Items 1. and 2. Business and Properties
Our periodic and current reports filed or furnished with or to the United States Securities and Exchange Commission (SEC) pursuant to Section 13(a) or 15(d) of the Exchange Act are available, free of charge, through our website, http://gultu.investorhq.businesswire.com, including our annual reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K, and any amendments to those reports. These reports and amendments are available through our website as soon as reasonably practicable after we electronically file or furnish such materials with or to the SEC.
References to “we,” “us,” and “our” refer to the Royalty Trust. References to “Notes” refer to the Notes to the Financial Statements included herein (refer to Part II, Item 8. "Financial Statements and Supplementary Data" of this Form 10-K). We have also provided a glossary of definitions for some of the oil and gas industry terms we use in this Form 10-K beginning on page 49.
THE ROYALTY TRUST
The Royalty Trust.
On
June 3, 2013
, FCX and McMoRan Exploration Co. (MMR) completed the transactions contemplated by the Agreement and Plan of Merger, dated as of
December 5, 2012
(the merger agreement), by and among MMR, FCX, and INAVN Corp., a Delaware corporation and indirect wholly owned subsidiary of FCX (Merger Sub). Pursuant to the merger agreement, Merger Sub merged with and into MMR, with MMR surviving the merger as an indirect wholly owned subsidiary of FCX (the merger).
FCX's oil and gas assets are held through its wholly owned subsidiary, FCX Oil & Gas LLC (FM O&G). As a result of the merger, MMR and McMoRan Oil & Gas LLC (McMoRan) are both indirect wholly owned subsidiaries of FM O&G.
The Royalty Trust is a statutory trust created as contemplated by the merger agreement by FCX under the Delaware Statutory Trust Act pursuant to a trust agreement entered into on
December 18, 2012
(inception), by and among FCX, as depositor, Wilmington Trust, National Association, as Delaware trustee, and certain officers of FCX, as regular trustees. On
May 29, 2013
, Wilmington Trust, National Association, was replaced by BNY Trust of Delaware, as Delaware trustee (the Delaware Trustee), through an action of the depositor. Effective
June 3, 2013
, the regular trustees were replaced by The Bank of New York Mellon Trust Company, N.A., a national banking association, as trustee (the Trustee).
The Royalty Trust was created to hold a
5%
gross overriding royalty interest (collectively, the overriding royalty interests) in future production from each of McMoRan's Inboard Lower Tertiary/Cretaceous exploration prospects located in the shallow waters of the Gulf of Mexico and onshore in South Louisiana that existed as of
December 5, 2012
, the date of the merger agreement (collectively, the subject interests). The subject interests were "carved out" of the mineral interests acquired by FCX pursuant to the merger and were not considered part of FCX's purchase consideration of MMR.
As described below, as of
December 31, 2017
, only the onshore Highlander subject interest had any reserves classified as proved, probable or possible and had established commercial production. During 2016 and the first quarter of 2017, FCX completed sales of oil and gas properties representing in the aggregate
94%
of its total proved reserves as of December 31, 2015. Although none of these transactions impacted the subject interests, McMoRan has informed the Trustee that it has no plans to pursue, has relinquished, or has allowed to expire all subject interests except for the onshore Highlander subject interest. Additionally, McMoRan has informed the Trustee that it is unlikely to drill additional wells on the onshore Highlander subject interest at the current time, considering existing natural gas prices and the cost of drilling and completing these wells. Under the operating agreement applicable to the leases associated with the subject interests, McMoRan is obligated to offer its interest in any acreage it decides to release to its co-lessees free and clear of the overriding royalty interest.
The overriding royalty interests are passive in nature, and neither the Trustee nor the Royalty Trust unitholders has any control over or responsibility for any costs relating to the drilling, development or operation of the subject interests. The Royalty Trust is not permitted to acquire other oil and natural gas properties or mineral interests or otherwise engage in activities beyond those necessary for the conservation and protection of the overriding royalty interests.
As of
December 31, 2017
, FCX owned
27.1%
of the outstanding royalty trust units. All information in this Form 10-K regarding the subject interests has been furnished to the Trustee by FCX and McMoRan. The reserve estimates have been prepared by independent petroleum engineers as described herein, based on information furnished by FM O&G subsidiaries.
The Royalty Trust Agreement.
In connection with the merger, on
June 3, 2013
, (1) FCX, as depositor, McMoRan, as grantor, the Trustee and the Delaware Trustee entered into the amended and restated royalty trust agreement to govern the Royalty Trust and the respective rights and obligations of FCX, the Trustee, the Delaware Trustee, and the Royalty Trust unitholders with respect to the Royalty Trust (the royalty trust agreement); and (2) McMoRan, as grantor, and the Royalty Trust, as grantee, entered into the master conveyance of overriding royalty interest (the master conveyance) pursuant to which McMoRan conveyed to the Royalty Trust the overriding royalty interests in future production from the subject interests.
Duties and Limited Powers of the Trustee.
The duties of the Trustee are specified in the royalty trust agreement and by the laws of the State of Delaware. The Trustee’s principal duties consist of:
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collecting income attributable to the overriding royalty interests;
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paying expenses, charges and obligations of the Royalty Trust from the Royalty Trust’s income and assets;
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distributing distributable income to the Royalty Trust unitholders; and
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prosecuting, defending or settling any claim of or against the Trustee, the Royalty Trust or the overriding royalty interests, including the authority to dispose of or relinquish title to any of the overriding royalty interests that are the subject of a dispute upon the receipt of sufficient evidence regarding the facts of such dispute.
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The Trustee has no authority to incur any contractual liabilities on behalf of the Royalty Trust that are not limited solely to claims against the assets of the Royalty Trust.
If a liability is contingent or uncertain in amount or not yet currently due and payable, the Trustee may create a cash reserve to pay for the liability. If the Trustee determines that the cash on hand and the cash to be received are insufficient to cover expenses or liabilities of the Royalty Trust, the Trustee may borrow funds required to pay those expenses or liabilities. The Trustee may borrow the funds from any person, including FCX or itself. The Trustee may also encumber the assets of the Royalty Trust (i.e., the overriding royalty interests) to secure payment of the indebtedness. If the Trustee, on behalf of the Royalty Trust, borrows funds, whether from FCX or from any other source, to cover expenses or liabilities, the Royalty Trust unitholders will not receive distributions until the borrowed funds are repaid. Since the Royalty Trust does not conduct an active business and the Trustee has little power to incur obligations, it is expected that the Royalty Trust will only incur liabilities for routine administrative expenses, such as the Trustee’s fees and accounting, engineering, legal, tax advisory and other professional fees.
The only assets of the Royalty Trust are the overriding royalty interests and the only investment activity the Trustee may engage in is the investment of cash on hand. Other than (a) its formation, (b) its receipt of contributions and loans from FCX for administrative and other expenses as provided for in the royalty trust agreement, (c) its payment of such administrative and other expenses, (d) its repayment of loans from FCX, (e) its receipt of the conveyance of the overriding royalty interests from McMoRan pursuant to the master conveyance, (f) its receipt of royalties from McMoRan, and (g) its cash distributions to unitholders, if any, the Royalty Trust has not conducted any activities. The Trustee has no involvement with, control over, or responsibility for, any aspect of any operations on or relating to the subject interests.
The Trustee has the right to require any Royalty Trust unitholder to dispose of his royalty trust units if an administrative or judicial proceeding seeks to cancel or forfeit any of the property in which the Royalty Trust holds an interest because of the nationality or any other status of a Royalty Trust unitholder. If a Royalty Trust unitholder fails to dispose of his royalty trust units, FCX is obligated to purchase them (up to a cap of $1 million) at a price determined in accordance with a formula set forth in the royalty trust agreement.
The Trustee is authorized to agree to modifications of the terms of the conveyances of the overriding royalty interests or to settle disputes involving such conveyances, so long as such modifications or settlements do not alter the nature of the overriding royalty interests as rights to receive a share of the proceeds from the underlying properties free of any obligation for drilling, development or operating expenses or rights that do not possess any operating rights or obligations.
Pursuant to the royalty trust agreement, FCX has agreed to pay annual trust expenses up to a maximum amount of
$350,000
, with no right of repayment or interest due, to the extent the Royalty Trust lacks sufficient funds to pay administrative expenses. No such contributions were made during the years ended
December 31, 2017
, and
December 31, 2016
. In addition to such annual contributions, FCX has agreed to lend money, on an unsecured, interest-free basis, to the Royalty Trust to fund the Royalty Trust's ordinary administrative expenses as set forth in the royalty trust agreement. Since inception, FCX has loaned
$650,000
to the Royalty Trust under this arrangement, all of which had been repaid prior to
December 31, 2017
, including
$500,000
during 2017, and no amounts were outstanding at
December 31, 2017
. All funds the Trustee borrows to cover expenses or liabilities, whether from FCX or from any other source, must be repaid before the Royalty Trust unitholders will receive any distributions.
Pursuant to the royalty trust agreement, FCX agreed to provide and maintain a
$1.0 million
stand-by reserve account or an equivalent letter of credit for the benefit of the Royalty Trust to enable the Trustee to draw on such reserve account or letter of credit to pay obligations of the Royalty Trust if its funds are inadequate to pay its obligations at any time. Currently, with the consent of the Trustee, FCX may reduce the reserve account or substitute a letter of credit with a different face amount for the original letter of credit or any substitute letter of credit. In connection with this arrangement, FCX has provided
$1.0 million
in the form of a reserve fund cash account to the Royalty Trust. As of
December 31, 2017
, the Royalty Trust had not drawn any funds from the reserve account, and FCX had not requested a reduction of such reserve account.
Fiduciary Responsibility and Liability of the Trustee.
The duties and liabilities of the Trustee are set forth in the royalty trust agreement and the laws of the State of Delaware. The Trustee may not make business decisions affecting the assets of the Royalty Trust. Therefore, substantially all of the Trustee’s functions under the royalty trust agreement are expected to be ministerial in nature. See the description in the section above entitled “
Duties and Limited Powers of the Trustee
.” The royalty trust agreement, however, provides that the Trustee may:
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charge for its services as trustee;
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retain funds to pay for future expenses and deposit them with one or more banks or financial institutions (which may include the Trustee to the extent permitted by law);
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lend funds at commercial rates to the Royalty Trust to pay the Royalty Trust’s expenses (however, the Trustee does not intend to lend funds to the Royalty Trust); and
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seek reimbursement from the Royalty Trust for its out-of-pocket expenses.
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In performing its duties to Royalty Trust unitholders, the Trustee may act in its discretion and is liable to the Royalty Trust unitholders only for willful misconduct, bad faith or gross negligence. The Trustee is not liable for any act or omission of its agents or employees unless the Trustee acted with willful misconduct, bad faith or gross negligence in its selection and retention. The Trustee will be indemnified individually or as trustee out of the Royalty Trust's assets for any liability or cost that it incurs in the administration of the Royalty Trust, except in cases of willful misconduct, bad faith or gross negligence. The Trustee has a lien on the assets of the Royalty Trust as security for this indemnification and its compensation earned as trustee. The Royalty Trust unitholders are not liable to the Trustee for any indemnification. The Trustee ensures that all contractual liabilities of the Royalty Trust are limited to the assets of the Royalty Trust.
