typically entitle the landowner to receive 12.5% of the revenue derived from oil and natural
gas production resulting from wells drilled on the landowner's land, without any deduction for drilling costs or other costs related to production of oil and natural gas. A working interest percentage
represents a working interest owner's proportionate ownership interest in a property in relation to all other working interest
owners in that property, whereas a net revenue interest percentage is a working interest owner's percentage of production after reducing such percentage by the percentage of burdens on such production
such as royalties and overriding royalties.
Based
on the reserve report, the net profits interest would entitle the trust to receive net proceeds from the sale of production of not less than 10.6 MMBoe of proved reserves
attributable to the underlying properties expected to be produced over the term of the trust. The trust is entitled to receive 80% of the net proceeds from the sale of production of oil and natural
gas attributable to the underlying properties that are produced during the term of the trust, whereas total reserves as reflected on the summary reserve reports and attributable to the underlying
properties include all reserves expected to be economically produced during the economic life of the properties.
In
general, the producing wells included in the underlying properties have stable production profiles and their production is long-lived. Based on the reserve report, annual production
from the underlying properties is expected to decline at an average annual rate of 6.6% over the next 20 years assuming no additional development drilling or other development expenditures are
made on the underlying properties after 2021. VOC Brazos expects total development expenditures for the underlying properties through December 31, 2021 will be approximately
$22.4 million, which it expects will partially offset the natural decline in production otherwise expected to occur with respect to the underlying properties as described in more detail below.
Reserves
The engineering department of Vess Oil Corporation, who serves as contract operator for VOC Brazos, maintains oversight and compliance
responsibility for the internal reserve estimate process and, in accordance with internal policies and procedures, provides appropriate data to independent third party engineers for the annual
estimation of year-end reserves. This engineering department accumulates historical production data for the underlying properties, calculates historical lease operating expenses and differentials,
updates working interests and net revenue interests, and obtains logs, 3-D seismic and other geological and geophysical information. This data is forwarded to Cawley, Gillespie &
Associates, Inc., which we refer to as "CG&A," thereby allowing CG&A to prepare estimated proved reserves in their entirety based on such data.
Estimates
of the proved oil and gas reserves attributable to the trust as of December 31, 2015, 2016 and 2017 are based on reports prepared by CG&A. CG&A has been in business
since 1961 and serves many organizations and individuals in the petroleum industry, including owners and operators of oil and gas properties, exploration groups, planners, and professionals in
investment and finance. One of the principal businesses of CG&A is providing detailed assessment of producing reservoirs. CG&A is an independent firm of petroleum engineers, geologists, geophysicists
and petrophysicists and does not own an interest in the underlying properties and is not employed on a contingent basis. Mr. W. Todd Brooker, Senior Vice President, is the technical person at
CG&A who is primarily responsible for
overseeing CG&A's preparation of the reserve estimates. Mr. Brooker is a graduate of the University of Texas at Austin with a Bachelor of Science degree in Petroleum Engineering and has
25 years of
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experience
in petroleum engineering. He is a licensed professional engineer in the State of Texas (License #83462).
Oil
and gas proved reserves are disclosed by significant geographic area, using the 12-month average beginning-of-month price for the year, based on the use of reliable technologies to
estimate proved oil and gas reserves, if those technologies have been demonstrated to result in reliable conclusions about reserves volumes. Reserve and related information for 2015, 2016 and 2017 is
presented consistent with these requirements.
Proved Reserves of VOC Energy Trust.
The following table sets forth, as of December 31, 2017, estimated proved reserves
attributable to the
trust derived from the reserve report. A summary of the reserve report is included below.
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Oil
(MBbls)
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Natural
gas
(MMcf)
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Oil
equivalents
(MBoe)
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Proved Developed
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3,343
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|
|
1,320
|
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3,564
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Proved Undeveloped
|
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657
|
|
|
387
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|
|
721
|
|
Total Proved
|
|
|
4,000
|
|
|
1,707
|
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|
4,285
|
|
Information
concerning historical changes in net proved reserves attributable to the trust, and the calculation of the standardized measure of discounted future net revenues related
thereto, is contained in Note J to the financial statements of the trust included in this Form 10-K. VOC Brazos has not filed reserve estimates covering the underlying properties with
any other federal authority or agency.
15
Table of Contents
The following table summarizes the changes in estimated proved reserves of the trust for the periods indicated.
|
|
|
|
|
|
|
|
|
|
|
|
|
VOC Energy Trust
|
|
|
|
Oil
(MBbl)
|
|
Natural
Gas
(MMcf)
|
|
Oil
Equivalents
(MBoe)
|
|
Proved Reserves:
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2014
|
|
|
6,670
|
|
|
3,970
|
|
|
7,332
|
|
Revisions of previous estimates
|
|
|
(729
|
)
|
|
(1,070
|
)
|
|
(907
|
)
|
Production(1)
|
|
|
(493
|
)
|
|
(329
|
)
|
|
(548
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2015
|
|
|
5,448
|
|
|
2,571
|
|
|
5,877
|
|
Revisions of previous estimates
|
|
|
(160
|
)
|
|
(278
|
)
|
|
(206
|
)
|
Production(1)
|
|
|
(450
|
)
|
|
(272
|
)
|
|
(495
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2016
|
|
|
4,838
|
|
|
2,021
|
|
|
5,176
|
|
Revisions of previous estimates
|
|
|
(407
|
)
|
|
(46
|
)
|
|
(415
|
)
|
Production(1)
|
|
|
(431
|
)
|
|
(268
|
)
|
|
(476
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2017
|
|
|
4,000
|
|
|
1,707
|
|
|
4,285
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Proved Developed Reserves:
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2014
|
|
|
5,240
|
|
|
3,209
|
|
|
5,775
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2015
|
|
|
4,288
|
|
|
1,682
|
|
|
4,569
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2016
|
|
|
3,667
|
|
|
1,311
|
|
|
3,886
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2017
|
|
|
3,343
|
|
|
1,320
|
|
|
3,564
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Proved Undeveloped Reserves:
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2014
|
|
|
1,430
|
|
|
761
|
|
|
1,557
|
|
Proved undeveloped reserves converted to proved developed by drilling
|
|
|
0
|
|
|
0
|
|
|
0
|
|
Additional proved undeveloped reserves added
|
|
|
98
|
|
|
164
|
|
|
125
|
|
Revisions of previous estimates
|
|
|
(368
|
)
|
|
(35
|
)
|
|
(374
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2015
|
|
|
1,160
|
|
|
890
|
|
|
1,308
|
|
Proved undeveloped reserves converted to proved developed by drilling
|
|
|
(35
|
)
|
|
0
|
|
|
(35
|
)
|
Additional proved undeveloped reserves added
|
|
|
54
|
|
|
0
|
|
|
54
|
|
Revisions of previous estimates
|
|
|
(7
|
)
|
|
(179
|
)
|
|
(37
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2016
|
|
|
1,172
|
|
|
711
|
|
|
1,290
|
|
Proved undeveloped reserves converted to proved developed by drilling
|
|
|
0
|
|
|
0
|
|
|
0
|
|
Additional proved undeveloped reserves added
|
|
|
377
|
|
|
232
|
|
|
416
|
|
Revisions of previous estimates
|
|
|
(892
|
)
|
|
(556
|
)
|
|
(985
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2017
|
|
|
657
|
|
|
387
|
|
|
721
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
-
(1)
-
Reflects
sales volumes produced during the noted year regardless whether royalty payments thereon have been remitted to the Trust by VOC Brazos.
None
of the proved undeveloped reserves have remained undeveloped for five years or more after they were initially disclosed as proved undeveloped reserves.
The
reserves above represent the trust's 80% net profits interest in the underlying properties for the remainder of the term of the trust.
16
Table of Contents
The
following table sets forth the estimates of total proved reserves and forecasts of economics attributable to the underlying properties as of December 31, 2017 for the
remainder of the term of the trust, as presented in the summary prepared by CG&A of its reserve report as of December 31, 2017 for the trust. The estimates of proved reserves have not been
filed with or included in reports to any federal authority or agency. The discounted cash flow value shown in the table is not intended to represent the current market value of the trust's estimated
oil and natural gas reserves.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Proved
Developed
Producing
|
|
Proved
Developed
Non-Producing
|
|
Proved
Undeveloped
|
|
Total
Proved
|
|
|
|
(dollars in thousands)
|
|
Net Reserves
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil (MBbl)
|
|
|
4,133.2
|
|
|
46.3
|
|
|
821.0
|
|
|
5,000.6
|
|
Gas (MMcf)
|
|
|
1,650.0
|
|
|
0.0
|
|
|
483.8
|
|
|
2,133.7
|
|
Revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil
|
|
$
|
197,195.1
|
|
$
|
2,121.3
|
|
$
|
40,616.7
|
|
$
|
239,933.0
|
|
Gas
|
|
|
4,892.4
|
|
|
0.0
|
|
|
1,805.4
|
|
|
6,697.8
|
|
Severance Taxes
|
|
|
4,973.9
|
|
|
54.4
|
|
|
1,847.3
|
|
|
6,875.6
|
|
Ad Valorem Taxes
|
|
|
5,118.4
|
|
|
88.8
|
|
|
1,398.4
|
|
|
6,605.6
|
|
Operating Expenses
|
|
|
91,462.0
|
|
|
0.0
|
|
|
2,624.1
|
|
|
94,086.1
|
|
Workover Expenses
|
|
|
10,371.3
|
|
|
0.0
|
|
|
0.0
|
|
|
10,371.3
|
|
COPAS Overhead
|
|
|
12,972.2
|
|
|
0.0
|
|
|
307.0
|
|
|
13,279.2
|
|
Investments
|
|
|
0.0
|
|
|
403.8
|
|
|
21,966.6
|
|
|
22,370.4
|
|
80% Net Profits Interest Net Operating Income (NPI)(1)
|
|
$
|
61,751.9
|
|
$
|
1,259.4
|
|
$
|
11,422.9
|
|
$
|
74,434.2
|
|
80% NPI(2)
|
|
$
|
40,280.6
|
|
$
|
809.9
|
|
$
|
4,151.6
|
|
$
|
45,242.0
|
|
-
(1)
-
Before
interest and taxes.
-
(2)
-
Discounted
at 10%.
The
net profits interest entitles the trust to receive 80% of the net proceeds attributable to the underlying properties. The net profits interest will terminate on the later to occur of
(1) December 31, 2030, or (2) the time when 10.6 MMBoe have been produced from the underlying properties and sold, and the trust will soon thereafter wind up its affairs and
terminate. Based on the reserve report for the year ended December 31, 2017, CG&A estimated that the trust would terminate December 31, 2030 based on the calculation that 10.6 MMBoe
would have been produced from the underlying properties and sold (which amount is the equivalent of 8.5 MMBoe in respect of the trust's right to receive 80% of the net proceeds from the underlying
properties pursuant to the net profits interest) prior to this date.
