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PART I. FINANCIAL INFORMATION
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Page
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Item 1.
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Statements of Assets and Trust Corpus
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Item 2.
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Item 3.
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Quantitative and Qualitative Disclosure About Market Risk
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Item 4.
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PART II. OTHER INFORMATION
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Item 1.
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Legal Proceedings
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Item 1A.
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Risk Factors
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Item 6.
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All references to “we,” “us,” “our,” or the “Trust” refer to Chesapeake Granite Wash Trust. The royalty interests conveyed on November 16, 2011 by Chesapeake from its interests in certain properties in the Colony Granite Wash formation in Oklahoma and held by the Trust are referred to as the “Royalty Interests.” References to “Chesapeake” refer to Chesapeake Energy Corporation and, where the context requires, its subsidiaries.
DISCLOSURES REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q (“Quarterly Report”) includes “forward-looking statements” about the Trust and Chesapeake and other matters discussed herein that are subject to risks and uncertainties that are intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995 and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). All statements other than statements of historical fact included in this document, including, without limitation, statements under “Trustee’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 2 of Part I and elsewhere herein regarding the continuing effects of the COVID-19 pandemic and the impact thereof on our and Chesapeake’s business, financial condition, results of operations and cash flows, actions by, or disputes among or between, members of OPEC+, market factors, market prices, the proved oil, natural gas and natural gas liquids ("NGL") reserves associated with the properties underlying the Royalty Interests, the Trust’s or Chesapeake’s future financial position, Chesapeake's Chapter 11 bankruptcy and its ability to emerge from Chapter 11 bankruptcy, business strategy, budgets, projected costs and plans and objectives for future operations, information regarding target distributions, statements pertaining to future development activities and costs, information regarding production and reserve growth and statements regarding the Trust's continued listing on the OTC Markets Group, Inc., are forward-looking statements. Actual outcomes and results may differ materially from those projected. Our forward-looking statements are generally accompanied by words such as “estimate,” “project,” “predict,” “believe,” “expect,” “anticipate,” “potential,” “could,” “may,” “foresee,” “seek,” “plan,” “goal,” “assume,” “target,” “should,” “intend,” “ability,” “will,” “would,” “forecast” or other words that convey the uncertainty of future events or outcomes. These statements are based on certain assumptions made by the Trust, and by Chesapeake, in light of its experience and perception of historical trends, current conditions and expected future developments, as well as other factors we believe are appropriate under the circumstances. However, whether actual results and developments will conform with such expectations and predictions is subject to a number of risks and uncertainties, including the risk factors discussed in Item 1A of Part I of the Trust’s Annual Report on Form 10-K for the year ended December 31, 2019 (the "2019 Form 10-K") and in Item 1A of Part II of this Quarterly Report and those set forth from time to time in the Trust’s filings with the United States Securities and Exchange Commission (the "SEC"), which could affect the future results of the energy industry in general, and the Trust and Chesapeake in particular, and could cause those results to differ materially from those expressed in such forward-looking statements. The actual results or developments anticipated may not be realized or, even if substantially realized, may not have the expected consequences to or effects on Chesapeake’s business and the Trust. Such statements are not guarantees of future performance and actual results or developments may differ materially from those projected in such forward-looking statements. These factors should not be construed as exhaustive, and there may also be other risks that we are unable to predict at this time. The Trustee relies on Chesapeake for information regarding the Royalty Interests, the Underlying Properties (as defined below) and Chesapeake itself. The Trust undertakes no obligation to publicly update or revise any forward-looking statements and expressly disclaims any obligation to do so, except as required by applicable law.
PART I. FINANCIAL INFORMATION
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ITEM 1.
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Financial Statements
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CHESAPEAKE GRANITE WASH TRUST
STATEMENTS OF ASSETS AND TRUST CORPUS
(Unaudited)
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September 30, 2020
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December 31, 2019
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($ in thousands)
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ASSETS:
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Cash and cash equivalents
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$
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1,616
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$
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1,600
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Investment in Royalty Interests
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487,793
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487,793
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Less: accumulated amortization and impairment
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(473,055
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)
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(467,588
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)
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Net investment in Royalty Interests
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14,738
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20,205
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Total assets
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$
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16,354
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$
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21,805
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TRUST CORPUS:
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Trust corpus; 46,750,000 common units issued and outstanding
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16,354
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21,805
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Total Trust corpus
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$
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16,354
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$
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21,805
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The accompanying notes are an integral part of these financial statements.
1
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CHESAPEAKE GRANITE WASH TRUST
STATEMENTS OF DISTRIBUTABLE INCOME
(Unaudited)
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Three Months Ended
September 30,
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Nine Months Ended
September 30,
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2020
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2019
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2020
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2019
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($ in thousands, except unit and per unit data)
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REVENUES:
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Royalty income
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$
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377
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$
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2,157
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$
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4,181
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$
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8,030
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EXPENSES:
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Production taxes
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(27
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)
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(131
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)
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91
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(554
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Trust administrative expenses
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(33
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(445
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)
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(722
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(1,349
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)
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Cash reserves withheld
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(70
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)
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(70
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)
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(210
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)
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(247
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)
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Total expenses
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(130
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)
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(646
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)
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(841
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)
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(2,150
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)
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Distributable income available to unitholders
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$
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247
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$
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1,511
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$
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3,340
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$
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5,880
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Distributable income per common unit (46,750,000 common units)
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$
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0.0053
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$
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0.0323
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$
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0.0715
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$
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0.1258
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CHESAPEAKE GRANITE WASH TRUST
STATEMENTS OF CHANGES IN TRUST CORPUS
(Unaudited)
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Three Months Ended
September 30,
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Nine Months Ended
September 30,
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2020
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2019
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2020
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2019
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($ in thousands)
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TRUST CORPUS: Beginning of period
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$
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17,762
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$
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23,396
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$
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21,805
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$
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24,378
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Cash reserve surplus (deficit)
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(237
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)
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(1
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16
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435
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Amortization of Investment in Royalty Interests
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(531
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(796
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(1,781
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(2,214
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)
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Impairment of Investment in Royalty Interests
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(640
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)
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—
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(3,686
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)
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—
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Distributable income available to unitholders
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247
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1,511
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3,340
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5,880
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Distributions paid to unitholders
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(247
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)
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(1,511
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)
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(3,340
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)
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(5,880
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TRUST CORPUS: End of period
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$
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16,354
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$
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22,599
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$
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16,354
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$
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22,599
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The accompanying notes are an integral part of these financial statements.
2
CHESAPEAKE GRANITE WASH TRUST
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
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1.
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Organization of the Trust
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Chesapeake Granite Wash Trust (the “Trust”) is a statutory trust formed in June 2011 under the Delaware Statutory Trust Act pursuant to an initial trust agreement by and among Chesapeake Energy Corporation ("Chesapeake"), as Trustor, The Bank of New York Mellon Trust Company, N.A., as Trustee (the “Trustee”), and The Corporation Trust Company, as Delaware Trustee (the “Delaware Trustee” and, together with the Trustee, the "Trustees").