Protection of Trustee
. Pursuant to the royalty trust agreement, the Trustee may request certification of any fact, circumstance, computation or other matter relevant to the Royalty Trust or the Trustee’s performance of its duties, and will be fully protected in relying on any such certification or other statement or advice from FCX or McMoRan or any officer or other employee of FCX or McMoRan. Any person having any claim against the Trustee by reason of the transactions contemplated by the royalty trust agreement or any of the related documents or agreements will look only to the Royalty Trust’s property for payment or satisfaction thereof.
Amendment of Trust Agreement.
Amendments to the royalty trust agreement generally require the affirmative vote of holders of a majority of royalty trust units constituting a quorum, although less than a majority of the royalty trust units then outstanding (including any royalty trust units held by FCX, other than with respect to matters where a conflict of interest between FCX and unaffiliated Royalty Trust unitholders is present). However, any amendment that would permit holders of fewer than
80%
(which, after
June 3, 2018
, will be reduced to
66⅔%
) of the outstanding royalty trust units to (i) approve a sale of all or substantially all of the overriding royalty interests or (ii) terminate the Royalty Trust requires the affirmative vote of holders of
80%
(which, after
June 3, 2018
, will be reduced to
66⅔%
) or more of the outstanding royalty trust units held by persons other than FCX or its affiliates.
FCX and the Trustee are permitted to supplement or amend the royalty trust agreement, without the approval of the Royalty Trust unitholders, in order to cure any ambiguity, to correct or supplement any provision which may be defective or inconsistent with any other provision thereof, or to change the name of the Royalty Trust, as long as such supplement or amendment does not adversely affect the interests of the Royalty Trust unitholders. However, no amendment may:
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alter the purposes of the Royalty Trust or permit the Trustee to engage in any business or investment activities other than as specified in the royalty trust agreement;
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alter the rights of the Royalty Trust unitholders as among themselves;
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permit the Trustee to distribute the overriding royalty interests in kind; or
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adversely affect the rights and duties of the Trustee unless such amendment is approved by the Trustee.
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Compensation of the Trustee.
The Trustee’s annual compensation has been $200,000 since 2016, when it increased from $150,000 as a result of the Royalty Trust’s receipt of royalties related to production from the onshore Highlander subject interest beginning in the second quarter of 2015. Additionally, the Trustee receives reimbursement for its reasonable out-of-pocket expenses incurred in connection with the administration of the Royalty Trust. In the event of litigation involving the Royalty Trust, audits or inspection of the records of the Royalty Trust pertaining to the transactions affecting the Royalty Trust or any other unusual or extraordinary services rendered in connection with the administration of the Royalty Trust, the Trustee would be entitled to receive additional reasonable compensation for the services rendered, including the payment of the Trustee’s standard rates for all time spent by personnel of the Trustee on such matters. The Trustee’s compensation is paid out of the Royalty Trust's assets. The Trustee has a lien on the Royalty Trust’s assets to secure payment of its compensation and any indemnification expenses and other amounts to which it is entitled under the royalty trust agreement.
Approval of Matters by Royalty Trust Unitholders.
The Trustee or Royalty Trust unitholders owning at least
15%
of the outstanding royalty trust units are permitted to call meetings of Royalty Trust unitholders. Meetings must be held in New York, New York. Written notice setting forth the time and place of the meeting and the matters proposed to be acted upon must be given to all Royalty Trust unitholders of record as of a record date set by the Trustee at least
20
days but not more than
60
days before the meeting. The presence in person or by proxy of Royalty Trust unitholders representing a majority of royalty trust units outstanding will constitute a quorum. Subject to the provisions of the royalty trust agreement regarding voting in the case of a material conflict of interest between FCX or its affiliates, and Royalty Trust unitholders other than FCX or its affiliates, each Royalty Trust unitholder will be entitled to one vote for each royalty trust unit owned.
Unless otherwise required by the royalty trust agreement, any matter (including unit splits or reverse splits) may be approved by the affirmative vote of holders of a majority of royalty trust units constituting a quorum, although less than a majority of the royalty trust units then outstanding (including any royalty trust units held by FCX, other than with respect to matters where a conflict of interest between FCX and unaffiliated Royalty Trust unitholders is present). The affirmative vote of the holders of
80%
(which, after
June 3, 2018
, will be reduced to
66⅔%
) of the outstanding royalty trust units will be required to (i) approve a sale of all or substantially all of the overriding royalty interests, (ii) terminate the Royalty Trust or (iii) amend the royalty trust agreement to permit the holders of fewer than
80%
(which, after
June 3, 2018
, will be reduced to
66⅔%
) of the outstanding royalty trust units to approve a sale of all or substantially all of the overriding royalty interests, or to terminate the Royalty Trust.
The Trustee may be removed, with or without cause, by the affirmative vote of holders of a majority of the outstanding royalty trust units.
Any action required or permitted to be authorized or taken at any meeting of Royalty Trust unitholders may be taken without a meeting, without prior notice and without a vote if a consent in writing setting forth the authorization or action taken is signed by Royalty Trust unitholders holding royalty trust units representing at least the minimum number of votes that would be necessary to authorize or take such action at a meeting.
If a meeting of Royalty Trust unitholders is called for any purpose or a written consent is executed at the request of any Royalty Trust unitholder while the Royalty Trust is subject to the requirements of Section 12 of the Exchange Act, the Royalty Trust unitholder requesting the meeting or soliciting the written consent will be required to prepare and file a proxy or information statement with the SEC regarding such meeting or written consent at its expense. The Royalty Trust unitholder requesting the meeting or written consent will bear the expense of distributing the notice of meeting and the proxy or information statement. The Trustee will be required only to provide a list of Royalty Trust unitholders to the extent required by law.
Duration of the Royalty Trust.
The Royalty Trust will dissolve on the earliest to occur of (i)
June 3, 2033
, (ii) the sale of all of the overriding royalty interests, (iii)
the election by the Trustee following its resignation for cause (as more fully described in the royalty trust agreement), (iv) a vote of the holders of
80%
(which after
June 3, 2018
, will be reduced to
66⅔%
) or more of the outstanding royalty trust units held by persons other than FCX or any of its
affiliates, at a duly called meeting of the Royalty Trust unitholders at which a quorum is present, or (v) the exercise by FCX of the right to call all of the royalty trust units as described in the next paragraph.
The overriding royalty interests terminate upon the termination of the Royalty Trust, other than in certain limited circumstances where the Royalty Trust has been permitted to transfer the overriding royalty interests to a third party pursuant to the terms of the royalty trust agreement (in which case the overriding royalty interests may extend through
June 3, 2033
).
FCX Call Rights.
FCX has a call right with respect to the outstanding royalty trust units at
$10
per royalty trust unit, which may not be exercised prior to
June 3, 2018
.
In addition, at any time after
June 3, 2018
, if the royalty trust units are then listed for trading or admitted for quotation on a national securities exchange or any quotation system and the volume weighted average price per royalty trust unit is equal to
$0.25
or less for the immediately preceding consecutive nine-month period, FCX may purchase all, but not less than all, of the outstanding royalty trust units at a price of
$0.25
per royalty trust unit so long as FCX tenders payment within
30
days following the end of such nine-month period. The volume weighted average price per royalty trust unit was
$0.04
for the nine-month period ended
March 15, 2018
.
Resignation of Trustee.
The Trustee may resign, with or without cause, at any time by providing at least
60
days notice to FCX and the Royalty Trust unitholders of record, but the resignation of the Trustee will not be effective until a successor trustee has accepted its appointment. The Trustee may nominate a successor trustee, which may be approved and appointed by FCX without a meeting or vote of the Royalty Trust unitholders. If the Trustee has given notice of resignation for cause and a successor trustee has not accepted its appointment as successor trustee during the
90-day
period following FCX's receipt of such notice, the annual fee payable to the Trustee will be increased by
5%
as of the end of such
90-day
period, and will be further increased by
5%
for each month or portion of a month thereafter (up to a maximum of two times the fee payable at the time the notice of resignation was received by FCX) until a successor trustee has accepted its appointment.
If at any time (a) the Trustee has not received compensation for its services or expenses or other amounts owed to the Trustee pursuant to the royalty trust agreement, (b) FCX has failed to fully fund a loan to the Royalty Trust in a reasonably timely manner after the Trustee has requested the loan pursuant to the royalty trust agreement or has failed to contribute funds to the Royalty Trust as required by the royalty trust agreement, (c) the Royalty Trust’s obligations exceed the amount of funds of the Royalty Trust available to pay such obligations, and (d) a stand-by reserve account or letter of credit is available to the Trustee as described in the royalty trust agreement, the Trustee is entitled to draw on the stand-by reserve account or letter of credit, then the Trustee would be permitted to resign for cause, and would be entitled to cause the sale of the overriding royalty interests and to dissolve, windup and terminate the Royalty Trust.
Overriding Royalty Interests
.
The royalty trust units represent beneficial interests in the Royalty Trust, which holds a
5%
gross overriding royalty interest in future production from each of the subject interests during the life of the Royalty Trust. An "overriding" royalty interest in general represents a non-operating interest in an oil and gas property that provides the owner a specified share of production without any related operating expenses or development costs and is carved out of an oil and gas lessee's working or cost-bearing interest in the lease. In contrast, a "working" or "cost-bearing" interest in general represents an operating interest in an oil and gas property that provides the owner a specified share of production that is subject to all production expenses and development costs. An owner of a working or cost-bearing interest, subject to the terms of an applicable operating agreement, generally has the right to participate in the selection of a prospect, drilling location or drilling contractor; to propose the drilling of a well; to determine the timing and sequence of drilling operations; to commence or shut down production; to take over operations; or to share in any operating decision. An owner of an overriding royalty interest generally has none of the rights described in the preceding sentence, and neither the Royalty Trust nor the Royalty Trust unitholders has any such rights.
The overriding royalty interests are free and clear of any and all drilling, development and operating costs and expenses, except that the overriding royalty interests bear a proportional share of costs incurred for activities downstream of the wellhead for gathering, transporting, compressing, treating, handling, separating, dehydrating or processing the produced hydrocarbons prior to their sale, and certain production, severance, sales, excise and similar taxes related to the sale of the produced hydrocarbons and property or ad valorem taxes to the extent assessed on the subject interests (the specified post-production costs and specified taxes, respectively). The hydrocarbons underlying the overriding royalty interests are valued at the wellhead (after deduction or withholding of specified taxes and less any specified post-production costs) and neither McMoRan nor FCX has any duty to transport or market the produced hydrocarbons away from the wellhead without cost. The hydrocarbons underlying the overriding royalty interests are subject to and bear production and similar taxes.