Oil
and gas prices were adjusted to a WTI Cushing oil price of $51.34 per Bbl and a Henry Hub natural gas price of $2.964 per MMBtu. As specified by the SEC, these prices are 12-month
averages based upon the price on the first day of each month during 2017. The price adjustments were based on oil price differentials forecast at $5.50 per Bbl for the Kansas
underlying properties, $1.00 per Bbl for the Kurten (Woodbine) Field wells in Texas, $2.15 per Bbl for the Sand Flat Unit wells in Texas and $1.00
per Bbl for all other Texas underlying properties. Oil price differentials were not escalated. Gas price differentials were forecast on a per property basis as provided by VOC Brazos and were also not
escalated. Price differentials include adjustments for transportation and basis differential. Gas prices were further adjusted with a heating value (Btu content) applied on a per-property basis.
Operating expenses, workover expenses, COPAS overhead charges and investments were forecast on a per
property basis as furnished by VOC Brazos. Expenses and investments were held constant in accordance with SEC rules and guidelines. For Kansas properties, severance taxes were applied at
17
Table of Contents
4.33 percent
of revenue until exemption levels were forecasted to be reached. The severance tax rate was dropped to zero (0) when a rate of six (6) Bbl/day per well were reached
or when gross gas production value reached $87/day per gas well. Severance taxes were forecasted at 4.6 percent of oil revenue and 7.5 percent of gas revenue for properties in Texas. Ad
valorem taxes for Kansas properties were applied at 6.0 percent of revenue, but dropped to 2.0 percent as properties qualified for the tax exemption. Kansas oil and gas conservation
taxes were included within the severance tax estimates. Ad valorem taxes were applied at 3.29 percent of revenue (after severance taxes) for the Texas properties.
The
estimates of proved oil and natural gas reserves attributable to the underlying properties are based on estimates prepared by CG&A. Rules and guidelines established by the SEC
regarding the present value of future net revenues were used to prepare these reserve estimates. Oil and natural gas reserve engineering is a subjective process of estimating underground accumulations
of oil and natural gas that cannot be measured in an exact manner, and estimates of other engineers might differ materially from those included in the report. The accuracy of any reserve estimate is a
function of the quality of available data and engineering, and estimates may justify revisions based on the results of drilling, testing, and production activities. Accordingly, reserve estimates are
inherently imprecise and should not be construed as representing the actual quantities of future production or cash flows to be realized from oil and natural gas properties or the fair market value of
such properties.
Producing Acreage and Well Counts
For the following data, "gross" refers to the total wells or acres in which VOC Brazos owns a working interest and "net" refers to gross wells
or acres multiplied by the percentage working interest owned by VOC Brazos. Although many of VOC Brazos' wells produce both oil and natural gas, a well is categorized as an oil well or a natural gas
well based upon the ratio of oil to natural gas production.
The
underlying properties are interests in developed properties located in oil and natural gas producing regions of Kansas and Texas. The following is a summary of the approximate
acreage of the underlying properties at December 31, 2017.
|
|
|
|
|
|
|
|
|
|
Gross
|
|
Net
|
|
|
|
(acres)
|
|
Developed Acreage:
|
|
|
|
|
|
|
|
Kansas
|
|
|
66,199
|
|
|
38,895.6
|
|
Texas
|
|
|
23,693
|
|
|
16,841.3
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
89,892
|
|
|
55,736.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Undeveloped Acreage:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The
following is a summary of the producing wells on the underlying properties as of December 31, 2017:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operated Wells
|
|
Non-
Operated
Wells
|
|
Total
|
|
|
|
Gross
|
|
Net
|
|
Gross
|
|
Net
|
|
Gross
|
|
Net
|
|
Oil
|
|
|
748
|
|
|
474.7
|
|
|
33
|
|
|
7.7
|
|
|
781
|
|
|
482.4
|
|
Natural gas
|
|
|
17
|
|
|
9.4
|
|
|
3
|
|
|
0.7
|
|
|
20
|
|
|
10.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
765
|
|
|
484.1
|
|
|
36
|
|
|
8.4
|
|
|
801
|
|
|
492.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
18
Table of Contents
The
following is a summary of the number of developmental wells drilled by VOC Brazos on the underlying properties during the last three years. VOC Brazos did not drill any exploratory
wells during the periods presented.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2015
|
|
2016
|
|
2017
|
|
|
|
Gross
|
|
Net
|
|
Gross
|
|
Net
|
|
Gross
|
|
Net
|
|
Completed:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil wells
|
|
|
|
|
|
|
|
|
1
|
|
|
1
|
|
|
2
|
|
|
2
|
|
Natural gas wells
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-productive
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
|
|
|
|
|
1
|
|
|
1
|
|
|
2
|
|
|
2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As
of December 31, 2017, no wells were being drilled. Capital expenditures associated with converting proved undeveloped reserves to proved developed reserves for the year ended
December 31, 2017 were $0 as both wells completed in 2017 were classified as proved developed non producing at December 31, 2016. VOC Brazos continues to develop further proved
undeveloped reserves pursuant to its planned development and workover program. See "Trustee's Discussion and Analysis of Financial Condition and Results of OperationsPlanned Development
and Workover Program."
The
following table shows the average sales prices per Bbl of oil and Mcf of natural gas produced and the production costs and production and property taxes per Boe received by the trust
from the underlying properties.
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2015
|
|
2016
|
|
2017
|
|
Sales prices:
|
|
|
|
|
|
|
|
|
|
|
Oil (per Bbl)
|
|
$
|
56.02
|
|
$
|
37.58
|
|
$
|
45.26
|
|
Natural gas (per Mcf)
|
|
$
|
3.20
|
|
$
|
1.83
|
|
$
|
2.78
|
|
Lease operating expense (per Boe)
|
|
$
|
19.32
|
|
$
|
18.29
|
|
$
|
19.41
|
|
Production and property taxes (per Boe)
|
|
$
|
5.57
|
|
$
|
3.18
|
|
$
|
2.59
|
|
19
Table of Contents
Major Producing Areas
The following table summarizes the estimated proved reserves by operating area attributable to the underlying properties according to the
reserve report and the corresponding pre-tax PV-10 value as of December 31, 2017.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Proved Reserves(1)
|
|
Operating Area
|
|
Oil
(MBbls)
|
|
Natural
Gas
(MMcf)
|
|
Total
(MBoe)
|
|
% of
Total
Reserves
|
|
Pre-Tax
PV-10%
Value(2)
|
|
% of
Pre-Tax
PV-10%
Value
|
|
|
|
|
|
|
|
|
|
|
|
(In Thousands)
|
|
|
|
Kansas (168 Fields)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fairport
|
|
|
634
|
|
|
0
|
|
|
634
|
|
|
7.9
|
%
|
$
|
6,306
|
|
|
10.2
|
%
|
Marcotte
|
|
|
291
|
|
|
0
|
|
|
291
|
|
|
3.7
|
|
|
3,136
|
|
|
5.1
|
|
Chase-Silica
|
|
|
249
|
|
|
0
|
|
|
249
|
|
|
3.1
|
|
|
2,488
|
|
|
4.0
|
|
Bindley
|
|
|
197
|
|
|
0
|
|
|
197
|
|
|
2.5
|
|
|
1,932
|
|
|
3.1
|
|
Mueller
|
|
|
107
|
|
|
0
|
|
|
107
|
|
|
1.3
|
|
|
1,324
|
|
|
2.1
|
|
Codell
|
|
|
76
|
|
|
0
|
|
|
76
|
|
|
1.0
|
|
|
1,030
|
|
|
1.7
|
|
Wesley
|
|
|
70
|
|
|
0
|
|
|
70
|
|
|
0.9
|
|
|
942
|
|
|
1.5
|
|
Griston SW
|
|
|
43
|
|
|
0
|
|
|
43
|
|
|
0.5
|
|
|
885
|
|
|
1.4
|
|
Adell Northwest
|
|
|
61
|
|
|
0
|
|
|
61
|
|
|
0.8
|
|
|
768
|
|
|
1.2
|
|
Yaege
|
|
|
69
|
|
|
0
|
|
|
69
|
|
|
0.9
|
|
|
583
|
|
|
0.9
|
|
Rosa Northwest
|
|
|
43
|
|
|
0
|
|
|
43
|
|
|
0.5
|
|
|
491
|
|
|
0.8
|
|
Zurich
|
|
|
38
|
|
|
0
|
|
|
38
|
|
|
0.5
|
|
|
473
|
|
|
0.8
|
|
Gerberding
|
|
|
37
|
|
|
190
|
|
|
69
|
|
|
0.9
|
|
|
465
|
|
|
0.8
|
|
Other
|
|
|
1,273
|
|
|
988
|
|
|
1,438
|
|
|
18.0
|
|
|
5,749
|
|
|
9.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Kansas Total
|
|
|
3,188
|
|
|
1,178
|
|
|
3,385
|
|
|
42.5
|
|
|
26,572
|
|
|
42.8
|
|
Texas (3 Fields)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Kurten
|
|
|
2,885
|
|
|
1,892
|
|
|
3,200
|
|
|
40.1
|
|
|
20,709
|
|
|
33.4
|
|
Hitts Lake North
|
|
|
740
|
|
|
0
|
|
|
740
|
|
|
9.3
|
|
|
10,925
|
|
|
17.6
|
|
Sand Flat
|
|
|
648
|
|
|
0
|
|
|
648
|
|
|
8.1
|
|
|
3,824
|
|
|
6.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Texas Total
|
|
|
4,273
|
|
|
1,892
|
|
|
4,588
|
|
|
57.5
|
|
|
35,458
|
|
|
57.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
7,461
|
|
|
3,070
|
|
|
7,973
|
|
|
100.0
|
%
|
$
|
62,030
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
-
(1)
-
In
accordance with the rules and regulations promulgated by the SEC, the proved reserves presented above were determined using the twelve month unweighted arithmetic
average of the first-day-of-the-month price for the period from January 1, 2017 through December 1, 2017 and were held constant for the life of the properties. This yielded a price for
oil of $51.34 per barrel and a price for natural gas of $2.96 per MMBtu.
-
(2)
-
Because
the trust bears no federal tax expense and taxable income is passed through to the unitholders of the trust, no provision for federal or state income taxes
is included in the summary reserve reports and therefore the standardized measure of discounted future net cash flows attributable to the underlying properties is equal to the pre-tax PV-10 value.