The Trust was created to own royalty interests (the “Royalty Interests”) for the benefit of Trust unitholders pursuant to a trust agreement dated as of June 29, 2011, and subsequently amended and restated as of November 16, 2011, by and among Chesapeake, Chesapeake Exploration, L.L.C., a wholly owned subsidiary of Chesapeake, and the Trustees (the “Trust Agreement”). The Royalty Interests are derived from Chesapeake’s interests in specified oil and natural gas properties located within an area of mutual interest (the "AMI") in the Colony Granite Wash play in Washita County in the Anadarko Basin of western Oklahoma (the “Underlying Properties”). Chesapeake conveyed the Royalty Interests to the Trust from (a) Chesapeake’s interests in 69 existing horizontal wells (the “Producing Wells”), and (b) Chesapeake’s interests in 118 horizontal development wells as calculated pursuant to the development agreement (the “Development Wells”), which Chesapeake was obligated to drill, cause to be drilled or participate as a non-operator in the drilling of, from drill sites in the AMI, on or prior to June 30, 2016. As of June 30, 2016, Chesapeake fulfilled its drilling obligation under the development agreement. Chesapeake retained an interest in each of the Producing Wells and Development Wells, and currently operates 96% of the Producing Wells and the completed Development Wells.
The business and affairs of the Trust are managed by the Trustee. The Trust Agreement limits the Trust’s business activities generally to owning the Royalty Interests and any activity reasonably related to such ownership, including activities required or permitted by the terms of the conveyances related to the Royalty Interests. The royalty interests in the Producing Wells entitle the Trust to receive 90% of the proceeds (exclusive of any production or development costs but after deducting certain post-production expenses and any applicable taxes) from the sales of oil, natural gas and NGL production attributable to Chesapeake’s net revenue interest in the Producing Wells. The royalty interests in the Development Wells entitle the Trust to receive 50% of the proceeds (exclusive of any production or development costs but after deducting certain post-production expenses and any applicable taxes) from the sales of oil, natural gas and NGL production attributable to Chesapeake’s net revenue interest in the Development Wells.
The Trust will dissolve and begin to liquidate on June 30, 2031, or earlier upon the below events (the "Termination Date"):
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•
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the Trust sells all of the Royalty Interests;
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•
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the aggregate quarterly cash distribution amounts for any four consecutive quarters is less than $1.0 million;
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•
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the holders of a majority of the Trust units and a majority of the common units (excluding common units owned by Chesapeake and its affiliates), in each case voting in person or by proxy at a meeting of such holders at which a quorum is present, vote in favor of dissolution; except that at any time that Chesapeake and its affiliates collectively own less than 10% of the outstanding Trust units, the standard for approval will be a majority of the Trust units, including units owned by Chesapeake voting in person or by proxy at a meeting of such holders at which a quorum is present; or
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•
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the Trust is judicially dissolved.
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At the Termination Date, (a) 50% of the total Royalty Interests conveyed by Chesapeake will revert automatically to Chesapeake and (b) 50% of the total Royalty Interests conveyed by Chesapeake (the “Perpetual Royalties”) will be retained by the Trust and thereafter sold. The net proceeds of the sale of the Perpetual Royalties, as well as any remaining Trust cash reserves, will be distributed to the unitholders on a pro rata basis. Chesapeake will have a right of first refusal to purchase the Perpetual Royalties retained by the Trust at the Termination Date.
As previously disclosed, on August 28, 2019, the Trust received written notification from the NYSE that the Trust was not in compliance with the continued listing standards set forth in Rule 802.01C of the NYSE Listed Company Manual because the average closing price of the Trust’s common units was less than $1.00 over a consecutive 30 trading-day period. Because the Trust was unable to regain compliance with the applicable standards within a six-month cure period concluded February 28, 2020, the NYSE announced the suspension of trading of the Trust's common units due to non-compliance with Rule 802.01C of the NYSE Listed Company Manual, effective as of the close of
CHESAPEAKE GRANITE WASH TRUST
NOTES TO FINANCIAL STATEMENTS - (Continued)
(Unaudited)
trading on February 28, 2020. As a result, the Trust's common units began trading on March 2, 2020 under the symbol "CHKR" on the OTC Markets Group, Inc. (the "OTC Pink"). On March 18, 2020, the NYSE filed a Form 25 with the SEC to delist the Trust's common units from the NYSE. The delisting was effective 10 days after the Form 25 was filed. The deregistration of the Trust’s common units under Section 12(b) of the Exchange Act became effective on June 16, 2020. The OTC Pink is a significantly more limited market than the NYSE, and the quotation of the Trust's common units on the OTC Pink may result in a reduction in demand for and the market price of the Trust's common units, and could diminish interest in the Trust from investors, analysts and other market participants.
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2.
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Basis of Presentation and Significant Accounting Policies
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Basis of Accounting. The accompanying Statement of Assets and Trust Corpus as of September 30, 2020 and December 31, 2019 and the unaudited interim financial statements of the Trust as of and for the three and nine months ended September 30, 2020 (the “Current Quarter” and the “Current Period”, respectively) and the three and nine months ended September 30, 2019 (the “Prior Quarter” and the “Prior Period”, respectively) have been presented in accordance with the rules and regulations of the SEC and include all adjustments which are, in the opinion of the Trustee, necessary to fairly state the Trust's financial position and results of operations for the periods presented. The accompanying unaudited interim financial statements should be read in conjunction with the December 31, 2019 audited financial statements and notes of the Trust, included in the Trust’s Annual Report on Form 10-K for the year ended December 31, 2019. These financial statements have been prepared in accordance with the SEC instructions to Form 10-Q and, therefore, do not include all disclosures required for financial statements prepared in conformity with accounting principles generally accepted in the United States of America ("GAAP").
Financial statements of the Trust differ from financial statements prepared in accordance with GAAP, as the Trust records revenues when received and expenses when paid and may also establish certain cash reserves for contingencies which would not be accrued in financial statements prepared in accordance with GAAP. This non-GAAP comprehensive basis of accounting corresponds to the accounting principles permitted for royalty trusts by the SEC as specified by Staff Accounting Bulletin Topic 12:E, Financial Statements of Royalty Trusts.
Most accounting pronouncements apply to entities whose financial statements are prepared in accordance with GAAP, directing such entities to accrue or defer revenues and expenses in a period other than when such revenues were received or expenses were paid. Because the Trust’s financial statements are prepared on the modified cash basis as described above, most accounting pronouncements are not applicable to the Trust’s financial statements.
Use of Estimates. The preparation of financial statements requires the Trust to make estimates and assumptions that affect the reported amounts of assets, liabilities and Trust corpus during the reporting period. Significant estimates that impact the Trust’s financial statements include estimates of proved oil, natural gas and NGL reserves, which are used to compute the Trust’s amortization of the Investment in Royalty Interests (as defined in Investment in Royalty Interests below) and, as necessary, to evaluate potential impairments of Investment in Royalty Interests. Actual results could differ from those estimates.
Risks and Uncertainties. The global spread of coronavirus (COVID-19) created significant volatility, uncertainty, and economic disruption during the first nine months of 2020. The pandemic has reached more than 200 countries and territories and has resulted in widespread adverse impacts on the global economy and on Chesapeake’s customers and other parties with whom it has business relations. State and local authorities have also implemented multi-step policies with the goal of re-opening. However, certain jurisdictions began re-opening only to return to restrictions in the face of increases in new COVID-19 cases. To date, Chesapeake has experienced limited operational impacts as a result of the restrictions from working remotely or COVID-19 directly. As an essential business under the guidelines issued by each of the states in which it operates, Chesapeake has been allowed to continue operations. As a result, since mid-March, Chesapeake has restricted access to all of its offices and for a period of time directed employees to work remotely to the extent possible. Chesapeake began to re-open its offices in phases beginning mid-May and special precautions have been implemented to minimize the risk of exposure. These actions have allowed Chesapeake to maintain the engagement and connectivity of its personnel. However, due to the severe impacts from the global COVID-19 pandemic on the global demand for oil and natural gas, financial results may not necessarily be indicative of operating results for the entire year. Moreover, future operations could be negatively affected if a significant number of Chesapeake employees are quarantined as a result of exposure to the virus.
