that the carrying value of the Trusts royalty interests may not be recoverable, an impairment will be recognized as measured by the amount by which the carrying amount of the royalty
interests exceeds the fair value of these assets, which would likely be measured by discounting projected cash flows and is charged directly to trust corpus instead of as an expense. There was no impairment of the Trusts assets as of
June 30, 2021.
For federal income tax purposes, the Trust constitutes a fixed investment trust that is taxed as a grantor trust. A grantor trust is not
subject to tax at the trust level. The Unit Holders are considered to own the Trusts income and principal as though no trust were in existence. The income of the Trust is deemed to have been received or accrued by each Unit Holder at the time
such income is received or accrued by the Trust rather than when distributed by the Trust.
The Trust is a widely held fixed investment
trust (WHFIT) classified as a non-mortgage widely held fixed investment trust (NMWHFIT) for federal income tax purposes. The Trustee is the representative of the Trust that will provide
tax information in accordance with the applicable U.S. Treasury Regulations governing the information reporting requirements of the Trust as a WHFIT and a NMWHFIT.
The Royalty constitutes an economic interest in oil and natural gas properties for federal income tax purposes. Unit Holders must
report their share of the production revenues of the Trust as ordinary income from oil and natural gas royalties and are entitled to claim depletion with respect to such income. The Royalty is treated as a single property for depletion purposes. The
Trust has on file technical advice memoranda confirming such tax treatment.
The classification of the Trusts income for purposes of
the passive loss rules may be important to a Unit Holder. Royalty income such as that derived through the Trust will generally be treated as portfolio income that may not be offset or reduced by passive losses.
Tax positions taken by the Trust related to the Trusts pass-through status and state tax positions have been reviewed, and the Trustee
is of the opinion that the material tax positions it has taken would more likely than not be sustained by examination. As of June 30, 2021, the Trusts tax years 2017 and thereafter remain subject to examination.
Each Unit Holder should consult his or her own tax advisor regarding tax compliance matters related to such Unit Holders interest in
the Trust.
3.
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Commitments and Contingencies
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Contingencies related to the Subject Interests that are unfavorably resolved would generally be reflected by the Trust as reductions to future
Royalty Income payments to the Trust with corresponding reductions to cash distributions to Unit Holders. See Note 1 Basis of Presentation, for a summary of the terms of the Conveyance with respect to recovery of costs.
Covid-19 Pandemic. The Trust continues to request periodic updates from Hilcorp as to its
production and financial expectations with respect to the Subject Interests due to any effects caused by the ongoing Covid-19 pandemic and the recent fluctuations in oil and gas pricing. Hilcorp has informed
the Trust that, given the current natural gas pricing environment, Hilcorp does not anticipate materially reducing any of the Subject Interests production or taking any of the Subject Interests wells offline; however, both the Trust and
Hilcorp continue to monitor the impact that Covid-19 may have on production, including as it relates to personnel availability in New Mexico and other Subject Interest areas. Hilcorp further informed the Trust
that Covid-19 has not had, nor does it anticipate that Covid-19 will have any material impact on its operation of the Subject Interests or on its payments of Royalty
Income to the Trust. However, the continuing impact of the ongoing Covid-19 pandemic, including additional surges or variants and required or recommended pandemic mitigation efforts, on Hilcorp and the Subject
Interests remains unknown and any such impact could result in actual results being different from Hilcorps expectations, despite the lack of a materially adverse impact to-date of the pandemic.
Gross Proceeds and Severance Tax Estimates. Hilcorp has advised the Trust that for certain months (since the closing of its
purchase of the assets), it has reported estimates of cash revenues and expenses based on the best information available to it at the time, instead of reporting actual amounts. Hilcorp further has informed the Trust that it believes that its
estimates have been prepared in accordance with the Conveyance, and the Trust and its advisors continue to review such estimates for compliance with the Conveyance.
Hilcorps process of reconciling actual revenue and severance taxes to previously reported estimates (which the Trust refers to as
true-ups) are still occurring and being reported in 2021. In addition, Hilcorp informed the Trust that due to Hilcorps transition to a new accounting system, the February, March and April 2021 production months were based on
estimated production, estimated prices and estimated costs utilizing historical trends. Thus, distributions to the Trust from Hilcorp in any given month may be subject to adjustments based upon prior months true-ups and rebooking, plus
interest. During the three months ended June 30, 2021, Hilcorp made no true-up adjustments.
Hilcorp notified the Trust that as of the
date of this Quarterly Report, Hilcorp anticipates that it will adjust the previously reported production and financial information for the production months of January 2021 through April 2021 for operated wells and November 2020 through April 2021
for non-operated wells. Therefore, Hilcorp believes that these adjustments will result in changes to future distributions of net proceeds to the Trust that reflects such rebooking and true-ups plus interest on such amounts (as required by the
Conveyance) to the extent an under payment to the Trust has occurred. Hilcorp has confirmed that it will continue to waive interest to the extent there were any overpayments to the Trust based on true-ups in 2021.
4.
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Settlements and Litigation
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None
On July 20, 2021, the Trust announced a cash distribution of $3,949,643.61 or $0.084740 per Unit, based primarily upon estimated
production during the month of May 2021, which was paid on August 13, 2021. In addition, Hilcorp advised the Trust that the May 2021 reporting month included additional gross profits of $2,559,341 ($1,919,505 net to the Trust) based on true-ups to the lease operating expense, property tax and capital cost categories for the January 2021 through April 2021 production months.
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