PV-10 may not be considered a GAAP financial measure as defined by the SEC and is derived from the standardized measure of discounted future net cash flows, which is the most directly comparable GAAP
financial measure. The pre-tax PV-10 value and the standardized measure of discounted future net cash flows do not purport to present the fair value of the oil and natural gas reserves attributable to
underlying properties.
20
Table of Contents
Kansas.
As of December 31, 2017, proved reserves attributable to the portion of the Kansas underlying properties were
approximately 3.4 MMBoe
and were located in three primary areas: the Central Kansas Uplift, Western Kansas and South Central Kansas. As of December 31, 2017, the VOC Operators operated 96.1% of the total proved
reserves attributable to the Kansas underlying properties based on PV-10 value.
The
major fields in the Central Kansas Uplift include Fairport Field, Chase-Silica Field and Marcotte Field, all of which are producing primarily from the Arbuckle and Lansing Kansas
City zones. The major fields in Western Kansas include the Bindley, Moore-Johnson and Wesley fields, which are producing primarily from the Mississippian, Morrow, Lansing Kansas City and Cherokee
zones. The major fields in South Central Kansas include the Gerberding, Spivey Grabs and Alford fields, which are producing primarily from the Mississippian, Simpson and Lansing Kansas City zones.
Texas.
As of December 31, 2017, proved reserves attributable to the Texas underlying properties were approximately 4.6 MMBoe and
are located
in two areas: Central Texas and East Texas. As of December 31, 2017, the VOC Operators operated approximately 98.3% of the total proved reserves attributable to the Texas underlying properties
based on PV-10 value.
Central
Texas production is attributable to the Kurten Woodbine Unit, which is producing primarily from the EagleBine Interval, Buda and Georgetown zones. East Texas properties include
the Sand Flat field and Hitts Lake North field, each of which is producing primarily from the Paluxy and Chisum zones.
The
following table summarizes the production by product for the years indicated for the only field, Kurten, that contains 15% or more of total proved reserves attributable to the
underlying properties from the above table:
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil
(MBbl)
|
|
Natural
Gas
(MMcf)
|
|
Oil
Equivalents
(MBoe)
|
|
2015
|
|
|
140
|
|
|
137
|
|
|
163
|
|
2016
|
|
|
152
|
|
|
160
|
|
|
179
|
|
2017
|
|
|
96
|
|
|
136
|
|
|
119
|
|
Marketing and Post-Production Services
Pursuant to the terms of the conveyance that created the net profits interest, VOC Brazos has the responsibility to market, or cause to be
marketed, the oil and natural gas production attributable to the underlying properties. The terms of the conveyance that created the net profits interest do not permit VOC Brazos to charge any
marketing fee when determining the net proceeds upon which the net profits interest is calculated. As a result, the net proceeds to the trust from the sales of oil and natural gas production from the
underlying properties are determined based on the same price that VOC Brazos receives for oil and natural gas production attributable to VOC Brazos' remaining interest in the underlying properties.
Texas
is a mature oil producing state with a well-developed crude oil refining, transportation and marketing infrastructure. According to the Texas Railroad Commission, more than 5,000
operators reported aggregate oil production of approximately 1.033 billion barrels for the State of Texas during 2017. There were 30 operating oil refineries located in Texas in 2017 with
combined capacity to refine over 5.67 million barrels of oil per day. With oil production in the state of Texas averaging approximately 2.83 million barrels of oil per day, Texas
refineries are net importers of crude oil. As a
result, oil producers in Texas benefit from competitive marketing conditions for their oil production as a result of the high demand from the crude oil marketing companies and refineries located in
Texas.
21
Table of Contents
Kansas
is a mature oil producing state with a well-developed transportation infrastructure for crude oil transportation and marketing. According to the Kansas Geological Society, more
than 1,900 operators reported aggregate oil production of approximately 36.0 million barrels for the state of Kansas in 2017. Kansas is home to three oil refineries located in McPherson, El
Dorado and Coffeyville, Kansas. These refineries have combined capacity to refine over 361,000 barrels of oil per day. With oil production in the state of Kansas averaging approximately 99,000 barrels
of oil per day, Kansas is a net importer of crude oil. As a result, Kansas operators benefit from the competitive marketing conditions for their oil production as a result of the high demand from the
refineries located in Kansas.
Vess
Oil Corporation generally sells production from the underlying properties to several purchasers, including MV Purchasing LLC, an affiliate of VOC Brazos, which we refer to as
"MV Purchasing," under short-term arrangements using market sensitive pricing. These sales to purchasers are under terms ranging from one month to six months, using market sensitive pricing. Five
purchasers, including MV Purchasing, have been purchasing substantially all of the crude oil production, and a substantial portion of the crude oil production may continue be acquired by one or more
single purchasers. For the years ended December 31, 2015, 2016 and 2017, MV Purchasing purchased 37%, 31% and 38%, respectively, of the production sold from the underlying properties. VOC
Brazos does not believe that loss of any of these parties as a purchaser would have a material adverse impact on the business of VOC Brazos, as substitute purchasers are generally available; however,
a purchaser's failure to pay for purchased crude oil could have a significant adverse impact on VOC Brazos' business.
Oil
production is typically transported by truck from the field to the closest gathering facility or refinery. VOC Brazos sells the majority of the oil production from the underlying
properties under short-term arrangements using market sensitive pricing. The price received by VOC Brazos for the oil production from the underlying properties is usually based on the NYMEX price
applied to equal daily quantities on the month of delivery, which price is then reduced for differentials based upon delivery location and oil quality. The average differential for oil production
during the years ended December 31, 2015, 2016 and 2017 received by the trust from the underlying properties were $4.48, $3.98 and $3.78 per barrel, respectively.
All
natural gas produced by VOC Brazos is marketed and sold to third-party purchasers. The natural gas is sold on a contract basis and, in all but two cases, the contracts are in their
secondary terms and are on a month-to-month basis. In all cases, the contract price is based on a percentage of a published regional index price, after adjustments for Btu content, transportation and
related charges.
Vess
Oil Corporation has committed to sell all of its natural gas production attributable to the Kurten Woodbine Unit in Texas to ETC Texas Pipeline, Ltd., on a year-to-year basis
effective October 1, 2014. Vess Oil Corporation has also committed to sell to ONEOK Field Services Company, L.L.C. all of its natural gas production attributable to seven wells in Kingman and
Barber Counties, Kansas on a month-to-month basis effective as of August 31, 2015.
VOC
Brazos does not have any volume commitments or take or pay arrangements.
Sale and Abandonment of Underlying Properties
VOC Brazos and any transferee of any of an underlying property will have the right to abandon its interest in any well or property if it
reasonably believes a well or property ceases to produce or is not capable of producing in commercially paying quantities. To reduce the potential conflict of interest between VOC Brazos and the trust
in determining whether a well is capable of producing in commercially paying quantities, VOC Brazos is required under the applicable conveyance to use commercially reasonable efforts to cause the
operators of the underlying properties to operate these properties as would a reasonably prudent operator acting with respect to its own properties, disregarding the existence of the net profits
interest as a burden on such property. Upon termination of
22
Table of Contents
the
lease, the portion of the net profits interest relating to the abandoned property will be extinguished. For the years ended December 31, 2015, 2016 and 2017, VOC Brazos plugged and
abandoned 14, 13 and 11 wells, respectively, located on leases within the underlying properties based on its determination that such wells could no longer produce oil or natural gas in commercially
economic quantities.
VOC
Brazos generally may sell all or a portion of its interests in the underlying properties, subject to and burdened by the net profits interest, without the consent of the trust
unitholders. In addition, VOC Brazos may, without the consent of the trust unitholders, require the trust to release the net profits interest associated with any lease that accounts for less than or
equal to 0.25% of the total production from the underlying properties in the prior 12 months and provided that the net profits interest covered by such releases cannot exceed, during any
12-month period, an aggregate fair market value to the trust of $500,000. These releases will be made only in connection with a sale by VOC Brazos to a non-affiliate of the relevant underlying
properties and are conditioned upon the trust receiving an amount equal to the fair value to the trust of such net profits interest. Any net sales proceeds paid to the trust are distributable to trust
unitholders for the quarter in which they are received. Net sales
proceeds of $0 and $0 were paid to the trust during 2016 and 2017, respectively, for its share of interest in certain underlying properties that were sold. VOC Brazos has not identified any of the
underlying properties for sale as of December 31, 2017.
Title to Properties
The underlying properties are subject to certain burdens that are described in more detail below. To the extent that these burdens and
obligations affect VOC Brazos' rights to production and the value of production from the underlying properties, they have been taken into account in calculating the trust's interests and in estimating
the size and the value of the reserves attributable to the underlying properties.
VOC
Brazos' interests in the oil and natural gas underlying properties are typically subject, in one degree or another, to one or more of the
following:
-
-
royalties, overriding royalties and other burdens, express and implied, under oil and natural gas leases;
-
-
overriding royalties, production payments and similar interests and other burdens created by VOC Brazos or its predecessors in title;
-
-
a variety of contractual obligations arising under operating agreements, farm-out agreements, production sales contracts and other agreements
that may affect the underlying properties or their title;
-
-
liens that arise in the normal course of operations, such as those for unpaid taxes, statutory liens securing unpaid suppliers and contractors
and contractual liens under operating agreements that are not yet delinquent or, if delinquent, are being contested in good faith by appropriate proceedings;
-
-
pooling, unitization and communitization agreements, declarations and orders;
-
-
easements, restrictions, rights-of-way and other matters that commonly affect property;
-
-
conventional rights of reassignment that obligate VOC Brazos to reassign all or part of a property to a third party if VOC Brazos intends to
release or abandon such property; and
-
-
rights reserved to or vested in the appropriate governmental agency or authority to control or regulate the underlying properties and the net
profits interest therein.
VOC
Brazos has informed the trustee that VOC Brazos believes that the burdens and obligations affecting the underlying properties are conventional in the industry for similar properties.
VOC Brazos
23
Table of Contents
also
has informed the trustee that VOC Brazos believes that the existing burdens and obligations do not, in the aggregate, materially interfere with the use of the underlying properties and do not
materially adversely affect the value of the net profits interest.