CHESAPEAKE GRANITE WASH TRUST
NOTES TO FINANCIAL STATEMENTS - (Continued)
(Unaudited)
There is considerable uncertainty regarding the extent to which COVID-19 will continue to spread and the extent and duration of governmental and other measures implemented to try to slow the spread of the virus, such as large-scale travel bans and restrictions, border closures, quarantines, shelter-in-place orders and business and government shutdowns. One of the largest impacts of the pandemic has been a significant reduction in global demand for oil and, to a lesser extent, natural gas. Prices in the oil and gas market have remained depressed, as the oversupply and lack of demand in the market persist. Oil and natural gas prices are expected to continue to be volatile as a result of the near-term production instability and the ongoing COVID-19 outbreaks and as changes in oil and natural gas inventories, industry demand and global and national economic performance are reported.
The Trust's reserves and quarterly cash distributions depend primarily upon the prices realized by Chesapeake from the sales of oil, natural gas and NGL. Low oil, natural gas and NGL prices negatively affect the amount of cash available for capital expenditures and debt repayment and the ability to borrow money or raise additional capital and, as a result, could have a material adverse effect on Chesapeake’s financial condition, results of operations, cash flows and reserves and the Trust’s reserves and quarterly cash distributions. There is no guarantee that any actions taken by Chesapeake in light of COVID-19 will be effective in preventing future disruptions to its business. Moreover, future operations of Chesapeake could be negatively affected if a significant number of its employees are quarantined as a result of exposure to the virus, which in turn could negatively affect proceeds to the Trust and the Trust’s reserves and quarterly cash distributions to unitholders.
The Trust's revenues and distributable income available to unitholders have been adversely affected to date in 2020 due to natural declines in production and depressed commodity prices as a result of COVID-19. The Trust expects production to continue to decline and expects distributable income to continue to be adversely affected. On November 4, 2020, the Trust declared a cash distribution of $0.0012 per common unit (the "November 2020 Distribution"), consisting of proceeds attributable to production from June 1, 2020 to August 31, 2020. The distribution will be paid on November 30, 2020 to common unitholders of record as of November 19, 2020. See Note 5 for information regarding prior distributions paid and Note 6 for information on the November 2020 Distribution.
Chesapeake's ability to perform its obligations to the Trust depends on its future results of operations, financial condition and liquidity, which in turn depend upon the supply and demand for oil, natural gas and NGL, prevailing economic conditions, and financial, business and other factors, many of which are beyond Chesapeake's control. On June 28, 2020, Chesapeake and certain of its subsidiaries (collectively, the “Debtors”) filed voluntary petitions (the "Chapter 11 Cases") for reorganization (the “Bankruptcy Filing”) under Chapter 11 of Title 11 of the United States Code (the "Bankruptcy Code") in the United States Bankruptcy Court for the Southern District of Texas (the “Bankruptcy Court”). On June 29, 2020, the Bankruptcy Court entered an order authorizing the joint administration of the Chapter 11 Cases under the caption In re Chesapeake Energy Corporation, Case No. 20-33233. Subsidiaries with noncontrolling interests, consolidated variable interest entities and certain de minimis subsidiaries (collectively, the “Non-Filing Entities”) were not part of the Bankruptcy Filing. The Non-Filing Entities and the Trust will continue to operate in the ordinary course of business. The Debtors continue to operate the business as “debtors-in-possession” under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code and orders of the Bankruptcy Court. Chesapeake’s ability to continue as a going concern is contingent on its ability to comply with the financial and other covenants set forth in the senior secured super-priority debtor-in-possession revolving credit facility provided to the Debtors by certain lenders (the “DIP Credit Facility”), the Bankruptcy Court’s approval of Chesapeake’s plan of reorganization (the “Plan”) and Chesapeake’s ability to successfully implement the Plan and obtain exit financing, among other factors. As a result of the Bankruptcy Filing, the realization of assets and the satisfaction of liabilities are subject to uncertainty. While operating as debtors-in-possession under Chapter 11, Chesapeake may sell or otherwise dispose of or liquidate assets or settle liabilities, subject to the approval of the Bankruptcy Court or as otherwise permitted in the ordinary course of business (and subject to restrictions contained in the DIP Credit Facility), for amounts other than those reflected in Chesapeake’s condensed consolidated financial statements. Further, the Plan could materially change the amounts and classifications of assets and liabilities reported in Chesapeake’s condensed consolidated financial statements.
The Trust is highly dependent on Chesapeake for multiple services, including the operation of wells, remittance of net proceeds generated by the interests in specified oil and natural gas properties located within the AMI and administrative services performed on behalf of the Trust. The ability to operate the properties depends on Chesapeake’s future financial condition and economic performance, access to capital, and other factors, many of which are out of the control of Chesapeake. The factors noted above raise substantial doubt about Chesapeake’s ability to continue
CHESAPEAKE GRANITE WASH TRUST
NOTES TO FINANCIAL STATEMENTS - (Continued)
(Unaudited)
as a going concern. As a result, Chesapeake could also be unable to provide support to the Trust through loans and performance of its management duties. In addition, the Trust could lose the value of all of the Royalty Interests if the Bankruptcy Court were to hold that the Royalty Interests constitute an asset of the bankruptcy estate.
Cash and Cash Equivalents. Cash equivalents include all highly-liquid instruments with maturities of three months or less at the time of acquisition. The Trustee maintains a minimum cash reserve of $1.0 million and may, at the Trustee’s discretion, reserve funds for future expected administrative expenses.
Investment in Royalty Interests. The Investment in Royalty Interests is amortized as a single cost center on a units-of-production basis over total proved reserves. Such amortization does not reduce distributable income, rather it is charged directly to Trust corpus. Revisions to estimated future units-of-production are treated on a prospective basis beginning on the date such revisions are known. The carrying value of the Trust’s Investment in Royalty Interests will not necessarily be indicative of the fair value of such Royalty Interests. The Trust is not burdened by development costs of the Royalty Interests.
On a quarterly basis, the Trust evaluates the carrying value of the Investment in Royalty Interests under the full cost accounting rules of the SEC. This quarterly review is referred to as a ceiling test. Under the ceiling test, the carrying value of the Investment in Royalty Interests may not exceed an amount equal to the sum of the present value (using a 10% discount rate) of the estimated future net revenues from proved reserves. As of September 30, 2020, the carrying amount exceeded the estimated future net revenues from proved reserves resulting in the Trust recognizing a $0.64 million impairment of the Royalty Interests in the Current Quarter. As of June 30, 2020, the carrying amount exceeded the estimated future net revenues from proved reserves resulting in the Trust recognizing a $3.05 million impairment of the Royalty Interests in the second quarter of 2020. In the Prior Quarter and the Prior Period, the Trust recognized no impairments of the Royalty Interests. Impairments do not impact royalty income or the cash distribution to unitholders.