Royalty Trust Units.
Each royalty trust unit represents a pro rata undivided share of beneficial ownership in the Royalty Trust. Each royalty trust unit entitles its holder to the same rights and benefits as the holder of any other royalty trust unit, and the Royalty Trust has no other authorized or outstanding class of equity security.
Distributions and Income Computations.
Royalties received by the Royalty Trust must first be used to (i) satisfy Royalty Trust administrative expenses and (ii) reduce Royalty Trust indebtedness. The Royalty Trust had no indebtedness outstanding as of
December 31, 2017
. Additionally, the Trustee has established a minimum cash reserve of
$250,000
. As a result, distributions will be made to Royalty Trust unitholders only when royalties received less administrative expenses incurred and repayment of any indebtedness exceeds the
$250,000
minimum cash reserve. Distributable income totaled
$356,486
for the year ended
December 31, 2017
. On January 17, 2018, the Royalty Trust declared a cash distribution of $0.000901 per unit payable on February 13, 2018, to unitholders of record on January 30, 2018, and on October 16, 2017, the Royalty Trust declared a cash distribution of $0.000648 per unit payable on November 13, 2017, to unitholders of record on October 30, 2017. The Royalty Trust has made no other distributions to date, and these distributions are not necessarily indicative of future distributions. There was no distributable income for the year ended
December 31, 2016
or any prior periods. The Royalty Trust's only other sources of liquidity are mandatory annual contributions, any loans and the required standby reserve account or letter of credit from FCX. As a result, any material adverse change in FCX's or McMoRan's financial condition or results of operations could materially and adversely affect the Royalty Trust and the underlying royalty trust units. Royalty Trust unitholders that own their royalty trust units on the close of business on the record date for each calendar quarter will receive a pro-rata distribution of the amount of the cash available for distribution generally 10 business days after the quarterly record date.
Unless otherwise advised by counsel or the Internal Revenue Service (IRS), the Trustee will record the income and expenses of the Royalty Trust for each quarterly period as belonging to the Royalty Trust unitholders of record on the quarterly record date. The Royalty Trust unitholders will recognize income and expenses for tax purposes in the quarter of receipt or payment by the Royalty Trust, rather than in the quarter of distribution by the Royalty Trust. Minor variances may occur; for example, a reserve could be established in one quarterly period that would not give rise to a tax deduction until a later quarterly period, or an expenditure paid in one quarterly period might be amortized for tax purposes over several quarterly periods.
Transfer of the Royalty Trust Units
. Royalty Trust unitholders are permitted to transfer their royalty trust units in accordance with the royalty trust agreement. The Trustee will not require either the transferor or transferee to pay a service charge for any transfer of a royalty trust unit. The Trustee may require payment of any tax or other governmental charge imposed for a transfer. The Trustee may treat the owner of any royalty trust unit as shown by its records as the owner of the royalty trust unit. The Trustee will not be considered to know about any claim or demand on a royalty trust unit by any party except the record owner. A person who acquires a royalty trust unit after any quarterly record date will not be entitled to the distribution relating to that quarterly record date. Delaware law and the royalty trust agreement will govern all matters affecting the title, ownership or transfer of royalty trust units.
Periodic Reports.
Within
45
days following the end of each of the first three fiscal quarters, and within
90
days following the end of each fiscal year, the Royalty Trust files a quarterly report on Form 10-Q, or annual report on Form 10-K, as appropriate, with the SEC.
The Royalty Trust files all required federal and state income tax and information returns. Within
75
days following the end of each fiscal year, the Royalty Trust prepares and mails to each Royalty Trust unitholder of record as of a quarterly record date during such year a report in reasonable detail with the information that Royalty Trust unitholders need to correctly report their share of the income and deductions of the Royalty Trust.
The royalty trust agreement also requires FCX or McMoRan to provide to the Royalty Trust such other information available to FCX or McMoRan concerning the overriding royalty interests and the subject interests burdened by the overriding royalty interests and related matters as may be necessary for the Royalty Trust to comply with its reporting obligations. In addition, the royalty trust agreement requires FCX or McMoRan to provide to the Royalty Trust all information required to comply with the requirements of the Exchange Act (including a “Trustee’s Discussion and Analysis of Financial Condition and Results of Operations” relating to the Royalty Trust's financial statements) and such further information as may be required or reasonably requested by the Trustee from time to time. Pursuant to the royalty trust agreement, the Royalty Trust and the Trustee are entitled to rely on the information provided by FCX or McMoRan without investigation and are fully protected and will incur no liability in doing so. However, neither FCX nor McMoRan nor their affiliates may be required to disclose, produce or prepare any information, documents or other materials which were generated for analysis or discussion purposes, contain
interpretative data, or are subject to the attorney-client or attorney-work-product privileges, or any other privileges to which they may be entitled pursuant to applicable law.
A Royalty Trust unitholder and his representatives may examine, during reasonable business hours and at the expense of such Royalty Trust unitholder, the records of the Royalty Trust and the Trustee.
Liability of the Royalty Trust Unitholders and the Royalty Trust
. Under the Delaware Statutory Trust Act, Royalty Trust unitholders are entitled to the same limitation of personal liability extended to stockholders of private for-profit corporations under the Delaware General Corporation Law. Nevertheless, courts in jurisdictions outside of Delaware may not give effect to such limitation of personal liability.
Uncertificated Interests; Transfer Agent
. The royalty trust units are uncertificated, and ownership of the royalty trust units is evidenced by entry of a notation in an ownership ledger maintained by the Trustee or a transfer agent designated by the Trustee. The transfer agent is American Stock Transfer & Trust Company, LLC. The Trustee may dismiss the transfer agent and designate a successor transfer agent at any time.
THE SUBJECT INTERESTS
As more fully discussed below, McMoRan has informed the Trustee that it has no plans to pursue, has relinquished, or has allowed to expire all subject interests except for the onshore Highlander subject interest.
The subject interests originally consisted of
20
specified Inboard Lower Tertiary/Cretaceous prospects (with target depths generally greater than
18,000
feet total vertical depth) located in the shallow waters of the Gulf of Mexico and onshore in South Louisiana. The offshore subject interests consisted of the following exploration prospects: (1) Barataria; (2) Barbosa; (3) Blackbeard East; (4) Blackbeard West; (5) Blackbeard West #3; (6) Bonnet; (7) Calico Jack; (8) Captain Blood; (9) Davy Jones; (10) Davy Jones West; (11) Drake; (12) England; (13) Hook; (14) Hurricane; (15) Lafitte; (16) Morgan; and (17) Queen Anne's Revenge. The onshore subject interests consisted of (1) Highlander; (2) Lineham Creek; and (3) Tortuga. Other than the onshore Highlander subject interest, which began commercial production on
February 25, 2015
, the onshore subject interests remained exploration prospects. McMoRan owns
72%
of the working interest associated with the onshore Highlander subject interest. The overriding royalty interests in future production from the subject interests burdened all of McMoRan's leasehold interests associated with such prospects as of
December 5, 2012
, and also burdened any leasehold interests associated with such prospects that McMoRan acquired on or before
December 5, 2017
, up to the estimated working interests reflected in the master conveyance (subject to McMoRan's right to dispose of a portion of the working interests to a percentage not less than the estimated working interests reflected in the master conveyance). Each of the overriding royalty interests has been, or will be, proportionately reduced based on McMoRan's working interest to equal the product of
5%
multiplied by a fraction, the numerator of which is the working interest held by McMoRan and its affiliates associated with the applicable subject interest (subject to a cap equal to McMoRan's estimated working interest (equal to the working interest McMoRan owns or expects to acquire and as reflected in the master conveyance) associated with each subject interest, on a prospect-by-prospect basis) and the denominator of which is
100%
.
As of
December 5, 2012
, the date of the merger agreement, the subject interests comprised all of McMoRan's Inboard Lower Tertiary/Cretaceous exploration prospects. Additional Inboard Lower Tertiary/Cretaceous exploration prospects developed by McMoRan (other than those reflected below), if any, will not be included in the subject interests. As of December 31, 2017, McMoRan had acquired working interests in additional Inboard Lower Tertiary/Cretaceous exploration prospects that are not part of the subject interests.
As of
December 31, 2017
, only the onshore Highlander subject interest had any reserves classified as proved, probable or possible and had established commercial production. During 2016 and the first quarter of 2017, FCX completed sales of oil and gas properties representing in the aggregate
94%
of its total proved reserves as of December 31, 2015. Although none of these transactions impacted the subject interests, McMoRan has informed the Trustee that it has no plans to pursue, has relinquished, or has allowed to expire all subject interests except for the onshore Highlander subject interest. Additionally, McMoRan has informed the Trustee that it is unlikely to drill additional wells on the onshore Highlander subject interest at the current time, considering existing natural gas prices and the cost of drilling and completing these wells. Under the operating agreement applicable to the leases associated with the subject interests, McMoRan is obligated to offer its interest in any acreage it decides to release to its co-lessees free and clear of the overriding royalty interest.
Exploratory and Development Drilling.
McMoRan did not drill any exploration or development wells on the subject interests during the years ended
December 31, 2017
, and
December 31, 2016
. Additionally, there were no in-progress or suspended wells associated with the subject interests during the years ended
December 31, 2017
, and
December 31, 2016
.
The onshore Highlander subject interest is the only producing subject interest and began commercial production on
February 25, 2015
. Prior to this date, there had been no commercial production of hydrocarbons from any of the subject interests. During the year ended
December 31, 2017
, the Royalty Trust received royalties of
$1,376,758
from McMoRan related to
525,972
thousand cubic feet (Mcf) of natural gas production attributable to the onshore Highlander subject interest with average post-production expense costs of
$0.30
per Mcf and an average receipt price of
$2.91
per Mcf. During the year ended
December 31, 2016
, the Royalty Trust received royalties of
$835,963
from McMoRan related to
420,468
Mcf of natural gas production attributable to the onshore Highlander subject interest with average post-production expense costs of
$0.25
per Mcf and an average receipt price of
$2.24
per Mcf.
Acreage.
During the year ended
December 31, 2017
,
19,945
gross acres (
12,167
acres net to McMoRan's interest) associated with the offshore Davy Jones, Hurricane and Lafitte and onshore Highlander subject interests expired or were relinquished. At
December 31, 2017
, McMoRan owned interests in approximately
170
oil and gas leases in the shallow waters of the Gulf of Mexico and onshore in South Louisiana, covering approximately
14,306
gross acres (
7,257
acres net to McMoRan's interests) associated with the subject interests. Approximately
3%
of those net acres associated with the subject interests are scheduled to expire between 2018 and 2020, unless a lease on such acreage is perpetuated by a lease holding operation. Whether or not McMoRan maintains the acreage scheduled to expire is determined by McMoRan's current and future plans, over which the Royalty Trust has no control. McMoRan has informed the Trustee that it has no plans to pursue, has relinquished, or has allowed to expire all subject interests except for the onshore Highlander subject interest. Additionally, McMoRan has informed the Trustee that it is unlikely to drill additional wells on the onshore Highlander subject interest at the current time, considering existing natural gas prices and the cost of drilling and completing these wells. Under the operating agreement applicable to the leases associated with the subject interests, McMoRan is obligated to offer its interest in any acreage it decides to release to its co-lessees free and clear of the overriding royalty interest.