VOC
Brazos recorded the conveyance of the net profits interest in Kansas and Texas in the real property records in each Kansas or Texas county in which the underlying properties are
located. Although under Texas law it is well-established that the recording in the appropriate real property records of an interest such as the net profits interest constitutes the conveyance of a
fully vested real property interest to the trust, the law in Kansas is less certain. VOC Brazos and the trust believe that
the recording in the appropriate real property records in Kansas of the net profits interest should constitute the conveyance of a fully vested real property interest, interests in hydrocarbons in
place or to be produced or a production payment as such is defined under the United States Bankruptcy Code. In a bankruptcy of VOC Brazos, creditors of VOC Brazos would be able to claim the net
profits interest as an asset of the bankruptcy estate to satisfy obligations to them if the conveyance of the net profits interest did not constitute the conveyance of a real property interest or
interests in hydrocarbons in place or to be produced under applicable state law or a production payment, in which case the trust would be an unsecured creditor of VOC Brazos at risk of losing the
entire value of the net profits interest to senior creditors.
VOC
Brazos believes that its title to the underlying properties is, and the trust's title to the net profits interest is, good and defensible in accordance with standards generally
accepted in the oil and gas industry, subject to such exceptions as are not so material to detract substantially from the use or value of such properties or royalty interests. Please see
"Item 1A. Risk FactorsThe trust units may lose value as a result of title deficiencies with respect to the underlying properties."
Competition and Markets
The oil and natural gas industry is highly competitive. VOC Brazos competes with major oil and natural gas companies and independent oil and
natural gas companies for oil and natural gas, equipment, personnel and markets for the sale of oil and natural gas. Many of these competitors are financially stronger than VOC Brazos, but even
financially troubled competitors can affect the market because of their need to sell oil and natural gas at any price to attempt to maintain cash flow. The trust is subject to the same competitive
conditions as VOC Brazos and other companies in the oil and natural gas industry.
Oil
and natural gas compete with other forms of energy available to customers, primarily based on price. These alternate forms of energy include electricity, coal and fuel oils. Changes
in the availability or price of oil, natural gas or other forms of energy, as well as business conditions, conservation, legislation, regulations and the ability to convert to alternate fuels and
other forms of energy may affect the demand for oil and natural gas.
Future
price fluctuations for oil and natural gas will directly impact trust distributions, estimates of reserves attributable to the trust's interests and estimated and actual future
net revenues to the trust. In view of the many uncertainties that affect the supply and demand for oil and natural gas, neither the trust nor VOC Brazos can make reliable predictions of future oil and
natural gas supply and demand, future product prices or the effect of future product prices on the trust.
Regulation
The production of oil and gas from the underlying properties is affected by many state and federal regulations with respect to allowable rates
of production, drilling permits, well spacing, marketing, environmental matters and pricing. Future regulations could change allowable rates of production or the manner in which oil and gas operations
may be lawfully conducted.
24
Table of Contents
Historically, the transportation and sale for resale of natural gas in interstate commerce has been regulated by the Federal Energy Regulatory
Commission, or FERC, under the Natural Gas Act of 1938, or NGA, the Natural Gas Policy Act of 1978, or NGPA, and regulations issued under those statutes. Over the last two decades, the FERC has issued
orders and adopted regulations resulting in a restructuring of the natural gas industry. The principal elements of this restructuring were the requirement that interstate pipelines separate, or
"unbundle," into individual components the various services offered on their systems, with all transportation services to be provided on a non-discriminatory basis, and the prohibition against an
interstate pipeline providing gas sales services except through separately organized affiliates. In various rulemaking proceedings following its initial unbundling requirement, the FERC has refined
its regulatory program applicable to interstate pipelines in various respects, and it has announced that it will continue to monitor these and other regulations to determine whether further changes
are needed. In addition to rulemaking proceedings, the FERC establishes new policies and regulations through policy statements and adjudications of individual pipeline matters. Further, additional
changes to regulations may occur based on actions taken by the United States Congress and/or the courts.
In
the past, the federal government has regulated the prices at which natural gas could be sold. While sales by producers of natural gas can currently be made at market prices, Congress
could reenact price controls in the future. Deregulation of wellhead natural gas sales began with the enactment of the NGPA and culminated in adoption of the Natural Gas Wellhead Decontrol Act which
removed all price controls affecting wellhead sales of natural gas effective January 1, 1993.
Sales
of crude oil, condensate, and natural gas liquids are not currently regulated and are made at negotiated prices. Nevertheless, Congress could reenact price controls in the future.
Sales of crude oil are affected by the availability, terms and cost of transportation. The transportation of oil in common carrier pipelines is subject to rate and access regulation. The FERC
regulates interstate oil pipeline transportation rates under the Interstate Commerce Act. In general, interstate oil pipeline rates must be just and reasonable and may not be unduly discriminatory or
confer any undue preference upon any shipper. Rates generally are cost-based, although settlement rates agreed to by all shippers are permitted and market-based rates may be permitted in certain
circumstances.
Although
the price at which VOC Brazos sells oil and natural gas is not currently subject to federal rate regulation and, for the most part, is not subject to state regulation, with
regard to physical sales of natural gas and oil, VOC Brazos is required to observe anti-market manipulation laws and related regulations enforced by the FERC and/or the Commodity Futures Trading
Commission, or the CFTC, and the Federal Trade Commission, or FTC. If VOC Brazos were to violate the anti-market manipulation laws and regulations, VOC Brazos could also be subject to related
third-party damage claims by, among others, sellers, royalty owners and taxing authorities.
As
to these various developments, VOC Brazos has advised the trust that the on-going and evolving nature of these regulatory initiatives makes it impossible to predict their ultimate
impact on the prices, markets or terms of sale of natural gas related to the trust.
In general, the jurisdictions in which royalty properties are located have statutory provisions regulating the production and sale of crude oil
and natural gas. The regulations often require permits for the drilling of wells but extend also to the spacing of wells, the prevention of waste of oil and gas resources, the rate of production,
prevention and clean-up of pollution and other matters.
25
Table of Contents
General.
The operations of the underlying properties are subject to stringent and complex federal, regional, state and local laws and
regulations
governing environmental protection as well as the discharge of materials into the environment. These laws and regulations may impose significant obligations on VOC Brazos' operations, including
requirements to, among other things:
-
-
obtain permits to conduct regulated activities;
-
-
restrict the types, quantities and concentration of various substances that can be released into the environment in the performance of drilling
and production activities;
-
-
limit or prohibit drilling activities on certain lands lying within wilderness, wetlands and other protected areas;
-
-
initiate remedial activities or corrective actions to mitigate pollution from former or current operations, such as restoration of drilling
pits and plugging of abandoned wells;
-
-
apply specific health and safety criteria addressing workover protection; and
-
-
impose substantial liabilities on VOC Brazos for pollution resulting from VOC Brazos' operations.
Failure
to comply with environmental laws and regulations may result in the assessment of administrative, civil and criminal sanctions, including monetary penalties, the imposition of
investigatory and remedial obligations, and the issuance of injunctions limiting or prohibiting some or all of VOC Brazos' operations. Moreover, these laws, rules and regulations may restrict the rate
of oil and natural gas production below the rate that would otherwise be possible. The regulatory burden on the oil and natural gas industry increases the cost of doing business in the industry and
consequently affects profitability. VOC Brazos believes that it is in substantial compliance with all existing environmental laws and regulations applicable to its current operations and that its
continued compliance with existing requirements will not have a material adverse effect on the cash distributions to the trust unitholders. However, the clear trend in environmental regulation is to
place more restrictions and limitations on activities that may affect the environment, and thus, any changes in environmental laws and regulations or re-interpretation of enforcement policies that
result in more stringent and costly emission or discharge limits or waste handling, disposal or remediation obligations could have a material adverse effect on VOC Brazos' development expenditures,
results of operations and financial position. VOC Brazos may be unable to pass on those increases to its customers.
The
following is a summary of the more significant existing environmental, health and safety laws and regulations, each as amended from time to time, to which VOC Brazos' business
operations are subject:
Hazardous substance and wastes.
The Comprehensive Environmental Response, Compensation and Liability Act, or "CERCLA," also
known as the Superfund
law, and comparable state laws impose liability without regard to fault or the legality of the original conduct on certain classes of persons who are considered to be responsible for the release of a
"hazardous substance" into the environment. Under CERCLA, these "responsible persons" may include the owner or operator of the site where the release occurred, and entities that transport or disposed
or arranged for the transport or disposal of hazardous substances released at the site. These responsible persons may be subject to joint and several, strict liability for the costs of cleaning up the
hazardous substances that have been released into the environment, for damages to natural resources and for the costs of certain health studies. CERCLA also authorizes the U.S. Environmental
Protection Agency, or "EPA," and, in some instances, third parties to act in response to threats to the public health or the environment and to seek to recover from the responsible classes of persons
the costs they incur. It is not uncommon for neighboring landowners and other third-parties to file claims for personal injury and property damage allegedly caused by the hazardous substances released
into the environment. VOC Brazos generates materials in the course of its operations that may be regulated as hazardous substances.
26
Table of Contents
The
Resource Conservation and Recovery Act, or "RCRA," and comparable state laws regulate the generation, transportation, treatment, storage, disposal and cleanup of hazardous and
non-hazardous wastes. Under the auspices of the EPA, the individual states administer some or all of the provisions of RCRA, sometimes in conjunction with their own, more stringent requirements.
Drilling fluids, produced waters and most of the other wastes associated with the exploration, production and development of crude oil or natural gas are currently exempt from regulations as hazardous
wastes under RCRA. However, EPA entered a consent decree in 2016 which requires EPA to assess whether the RCRA rules pertaining to oil and natural gas wastes should be revised. It is possible that
certain oil and natural gas exploration and production wastes now classified as non-hazardous could be classified as hazardous wastes in the future. In December 2016, the EPA entered a consent decree
with several groups, including the National Resources Defense Council, requiring the EPA to revisit the oil and gas waste exemption for hazardous waste. Any change in the RCRA exemption for such
wastes could result in an increase in the costs to manage and dispose of wastes, which could have a material adverse effect on the cash distributions to the trust unitholders. In addition, VOC Brazos
generates industrial wastes in the ordinary course of its operations that may be regulated as hazardous wastes.
The
real properties upon which VOC Brazos conducts its operations have been used for oil and natural gas exploration and production for many years. Although VOC Brazos may have utilized
operating and disposal practices that were standard in the industry at the time, petroleum hydrocarbons and wastes may have been disposed of or released on or under the real properties upon which VOC
Brazos conducts its operations, or on or under other, offsite locations, where these petroleum hydrocarbons and wastes have been taken for recycling or disposal. In addition, the real properties upon
which VOC Brazos conducts its operations may have been operated by third parties or by previous owners or operators whose treatment and disposal of hazardous substances, wastes or hydrocarbons was not
under VOC Brazos' control. These real properties and the petroleum hydrocarbons and wastes disposed or released thereon may be subject to CERCLA, RCRA and analogous state laws. Under such laws, VOC
Brazos could be required to remove or remediate previously disposed wastes, to clean up contaminated property, and to perform remedial operations such as restoration of pits and plugging of abandoned
wells to prevent future contamination.