Loan Commitment. Pursuant to the Trust Agreement, if at any time the Trust’s cash on hand (including available cash reserves, if any) is not sufficient to pay the Trust’s ordinary course expenses as they become due, Chesapeake will loan funds to the Trust necessary to pay such expenses; provided, however, that this obligation may not be fulfilled during the pendency of Chesapeake’s bankruptcy. Such loans will be recorded as a liability on the Statements of Assets, Liabilities and Trust Corpus until repaid. A loan neither increases nor decreases distributions to unitholders; however, no further distributions will be made to unitholders (except in respect of any previously determined quarterly cash distribution amount and unless Chesapeake otherwise consents in writing) until the loan is repaid. There were no loans outstanding as of September 30, 2020 and December 31, 2019.
Revenues and Expenses. Neither the Trust nor the Trustee is responsible for, or has any control over, any costs related to the drilling of the Development Wells or any other operating or capital costs of the Underlying Properties. The Trust’s revenues with respect to the Royalty Interests in the Underlying Properties are net of existing royalties and overriding royalties associated with Chesapeake's interests and are determined after deducting certain post-production expenses and any applicable taxes associated with the Royalty Interests. Post-production expenses generally consist of costs incurred to gather, store, compress, transport, process, treat, dehydrate and market the oil, natural gas and NGL produced. However, the Trust is not responsible for costs of marketing services provided by affiliates of Chesapeake. Cash distributions to unitholders are reduced by the Trust’s general and administrative expenses.
The Trust is a Delaware statutory trust that is treated as a partnership for U.S. federal income tax purposes. The Trust is not required to pay federal or state income taxes. Accordingly, no provision for federal or state income tax has been made.
CHESAPEAKE GRANITE WASH TRUST
NOTES TO FINANCIAL STATEMENTS - (Continued)
(Unaudited)
Trust unitholders are treated as partners of the Trust for U.S. federal income tax purposes. The Trust Agreement contains tax provisions that generally allocate the Trust’s income, deductions and credits among the Trust unitholders in accordance with their percentage interests in the Trust. The Trust Agreement also sets forth the tax accounting principles to be applied by the Trust.
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4.
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Related Party Transactions
|
Trustee Administrative Fee. Under the terms of the Trust Agreement, the Trust is required to pay an annual administrative fee of $175,000 to the Trustee, paid in equal quarterly installments. The administrative fee may be adjusted for inflation by no more than 3% in any calendar year beginning in 2015. To date, the Trustee's annual administrative fees have been adjusted upward by a total of 8.7% from the original fee including 2019 and 2020 increases of 1.9% and 2.3%, respectively, to the current annual amount of $190,169.
Agreements with Chesapeake. In connection with the initial public offering and the conveyance of the Royalty Interests to the Trust, the Trust entered into an administrative services agreement, a development agreement and a registration rights agreement with Chesapeake.
Pursuant to the administrative services agreement, Chesapeake provides the Trust with certain accounting, tax preparation, bookkeeping and information services related to the Royalty Interests and the registration rights agreement. In return for the services provided by Chesapeake under the administrative services agreement, the Trust pays Chesapeake, in equal quarterly installments, an annual fee of $200,000, which will remain fixed for the life of the Trust. Chesapeake is also entitled to receive reimbursement for its actual out-of-pocket fees, costs and expenses incurred in connection with the provision of any of the services under the administrative services agreement.
The administrative services agreement will terminate upon the earliest to occur of (a) the date the Trust shall have dissolved and wound up its business and affairs in accordance with the Trust Agreement, (b) the date that all of the Royalty Interests have been terminated or are no longer held by the Trust, (c) with respect to services to be provided with respect to any Underlying Properties transferred by Chesapeake to a third party, the date that either Chesapeake or the Trustee may designate by delivering 90-days prior written notice, provided that Chesapeake’s drilling obligation has been completed and the transferee of such Underlying Properties assumes responsibility to perform the services in place of Chesapeake, or (d) a date mutually agreed upon by Chesapeake and the Trustee.
The Trust also entered into a registration rights agreement for the benefit of Chesapeake and certain of its affiliates (each, a “holder”). Pursuant to the registration rights agreement, the Trust agreed to register the Trust units held by each such holder for resale under the Securities Act of 1933, as amended, under certain circumstances. In connection with the preparation and filing of any registration statement, Chesapeake will bear all costs and expenses incidental to such registration statement, excluding certain internal expenses of the Trust, which will be borne by the Trust, and any underwriting discounts and commissions, which will be borne by the seller of the Trust units.
Loan Commitment. Pursuant to the Trust Agreement, if at any time the Trust’s cash on hand (including available cash reserves, if any) is not sufficient to pay the Trust’s ordinary course expenses as they become due, Chesapeake will loan funds to the Trust necessary to pay such expenses; provided, however, that this obligation may not be fulfilled during the pendency of Chesapeake’s bankruptcy. Any funds loaned by Chesapeake pursuant to this commitment will be limited to the payment of current accounts payable or other obligations to trade creditors in connection with obtaining goods or services or the payment of other current liabilities arising in the ordinary course of the Trust’s business, and may not be used to satisfy Trust indebtedness for borrowed money of the Trust. If Chesapeake loans funds pursuant to this commitment, no further distributions will be made to unitholders (except in respect of any previously determined quarterly cash distribution amount and unless Chesapeake otherwise consents in writing) until such loan is repaid. There were no loans outstanding as of September 30, 2020 and December 31, 2019.
CHESAPEAKE GRANITE WASH TRUST
NOTES TO FINANCIAL STATEMENTS - (Continued)
(Unaudited)
|
|
|
|
5.
|
Distributions to Unitholders
|
The Trust makes quarterly cash distributions of substantially all of its cash receipts, after deducting the Trust’s expenses, approximately 60 days following the completion of each quarter through (and including) the quarter ending June 30, 2031.
For the nine months ended September 30, 2020 and 2019, the Trust declared and paid the following cash distributions:
|
|
|
|
|
|
|
|
|
Production Period
|
|
Distribution Date
|
|
Cash Distribution per
Common Unit
|
|
September 2019 - November 2019
|
|
March 2, 2020
|
|
$0.0371
|
|
December 2019 - February 2020
|
|
June 1, 2020
|
|
$0.0291
|
|
March 2020 - May 2020
|
|
August 31, 2020
|
|
$0.0053
|
|
|
|
|
|
|
|
September 2018 - November 2018
|
|
March 1, 2019
|
|
$0.0631
|
|
December 2018 - February 2019
|
|
May 30, 2019
|
|
$0.0303
|
|
March 2019 - May 2019
|
|
August 29, 2019
|
|
$0.0323
|
6. Subsequent Events
The Trust's quarterly income available for distribution was $0.0012 per common unit for the production period from June 1, 2020 to August 31, 2020. On November 4, 2020, the Trust declared the November 2020 Distribution attributable to such production period. The distribution will be paid on November 30, 2020 to common unitholders of record as of November 19, 2020. All Trust unitholders share on a pro rata basis in the Trust's distributable income.