The following table reflects the oil and gas acreage associated with the subject interests in which McMoRan owned rights to the related leases as of
December 31, 2017
.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Developed
|
|
Undeveloped
(a)
|
|
|
|
Gross
|
|
Net
|
|
Gross
|
|
Net
|
|
|
|
Acres
|
|
Acres
|
|
Acres
|
|
Acres
|
|
Offshore (federal waters)
|
|
—
|
|
|
—
|
|
|
5,000
|
|
|
600
|
|
|
Onshore South Louisiana
|
|
9,000
|
|
|
6,463
|
|
|
306
|
|
|
194
|
|
|
Total as of December 31, 2017
|
|
9,000
|
|
|
6,463
|
|
|
5,306
|
|
|
794
|
|
|
|
|
(a)
|
As a result of impairment charges recorded in 2015 and prior years, there is no carrying value associated with undeveloped acreage remaining at
December 31, 2017
as McMoRan has informed the Trustee that it has no plans to pursue any of the subject interests associated with this acreage.
|
Oil and Natural Gas Reserves.
McMoRan's estimated proved reserves related to the subject interests are based upon a reserve report prepared by Netherland, Sewell & Associates, Inc. (NSAI), an independent petroleum engineering firm. A copy of NSAI's reserve report is filed as an exhibit to this Form 10-K. These reserve estimates are prepared in accordance with guidelines established by the SEC as prescribed by Regulation S-X, Rule 4-10. McMoRan's technical staff estimates, with reasonable certainty, the economically producible oil and natural gas associated with the subject interests. The practices for estimating hydrocarbons in place include, but are not limited to, mapping, seismic interpretation of two-dimensional and/or three-dimensional data, core analysis, mechanical properties of formations, thermal maturity, well logs of existing penetrations, correlation of known penetrations, decline curve analysis of producing locations with significant production history, well testing, static bottom hole testing, flowing bottom hole pressure analysis and pressure and rate transient analysis.
Internal Control and Qualifications of Third Party Engineers and Internal Staff.
The technical personnel responsible for preparing the reserve estimates at NSAI meet the requirements regarding qualifications, independence, objectivity, and confidentiality set forth in the Standards Pertaining to the Estimating and Auditing of Oil and Gas
Reserves Information promulgated by the Society of Petroleum Engineers. NSAI is an independent firm of petroleum engineers, geologists, geophysicists, and petrophysicists; the firm does not own an interest in McMoRan's properties and is not employed on a contingent fee basis. McMoRan's internal staff of petroleum engineers and geoscience professionals work closely with its independent reserve engineers to ensure the integrity, accuracy and timeliness of data furnished to NSAI in their reserve estimation process. Throughout each fiscal year, McMoRan's technical staff meets with representatives of NSAI to review properties and discuss methods and assumptions used in preparation of the proved reserves estimates. McMoRan provides historical information to NSAI, including ownership interest, oil and gas production, well test data, commodity prices and operating and development costs. The NSAI reserve report is reviewed with representatives of NSAI and McMoRan's internal technical staff before dissemination of the information. Additionally, McMoRan's senior management reviews the NSAI reserve report.
The internal reservoir engineering staff is supervised by FM O&G's Vice President of Operations, who has
36
years of technical experience in petroleum engineering and reservoir evaluation and analysis. This individual directs the activities of its internal reservoir engineering staff for the internal reserve estimation process and also to provide the appropriate data to NSAI for the year-end oil and gas reserves estimation process. The preparation of proved oil and gas reserve estimates are completed in accordance with McMoRan's internal control procedures. These procedures, which are intended to ensure reliability of reserve estimations, include (i) the review and verification of historical production data, (ii) the review by FM O&G's Vice President of Operations of annually reported proved reserves, including the review of significant reserve changes and new proved undeveloped reserves additions, if any, (iii) the verification of property ownership by McMoRan’s land department; and (iv) none of McMoRan's employee’s compensation being tied to the amount of reserves reported.
Proved Reserves.
Proved reserve volumes attributable to the subject interests have been determined in accordance with SEC guidelines, which require the use of an average price, calculated as the twelve-month historical average of the first-day-of-the-month historical reference price as adjusted for location and quality differentials, unless prices are defined by contractual arrangements, excluding escalations based upon future conditions and the impact of derivatives. The reference price for reserve determination is the Henry Hub spot price for natural gas, which was
$2.98
per million British thermal units (MMBtu) as of
December 31, 2017
. The price is held constant throughout the life of the property, except where such guidelines permit alternate treatment, including the use of fixed and determinable contractual escalations. In accordance with the guidelines, the average realized price used in McMoRan's reserve reports as of
December 31, 2017
, was
$2.84
per Mcf of natural gas. All of the natural gas reserves attributable to the subject interests are located in the U.S. There were no oil reserves as of
December 31, 2017
.
The scope and results of procedures employed by NSAI are summarized in their reserve report. For purposes of reserve estimation, McMoRan and NSAI use technical and economic data including well logs, geologic maps, seismic data, well test data, production data, historical price and cost information, and property ownership interests. McMoRan's reserves have been estimated using deterministic methods. Standard engineering and geoscience methods were used, or a combination of methods, including performance analysis, volumetric analysis and analogy, which McMoRan and NSAI considered to be appropriate and necessary to categorize and estimate reserves in accordance with SEC definitions and regulations. Because these estimates depend on many assumptions, any or all of which may differ substantially from actual results, reserve estimates may differ from the quantities of oil and natural gas that McMoRan ultimately recovers.
Proved reserves represent quantities of oil and natural gas, which, by analysis of geoscience and engineering data, can be estimated with reasonable certainty to be economically producible from a given date forward, from known reservoirs, and under existing economic conditions, operating methods and government regulations. The term “reasonable certainty” implies a high degree of confidence that the quantities of oil and natural gas actually recovered will equal or exceed the estimate. The following table presents estimated proved reserves attributable to the subject interests as of
December 31, 2017
:
|
|
|
|
|
Natural Gas
|
|
(MMcf)
|
|
|
Proved developed
|
1,528
|
|
Proved undeveloped
|
—
|
|
Total proved reserves
|
1,528
|
|
The following table reflects the present value of estimated future net cash flows before income taxes from the production and sale of estimated proved reserves attributable to the subject interests reconciled to the standardized measure of discounted net cash flows (standardized measure) at
December 31, 2017
.
|
|
|
|
|
|
|
|
Estimated undiscounted future net cash flows before income taxes
|
$
|
3,713,800
|
|
Present value of estimated future net cash flows before income taxes (PV-10)
(a), (b)
|
$
|
3,263,600
|
|
Discounted future income taxes
(c)
|
|
—
|
|
Standardized measure (See Note 9)
|
$
|
3,263,600
|
|
|
|
(a)
|
In accordance with SEC guidelines, estimates of future net cash flows from proved reserves and the present value thereof are made using the twelve-month average of the first-day-of-the-month historical reference prices as adjusted for location and quality differentials. The reference price as of
December 31, 2017
, was
$2.98
per MMBtu of natural gas. These prices are held constant throughout the life of the oil and natural gas properties, except where such guidelines permit alternate treatment, including the use of fixed and determinable contractual price escalations. In accordance with the guidelines, the average realized price used in the Royalty Trust reserve report as of
December 31, 2017
, was
$2.84
per Mcf of natural gas. The Royalty Trust's reference prices are the Henry Hub spot price for natural gas.
|
|
|
(b)
|
The present value of estimated future net cash flows before income taxes (PV-10) is not considered a U.S. generally accepted accounting principle (GAAP) financial measure. The Royalty Trust believes that the PV-10 presentation is relevant and useful to its investors because it presents the discounted future net cash flows attributable to the subject interest's proved reserves. PV-10 is not a measure of financial or operating performance under GAAP and is not intended to represent the current market value of our estimated oil and natural gas reserves. PV-10 should not be considered in isolation or as a substitute for the standardized measure of discounted future net cash flows as defined under GAAP. See Note 9 to the Notes to Financial Statements located in Part II, Item 8. “Financial Statements and Supplementary Data” of this Form 10-K.
|
|
|
(c)
|
For tax reporting purposes, the Royalty Trust is considered a non-taxable "pass-through" entity, see Note 4.
|
Refer to Note 8 to the Notes to Financial Statements located in Part II, Item 8. “Financial Statements and Supplementary Data” of this Form 10-K for further discussion of proved reserves.
Production and Productive Well Interests
.
As of
December 31, 2017
, only the onshore Highlander subject interest had established commercial production, which began on
February 25, 2015
. Prior to this date there had been no commercial production of hydrocarbons from any of the subject interests. During the year ended
December 31, 2017
, the Royalty Trust received royalties of
$1,376,758
from McMoRan related to
525,972
Mcf of natural gas production attributable to the onshore Highlander subject interest with average post-production expense costs of
$0.30
per Mcf and an average receipt price of
$2.91
per Mcf. During the year ended
December 31, 2016
, the Royalty Trust received royalties of
$835,963
from McMoRan related to
420,468
Mcf of natural gas production attributable to the onshore Highlander subject interest with average post-production expense costs of
$0.25
per Mcf and an average receipt price of
$2.24
per Mcf.
REGULATION
Although the Royalty Trust is not responsible for the activities, expenses, and obligations discussed in this section, such matters relate to McMoRan’s activities with respect to the subject interests.
General
.
McMoRan’s exploration, development and production activities are subject to federal, state and local laws and regulations governing exploration, development, production, environmental matters, occupational health and safety, taxes, labor standards and other matters. McMoRan has obtained or timely applied for all material licenses, permits and other authorizations currently required for operations. Compliance is often burdensome, and failure to comply carries substantial penalties. The regulatory burden on the oil and gas industry increases the cost of doing business and affects profitability.
Exploration, Production and Development
. Among other things, federal and state level regulation of McMoRan’s operations mandate that operators obtain permits to drill wells and to meet bonding and insurance requirements in order to drill, own or operate wells. These regulations also control the location of wells, the method of drilling and casing wells, the restoration of properties upon which wells are drilled and the plugging and abandoning of wells. McMoRan’s oil and natural gas operations are also subject to various conservation laws and regulations, which regulate the size of drilling units, the number of wells that may be drilled in a given area, the levels of production, and the unitization or pooling of oil and natural gas properties.