Water discharges and hydraulic fracturing.
The Federal Water Pollution Control Act, also known as the "Clean Water Act," and analogous
state laws
impose restrictions and strict controls with respect to the discharge of pollutants, including spills and leaks of oil, into federal and state waters. The discharge of pollutants into regulated waters
is prohibited, except in accordance with the terms of a permit issued by EPA or an analogous state agency. Any unpermitted discharge of pollutants could result in penalties and significant remedial
obligations. Spill prevention, control and countermeasure requirements under federal law require appropriate containment berms and similar structures to help prevent the contamination of navigable
waters in the event of a petroleum hydrocarbon tank spill, rupture or leak.
It
is customary to recover oil and natural gas from deep shale and tight sand formations through the use of hydraulic fracturing, combined with sophisticated horizontal drilling.
Hydraulic fracturing involves the injection of water, sand and chemical additives under pressure into rock formations to stimulate gas production. The federal Energy Policy Act of 2005 amended the
Underground Injection Control provisions of the federal Safe Drinking Water Act to exclude certain hydraulic fracturing activities from the definition of "underground injection." At present, hydraulic
fracturing is regulated at the state and local level. Due to public concerns raised regarding potential impacts of hydraulic fracturing on groundwater quality, legislative and regulatory efforts at
the federal, state and local level and in some states have been initiated to require or make more stringent the permitting and compliance requirements for hydraulic fracturing operations. Repeal of
the exemption would allow the EPA to promulgate new regulations. Many states have adopted rules that required operators to disclose chemicals and water volumes associated with hydraulic fracturing. In
addition, the EPA finalized a study
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of
the potential environmental impacts of hydraulic fracturing activities in 2016, finding that under certain circumstances the "water cycle" activities associated with hydraulic fracturing could
impact drinking water resources. More recently, the injection of water produced as a result of hydraulic fracturing has been associated with seismic activity leading to restrictions on injection in
some areas. If new laws or regulations that significantly restrict hydraulic fracturing are adopted, such legal requirements could make it more difficult or costly for VOC Brazos to perform hydraulic
fracturing activities. Moreover, required disclosure without protection for trade secret or proprietary products could discourage service companies from using such products and as a result impact the
degree to which some oil and gas wells may be efficiently and economically completed or brought into production. Finally, VOC Brazos believes that enactment of legislation regulating hydraulic
fracturing at the federal level may have a material adverse effect on its business.
Air emissions.
The federal Clean Air Act and comparable state laws restrict the emission of air pollutants from many sources through air
emissions
permitting programs and also impose various monitoring and reporting requirements. The EPA finalized rules that define the terms used to determine whether a source is considered to be a major souce
under the Clean Air Act in May 2016. These laws and regulations may require VOC Brazos to obtain pre-approval for the construction or modification of certain projects or facilities expected to produce
or significant increase air emissions, obtain and strictly comply with stringent air permit requirements or incur development expenditures to install and utilize specific equipment or technologies to
control emissions. Obtaining permits has the potential to delay the development of oil and natural gas projects. Federal and state regulatory agencies may impose administrative, civil and criminal
penalties for non-compliance with air permits or other requirements of the federal Clean Air Act and associated state laws and regulations.
Climate change.
In response to certain scientific studies suggesting that emissions of certain gases, commonly referred to as
greenhouse gases, or
"GHGs," and including carbon dioxide and methane, are contributing to the warming of the Earth's atmosphere and other climatic conditions the EPA issued regulations restricting GHGs. These
restrictions include additional reductions of volatile organic compounds, hazardous air pollutants and methane emissions from the oil and gas sector. Such regulations limiting emissions of GHGs from
the equipment and operations of VOC Brazos could require VOC Brazos to incur costs to monitor and report on GHG emissions or reduce emissions of GHGs associated with its operations, and such
requirements also could adversely affect demand for the oil and natural gas that VOC Brazos produces. However, more recently EPA announced that it will reconsider the current standards and issued a
proposal to stay certain portions of the rules. Apart from EPA, almost one-half of the states have already taken legal measures to reduce emissions of GHGs, primarily through the planned development
of GHG emission inventories and/or regional GHG cap and trade programs. Most of these cap and trade programs work by requiring either major sources of emissions or major producers of fuels to acquire
and surrender emission allowances, with the number of allowances available for purchase reduced each year until the overall GHG emission reduction goal is achieved. These allowances would be expected
to escalate significantly in cost over time. Although it is not possible at this time to predict if Congress may pass climate change legislation, any future federal or state laws that may be adopted
to address GHG emissions could require VOC Brazos to incur increased operating costs and could adversely affect demand for the oil and natural gas VOC Brazos produces.
Finally,
it should be noted that some scientists have concluded that increasing concentrations of greenhouse gases in the Earth's atmosphere may produce climate changes that have
significant physical effects, such as increased frequency and severity of storms, floods, drought and other climatic events. If any such effects were to occur, they could adversely affect or delay
demand for the oil or natural gas produced by VOC Brazos or otherwise cause VOC Brazos to incur significant costs in preparing for or responding to those effects.
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Endangered Species Act.
The federal Endangered Species Act, or "ESA," restricts activities that may affect endangered and threatened
species or their
habitats. The designation of previously unidentified endangered or threatened species could cause VOC Brazos to incur additional costs or become subject to operating delays, restrictions or bans in
the affected areas. While some of VOC Brazos' facilities or leased acreage may be located in areas that are designated as habitat for endangered or threatened species, VOC Brazos believes that it is
in substantial compliance with the ESA.
Employee health and safety.
The operations of VOC Brazos are subject to a number of federal and state laws and regulations, including
the federal
Occupational Safety and Health Act, or "OSHA," and
comparable state statutes, whose purpose is to protect the health and safety of workers. In addition, the OSHA hazard communication standard, the EPA community right-to-know regulations under Title
III of the federal Superfund Amendment and Reauthorization Act and comparable state statutes require that information be maintained concerning hazardous materials used or produced in operations and
that this information be provided to employees, state and local government authorities and citizens. VOC Brazos believes that it is in substantial compliance with all applicable laws and regulations
relating to worker health and safety.
Item 1A. Risk Factors.
Prices of oil and natural gas fluctuate, and lower prices could reduce proceeds to the trust and cash
distributions to unitholders.
The reserves attributable to the underlying properties and quarterly cash distributions of the trust are highly dependent upon the prices
realized from the sale of oil and natural gas. Prices of oil and natural gas can fluctuate widely on a quarter-to-quarter basis in response to a variety of factors that are beyond the control of the
trust and VOC Brazos. These factors include, among others:
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regional, domestic and foreign supply and perceptions of supply of oil and natural gas;
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the level of demand and perceptions of demand for oil and natural gas;
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political conditions or hostilities in oil and natural gas producing regions, such as the recent geopolitical turmoil in North Africa and the
Middle East;
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anticipated future prices of oil and natural gas and other commodities;
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weather conditions and seasonal trends;
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technological advances affecting energy consumption and energy supply;
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U.S. and worldwide economic conditions;
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the price and availability of alternative fuels;
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the proximity, capacity, cost and availability of gathering and transportation facilities;
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the volatility and uncertainty of regional pricing differentials;
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governmental regulations and taxation;
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energy conservation and environmental measures; and
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acts of force majeure.
Crude
oil prices have been volatile the last several years and in 2017, ranged from a high of $60.42 to a low of $42.53. The NYMEX crude oil spot prices per Bbl were $37.04, $53.72 and
$60.42 as of December 31, 2015, 2016 and 2017, respectively. Neither VOC Brazos nor the trust can predict the timing or the duration of any economic cycle and, depending on the prices realized,
the operating results of VOC Brazos and the financial condition of the trust could be materially and adversely affected.
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Lower
prices of oil and natural gas will reduce the amount of the net proceeds to which the trust is entitled and may ultimately reduce the amount of oil and natural gas that is economic
to produce from the underlying properties. As a result, the operator of any of the underlying properties could determine during periods of low commodity prices to shut in or curtail production from
wells on the underlying properties. In addition, the operator of the underlying properties could determine during periods of low commodity prices to plug and abandon marginal wells that otherwise may
have been allowed to continue to produce for a longer period under conditions of higher prices. Specifically, VOC Brazos may abandon any well or property if it reasonably believes that the well or
property can no longer produce oil or natural gas in commercially paying quantities. This could result in termination of the net profits interest relating to the abandoned well or property. In making
such decisions, VOC Brazos and any transferee will be required under the applicable conveyance to operate, or to use commercially reasonable efforts to cause the operators of the underlying properties
to operate, these properties as would a reasonably prudent operator, acting with respect to its own properties (without regard to the existence of the net profits interest). Because substantially all
the underlying properties are located in mature fields, decreases in commodity prices could have a more significant effect on the economic viability of these properties compared to more recently
discovered properties. The commodity price sensitivity of these mature wells is due to a variety of factors that vary from well-to-well, including the additional costs associated with water handling
and disposal, chemicals, surface equipment maintenance, downhole casing repairs and reservoir pressure maintenance activities that are necessary to maintain production. As a result, the volatility of
commodity prices may cause the amount of future cash distributions to trust unitholders to fluctuate, and a substantial decline in the price of oil or
natural gas will reduce the amount of cash available for distribution to the trust unitholders. The volatility of commodity prices also reduces the accuracy of estimates of future cash distributions
to trust unitholders.
Actual reserves and future production may be less than current estimates of proved reserves, which could
reduce cash distributions by the trust and the value of the trust units.
The value of the trust units and the amount of future cash distributions to the trust unitholders will depend upon, among other things, the
accuracy of the reserves and future production estimated to be attributable to the underlying properties and the net profits interest. It is not possible to measure underground accumulations of oil
and natural gas in an exact manner, and estimating reserves is inherently uncertain. Ultimately, actual production and revenues for the underlying properties could vary negatively and in material
amounts from estimates. Furthermore, development expenditures and production costs relating to the underlying properties could be higher than current estimates. Petroleum engineers are required to
make subjective estimates of underground accumulations of oil and natural gas based on factors and assumptions that include:
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historical production from the area compared with production rates from other producing areas;
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oil and natural gas prices, production levels, Btu content, production expenses, transportation costs, severance and excise taxes and
development expenditures; and
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the effect of expected governmental regulation.
Changes
in these assumptions and amounts of actual production and development costs could materially decrease reserve estimates.
The processes of drilling and completing wells are high risk activities.