Distributable income attributable to production from June 1, 2020 to August 31, 2020 was calculated as follows (in thousands, except for unit and per unit amounts):
|
|
|
|
|
|
|
|
REVENUES:
|
|
|
Royalty income
|
$
|
766
|
|
|
EXPENSES:
|
|
|
Production taxes
|
(55
|
)
|
|
Trust administrative expenses(a)
|
(585
|
)
|
|
Total expenses
|
(640
|
)
|
|
Cash withheld to increase cash reserves(b)
|
(70
|
)
|
|
Distributable income available to common unitholders
|
$
|
56
|
|
|
|
|
|
Distributable income per common unit(c)
|
$
|
0.0012
|
|
___________________________________________________
|
|
|
|
(a)
|
Includes the cash advance for administrative expenses.
|
|
|
|
|
(b)
|
Commencing with the distribution to unitholders payable in the first quarter 2019, the Trustee began withholding the greater of $70,000 or 3.5% of the funds otherwise available for distribution each quarter to gradually increase existing cash reserves by a total of approximately $850,000. The Trustee may increase or decrease the targeted amount at any time, and may increase or decrease the rate at which it is withholding funds to build the cash reserve at any time, without advance notice to the unitholders. Cash held in reserve will be invested as required by the Trust Agreement. Any cash reserved in excess of the amount necessary to pay or provide for the payment of future known, anticipated or contingent expenses or liabilities eventually will be distributed to unitholders, together with interest earned on the funds.
|
CHESAPEAKE GRANITE WASH TRUST
NOTES TO FINANCIAL STATEMENTS - (Continued)
(Unaudited)
|
|
|
|
(c)
|
Calculation of distributable income per common unit is based on 46,750,000 common units issued and outstanding as of November 12, 2020.
|
On October 13, 2020, Chesapeake filed a notice with the Bankruptcy Court that it had reached an agreement with Tapstone Energy, LLC as the “Stalking Horse” bidder to sell its Mid-Continent asset, which includes the Underlying Properties (as defined in Note 1) of the Trust, for $85 million in a 363 transaction under the Bankruptcy Code. A Bankruptcy Court supervised auction was held on November 10, 2020, in which other pre-qualified buyers were able to submit bids for the asset. At the conclusion of the auction, the successful bidder was Tapstone Energy, LLC and KL CHK SPV, LLC for an aggregate purchase price of $130.45 million. Chesapeake will present these auction results to the Bankruptcy Court for its final approval of the sale on November 13, 2020. The transaction is expected to close on December 11, 2020. If Chesapeake were to sell the Underlying Properties of the Trust, per the Trust Agreement, the Trust would continue to operate, and any responsibilities Chesapeake has regarding the Trust would transfer to the buyer.
|
|
|
|
ITEM 2.
|
Trustee's Discussion and Analysis of Financial Condition and Results of Operations
|
Introduction
The following discussion and analysis is intended to help the reader understand the Trust’s financial condition and results of operations. This discussion and analysis should be read in conjunction with the Trust’s unaudited interim financial statements and the accompanying notes relating to the Trust and the Underlying Properties included in Item 1 of Part I of this Quarterly Report as well as the Trust’s Annual Report on Form 10-K for the year ended December 31, 2019.
Recent Developments
Chesapeake's Voluntary Reorganization Under Chapter 11
On June 28, 2020, Chesapeake and certain of its subsidiaries (collectively, the “Debtors”) filed voluntary petitions (the "Chapter 11 Cases") for reorganization (the “Bankruptcy Filing”) under Chapter 11 of Title 11 of the United States Code (the "Bankruptcy Code") in the United States Bankruptcy Court for the Southern District of Texas (the “Bankruptcy Court”). On June 29, 2020, the Bankruptcy Court entered an order authorizing the joint administration of the Chapter 11 Cases under the caption In re Chesapeake Energy Corporation, Case No. 20-33233 (DRJ). Subsidiaries with noncontrolling interests, consolidated variable interest entities and certain de minimis subsidiaries (collectively, the “Non-Filing Entities”) were not part of the Bankruptcy Filing. The Non-Filing Entities and the Trust will continue to operate in the ordinary course of business. The Debtors continue to operate the business as “debtors-in-possession” under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code and orders of the Bankruptcy Court.
Chesapeake's Agreement to Sell Mid-Continent Asset which includes the Underlying Properties
On October 13, 2020, Chesapeake filed a notice with the Bankruptcy Court that it had reached an agreement with Tapstone Energy, LLC as the “Stalking Horse” bidder to sell its Mid-Continent asset, which includes the Underlying Properties (as defined in Note 1) of the Trust, for $85 million in a 363 transaction under the Bankruptcy Code. A Bankruptcy Court supervised auction was held on November 10, 2020, in which other pre-qualified buyers were able to submit bids for the asset. At the conclusion of the auction, the successful bidder was Tapstone Energy, LLC and KL CHK SPV, LLC for an aggregate purchase price of $130.45 million. Chesapeake will present these auction results to the Bankruptcy Court for its final approval of the sale on November 13, 2020. The transaction is expected to close on December 11, 2020. If Chesapeake were to sell the Underlying Properties of the Trust, per the Trust Agreement, the Trust would continue to operate, and any responsibilities Chesapeake has regarding the Trust would transfer to the buyer.
COVID-19 Pandemic and Impact on Global Demand for Oil and Natural Gas
The global spread of coronavirus (COVID-19) created significant volatility, uncertainty, and economic disruption during the first nine months of 2020. The pandemic has reached more than 200 countries and territories and has resulted in widespread adverse impacts on the global economy and on Chesapeake’s customers and other parties with whom it has business relations. State and local authorities have also implemented multi-step policies with the goal of re-opening. However, certain jurisdictions began re-opening only to return to restrictions in the face of increases in new COVID-19 cases. To date, Chesapeake has experienced limited operational impacts as a result of the restrictions from working remotely or COVID-19 directly. As an essential business under the guidelines issued by each of the states in which it operates, Chesapeake has been allowed to continue operations. As a result, since mid-March, Chesapeake has restricted access to all of its offices and for a period of time directed employees to work remotely to the extent possible. Chesapeake began to re-open its offices in phases beginning mid-May and special precautions have been implemented to minimize the risk of exposure. These actions have allowed Chesapeake to maintain the engagement and connectivity of its personnel. However, due to severe impacts from the global COVID-19 pandemic on the global demand for oil and natural gas, financial results may not necessarily be indicative of operating results for the entire year. Moreover, future operations could be negatively affected if a significant number of Chesapeake employees are quarantined as a result of exposure to the virus.
There is considerable uncertainty regarding the extent to which COVID-19 will continue to spread and the extent and duration of governmental and other measures implemented to try to slow the spread of the virus, such as large-scale travel bans and restrictions, border closures, quarantines, shelter-in-place orders and business and government shutdowns. One of the largest impacts of the pandemic has been a significant reduction in global demand for oil and, to a lesser extent, natural gas. Prices in the oil and gas market have remained depressed, as the oversupply and lack of demand in the market persist. Oil and natural gas prices are expected to continue to be volatile as a result of the near-term production instability and the ongoing COVID-19 outbreaks and as changes in oil and natural gas inventories, industry demand and global and national economic performance are reported. The resulting supply/demand imbalance is having disruptive impacts on the oil and natural gas exploration and production industry and on other industries that serve exploration and production companies.