Federal Leases.
As of
December 31, 2017
, there is
one
offshore lease located in federal waters on the Gulf of Mexico’s outer continental shelf relating to the subject interests. McMoRan has informed the Trustee that it does not plan to develop or further develop the subject interest associated with this lease.
Federal offshore leases are administered by the BOEM and the BSEE. The lease was obtained through competitive bidding, contains relatively standard terms and requires compliance with detailed BOEM regulations, BSEE regulations and the Outer Continental Shelf Lands Act (OCSLA), each of which is subject to interpretation and change. Lessees must obtain BOEM approval for exploration, development and production plans prior to the commencement of offshore operations. In addition, approvals and permits are required from other agencies such as the U.S. Coast Guard and the Environmental Protection Agency (EPA). BSEE has regulations requiring offshore production facilities and pipelines located on the outer continental shelf to meet stringent engineering and construction specifications, and has proposed and/or promulgated additional safety-related regulations concerning the design and operating procedures of these facilities and pipelines, including regulations to safeguard against or respond to well blowouts and other catastrophes. BSEE regulations also restrict the flaring or venting of natural gas and prohibit the flaring of liquid hydrocarbons and oil without prior authorization.
State and Local Regulation of Drilling and Production.
McMoRan also owns interests in properties located in state waters of Louisiana and onshore in South Louisiana. Louisiana regulates drilling and operating activities by requiring, among other things, drilling permits and bonds and reports concerning operations. The laws of Louisiana also govern a number of environmental and conservation matters, including the handling and disposing of waste materials, unitization and pooling of oil and natural gas properties, and the levels of production from oil and natural gas wells.
McMoRan has informed the Trustee that it has no plans to pursue, has relinquished, or has allowed to expire all subject interests except for the onshore Highlander subject interest. Additionally, McMoRan has informed the Trustee that it is unlikely to drill additional wells on the onshore Highlander subject interest at the current time, considering existing natural gas prices and the cost of drilling and completing these wells. To the extent that McMoRan does not fund the exploration and development of the subject interests, or if for any other reason sufficient production from the onshore Highlander subject interest is not maintained in commercial quantities, Royalty Trust unitholders will not realize any additional value from their investment in the royalty trust units.
Environmental Matters
.
McMoRan’s operations are subject to numerous laws relating to environmental protection. These laws impose substantial penalties for any pollution resulting from McMoRan’s operations. The Trustee has been advised by McMoRan that McMoRan believes that its operations comply with applicable laws, including environmental laws, in all material respects.
Solid Waste.
McMoRan’s operations require the disposal of both hazardous and nonhazardous solid wastes that are subject to the requirements of the Federal Resource Conservation and Recovery Act (RCRA) and comparable
state statutes. In addition, the EPA and certain states in which McMoRan currently operates are presently in the process of developing stricter disposal standards for nonhazardous waste. Changes in these standards may impact McMoRan’s operations.
Hazardous Substances.
The Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA), also known as the “Superfund” law, imposes liability, without regard to fault or the legality of the original conduct, on some classes of persons that are considered to have contributed to the release of a “hazardous substance” into the environment. These persons include but are not limited to the owner or operator of the site or sites where the release occurred or was threatened to occur and companies that disposed or arranged for the disposal of the hazardous substances found at the site. Persons responsible for releases of hazardous substances under CERCLA may be subject to joint and several liability for the costs of cleaning up the hazardous substances and for damages to natural resources. Despite the RCRA exemption that encompasses wastes directly associated with crude oil and gas production and the “petroleum exclusion” of CERCLA, McMoRan may generate or arrange for the disposal of “hazardous substances” within the meaning of CERCLA or comparable state statutes in the course of its ordinary operations. Thus, McMoRan may be responsible under CERCLA (or the state equivalents) for costs required to clean up sites where the release of a “hazardous substance” has occurred. Also, it is not uncommon for neighboring landowners and other third parties to file claims for cleanup costs as well as personal injury and property damage allegedly caused by the hazardous substances released into the environment. Thus, McMoRan may be subject to cost recovery and to some other claims as a result of its operations.
Air.
McMoRan’s operations are also subject to regulation of air emissions under the Clean Air Act, comparable state and local requirements and the OCSLA. The scheduled implementation of these laws could lead to the imposition of new air pollution control requirements on McMoRan's operations. Therefore, McMoRan may incur future capital expenditures to upgrade its air pollution control equipment.
Water.
The Clean Water Act prohibits any discharge into waters of the U.S. except in strict conformance with permits issued by federal and state agencies. Failure to comply with the ongoing requirements of these laws or inadequate cooperation during a spill event may subject a responsible party to civil or criminal enforcement actions. Similarly, the Oil Pollution Act of 1990 (Oil Pollution Act) imposes liability on “responsible parties” for the discharge or substantial threat of discharge of oil into navigable waters or adjoining shorelines. A “responsible party” includes the owner or operator of a facility or vessel, or the lessee or permittee of the area in which a facility is located. The Oil Pollution Act assigns liability to each responsible party for oil removal costs and a variety of public and private damages. While liability limits apply in some circumstances, a party cannot take advantage of liability limits if the spill was caused by gross negligence or willful misconduct, or resulted from violation of a federal safety, construction or operating regulation. If the party fails to report a spill or to cooperate fully in the cleanup, liability limits likewise do not apply. Even if applicable, the liability limits for offshore facilities require the responsible party to pay all removal costs, plus up to $133.65 million in other damages. Few defenses exist to the liability imposed by the Oil Pollution Act.
The Oil Pollution Act also requires a responsible party to submit proof of its financial responsibility to cover environmental cleanup and restoration costs that could be incurred in connection with an oil spill. The Oil Pollution Act requires parties responsible for offshore facilities to provide financial assurance in amounts that vary from $35 million to $150 million depending on a company’s calculation of its “worst case” oil spill. McMoRan currently maintains insurance on its respective facilities to meet the financial assurance obligations under the Oil Pollution Act.
Climate Change.
The EPA has published findings that emissions of carbon dioxide, methane and certain other greenhouse gases (GHGs) present an endangerment to public health and the environment because emissions of such gases are, according to the EPA, contributing to warming of the earth’s atmosphere and other climatic changes. Based on its findings, the EPA has adopted and implemented regulations under existing provisions of the Clean Air Act that could result in additional permitting requirements and conditions, including performance standards, to limit or reduce GHG emissions, including the possible installation of additional pollution control equipment and technology to address GHGs. These requirements may result in increased costs of oil and gas operations and could adversely affect McMoRan’s operations and restrict or delay its ability to obtain air permits for new or modified facilities that exceed GHG thresholds. The extent to which the EPA may promulgate additional regulations and requirements relating to GHG emissions, or possibly reduce or eliminate existing regulations and requirements, is unclear. Such uncertainty and the inability to predict levels of expenditures required to comply with GHG regulations and requirements could adversely affect McMoRan’s operations.
While Congress has from time to time considered legislation to reduce emissions of GHGs, there has not been significant activity in the form of adopted legislation to reduce GHG emissions at the federal level. As a result, efforts have been made at the state and regional levels to track and/or reduce GHG emissions by means of cap and trade programs that typically requires major sources of GHG emissions to acquire and surrender emission allowances in return for emitting those GHGs. The adoption of any legislation or regulations imposing reporting obligations on McMoRan equipment and operations, limiting emissions of GHGs from McMoRan equipment and operations, or requiring McMoRan to acquire emission allowances or credits, could require additional costs to be incurred by McMoRan or inhibit or delay operations or expansion efforts.
On an international level, the United States is one of almost 200 nations that agreed in December 2015 to an international climate change agreement in Paris, France that calls for countries to set their own GHG emissions targets and disclose the measures each country will use to achieve its GHG emissions targets (the “Paris Agreement”). However, the Paris Agreement does not impose any binding obligations on the United States. Moreover, in June 2017, President Trump stated that the United States would withdraw from the Paris Agreement, but may enter into a future international agreement related to GHGs. In August 2017, the U.S. State Department officially informed the United Nations of the intent of the United States to withdraw from the Paris Climate Agreement. The United States’ adherence to the exit process is uncertain and/or the terms on which the United States may reenter the Paris Agreement or a separately negotiated agreement are unclear at this time. The adoption and implementation of any laws or regulations imposing reporting obligations on, or limiting emissions of GHG from operations could require additional costs incurred to reduce emissions of GHGs associated with operations or could adversely affect demand for the oil, natural gas and NGL production attributable to the overriding royalty interests, and thus possibly have a material adverse effect on the Royalty Trust’s revenues.
Endangered Species.
Several federal laws impose regulations designed to ensure that endangered or threatened plant and animal species are not jeopardized and their critical habitats are neither destroyed nor modified by federal action. These laws may restrict McMoRan’s exploration, development, and production operations and impose civil or criminal penalties for noncompliance.
EMPLOYEES
The Royalty Trust is a passive entity and has no employees. All administrative functions of the Royalty Trust are performed by the Trustee.
COMPETITION
The production and sale of oil and natural gas in the shallow waters of the Gulf of Mexico and onshore in South Louisiana is highly competitive, particularly with respect to hiring and retention of technical personnel, the acquisition of leases, interests and other properties, and access to drilling rigs and other services in such areas. McMoRan’s competitors in these areas include major integrated oil and gas companies and numerous independent oil and gas companies, individual producers and operators.
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.
Additionally, future price fluctuations for oil and natural gas will directly affect the amount of distributions to Royalty Trust unitholders and will also affect estimates of reserves attributable to the overriding royalty interests and estimated and actual future net revenues of the Royalty Trust. Neither McMoRan nor the Royalty Trust can make reliable predictions of future oil and natural gas supply and demand or future product prices. For more information regarding risks associated with oil and natural gas production and commodity price fluctuations, see Part I, Item 1A. “Risk Factors” of this Form 10-K.
SEASONALITY
All of the Royalty Trust’s assets are located in the U.S., where demand for natural gas is typically lower in summer than in the winter. Tropical storms and hurricanes, which are particularly common in the Gulf of Mexico and South Louisiana during the summer and early fall of each year, can damage or completely destroy drilling,
production and treatment facilities, which can result in the interruption or permanent cessation of production from associated wells. The Royalty Trust is not otherwise materially affected by seasonal factors.
TAX CONSIDERATIONS
The following is a summary of certain U.S. federal income tax matters that may be relevant to the Royalty Trust unitholders. This summary is based upon current provisions of the Internal Revenue Code of 1986, as amended (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 Royalty Trust or the Royalty Trust unitholders.