The processes of drilling and completing wells are subject to numerous risks beyond the trust's and VOC Brazos' control, including risks that
could delay VOC Brazos' current drilling schedule and the risk that drilling will not result in commercially viable oil production. VOC Brazos is not obligated to undertake any development activities,
so any drilling and completion activities will be subject to the
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reasonable
discretion of VOC Brazos. Furthermore, VOC Brazos' future business, financial condition, results of operations, liquidity or ability to finance its share of planned development expenditures
could be materially and adversely affected by any factor that may curtail, delay or cancel drilling, including the following:
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delays imposed by or resulting from compliance with regulatory requirements, including permitting;
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unusual or unexpected geological formations;
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shortages of or delays in obtaining equipment and qualified personnel;
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equipment malfunctions, failures or accidents;
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unexpected operational events and drilling conditions;
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reductions in oil or natural gas prices;
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market limitations for oil or natural gas;
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pipe or cement failures;
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casing collapses;
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lost or damaged drilling and service tools;
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loss of drilling fluid circulation;
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uncontrollable flows of oil and natural gas;
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fires and natural disasters;
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environmental hazards, such as oil and natural gas leaks, pipeline ruptures and discharges of toxic gases;
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adverse weather conditions; and
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oil or natural gas property title problems.
In
the event that drilling of development wells is delayed or cancelled, or development wells have lower than anticipated production, due to one or more of the factors above or for any
other reason, estimated future distributions to trust unitholders may be reduced.
Risks associated with the production, gathering, transportation and sale of oil and natural gas could
adversely affect cash distributions by the trust.
The amount of cash to be received by the trust from VOC Brazos with respect to the net profits interest, the value of the trust units and the
amount of cash distributions to the trust unitholders will depend upon, among other things, oil and natural gas production and prices and the costs incurred by VOC Brazos to develop and produce oil
and natural gas reserves attributable to the underlying properties. Drilling, production or transportation accidents as well as adverse weather conditions that temporarily or permanently halt the
production and sale of oil or natural gas at any of the underlying properties will reduce trust distributions by reducing the amount of net proceeds received by the trust and available for
distribution. For example, accidents may occur that result in personal injuries, property damage, damage to productive formations or equipment and environmental damages. To the extent VOC Brazos is
not able to recover from insurance any costs incurred by VOC Brazos in connection with any such accidents, the net proceeds available for distribution to the trust may be reduced or delayed. In
addition, curtailments or damage to pipelines used by VOC Brazos to transport oil and natural gas production to markets for sale could reduce the amount of net proceeds received by the trust and
available for distribution. Any such curtailment or damage to the gathering systems used
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by
VOC Brazos could also require VOC Brazos to find alternative means to transport the oil and natural gas production from the underlying properties, which could require VOC Brazos to incur additional
costs that will have the effect of reducing net proceeds received by the trust and available for distribution.
Production of oil and natural gas on the underlying properties could be materially and adversely affected by
severe or unseasonable weather.
Production of oil and natural gas on the underlying properties could be materially and adversely affected by severe weather. Repercussions of
severe weather conditions may include:
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evacuation of personnel and curtailment of operations;
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weather-related damage to drilling rigs or other facilities, resulting in suspension of operations;
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inability to deliver materials to worksites; and
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weather-related damage to pipelines and other transportation facilities.
VOC Brazos does not have any long term contracts related to the sale of production of oil and natural gas
from the underlying properties and may be unable to find purchasers.
VOC Brazos does not have any firm commitment contracts for the sale of any production nor has it received security or other guaranty of payment
for the production it sells. Therefore, there can be no assurance that VOC Brazos will be able to find buyers for its production, that buyers will pay the purchase price therefor or that the price at
which the production is sold will be the current market price for such hydrocarbons at the time of delivery. During the year ended December 31, 2017, VOC Brazos sold approximately 38% of the
oil produced from the underlying properties to MV Purchasing LLC, an affiliate of VOC Brazos. Any nonpayment by a purchaser of production, including MV Purchasing LLC, or inability by
VOC Brazos to sell any production, could reduce cash available for distribution to trust unitholders.
Neither the trust nor the trust's unitholders have the ability to influence VOC Brazos or control the
operations or development of the underlying properties.
The trust and the trust's unitholders have no voting rights with respect to VOC Brazos and therefore have no managerial, contractual or other
ability to influence VOC Brazos' activities or the operations of the underlying properties. Oil and natural gas properties are typically managed pursuant to an operating agreement among the working
interest owners of oil and natural gas properties. Vess Oil Corporation operates, or operates on a contract basis, substantially all of the underlying properties. The typical operating agreement
contains procedures whereby the owners of the working interests in the property designate one of the interest owners to be the operator of the property. Under these arrangements, the operator is
typically responsible for making all decisions relating to drilling activities, sale of production, compliance with regulatory requirements and other matters that affect the property.
Shortages or increases in costs of equipment, services and qualified personnel could result in a reduction in
the amount of cash available for distribution to the trust unitholders.
The demand for qualified and experienced personnel to conduct field operations, geologists, geophysicists, engineers and other professionals in
the oil and natural gas industry can fluctuate significantly, often in correlation with oil and natural gas prices, causing periodic shortages. Historically, there have been shortages of drilling rigs
and other equipment as demand for rigs and equipment has increased along with the number of wells being drilled. These factors also cause significant increases in costs for equipment, services and
personnel. Higher oil and natural gas prices generally stimulate demand and result in increased prices for drilling rigs, crews and associated supplies, equipment and services. Shortages of field
personnel and equipment or price increases could
significantly decrease the amount of cash received by the trust and available for distribution to the trust unitholders or restrict the ability of VOC Brazos to drill the development wells and conduct
the operations which it currently has planned for the underlying properties.
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The trust units may lose value as a result of title deficiencies with respect to the underlying properties.
VOC Brazos acquired the underlying properties over the past 30 years. The existence of a material title deficiency with respect to the
underlying properties could reduce the value of a property or render it worthless, thus adversely affecting the net profits interest and distributions to trust unitholders. VOC Brazos does not obtain
title insurance covering mineral leaseholds, and VOC Brazos' failure to cure any title defects may cause VOC Brazos to lose its rights to production from the underlying properties. In the event of any
such material title problem, proceeds available for distribution to trust unitholders and the value of the trust units may be reduced.
VOC Brazos may transfer all or a portion of the underlying properties at any time without trust unitholder
consent, subject to specified limitations.
VOC Brazos may at any time transfer all or part of the underlying properties, subject to and burdened by the net profits interest, and may
abandon individual wells or properties that it reasonably believes would no longer produce oil or natural gas in commercially paying quantities. For the years ended December 31, 2015, 2016 and
2017, VOC Brazos plugged and abandoned 14, 13 and 11 wells, respectively, located on leases on the underlying properties. Trust unitholders will not be entitled to vote on any transfer of the
underlying properties, and the trust will not receive any proceeds from any such transfer, except in certain limited circumstances when the net profits interest is released in connection with such
transfer, in which case the trust will receive an amount equal to the fair market value (net of sales costs) of the net profits interest released. Following any sale or transfer of any of the
underlying properties, if the net profits interest is not released in connection with such sale or transfer, the net profits interest will continue to burden the transferred property and net proceeds
attributable to such property will be calculated as part of the computation of net proceeds described in this Form 10-K. VOC Brazos may delegate to the transferee responsibility for all of VOC
Brazos' obligations relating to the net profits interest on the portion of the underlying properties transferred.
In
addition, VOC Brazos may, without the consent of the trust unitholders, require the trust to release the net profits interest associated with any lease that accounts for less than or
equal to 0.25% of the total production from the underlying properties in the prior 12 months and provided that the net profits interest covered by such releases cannot exceed, during any
12-month period, an aggregate fair market value to the trust of $500,000. These releases will be made only in connection with a sale by VOC Brazos of the relevant underlying properties and are
conditioned upon the trust's receiving an amount equal to the fair market value to the trust of such net profits interest. Any net sales proceeds paid to the trust will be distributable to trust
unitholders for the quarter in which they are received. Net sales proceeds of $0 and $0 were paid to the trust during 2016 and 2017 for its share of interest in certain underlying properties that were
sold in 2016 and 2017, respectively. VOC Brazos has not identified any of the underlying properties for sale as of December 31, 2017.
The reserves attributable to the underlying properties are depleting assets and production from those
properties will diminish over time. Furthermore, the trust is precluded from acquiring other oil and natural gas properties or net profits interests to replace the depleting assets and production.
The net proceeds payable to the trust attributable to the net profits interests are derived from the sale of production of oil and natural gas
from the underlying properties. The reserves attributable to the underlying properties are depleting assets, which means that the reserves and the quantity of oil and natural gas produced from the
underlying properties will decline over time. Furthermore, over approximately 90% of the estimated oil recovery attributable to the underlying properties has already been extracted from the producing
wells located on the underlying properties. Based on the estimated production volumes in the reserve report as of December 31, 2017, the oil and natural gas production from proved reserves
attributable to the underlying properties is projected to
decline at an average rate of approximately 6.6% per year over the next 20 years, assuming the level of development drilling and
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development
expenditures on the underlying properties disclosed elsewhere in this Form 10-K through 2020 and none thereafter. Actual decline rates may vary from this projected decline rate. In
the event expected future development is delayed, reduced or cancelled, the average rate of decline will likely exc
e
ed 6.6% per year.
The
trust agreement provides that the trust's activities are limited to owning the net profits interest and any activity reasonably related to such ownership, including activities
required or permitted by the terms of the conveyance. As a result, the trust is not permitted to acquire other oil and natural gas properties or net profits interests to replace the depleting assets
and production attributable to the net profits interest.
Because
the net proceeds payable to the trust are derived from the sale of depleting assets, the portion of the distributions to unitholders attributable to depletion may be considered
to have the effect of a return of capital as opposed to a return on investment. Eventually, the underlying properties burdened by the net profits interest may cease to produce in commercially paying
quantities and the trust may, therefore, cease to receive any distributions of net proceeds therefrom.
The amount of cash available for distribution by the trust will be reduced by the amount of any costs and
expenses related to the underlying properties and other costs and expenses incurred by the trust.
The net profits interest will bear its share of all costs and expenses related to the underlying properties, such as lease operating expenses,
production and property taxes and development expenses, which will reduce the amount of cash received by the trust and thereafter distributable to trust unitholders. Accordingly, higher costs and
expenses related to the underlying properties will directly decrease the amount of cash received by the trust in respect of its net profits interest. Historical costs may not be indicative of future
costs. In addition, cash available for distribution by the trust will be further reduced by the trust's general and administrative expenses.