We expect to see continued volatility in oil and natural gas prices for the foreseeable future, and such volatility, combined with the current depressed prices, has impacted and is expected to continue to adversely impact Chesapeake’s business, financial condition and results of operations and proceeds to the Trust and the Trust’s reserves and quarterly cash distributions to unitholders. The continued low level of demand and prices for oil and natural gas or otherwise has had and will continue to have a material adverse effect on Chesapeake’s business, financial condition and results of operations and on proceeds to the Trust and the Trust’s reserves and quarterly cash distributions to unitholders.
We cannot predict the full impact that COVID-19 or the significant disruption and volatility currently being experienced in the oil and natural gas markets will have on Chesapeake’s business, cash flows, liquidity, financial condition and results of operations or on proceeds to the Trust and the Trust’s reserves and quarterly cash distributions to unitholders due to numerous uncertainties. The ultimate impacts will depend on future developments, including, among others, the ultimate geographic spread of the virus, the consequences of governmental and other measures designed to prevent the spread of the virus, the development of effective treatments, the duration of the outbreak, actions taken by members of Organization of Petroleum Exporting Countries (OPEC+) and other foreign, oil-exporting countries, governmental authorities, Chesapeake’s customers and other thirds parties, workforce availability, and the timing and extent to which normal economic and operating conditions resume. For additional discussion regarding risks associated with the COVID-19 pandemic, see Item 1A “Risk Factors” in this Quarterly Report.
Overview
The Trust is a statutory trust formed in June 2011 under the Delaware Statutory Trust Act. The business and affairs of the Trust are managed by the Trustee and, as necessary, the Delaware Trustee. The Trust does not conduct any operations or activities other than owning the Royalty Interests and activities related to such ownership. The Trust’s purpose is generally to own the Royalty Interests, to distribute to the Trust unitholders cash that the Trust receives in respect of the Royalty Interests and to perform certain administrative functions in respect of the Royalty Interests and the Trust units. The Trust derives all or substantially all of its income and cash flow from the Royalty Interests. The Trust is treated as a partnership for U.S. federal income tax purposes.
Concurrent with the Trust's initial public offering in November 2011, Chesapeake conveyed the Royalty Interests to the Trust effective July 1, 2011, which included interests in (a) 69 Producing Wells in the Colony Granite Wash play and (b) 118 Development Wells that Chesapeake was obligated to drill, cause to be drilled or participate as a non-operator in the drilling of, from drill sites in the AMI, on or prior to June 30, 2016. As of June 30, 2016, Chesapeake fulfilled its drilling obligation under the development agreement. Chesapeake retained an interest in each of the Producing Wells and Development Wells, and currently operates 96% of the Producing Wells and the completed Development Wells.
The Trust was not responsible for any costs related to the drilling of the Development Wells and is not responsible for any other operating or capital costs of the Underlying Properties, and Chesapeake was not permitted to drill and complete any well in the Colony Granite Wash formation on acreage included within the AMI for its own account until it had satisfied its drilling obligation to the Trust.
The Royalty Interests entitle the Trust to receive 90% of the proceeds (after deducting certain post-production expenses and any applicable taxes) from the sales of production of oil, natural gas and NGL attributable to Chesapeake’s net revenue interest in the Producing Wells and 50% of the proceeds (after deducting certain post-production expenses and any applicable taxes) from the sales of oil, natural gas and NGL production attributable to Chesapeake’s net
revenue interest in the Development Wells. Post-production expenses generally consist of costs incurred to gather, store, compress, transport, process, treat, dehydrate and market the oil, natural gas and NGL produced. However, the Trust is not responsible for costs of marketing services provided by Chesapeake or its affiliates.
The Trust is required to make quarterly cash distributions of substantially all of its cash receipts, after deducting the Trust’s administrative expenses, on or about 60 days following the completion of each calendar quarter through (and including) the quarter ending June 30, 2031. During the nine months ended September 30, 2020, distributions were paid on March 2, 2020, June 1, 2020 and August 31, 2020. See Liquidity and Capital Resources below and Note 5 to the financial statements contained in Item 1 of Part I of this Quarterly Report for more information regarding these distributions.
The amount of Trust revenues and cash distributions to Trust unitholders fluctuates from quarter to quarter depending on several factors, including, but not limited to:
|
|
|
|
•
|
timing and amount of production and sales from the Development and Producing Wells;
|
|
|
|
|
•
|
oil, natural gas and NGL prices received;
|
|
|
|
|
•
|
volumes of oil, natural gas and NGL produced and sold;
|
|
|
|
|
•
|
certain post-production expenses and any applicable taxes; and
|
Results of Trust Operations
The quarterly payments to the Trust with respect to the Royalty Interests are based on the amount of proceeds actually received by Chesapeake during the preceding calendar quarter. Proceeds from production are typically received by Chesapeake in the month following the month of production. Due to the timing of the payment of production proceeds, quarterly distributions made by Chesapeake to the Trust generally include royalties attributable to sales of oil, natural gas and NGL for three months, comprised of the first two months of the quarter just ended and the last month of the quarter prior to that one. Chesapeake is required to make the Royalty Interest payments to the Trust within 35 days after the end of each calendar quarter. During the nine months ended September 30, 2020, the Trust received payments on the Royalty Interests representing royalties attributable to proceeds from sales of oil, natural gas and NGL for September 1, 2019 to May 31, 2020.
The Trust's revenues and distributable income available to unitholders were adversely affected throughout 2019 and to date in 2020 by natural declines in production and depressed commodity prices including, with respect to the Current Quarter, as a result of COVID-19. The Trust expects production to decline further and expects distributable income to continue to be adversely affected.
The Trust's Investment in Royalty Interests is subject to a quarterly full cost ceiling test. The Trust recognized a $3.69 million impairment of the Royalty Interests in the Current Period which included a $0.64 million impairment of the Royalty Interests in the Current Quarter as a result of a decrease in commodity prices. In the three and nine months ended 2019, the Trust recognized no impairments of the Royalty Interests. See Investment in Royalty Interests in Note 2 to the financial statements contained in Item 1 of Part I of this Quarterly Report and Trust Operations for further discussion.
Distributable Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
|
2020
|
|
2019
|
|
Change
|
|
2020
|
|
2019
|
|
Change
|
|
|
($ in thousands, except per unit data)
|
|
Distributable income available to unitholders
|
$
|
247
|
|
|
$
|
1,511
|
|
|
(84
|
)%
|
|
$
|
3,340
|
|
|
$
|
5,880
|
|
|
(43
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distributable income per common unit
|
$
|
0.0053
|
|
|
$
|
0.0323
|
|
|
(84
|
)%
|
|
$
|
0.0715
|
|
|
$
|
0.1258
|
|
|
(43
|
)%
|
The $1.26 million decrease in distributable income during the Current Quarter was primarily due to a decrease in sales volumes of oil, natural gas and NGL and the average realized price per boe in the production period from March 1, 2020 to May 31, 2020 (Current Production Quarter) as compared to the production period from March 1, 2019 to May 31, 2019 (Prior Production Quarter) resulting in a $1.78 million decrease in distributable income in the Current Production Quarter compared to the Prior Production Quarter. This decrease was partially offset by a $412,000 decrease in administrative expenses and a $104,000 decrease in production taxes in the Current Production Quarter compared to the Prior Production Quarter.