The summary has limited application to non-U.S. persons and persons subject to special tax treatment such as, without limitation: banks, insurance companies or other financial institutions; Royalty Trust unitholders subject to the alternative minimum tax; tax-exempt organizations; dealers in securities or commodities; regulated investment companies; real estate investment trusts; traders in securities that elect to use a mark-to-market method of accounting for their securities holdings; non-U.S. Royalty Trust unitholders that are “controlled foreign corporations” or “passive foreign investment companies”; persons that are S-corporations, partnerships or other pass-through entities; persons that own their interest in the Royalty Trust Units through S-corporations, partnerships or other pass-through entities; persons that at any time own more than 5% of the aggregate fair market value of the Royalty Trust Units; expatriates and certain former citizens or long-term residents of the United States; U.S. Royalty Trust unitholders whose functional currency is not the U.S. dollar; persons who hold the Royalty Trust Units as a position in a hedging transaction, “straddle”, “conversion transaction” or other risk reduction transaction; or persons deemed to sell the Royalty Trust Units under the constructive sale provisions of the Code. Each Royalty Trust unitholder should consult his own tax advisor with respect to his particular circumstances.
Tax counsel to the special committee of the board of directors of MMR advised the Royalty Trust at the time of formation that, for U.S. federal income tax purposes, in its opinion, the Royalty Trust would be treated as a grantor trust and not as an unincorporated business entity. No ruling has been or will be requested from the IRS or another taxing authority. The Tax Cuts and Jobs Act (the Act) enacted on December 22, 2017, includes significant modifications to existing U.S. tax laws. Aside from lowering corporate and individual rates, the Act did not impact the tax status of the Royalty Trust or the way unitholders will be taxed.
As a grantor trust, the Royalty Trust is not subject to tax at the Royalty Trust level. Rather, the Royalty Trust unitholders are considered to own and receive the Royalty Trust's assets and income and are directly taxable thereon as though no trust were in existence. Under Treasury Regulations, the Royalty Trust is classified as a widely held fixed investment trust. Pursuant to a de minimis test provided for in the Treasury Regulations, the Royalty Trust is only required to report the amount of sales proceeds distributed to a Royalty Trust unitholder during the year with respect to a sale or disposition of a trust asset. In addition, the Treasury Regulations require the sharing of tax information among trustees and intermediaries that hold a trust interest on behalf of or for the account of a beneficial owner or any representative or agent of a trust interest holder of fixed investment trusts that are classified as widely held fixed investment trusts.
The widely held fixed investment trust reporting requirements provide for the dissemination of trust tax information by the trustee to intermediaries who are ultimately responsible for reporting the investor-specific information through Form 1099 to the investors and the IRS. Every trustee or intermediary that is required to file a Form 1099 for a Royalty Trust unitholder must furnish a written tax information statement that is in support of the amounts as reported on the applicable Form 1099 to the Royalty Trust unitholder. In compliance with the reporting requirements of the Treasury regulations for non-mortgage widely held fixed investment trusts and the dissemination of Royalty Trust tax reporting information, the Trustee provides a generic tax information reporting booklet which is intended to be used only to assist Royalty Trust unitholders in the preparation of their 2017 U.S. federal and state income tax returns. This tax information booklet can be obtained at
http://gultu.investorhq.businesswire.com/. Any generic tax information provided by the Trustee is intended to be used only to assist Royalty Trust unitholders in the preparation of their U.S. federal and state income tax returns.
If the Royalty Trust were classified as a business entity, it would be taxable as a partnership unless it failed to meet certain qualifying income tests applicable to “publicly traded partnerships.” The income of the Royalty Trust is expected to meet such qualifying income tests. As a result, even if the Royalty Trust were considered to be a publicly traded partnership it should not be taxable as a corporation. The principal tax consequence of the Royalty
Trust's possible categorization as a partnership rather than a grantor trust is that all Royalty Trust unitholders would be required to report their share of taxable income from the Royalty Trust on the accrual method of accounting regardless of their own method of accounting. As a result, the Royalty Trust's tax reporting requirements would be more complex and costly to implement and maintain, and any distributions to Royalty Trust unitholders could be reduced as a result.
The Royalty Trust owns an overriding royalty interest burdening the subject interests, which are located in Louisiana and in federal waters offshore Louisiana. Tax counsel to the special committee of the board of directors of MMR advised the Royalty Trust at its formation that the Royalty Trust will be treated as a grantor trust and not as an unincorporated business entity for U.S. federal income tax purposes. If the Royalty Trust is treated as a grantor trust for U.S. federal income tax purposes, it would also be treated as a grantor trust for Louisiana income tax purposes. As a grantor trust, the Royalty Trust would not be subject to Louisiana income tax at the Royalty Trust level. Rather, for Louisiana individual income tax purposes, the Royalty Trust unitholders would be considered to own and receive the Royalty Trust’s assets and income and will be directly taxable thereon as though no trust were in existence. Consequently, individual Royalty Trust unitholders may be subject to Louisiana individual income tax on all or a portion of their shares of any Royalty Trust income. Individual Royalty Trust unitholders who are legal residents of Louisiana will be subject to Louisiana individual income tax on all of their shares of any Royalty Trust income. Individual Royalty Trust unitholders who are not legal residents of Louisiana generally will be subject to Louisiana individual income tax only on the portion of their shares of any Royalty Trust income that is sourced to Louisiana. For Louisiana individual income tax purposes, royalties from mineral properties are specifically sourced to the state where such property is located at the time the income is derived.
Individual Royalty Trust unitholders who are required to file Louisiana individual income tax returns and pay Louisiana individual income tax on all or a portion of their proportionate shares of any Royalty Trust income may be subject to penalties for failure to comply with such requirements. The highest marginal rates for the payment of Louisiana income taxes are 6% for individuals, trusts and estates, and 8% for corporations. Individual taxpayers are allowed a deduction for depletion in Louisiana. However, in 2015, the Louisiana legislature reduced the available depletion deduction by 28% through June of 2018, and is considering extending the reduction beyond such date. Louisiana currently does not require the Royalty Trust to withhold Louisiana individual income taxes from distributions made to non-resident Royalty Trust unitholders if the Royalty Trust is treated as a grantor trust for U.S. federal income tax purposes. Individual Royalty Trust unitholders who are legal residents of a state other than Louisiana may be subject to state and local individual income taxes, if any, in their states of residence on their receipt of any income from the Royalty Trust.
Royalty Trust unitholders should consult their tax advisors as to the specific tax consequences of the ownership and disposition of the royalty trust units, including the applicability and effect of U.S. federal, state, local and foreign income and other tax laws in light of their particular circumstances.
WHERE YOU CAN FIND OTHER INFORMATION
The Royalty Trust maintains a website at http://gultu.investorhq.businesswire.com. The Royalty Trust’s filings under the Exchange Act are available through its website and are also available electronically from the website maintained by the SEC at http://www.sec.gov. In addition, the Royalty Trust will provide electronic and paper copies of its recent filings free of charge upon request to the Trustee.
Item 1A. Risk Factors
This Form 10-K contains “forward-looking statements.” Please refer to the section above entitled “Forward-Looking Statements” for more information.
The value of the royalty trust units is uncertain. As of
March 15, 2018
, only the onshore Highlander subject interest has any reserves classified as proved, probable or possible and has established commercial production.
The Royalty Trust's only assets and sources of income are the overriding royalty interests burdening the subject interests. The overriding royalty interests entitle the Royalty Trust to receive a portion of the proceeds derived from the sale of hydrocarbons associated with the subject interests, if any. As of
March 15, 2018
, only the
onshore Highlander subject interest has any reserves classified as proved, probable or possible and has established commercial production. Other than the onshore Highlander subject interest, whose well began commercial production on February 25, 2015, the subject interests remain "exploration concepts."
Distributable income totaled
$356,486
for the year ended
December 31, 2017
. On January 17, 2018, the Royalty Trust declared a cash distribution of $0.000901 per unit payable on February 13, 2018 to unitholders of record on January 30, 2018 and on October 16, 2017, the Royalty Trust declared a cash distribution of $0.000648 per unit payable on November 13, 2017 to unitholders of record on October 30, 2017. The Royalty Trust has made no other distributions to date, and these distributions are not necessarily indicative of future distributions.
The Royalty Trust has no ability to direct or influence the exploration or development of the subject interests. In addition, neither FCX nor McMoRan is under any obligation to fund or to commit any resources to the exploration or development of the subject interests. During 2016 and the first quarter of 2017, FCX completed sales of oil and gas properties representing in the aggregate
94%
of its total proved reserves as of December 31, 2015. Although none of these transactions impacted the subject interests, McMoRan has informed the Trustee that it has no plans to pursue, has relinquished, or has allowed to expire all subject interests except for the onshore Highlander subject interest. Additionally, McMoRan has informed the Trustee that it is unlikely to drill additional wells on the onshore Highlander subject interest at the current time, considering existing natural gas prices and the cost of drilling and completing these wells. Under the operating agreement applicable to the leases associated with the subject interests, McMoRan is obligated to offer its interest in any acreage it decides to release to its co-lessees free and clear of the overriding royalty interest.
To the extent that McMoRan does not fund the exploration and development of the subject interests, or if for any other reason sufficient production from the subject interests is not maintained in commercial quantities, Royalty Trust unitholders will not realize any additional value from their investment in the royalty trust units.
Future Royalty Trust distributions are uncertain because the Royalty Trust does not control the operations of the subject interests and any royalties received must exceed administrative expenses, any indebtedness and a minimum cash requirement.
The Royalty Trust has no control over the operations of the subject interests, which are necessary to generate any royalties to be distributed to the unitholders. In addition, any royalties received by the Royalty Trust must first be used to (i) satisfy Royalty Trust administrative expenses and (ii) reduce Royalty Trust indebtedness. Lastly, the Trustee has established a minimum cash reserve of
$250,000
, which was in place as of December 31, 2017. As a result, distributions will be made to Royalty Trust unitholders only when royalties received less administrative expenses incurred and repayment of all indebtedness exceeds the
$250,000
minimum cash reserve.
Even though distributions were paid to Royalty Trust unitholders in 2017 and have been declared so far in 2018, there can be no assurance that distributions will be made in the future. The Royalty Trust's only other sources of liquidity are mandatory annual contributions, any loans and the required standby reserve account or letter of credit from FCX. As a result, any material adverse change in FCX's or McMoRan's financial condition or results of operations could materially and adversely affect the Royalty Trust and the underlying royalty trust units.
Oil and natural gas prices fluctuate due to a number of factors that are beyond the control of the Royalty Trust, FCX and McMoRan, and lower prices could reduce proceeds to the Royalty Trust and cash distributions to Royalty Trust unitholders.
Oil and gas prices fluctuate widely in response to relatively minor changes in supply, market uncertainty and a variety of additional factors that are beyond the control of FCX, McMoRan and the Royalty Trust. These factors include, among others:
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regional, domestic and foreign supply of, and demand for, oil and natural gas, as well as perceptions of supply of, and demand for, oil and natural gas;
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the price of foreign imports;
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U.S. and worldwide political and economic conditions;
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weather conditions and seasonal trends;
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anticipated future prices of oil and natural gas, alternative fuels and other commodities;
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technological advances affecting energy consumption and energy supply;
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the proximity, capacity, cost and availability of pipeline infrastructure, treating, transportation and refining capacity;
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natural disasters and other acts of force majeure;
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domestic and foreign governmental regulations and taxation;
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energy conservation and environmental measures; and
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the price and availability of alternative fuels.