If
production and development costs on the underlying properties together with the other costs exceed gross proceeds of production from the underlying properties, the trust will not
receive net proceeds from those properties until future gross proceeds from production exceed the total of the excess costs,
plus accrued interest. If the trust does not receive net proceeds pursuant to the net profits interest, or if such net proceeds are reduced, the trust will not be able to distribute cash to the trust
unitholders, or such cash distributions will be reduced, respectively. Development activities may not generate sufficient additional revenue to repay the costs.
A purchaser's failure to pay VOC Brazos for purchased production could have a significant adverse impact on
VOC Brazos, which in turn could result in VOC Brazos not having sufficient net proceeds attributable to the net profits interest for VOC Brazos to distribute cash to the trust.
A purchaser's failure to pay for purchased production could have a significant adverse impact on VOC Brazos' business, which could in turn
impact the trust. The recent tightening of credit in the financial markets may make it more difficult for purchasers to obtain financing and depending on the degree to which this occurs, there may be
a material increase in the nonpayment and nonperformance by such purchasers.
The trustee may, under certain circumstances, sell the net profits interest and dissolve the trust prior to
the expected termination of the trust. As a result, trust unitholders may not recover their investment.
The trustee must sell the net profits interest if the holders of a majority of the trust units approve the sale or vote to dissolve the trust.
The trustee must also sell the net profits interest if the annual gross proceeds from the underlying properties attributable to the net profits interest are less than $1.0 million for each of
any two consecutive years. The sale of the net profits interest will result in the dissolution of the trust. The net proceeds of any such sale will be distributed to the trust unitholders.
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The disposal by an affiliate of VOC Brazos of its remaining trust units may reduce the market price of the
trust units.
As of the date this Form 10-K, an affiliate of VOC Brazos, VOC Partners, LLC, owned 25% of the outstanding trust units. VOC
Partners, LLC may use some or all of the remaining trust units it owns for a number of business purposes, including:
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selling them for cash; and
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exchanging them for interests in oil and natural gas properties or securities of oil and natural gas companies.
If
it sells additional trust units or exchanges trust units in connection with acquisitions, then additional trust units will be available for sale in the market. The sale of additional
trust units may reduce the market price of the trust units. The trust has entered into a registration rights agreement with VOC Partners, LLC pursuant to which the trust has agreed to
file a registration statement or a shelf registration statement to register the resale of the remaining trust units held by VOC Partners, LLC and any transferee of the trust units upon
request by such holders. See "Item 13. Certain Relationships and Related Transactions, and Director IndependenceRegistration Rights."
The market price for the trust units may not reflect the value of the net profits interest held by the trust.
The trading price for publicly traded securities similar to the trust units tends to be tied to recent and expected levels of cash
distributions. The amounts available for distribution by the trust will vary in response to numerous factors outside the control of the trust, including prevailing prices for sales of oil and natural
gas production from the underlying properties and the timing and amount of production and development costs. Consequently, the trading price for the trust units may not necessarily be indicative of
the value that the trust would realize if it sold the net profits interest to a third-party buyer. In addition, such market price may not necessarily reflect the fact that since the assets of the
trust are depleting assets, a portion of each cash distribution paid on the trust units should be considered by investors as a return of capital, with the remainder being considered as a return on
investment. As a result, distributions made to a trust unitholder over the life of these depleting assets may not equal or exceed the purchase price paid by the trust unitholder.
Conflicts of interest could arise between VOC Brazos and its affiliates, on the one hand, and the trust and
the trust unitholders, on the other hand.
As working interest owners in, and operators of substantially all the wells on, the underlying properties, VOC Brazos and its affiliates could
have interests that conflict with the interests of the trust and the trust unitholders. For example:
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VOC Brazos' interests may conflict with those of the trust and the trust unitholders in situations involving the development, maintenance,
operation or abandonment of the underlying properties. VOC Brazos may also make decisions with respect to development expenditures that adversely affect the underlying properties. These decisions
include reducing development expenditures on these properties, which could cause oil and natural gas production to decline at a faster rate and thereby result in lower cash distributions by the trust
in the future.
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VOC Brazos may sell some or all of the underlying properties without taking into consideration the interests of the trust unitholders. Such
sales may not be in the best interests of the trust unitholders. These purchasers may lack VOC Brazos' experience or its credit worthiness. VOC Brazos also has the right, under certain limited
circumstances, to cause the trust to release all or a portion of the net profits interest in connection with a sale of a portion of the underlying properties to which such net profits interest
relates.
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MV Purchasing LLC, an affiliate of VOC Brazos, is expected to market and/or purchase a substantial portion of the oil produced from the
underlying properties, and it is expected to profit from this arrangement. Provisions in the net profits interest conveyance, however, require that charges and other terms under contracts with
affiliates of VOC Brazos be comparable to prices and other terms prevailing in the area for similar services or sales. During the year ended December 31, 2017, VOC Brazos sold approximately 38%
of the oil produced from the underlying properties to MV Purchasing, LLC.
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VOC Partners, LLC has registration rights and can sell its trust units without considering the effects such sale may have on trust unit
prices or on the trust itself. In addition, VOC Partners, LLC can vote its trust units in its sole discretion without considering the interests of the other trust unitholders.
The trust is managed by a trustee who cannot be replaced except by a majority vote of the trust unitholders
at a special meeting, which may make it difficult for trust unitholders to remove or replace the trustee.
The business and affairs of the trust are managed by the trustee. The voting rights of a trust unitholder are more limited than those of
stockholders of most public corporations. For example, there is no requirement for annual meetings of trust unitholders or for an annual or other periodic re-election of the trustee. The trust
agreement provides that the trustee may only be removed and replaced by the holders of a majority of the outstanding trust units, including trust units held by VOC Partners, LLC, at a special
meeting of trust unitholders called by either the trustee or the holders of not less than 10% of the outstanding trust units. As a result, it will be difficult for public unitholders to remove or
replace the trustee without the cooperation of VOC Partners, LLC as long as it holds a significant percentage of total trust units.
Trust unitholders have limited ability to enforce provisions of the net profits interest, and VOC Brazos'
liability to the trust is limited.
The trust agreement permits the trustee to sue VOC Brazos or any other future owner of the underlying properties to enforce the terms of the
conveyance creating the net profits interest. If the trustee does not take appropriate action to enforce provisions of the conveyance, trust unitholders' recourse would be limited to bringing a
lawsuit against the trustee to compel the trustee to take specified actions. The trust agreement expressly limits a trust unitholder's ability to directly sue VOC Brazos or any other third party other
than the trustee. As a result, trust unitholders will not be able to sue VOC Brazos or any future owner of the underlying properties to enforce these rights. Furthermore, the net profits interest
conveyance provides that, except as set forth in the conveyance,
VOC Brazos will not be liable to the trust for the manner in which it performs its duties in operating the underlying properties as long as it acts without gross negligence or willful misconduct.
Courts outside of Delaware may not recognize the limited liability of the trust unitholders provided under
Delaware law.
Under the Delaware Statutory Trust Act, trust unitholders are entitled to the same limitation of personal liability extended to stockholders of
corporations under the General Corporation Law of the State of Delaware. Courts in jurisdictions outside of Delaware, however, may not give effect to such limitation.
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The operations of the underlying properties are subject to environmental laws and regulations that may result
in significant costs and liabilities, which could reduce the amount of cash available for distribution to trust unitholders.
The oil and natural gas exploration and production operations of VOC Brazos are subject to stringent and comprehensive federal, state and local
laws and regulations governing the discharge of materials into the environment or otherwise relating to environmental protection. These laws and regulations may impose numerous obligations that apply
to VOC Brazos' operations, including the requirement to obtain a permit before conducting drilling, waste disposal or other regulated activities; the restriction of types, quantities and
concentrations of materials that can be released into the environment; the incurrence of significant development expenditures to install pollution or safety-related controls at the operated
facilities; the limitation or prohibition of drilling activities on certain lands lying within wilderness, wetlands and other protected areas; and the imposition of substantial liabilities for
pollution resulting from operations. Numerous governmental authorities, such as the EPA and analogous state environmental and oil and gas agencies, have the power to enforce compliance with these laws
and regulations and the permits issued under them, oftentimes requiring difficult and costly actions. Failure to comply with these laws and regulations may result in the assessment of administrative,
civil or criminal penalties; the imposition of investigatory or remedial obligations; and the issuance of injunctions limiting or preventing some or all of VOC Brazos' operations. Furthermore, the
inability to comply with environmental laws and regulations in a cost effective manner, such as removal and disposal of produced water and other generated oil and gas wastes, could impair VOC Brazos'
ability to produce oil and natural gas commercially from the underlying properties, which would reduce proceeds attributable to the net profits interest.
There
is inherent risk of incurring significant environmental costs and liabilities in the performance of VOC Brazos' operations as a result of its handling of petroleum hydrocarbons and
wastes, air emissions and wastewater discharges related to its operations, and historical industry operations and waste disposal practices. Under certain environmental laws and regulations, VOC Brazos
could be subject to joint and several strict liability for the removal or remediation of previously released materials or property contamination regardless of whether VOC Brazos was responsible for
the release or contamination or whether the operations were in compliance with all applicable laws at the time those actions were taken. Private parties, including the owners of properties upon which
VOC Brazos' wells are drilled and facilities where VOC Brazos' petroleum hydrocarbons or wastes are taken for reclamation or disposal, may also have the right to pursue legal actions to enforce
compliance as well as to seek damages for non-compliance with environmental laws and regulations or for personal injury or property damage. In addition, the risk of accidental spills or releases could
expose VOC Brazos to significant liabilities that could have a material adverse effect on its financial condition or results of operations. Changes in environmental laws and regulations occur
frequently, and any changes that result in more stringent or costly operational control requirements or waste handling, storage, transport, disposal or cleanup requirements could require VOC Brazos to
make significant expenditures to attain and maintain compliance and may otherwise have a material adverse effect on its results of operations, competitive position or financial condition. VOC Brazos
may be unable to recover some or any of these costs from insurance, in which case the amount of cash received by the trust may be decreased. The net profits interest held by the trust will bear 80% of
all costs and expenses incurred by VOC Brazos in regard to environmental costs and liabilities associated with the underlying properties, including costs and liabilities resulting from conditions that
existed prior to VOC Brazos' acquisition of the underlying properties unless such costs and expenses result from VOC Brazos' gross negligence or willful misconduct. In addition, as a result of the
increased cost of compliance, VOC Brazos may decide to discontinue drilling.
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The operations of the underlying properties are subject to complex federal, state, local and other laws and
regulations that could adversely affect the cost, manner or feasibility of conducting its operations or expose VOC Brazos to significant liabilities, which could reduce the amount of cash available
for distribution to trust unitholders.