The $2.54 million decrease in distributable income during the Current Period was primarily due to a decrease in sales volumes of oil, natural gas and NGL and the average realized price per boe in the production period from September 1, 2019 to May 31, 2020 (Current Production Period) as compared to the production period from September 1, 2018 to May 31, 2019 (Prior Production Period) resulting in a $3.85 million decrease in distributable income in the Current Production Period compared to the Prior Production Period. This decrease was partially offset by a $627,000 decrease in administrative expenses and a $645,000 decrease in production taxes in the Current Production Period compared to the Prior Production Period.
Royalty Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
|
2020
|
|
2019
|
|
Change
|
|
2020
|
|
2019
|
|
Change
|
|
|
($ in thousands, except per unit data)
|
|
Royalty income(a)
|
$
|
377
|
|
|
$
|
2,157
|
|
|
(83
|
)%
|
|
$
|
4,181
|
|
|
$
|
8,030
|
|
|
(48
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Estimated production from trust properties:
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil sales volumes (MBbl)
|
13
|
|
|
22
|
|
|
(41
|
)%
|
|
52
|
|
|
70
|
|
|
(26
|
)%
|
|
Natural gas sales volumes (MMcf)
|
357
|
|
|
515
|
|
|
(31
|
)%
|
|
1,353
|
|
|
1,679
|
|
|
(19
|
)%
|
|
Natural gas liquids sales volumes (MBbl)
|
30
|
|
|
48
|
|
|
(38
|
)%
|
|
114
|
|
|
143
|
|
|
(20
|
)%
|
|
Total sales volumes (Mboe)
|
102
|
|
|
156
|
|
|
(35
|
)%
|
|
392
|
|
|
493
|
|
|
(20
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average prices received for production(b):
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil ($/Bbl)
|
$
|
17.91
|
|
|
$
|
54.68
|
|
|
(67
|
)%
|
|
$
|
43.21
|
|
|
$
|
54.34
|
|
|
(20
|
)%
|
|
Natural gas ($/Mcf)
|
$
|
0.05
|
|
|
$
|
0.47
|
|
|
(89
|
)%
|
|
$
|
0.47
|
|
|
$
|
0.98
|
|
|
(52
|
)%
|
|
Natural gas liquids ($/Bbl)
|
$
|
4.48
|
|
|
$
|
14.49
|
|
|
(69
|
)%
|
|
$
|
11.39
|
|
|
$
|
18.09
|
|
|
(37
|
)%
|
|
Total average price received ($/boe)
|
$
|
3.70
|
|
|
$
|
13.83
|
|
|
(73
|
)%
|
|
$
|
10.67
|
|
|
$
|
16.29
|
|
|
(34
|
)%
|
_____________________________________________________
|
|
|
|
(a)
|
Net of certain post-production expenses.
|
|
|
|
|
(b)
|
Includes the impact of certain post-production expenses but excludes production taxes.
|
The decrease in the average price received per barrel of oil equivalent (boe) in the Current Production Quarter compared to the Prior Production Quarter resulted in a decrease of approximately $1.03 million in royalty income. Additionally, lower sales volumes in the Current Production Quarter decreased royalty income by approximately $0.75 million, for a total decrease in royalty income of approximately $1.78 million in the Current Production Quarter compared
to the Prior Production Quarter. The 54 mboe decrease in total sales attributable to the Royalty Interests for the Current Production Quarter compared to the Prior Production Quarter is primarily due to natural declines in production from the Producing Wells and Development Wells and curtailment in the Current Production Quarter due to a decrease in commodity prices.
The decrease in the average price received per barrel of oil equivalent (boe) in the Current Production Period compared to the Prior Production Period resulted in a decrease of approximately $2.20 million in royalty income. Additionally, lower sales volumes in the Current Production Period decreased royalty income by approximately $1.65 million, for a total decrease in royalty income of approximately $3.85 million in the Current Production Period compared to the Prior Production Period. The 101 mboe decrease in total sales attributable to the Royalty Interests for the Current Production Period compared to the Prior Production Period is primarily due to natural declines in production and shut-in wells from the Producing Wells and Development Wells and curtailment in the Current Production Period due to a decrease in commodity prices.
Production Taxes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
|
2020
|
|
2019
|
|
Change
|
|
2020
|
|
2019
|
|
Change
|
|
|
($ in thousands, except per unit data)
|
|
Production taxes
|
$
|
27
|
|
|
$
|
131
|
|
|
(79
|
)%
|
|
$
|
(91
|
)
|
|
$
|
554
|
|
|
(116
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Production taxes per boe
|
$
|
0.26
|
|
|
$
|
0.84
|
|
|
(69
|
)%
|
|
$
|
(0.23
|
)
|
|
$
|
1.12
|
|
|
(121
|
)%
|
Production taxes are calculated as a percentage of oil, natural gas and NGL revenues, net of any applicable tax credits. The decrease in production taxes in the Current Quarter is primarily due to decreases in the average price received per barrel of oil equivalent and in volumes produced. The decrease in production taxes in the Current Period is primarily due to a decrease in volumes produced and tax refunds received in the Current Period related to taxes paid from 2010 to 2017.
Trust Administrative Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
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Nine Months Ended
September 30,
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2020
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2019
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Change
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2020
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2019
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Change
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($ in thousands)
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Trust administrative expenses(a)
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$
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33
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$
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445
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(93
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)%
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$
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722
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$
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1,349
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(46
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)%
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_____________________________________________________
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(a)
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Includes cash advances for administrative expenses.
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Trust administrative expenses primarily consist of the administrative fees paid to the Trustees and Chesapeake as well as costs for accounting and legal services. The decrease in expenses in the Current Quarter and Current Period is primarily due to the timing and amount of cash advances.
Liquidity and Capital Resources
The Trust’s principal sources of liquidity and capital are cash flows generated from the Royalty Interests and the loan commitment as described below. The Trust’s primary uses of cash are distributions to Trust unitholders, payments of production taxes, payments of Trust administrative expenses, including any reserves established by the Trustee for future liabilities and repayment of loans and payments of expense reimbursements to Chesapeake for out-of-pocket expenses incurred on behalf of the Trust. Administrative expenses include payments to the Trustees, as well as a quarterly fee of $50,000 to Chesapeake pursuant to an administrative services agreement. Each quarter, the Trustee determines the amount of funds available for distribution. Available funds are the excess cash, if any, received by the Trust from the sales of oil, natural gas and NGL production attributable to the Royalty Interests during the quarter, over the Trust’s expenses for the quarter and any cash reserve for the payment of liabilities of the Trust. The Trust does not undertake or control any capital projects or capital expenditures. These capital expenditures, if any, are controlled and paid by Chesapeake.
The Trust’s revenue and distributions are substantially dependent upon the prevailing and future prices for oil, natural gas and NGL, each of which depends on numerous factors beyond the Trust’s control such as economic conditions, regulatory developments and competition from other energy sources. Oil, natural gas and NGL prices historically have been volatile and may be subject to significant fluctuations in the future; however, the volatility in the prices for these commodities has substantially increased as a result of COVID-19. We expect to see continued volatility in oil and natural gas prices for the foreseeable future, and such volatility has impacted and is expected to continue to adversely impact Chesapeake’s business, financial condition and results of operations and proceeds to the Trust and the Trust’s reserves and quarterly cash distributions to unitholders. The Trust does not have the ability to enter into derivative contracts to mitigate the effect of this price volatility.