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The downward pressure on oil and natural gas prices that began in mid-2014 and continued through 2016, stabilized in
2017
and early 2018. During
2017
, the New York Mercantile Exchange (NYMEX) natural gas price fluctuated from a low of
$2.52
per MMBtu to a high of
$3.57
per MMBtu and the West Texas Intermediate (WTI) crude oil price ranged from a low of
$42.05
per barrel to a high of
$60.51
per barrel. During the first quarter of 2018, natural gas prices remained steady since year end 2017, and on
March 15, 2018
, the NYMEX natural gas price was
$2.68
per MMBtu. On
March 15, 2018
, the WTI crude oil price per barrel was
$61.19
. Royalties that the Royalty Trust receives from its share of production will be reduced as a result of lower natural gas prices. As a result, future distributions from the Royalty Trust to its unitholders could be reduced or discontinued. In addition, lower oil and natural gas prices reduce the likelihood that the subject interests will be developed or that any oil or natural gas discovered will be economic to produce. McMoRan has informed the Trustee that it has no plans to pursue, has relinquished, or has allowed to expire all subject interests except for the onshore Highlander subject interest. Additionally, McMoRan has informed the Trustee that it is unlikely to drill additional wells on the onshore Highlander subject interest at the current time, considering existing natural gas prices and the cost of drilling and completing these wells. The volatility of energy prices reduces the accuracy of estimates of future cash distributions to the Royalty Trust unitholders and could affect the value of the royalty trust units.
The subject interests target Inboard Lower Tertiary/Cretaceous formations in the shallow waters of the Gulf of Mexico and onshore in South Louisiana, which have greater risks and costs associated with their exploration and development than conventional Gulf of Mexico prospects.
McMoRan's Inboard Lower Tertiary/Cretaceous exploration prospects target formations in the shallow waters of the Gulf of Mexico and onshore in South Louisiana. These targets have not traditionally been the subject of exploratory activity in these regions, and, therefore, little direct comparative data is available. To date, only the onshore Highlander subject interest has achieved commercial production of hydrocarbons from Inboard Lower Tertiary/Cretaceous reservoirs in these areas. The lack of comparative data and the limitations of diagnostic tools operating in the extreme temperatures and pressures encountered at these depths make it difficult to predict reservoir quality and well performance of these formations. It is also significantly more expensive and risky to drill and complete wells in these formations than at more conventional depths. Major contributors to such increased costs and risks include far higher temperatures and pressures encountered down hole, longer drilling times and the cost and extended procurement time related to the specialized equipment required to drill and complete these types of wells.
There is a limited public market for the royalty trust units, which could affect the market price, trading volume, liquidity and resale price of the royalty trust units.
During 2016, the Royalty Trust did not demonstrate compliance with the minimum bid price requirement of the OTCQX U.S. tier of the over-the-counter, or OTC, markets (OTCQX U.S.), and as such, on October 21, 2016, the royalty trust units moved from the OTCQX U.S. to the OTC Pink tier of the OTC markets. The OTC Pink is a significantly more limited market than the national securities exchanges, which could adversely affect the market price, trading volume, liquidity and resale price of the royalty trust units.
Although the royalty trust units are currently quoted on the OTC Pink, an active market in the royalty trust units may not continue at present levels or increase in the future. In addition, securities that trade on the OTC Pink
experience more volatility compared to securities that trade on a national securities exchange. This volatility may be caused by a variety of factors, including the lack of readily available price quotations, the absence of consistent administrative supervision of bid and ask quotations, lower trading volumes, and market conditions.
Because there is a limited public market for the royalty trust units, the market price and trading volume of the royalty trust units may be volatile.
Additionally, the royalty trust units could become subject to the SEC’s “penny stock” regulations. The SEC defines a “penny stock” as any equity security that has a market price of less than $5.00 per share subject to certain exceptions, including securities of issuers with net tangible assets in excess of $2.0 million that have been in continuous operation for at least three years. The Royalty Trust had approximately
$3.5 million
in net tangible assets at
December 31, 2017
. If the royalty trust units become subject to the SEC’s penny stock regulations, brokers may be less willing to execute transactions in the royalty trust units as a result of the requirements imposed by these regulations, which could further limit the liquidity of the royalty trust units. The closing bid price for the royalty trust units was
$0.05
on
March 15, 2018
.
The Royalty Trust unitholders may experience fluctuations in the market price and volume of the trading market for the royalty trust units for many reasons, including, without limitation:
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as a result of other risk factors discussed in this Form 10-K;
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the failure of the subject interests to produce hydrocarbons;
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decisions by McMoRan to delay or not to pursue the exploration or development of some or all of the subject interests;
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reasons unrelated to operational performance, such as reports by industry analysts, investor perceptions, or announcements by competitors regarding their own performance;
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legal or regulatory changes that could impact the business of McMoRan; and
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general economic, securities markets and industry conditions.
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Fluctuations in the volume of the trading market may have a negative effect on the market price for the royalty trust units. Accordingly, Royalty Trust unitholders may not be able to realize a fair price when they determine to sell their royalty trust units or may have to hold them for a substantial period of time until the market for the royalty trust units improves, if it does at all. FCX has a call right with respect to the outstanding royalty trust units at
$10
per royalty trust unit, which may not be exercised prior to
June 3, 2018
. This call right could impose a ceiling on the price of the royalty trust units. In addition, at any time after
June 3, 2018
, if the royalty trust units are then listed for trading or admitted for quotation on a national securities exchange or any quotation system and the volume weighted average price per royalty trust unit is equal to
$0.25
or less for the immediately preceding consecutive nine-month period, FCX may purchase all, but not less than all, of the outstanding royalty trust units at a price of
$0.25
per royalty trust unit so long as FCX tenders payment within
30
days following the end of such nine-month period. The volume weighted average price per royalty trust unit was
$0.04
for the nine-month period ended
March 15, 2018
. See Part I, Items 1. and 2. “Business and Properties - The Royalty Trust - The Royalty Trust Agreement - FCX Call Rights” of this Form 10-K. In addition, Royalty Trust unitholders may incur brokerage charges in connection with the resale of the royalty trust units, which in some cases could exceed the proceeds realized by a holder from the resale of its royalty trust units.
The tax treatment of the royalty trust units is uncertain.
The Tax Cuts and Jobs Act (the Act) enacted on December 22, 2017, includes significant modifications to existing U.S. tax laws effective January 1, 2018. The full impact of this legislation is still unclear, and these modifications could negatively impact the tax treatment of the Royalty Trust and/or the Royalty Trust unitholders. Although the tax treatment of overriding royalty interests in specified developed wells that have been drilled is well developed, the law is less developed in the area of overriding royalty interests on exploration prospects that are not classified as having proved, probable or possible reserves and have potential well locations that may be drilled in the future. As a result, there is uncertainty as to the proper tax treatment of the overriding royalty interests held by the Royalty Trust, and counsel is unable to express any opinion as to the proper tax treatment as either a mineral
royalty interest or a production payment. Based on the state of facts on the date on which this Form 10-K was filed, the Royalty Trust continues to treat the royalty trust units as mineral royalty interests for U.S. federal income tax purposes. However, no ruling has been requested from the IRS regarding the proper treatment of the royalty trust units; therefore, the IRS may assert, or a court may sustain the IRS in asserting, that the royalty trust units should be treated as “production payments” that are debt instruments for U.S. federal income tax purposes subject to the Treasury Regulations applicable to contingent payment debt instruments.
Royalty Trust unitholders should consult their tax advisors as to the specific tax consequences of the ownership and disposition of the royalty trust units, including the applicability and effect of U.S. federal, state, local and foreign income and other tax laws in light of their particular circumstances.
The Royalty Trust has not requested a ruling from the IRS regarding the tax treatment of ownership of the royalty trust units. If the IRS were to determine (and be sustained in that determination) that the Royalty Trust is not a “grantor trust” for federal income tax purposes, or that the overriding royalty interests are not properly treated as mineral royalty interests for U.S. federal income tax purposes, the Royalty Trust unitholders may receive different and potentially less advantageous tax treatment.
If the Royalty Trust were not treated as a grantor trust for U.S. federal income tax purposes, the Royalty Trust should be treated as a partnership for such purposes. Although the Royalty Trust would not become subject to U.S. 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 Royalty Trust unitholders, the Royalty Trust's tax reporting requirements would be more complex and costly to implement and maintain, and any distributions to Royalty Trust unitholders could be reduced as a result.
If the Royalty Trust were treated for U.S. federal income tax purposes as a partnership, it likely would be subject to new audit procedures that for taxable years beginning after December 31, 2017, alter the procedures for auditing large partnerships and also alters the procedures for assessing and collecting income taxes due (including applicable penalties and interest) as a result of an audit. These rules effectively would impose an entity level tax on the Royalty Trust, and unitholders may have to bear the expense of the adjustment even if they were not Royalty Trust unitholders during the audited taxable year.
If the overriding royalty interests were not treated as a mineral royalty interest, the amount, timing and character of income, gain, or loss in respect of an investment in the Royalty Trust could be affected.
The Royalty Trust has not requested a ruling from the IRS regarding these tax questions. The IRS could challenge these positions on audit, and such challenges could be sustained by a court.
No assurance can be given with respect to the availability and extent of percentage depletion deductions to the Royalty Trust unitholders for any taxable year.
Payments out of production that are received by a Royalty Trust unitholder in respect of a mineral royalty interest for U.S. federal income tax purposes are taxable under current law as ordinary income subject to an allowance for cost or percentage depletion in respect of such income. The rules with respect to this depletion allowance are complex and must be computed separately by each Royalty Trust unitholder and not by the Royalty Trust for each oil or natural gas property. As a result, no assurance can be given, and counsel is unable to express any opinion, with respect to the availability or extent of percentage depletion deductions to the Royalty Trust unitholders for any taxable year.
The Royalty Trust encourages Royalty Trust unitholders to consult their own tax advisors to determine whether and to what extent percentage depletion would be available to them for both U.S. federal income tax and state income tax purposes.
Royalty Trust unitholders will be required to pay taxes on their pro-rata share of the taxable income attributable to the assets of the Royalty Trust even if they do not receive any cash distributions from the Royalty Trust.
Because the holders of royalty trust units will be taxed directly on their pro-rata share of the taxable income attributable to the assets of the Royalty Trust and such taxable income could be different in amount than the cash the Royalty Trust distributes, Royalty Trust unitholders will be required to pay any U.S. federal income taxes and, in
some cases, state and local income taxes on such taxable income even if they receive no cash distributions from the Royalty Trust. Royalty Trust unitholders may not receive cash distributions from the Royalty Trust equal to their pro-rata share of the taxable income attributable to the assets of the Royalty Trust or even equal to the actual tax liability that results from that income.