The production and development operations on the underlying properties are subject to complex and stringent laws and regulations. In order to
conduct its operations in compliance with these laws and regulations, VOC Brazos must obtain and maintain numerous permits, drilling bonds, approvals and certificates from various federal, state and
local governmental authorities and engage in extensive reporting. VOC Brazos may incur substantial costs in order to maintain compliance with these existing laws and regulations, and the net profits
interest will bear its share of these costs. In addition, VOC Brazos' costs of compliance may increase if existing laws and regulations are revised or reinterpreted, or if new laws and regulations
become applicable to VOC Brazos' operations. Such costs could have a material adverse effect on VOC Brazos' business, financial condition and results of
operations and reduce the amount of cash received by the trust in respect of the net profits interest, VOC Brazos must also comply with laws and regulations prohibiting fraud and market manipulations
in energy markets. To the extent VOC Brazos is a shipper on interstate pipelines, it must comply with the tariffs of such pipelines and with federal policies related to the use of interstate capacity,
and such compliance costs will be borne indirectly in part by the trust.
Laws
and regulations governing exploration and production may also affect production levels. VOC Brazos is required to comply with federal and state laws and regulations governing
conservation matters, including: provisions related to the unitization or pooling of oil and natural gas properties; the establishment of maximum rates of production from wells; the spacing of wells;
the plugging and abandonment of wells; and the removal of related production equipment. These and other laws and regulations can limit the amount of oil and natural gas VOC Brazos can produce from its
wells, limit the number of wells it can drill, or limit the locations at which it can conduct drilling operations, which in turn could negatively impact trust distributions, estimated and actual
future net revenues to the trust and estimates of reserves attributable to the trust's interests.
New
laws or regulations, or changes to existing laws or regulations, may unfavorably impact VOC Brazos, could result in increased operating costs or have a material adverse effect on VOC
Brazos' financial condition and results of operations and reduce the amount of cash received by the trust. These and other potential regulations could increase the operating costs of the underlying
properties, reduce VOC Brazos' liquidity, delay VOC Brazos' operations or otherwise alter the way VOC Brazos conducts its business, any of which could have a material adverse effect on the net profits
interest and the trust's cash flows.
Climate change laws and regulations restricting emissions of "greenhouse gases" could result in increased
operating costs and reduced demand for the oil and natural gas that VOC Brazos produces while the physical effects of climate change could disrupt VOC Brazos' production and cause VOC Brazos to incur
significant costs in preparing for or responding to those effects.
The oil and gas industry is a direct source of certain greenhouse gases, or "GHG," emissions, namely carbon dioxide and methane, and future
restrictions on such emissions could impact our future operations. On December 15, 2009, the EPA published its findings that emissions of carbon dioxide, methane and other GHGs present an
endangerment to public health and the environment because emissions of such gases are, according to the EPA, contributing to the warming of the earth's atmosphere and other climate changes. Based on
these findings, the agency adopted regulations that restrict emissions of GHGs under existing provisions of the federal Clean Air Act. However, more recently EPA announced that it will reconsider the
current standards and issued a proposal to stay certain portions of the current rules. The future implementation of these rules is uncertain at this time, but could affect VOC Brazos' operations and
its ability to obtain air permits for new or modified facilities.
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In
addition, almost half of the states have already taken legal measures to reduce emissions of GHGs, primarily through the planned development of GHG emission inventories and/or
regional GHG cap and trade programs. Most of these cap and trade programs work by requiring either major sources of emissions or major producers of fuels to acquire and surrender emission allowances,
with the number of allowances available for purchase reduced each year until the overall GHG emission reduction goal is achieved. These reductions would be expected to cause the cost of allowances to
escalate significantly over time. The adoption of any legislation or regulations that requires reporting of GHGs or otherwise limits emissions of GHGs from VOC Brazos' equipment and operations could
require VOC Brazos to incur costs to monitor and report on GHG emissions or reduce emissions of GHGs associated with its operations, and such requirements also could adversely affect demand for the
oil and natural gas produced, all of which could reduce proceeds attributable to the net profits interest and, as a result, the trust's cash available for distribution.
Finally,
it should be noted that some scientists have concluded that increasing concentrations of greenhouse gases in the Earth's atmosphere may produce climate changes that have
significant physical effects, such as increased frequency and severity of storms, droughts, and floods and other climatic events. If any such effects were to occur, they could have an adverse effect
on VOC Brazos' assets and operations and, consequently, may reduce the proceeds attributable to the net profits interest and, as a result, the trust's cash available for distribution.
Federal and state legislative and regulatory initiatives relating to hydraulic fracturing could result in
increased costs and additional operating restrictions or delays as well as adversely affect VOC Brazos' services.
Hydraulic fracturing is an important and common practice that is used to stimulate production of hydrocarbons, particularly natural gas, from
tight formations. The process involves the injection of water, sand and chemicals under pressure into formations to fracture the surrounding rock and stimulate production. The process is typically
regulated by state oil and gas commissions. The EPA finalized a study of the potential environmental impacts of hydraulic fracturing activities in December 2016, finding that under certain
circumstances the "water cycle" activities associated with hydraulic fracturing could impact drinking water resources. Some states have adopted, and other states are considering adopting, regulations
that could restrict or impose additional requirements relating to hydraulic fracturing in certain circumstances. If hydraulic fracturing is regulated at the federal level, VOC Brazos' fracturing
activities could become subject to additional permit requirements or operational restrictions and also to associated permitting delays and potential increases in costs. If new laws or regulations that
significantly restrict or otherwise impact hydraulic fracturing are passed by Congress or adopted in Texas or Kansas such legal requirements could make it more difficult or costly for VOC Brazos to
perform hydraulic fracturing activities and thereby affect the determination of whether a well is commercially viable. More recently, the injection of water produced
as a result of hydraulic fracturing has been associated with seismic activity leading to restrictions on injection in some areas. Restrictions on hydraulic fracturing and disposal of water from such
production could reduce the amount of oil and natural gas that VOC Brazos is ultimately able to produce in commercially paying quantities from the underlying properties.
The bankruptcy of VOC Brazos or any operator of the underlying properties could impede the operation of the
wells and the development of the proved undeveloped reserves.
VOC Brazos is a privately-held limited partnership engaged in the production and development of oil and natural gas from properties located in
Kansas and Texas. VOC Brazos intends to implement a development and workover program, including the expenditure through 2021 of approximately $22.4 million to drill additional wells and
recomplete and workover other wells. Without this development and workover program, the average decline rate over the life of the trust of the oil and natural gas production from the proved reserves
attributable to the underlying properties will likely
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exceed
the 6.6% per year projected in the reserve report. The operator of substantially all of the underlying properties is a privately-held corporation engaged in the operation of oil and natural gas
wells in Kansas and Texas. Therefore, the value of the net profits interest and the trust's ultimate cash available for distribution will be highly dependent on the financial condition of VOC Brazos
and the operator. None of VOC Brazos or the operator is a reporting company or files periodic reports with the SEC. Therefore, trust unitholders do not have access to financial information about VOC
Brazos or the operator. Furthermore, neither VOC Brazos nor the operator has agreed with the trust to maintain a certain net worth or to be restricted by other similar covenants.
The
ability of VOC Brazos to develop the underlying properties and the ability of the operator to operate the wells on the underlying properties depends on the future financial condition
and economic performance and access to capital of VOC Brazos and the operator, which in turn will depend upon the supply and demand for oil and natural gas, prevailing economic conditions and
financial, business and other factors, many of which are beyond the control of VOC Brazos and the operator.
In
the event of the bankruptcy of VOC Brazos or the operator, the trust would have to seek a new party to perform the development and workover program or the operations of the wells
operated by such operator. The trust may not be able to find a replacement driller or operator, and it may not be able to enter into a new agreement with such replacement party on favorable terms
within a reasonable period of time. As a result, such a bankruptcy may result in reduced production from the reserves and decreased distributions to trust unitholders.
The trust may be treated as an unsecured creditor with respect to the net profits interest attributable to
properties in Kansas in the event of the bankruptcy of VOC Brazos if a court were to hold that the conveyance and recording of the net profits interest was not a conveyance of a fully vested real
property interest or an interest in hydrocarbons in place or to be produced.
VOC Brazos and the trust believe that the recording in the appropriate real property records in Kansas of the net profits interest should
constitute the conveyance of a fully vested real property interest, interests in hydrocarbons in place or to be produced or a production payment as such is defined under the United States Bankruptcy
Code. In a bankruptcy of VOC Brazos, creditors of VOC Brazos would be able to claim the net profits interest as an asset of the bankruptcy estate to satisfy obligations to them if the conveyance of
the net profits interest did not constitute the conveyance of a real property interest or interests in hydrocarbons in place or to be produced under applicable state law or a production payment, in
which case the trust would be an unsecured creditor of VOC Brazos at risk of losing the entire value of the net profits interest to senior creditors.
Due to lack of geographic diversification of the underlying properties, adverse developments in Kansas or
Texas could adversely impact the results of operations and cash flows of the underlying properties and reduce the amount of cash available for distributions to trust unitholders.
The operations of the underlying properties are focused on the production and development of oil and natural gas within the states of Kansas and
Texas. As a result, the results of operations and cash flows of the underlying properties depend upon continuing operations in these areas. Due to the lack of diversification in geographic location,
adverse developments in exploration and production of oil and natural gas in either of these areas of operation could have a significantly greater impact on the results of operations and cash flows of
the underlying properties than if the operations were more diversified.
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The trust has not requested a ruling from the IRS regarding the tax treatment of ownership of the trust
units. If the IRS were to determine (and be sustained in that determination) that the trust is not a "grantor trust" for federal income tax purposes, or that the net profits interest is not properly
treated as a production payment (and thus would fail to qualify as a debt instrument) for federal income tax purposes, the trust unitholders may receive different and potentially less advantageous tax
treatment than expected.
If the trust were not treated as a grantor trust for federal income tax purposes, the trust should be treated as a partnership for such
purposes. Although the trust would not become subject to federal income taxation at the entity level as a result of treatment as a partnership, and items of income, gain, loss and deduction would flow
through to the trust unitholders, the trust's tax reporting requirements would be more complex and costly to implement and maintain, and its distributions to trust unitholders could be reduced as a
result.
If
the net profits interest were not treated as a production payment (and thus would fail to qualify as a debt instrument for federal income tax purposes) the amount, timing and
character of income, gain, or loss in respect of an investment in the trust could be affected.
Neither
VOC Brazos nor the trustee has requested a ruling from the IRS regarding these tax questions, and neither VOC Brazos nor the trust can provide assurance that such a ruling would
be granted if requested or that the IRS will not challenge these positions on audit.