The Trust is required to make quarterly cash distributions of substantially all of its cash receipts, after deducting the Trust’s administrative expenses, on or about 60 days following the completion of each calendar quarter through (and including) the quarter ending June 30, 2031. The 2020 third quarter distribution of $0.0053 per common unit, consisting of proceeds attributable to production from March 1, 2020 through May 31, 2020, was made on August 31, 2020 to record unitholders as of August 19, 2020.
The Trust's quarterly income available for distribution was $0.0012 per common unit consisting of proceeds attributable to production from June 1, 2020 to August 31, 2020. On November 4, 2020, the Trust declared the November 2020 Distribution, attributable to such production period. The distribution will be paid on November 30, 2020 to common unitholders of record as of November 19, 2020. All Trust unitholders share on a pro rata basis in the Trust's distributable income. Distributable income attributable to production from June 1, 2020 to August 31, 2020 was calculated as follows (in thousands, except for unit and per unit amounts):
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REVENUES:
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Royalty income(a)
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$
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766
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EXPENSES:
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Production taxes
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(55
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)
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Trust administrative expenses(b)
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(585
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)
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Total expenses
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(640
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)
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Cash withheld to increase cash reserves(c)
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(70
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)
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Distributable income available to common unitholders
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$
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56
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Distributable income per common unit(d)
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$
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0.0012
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___________________________________________________
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(a)
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Net of certain post-production expenses.
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(b)
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Includes the cash advance for administrative expenses.
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(c)
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Commencing with the distribution to unitholders payable in the first quarter 2019, the Trustee began withholding the greater of $70,000 or 3.5% of the funds otherwise available for distribution each quarter to gradually increase existing cash reserves by a total of approximately $850,000. The Trustee may increase or decrease the targeted amount at any time, and may increase or decrease the rate at which it is withholding funds to build the cash reserve at any time, without advance notice to the unitholders. Cash held in reserve will be invested as required by the Trust Agreement. Any cash reserved in excess of the amount necessary to pay or provide for the payment of future known, anticipated or contingent expenses or liabilities eventually will be distributed to unitholders, together with interest earned on the funds. As of September 30, 2020, $527,075 has been withheld to increase cash reserves.
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(d)
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Calculation of distributable income per common unit is based on 46,750,000 commons units issued and outstanding as of November 12, 2020.
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The Trustee can authorize the Trust to borrow money to pay Trust expenses that exceed cash held by the Trust. The Trustee may authorize the Trust to borrow from the Trustee as a lender provided the terms of the loan are fair to the Trust unitholders. The Trustee may also deposit funds awaiting distribution in an account with itself, if the interest paid to the Trust at least equals amounts paid by the Trustee on similar deposits, and make other short-term investments with the funds distributed to the Trust. The Trustee may also hold funds awaiting distribution in a non-interest-bearing account.
Pursuant to the Trust Agreement, if at any time the Trust’s cash on hand (including cash reserves, if any) is not sufficient to pay the Trust’s ordinary course expenses as they become due, Chesapeake will loan funds to the Trust necessary to pay such expenses. Any funds loaned by Chesapeake pursuant to this commitment will be limited to the payment of current accounts payable or other obligations to trade creditors in connection with obtaining goods or services or the payment of other current liabilities arising in the ordinary course of the Trust’s business and may not be used to satisfy Trust indebtedness for borrowed money of the Trust. If Chesapeake loans funds pursuant to this commitment, unless Chesapeake agrees otherwise in writing, no further distributions may be made to unitholders (except in respect of any previously determined quarterly cash distribution amount) until such loan is repaid. There were no loans outstanding as of September 30, 2020 and December 31, 2019.
Off-Balance Sheet Arrangements
The Trust has no off-balance sheet arrangements. The Trust has not guaranteed the debt of any other party, nor does the Trust have any other arrangements or relationships with other entities that could potentially result in unconsolidated debt, losses or contingent obligations.
Critical Accounting Policies and Estimates
Refer to Note 2 to the financial statements contained in Item 1 of Part I of this Quarterly Report for a discussion of significant accounting policies and estimates that impact the Trust's financial statements. Critical accounting policies and estimates relating to the Trust are contained in Item 7 of Part II of the 2019 Form 10-K.
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ITEM 3.
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Quantitative and Qualitative Disclosures about Market Risk
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Oil, Natural Gas and NGL Price Risk. The Trust’s primary asset and source of income is the Royalty Interests, which generally entitles the Trust to receive a portion of the net proceeds from the sales of oil, natural gas and NGL from the Underlying Properties. The Trust is significantly exposed to fluctuations in the prices received for oil, natural gas and NGL produced and sold which have been historically volatile and are even more volatile as a result of COVID-19.
Credit Risk Associated with Chesapeake. Chesapeake’s ability to perform its obligations to the Trust will depend on its future results of operations, financial condition, liquidity, ability to emerge from Chapter 11 bankruptcy, ability to finance planned capital expenditures and ability to comply with the financial covenants contained in its debt instruments, which in turn will depend upon the supply and demand for oil, natural gas and NGL, prevailing economic conditions, and financial, business and other factors, many of which are beyond Chesapeake’s control and subject to the continued impact of the COVID-19 pandemic and related economic turmoil. See Risks and Uncertainties in Note 2 to the financial statements contained in Item 1 of Part 1 of this Quarterly Report for further discussion of Chesapeake's ability to continue as a going concern.
In addition, the Trust could lose the value of all of the Royalty Interests if the Bankruptcy Court were to hold that the Royalty Interests constitute an asset of the bankruptcy estate. Chesapeake may also be unable to provide support to the Trust through loans and performance of its management duties during the pendency of the Chapter 11 Cases.
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ITEM 4.
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Controls and Procedures
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Evaluation of Disclosure Controls and Procedures.
The Trust’s disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act are designed to ensure that the information required to be disclosed by the Trust in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed by the Trust is accumulated and communicated by Chesapeake to The Bank of New York Mellon Trust Company, N.A., as the Trustee of the Trust, and its employees who participate in the preparation of the Trust’s periodic reports as appropriate to allow timely decisions regarding required disclosures. The Vice President of the Trustee has evaluated the effectiveness of the Trust’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(b) as of the end of the period covered by this Quarterly Report. Based on her evaluation, as of September 30, 2020, she has concluded that the Trust’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) were effective.
Due to the nature of the Trust as a passive entity and in light of the contractual arrangements pursuant to which the Trust was created, including the provisions of (a) the Trust Agreement, (b) the administrative services agreement, (c) the development agreement and (d) the conveyances granting the Royalty Interests, the Trust’s disclosure controls and procedures necessarily rely on (i) information provided by Chesapeake, including information relating to results of operations, the costs and revenues attributable to the Trust’s interests under the conveyance and other operating and historical data, plans for future operating and capital expenditures, reserve information, information relating to projected production, and other information relating to the status and results of operations of the underlying properties and the Royalty Interests, and (ii) conclusions and reports regarding reserves by the Trust’s independent reserve engineers. Although the Trustee does rely on Chesapeake to perform certain functions and to provide certain information that impact the Trust’s financial statements, the Trustee remains responsible for evaluating, as appropriate, the Trust’s disclosure controls and procedures as well as its internal control over financial reporting.
Changes in Internal Control over Financial Reporting.
There were no changes in the Trust's internal control over financial reporting during the three months ended September 30, 2020 that materially affected, or were reasonably likely to materially affect, the Trust's internal control over financial reporting.