As a consequence of special reporting rules, Royalty Trust unitholders may not be able to recognize income/claim losses realized by the Royalty Trust until the unitholders dispose of Royalty Trust units.
If the Royalty Trust satisfies the general
de minimis
test prescribed by the IRS and elects to report using the
de minimis
test, the Royalty Trust will only be required to report, with respect to sales or dispositions of trust assets, the amount of sales proceeds distributed to a Royalty Trust unitholder during the year. Reporting under the
de minimis
exception will leave unitholders with inadequate information to be able to fully report the result of the sales and dispositions falling under the
de minimis
threshold in a given year. The reason for the
de minimis
exception is that the IRS and the Treasury Department believe that if a widely held fixed investment trust such as the Royalty Trust sells or disposes of assets infrequently, although there may be some deferral of gains and losses if sales and dispositions are not fully reported, the deferral is acceptable, in light of the burden of fully and accurately reporting the sales and dispositions.
Production risks can adversely affect distributions from the Royalty Trust.
The occurrence of drilling, production or transportation accidents at any of the subject interests could reduce or eliminate Royalty Trust distributions, if any. Although the Royalty Trust, as the owner of the overriding royalty interests, should not be responsible for the costs associated with any such accidents, any such accidents may result in the loss of a productive well and associated reserves or interruption of production.
The Royalty Trust is vulnerable to risks associated with operations in the Gulf of Mexico and onshore in South Louisiana because the subject interests are located exclusively in those areas.
These risks include:
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tropical storms and hurricanes, which are particularly common in the Gulf of Mexico and South Louisiana during the summer and early fall of each year, and which can damage or completely destroy drilling, production and treatment facilities, which can result in the interruption or permanent cessation of production from associated wells;
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extensive governmental regulation (including regulations that may, in certain circumstances, impose strict liability for pollution damage);
and
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interruption or termination of operations by governmental authorities based on environmental, safety or other considerations, including those relating to other operators and/or other geographical areas.
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These exposures in the Gulf of Mexico and onshore in South Louisiana could have a material adverse effect on the subject interests, on the Royalty Trust's results of operations and financial condition, and on the market price of the royalty trust units.
The Royalty Trust is dependent on FCX for funding unless royalty income from production on the subject interests is sufficient to cover the Royalty Trust's administrative expenses.
Pursuant to the royalty trust agreement, FCX has agreed to pay annual trust expenses up to a maximum amount of
$350,000
, with no right of repayment or interest due, to the extent the Royalty Trust lacks sufficient funds to pay administrative expenses. No such contributions were made during the years ended
December 31, 2017
and
December 31, 2016
. In addition to such annual contributions, FCX has agreed to lend money, on an unsecured, interest-free basis, to the Royalty Trust to fund the Royalty Trust's ordinary administrative expenses as set forth in the royalty trust agreement. Since inception, FCX has loaned
$650,000
to the Royalty Trust under this arrangement, all of which had been repaid prior to
December 31, 2017
, including
$500,000
during 2017, and no amounts were outstanding at
December 31, 2017
. All funds the Trustee borrows to cover expenses or liabilities, whether from FCX or from any other source, must be repaid before the Royalty Trust unitholders will receive any distributions.
Pursuant to the royalty trust agreement, FCX agreed to provide and maintain a
$1.0 million
stand-by reserve account or an equivalent letter of credit for the benefit of the Royalty Trust to enable the Trustee to draw on such reserve account or letter of credit to pay obligations of the Royalty Trust if its funds are inadequate to pay its obligations at any time. Currently, with the consent of the Trustee, FCX may reduce the reserve account or substitute a letter of credit with a different face amount for the original letter of credit or any substitute letter of credit. In connection with this arrangement, FCX has provided
$1.0 million
in the form of a reserve fund cash account to the Royalty Trust. As of
December 31, 2017
, the Royalty Trust had not drawn any funds from the reserve account, and FCX had not requested a reduction of such reserve account. If FCX requested and the Royalty Trust consented to reduce the current
$1.0 million
reserve cash fund, the Royalty Trust's ability to fund ongoing administrative expenses could be adversely affected.
Additionally, if any material adverse change in FCX's or McMoRan's financial condition or results of operations resulting in McMoRan not funding the exploration and development of the subject interests occurs, or if for any other reason sufficient production from the onshore Highlander subject interest is not maintained in commercial quantities, Royalty Trust unitholders will not realize any additional value from their investment in the royalty trust units.
FCX's interests and the interests of the Royalty Trust unitholders may not always be aligned.
Because of FCX's focus on its copper resources, FCX's interests and the interests of the Royalty Trust unitholders are not completely aligned. For example, in setting budgets for development and production expenditures for FCX's properties, including the subject interests, FCX may make decisions that could adversely affect future production from the subject interests. Additionally, during 2016 and the first quarter of 2017, FCX completed sales of oil and gas properties representing in the aggregate
94%
of its total proved reserves as of December 31, 2015. Although none of these transactions impacted the subject interests, McMoRan has informed the Trustee that it has no plans to pursue, has relinquished, or has allowed to expire all subject interests except for the onshore Highlander subject interest. Additionally, McMoRan has informed the Trustee that it is unlikely to drill additional wells on the onshore Highlander subject interest at the current time, considering existing natural gas prices and the cost of drilling and completing these wells. Under the operating agreement applicable to the leases associated with the subject interests, McMoRan is obligated to offer its interest in any acreage it decides to release to its co-lessees free and clear of the overriding royalty interest.
McMoRan may at any time transfer all or part of the subject interests and will not have control or influence over the activities related to the subject interests it does not operate.
McMoRan may at any time transfer all or part of the subject interests. The Royalty Trust unitholders are not entitled to vote on any transfer, and the Royalty Trust will not receive any proceeds from the transfer of the subject interests. Following any such transfer, the subject interests would continue to be subject to the overriding royalty interests, but the net proceeds from the transferred subject interests would be calculated separately and paid by the transferee. Unless McMoRan and the transferee agree otherwise, the transferee would be responsible for all of McMoRan's obligations relating to the overriding royalty interests on the portion of the subject interests transferred, and McMoRan would have no continuing obligation to the Royalty Trust for those subject interests.
During 2016 and the first quarter of 2017, FCX completed sales of oil and gas properties representing in the aggregate 94% of its total proved reserves as of December 31, 2015. Although none of these transactions impacted the subject interests, McMoRan has informed the Trustee that it has no plans to pursue, has relinquished, or has allowed to expire all subject interests except for the onshore Highlander subject interest. Additionally, McMoRan has informed the Trustee that it is unlikely to drill additional wells on the onshore Highlander subject interest at the current time, considering existing natural gas prices and the cost of drilling and completing these wells. Under the operating agreement applicable to the leases associated with the subject interests, McMoRan is obligated to offer its interest in any acreage it decides to release to its co-lessees free and clear of the overriding royalty interest.
The Royalty Trust is limited in duration, may be dissolved upon certain events and the royalty trust units are subject to call features after
June 3, 2018
.
The Royalty Trust will dissolve on the earliest to occur of (i)
June 3, 2033
, (ii) the sale of all of the overriding royalty interests, (iii)
the election of the Trustee following its resignation for cause (as more fully described in the royalty trust agreement), (iv) a vote of the holders of
80%
(which after
June 3, 2018
, will be reduced to
66⅔%
) or more of the outstanding royalty trust units held by persons other than FCX or any of its affiliates, at a duly called
meeting of the Royalty Trust unitholders at which a quorum is present, or (v) the exercise by FCX of the right to call all of the royalty trust units as described in the next paragraph. The overriding royalty interests terminate upon the termination of the Royalty Trust, other than in certain limited circumstances where the Royalty Trust has been permitted to transfer the overriding royalty interests to a third party pursuant to the terms of the royalty trust agreement (in which case the overriding royalty interests may extend through
June 3, 2033
).
FCX has a call right with respect to the outstanding royalty trust units at
$10
per royalty trust unit, which may not be exercised prior to
June 3, 2018
. In addition, at any time after
June 3, 2018
, if the royalty trust units are then listed for trading or admitted for quotation on a national securities exchange or any quotation system and the volume weighted average price per royalty trust unit is equal to
$0.25
or less for the immediately preceding consecutive nine-month period, FCX may purchase all, but not less than all, of the outstanding royalty trust units at a price of
$0.25
per royalty trust unit so long as FCX tenders payment within
30
days following the end of such nine-month period. The volume weighted average price per royalty trust unit was
$0.04
for the nine-month period ended
March 15, 2018
.
The Royalty Trust is passive in nature and neither the Royalty Trust nor the Royalty Trust unitholders have any ability to influence FCX or McMoRan or to control the development or operation of the subject interests.
The royalty trust units are a passive investment that entitle the Royalty Trust unitholders only to receive cash distributions, if any, from the overriding royalty interests. Royalty Trust unitholders have no voting rights with respect to FCX or McMoRan and, therefore, have no managerial, contractual or other ability to influence their activities or the development or operations of the subject interests. Additionally, neither FCX nor McMoRan is under any obligation to fund or to commit any resources to the exploration or development of the subject interests.
FCX may sell royalty trust units in the public or private markets, and any such sales would be highly likely to have a material adverse effect on the trading price of the royalty trust units.
FCX holds an aggregate of
62,286,299
royalty trust units, representing approximately
27.1%
of the outstanding royalty trust units. FCX may sell royalty trust units in the public or private markets. Any such sales would be highly likely to have a material adverse effect on the trading price of the royalty trust units. A small number of other unitholders also hold significant percentages of the outstanding royalty trust units, and sales by such holders could also have a material adverse effect on the trading price of the royalty trust units. See Part III, Item 12. "Security Ownership of Certain Beneficial Owners and Management and Related Royalty Trust Unitholder Matters" of this Form 10-K.
The Royalty Trust is managed by a Trustee who cannot be replaced except by a majority vote of the Royalty Trust unitholders, which may make it difficult for Royalty Trust unitholders to remove or replace the Trustee.
The affairs of the Royalty Trust are managed by the Trustee. The voting rights of Royalty Trust unitholders are more limited than those of stockholders of most public corporations. For example, there is no requirement for the Royalty Trust to hold annual meetings of Royalty Trust unitholders or for an annual or other periodic re-election of the Trustee. The Royalty Trust does not intend to hold annual meetings of Royalty Trust unitholders. The royalty trust agreement provides that the Trustee may only be removed by the affirmative vote of holders of a majority of the royalty trust units outstanding. As a result, it would be difficult for public Royalty Trust unitholders to remove or replace the Trustee without the cooperation of FCX so long as it holds a significant percentage of the total royalty trust units.
Item 1B. Unresolved Staff Comments
None.