SANDRIDGE MISSISSIPPIAN TRUST II Introduction
The following discussion and analysis is intended to help the reader understand the Trust's business, financial condition, results of operations, liquidity and capital resources. This discussion and analysis should be read in conjunction with other sections of this report, including: "Business" in Item 1 and "Financial Statements and Supplementary Data" in Item 8. The discussion and analysis relate to the following subjects:
•Recent Developments;
•Results of Trust Operations;
•Liquidity and Capital Resources;
•Critical Accounting Policies and Estimates; and
•Off-Balance Sheet Arrangements.
Trust Termination and Overview
The following is a brief overview of certain matters discussed more thoroughly elsewhere in this report.
The trust agreement requires the Trust to dissolve and begin to liquidate onDecember 31, 2031 unless any of the following occurs: (a) the Trust sells all of the royalty interests previously conveyed to the Trust; (b) cash available for distribution for any four consecutive quarters, on a cumulative basis, is less than$5.0 million ; (c) Trust unitholders approve an earlier dissolution of the Trust; or (d) the Trust is judicially dissolved. As cash available for distribution for the four consecutive quarters endedDecember 31, 2019 , on a cumulative basis, totaled approximately$4.392 million , the Trust was required to dissolve and commence winding up beginning as of the close of business onFebruary 14, 2020 (the "dissolution trigger date"). Accordingly, the Trustee is required to sell all of the Trust's assets, either by private sale or public auction, and distribute the net proceeds of the sale to the Trust unitholders after payment, or reasonable provision for payment, of all Trust liabilities, which is expected to include the establishment of cash reserves in such amounts as the Trustee in its discretion deems appropriate for the purpose of making reasonable provision for all claims and obligations of the Trust, including any contingent, conditional or unmatured claims and obligations, in accordance with the Delaware Statutory Trust Act. The sale process will involve costs that will reduce the amounts of any distributions to unitholders during the winding up period. As required by the trust agreement, within 30 days after the dissolution trigger date the Trustee plans to engage a third-party advisor to assist with the marketing and sale of the Trust's assets. As provided in the trust agreement, SandRidge has a right of first refusal with respect to any sale of assets to a third party. The Trustee expects to complete the sale of the Trust's assets and distribute the net proceeds of the sale to the Trust unitholders by the end of 2020, and the Trust units are expected to be canceled shortly thereafter. Pending the sale or sales of the Royalty Interests, and subject to the terms of such sales, the Trust anticipates that it will continue to receive income from the Royalty Interests and will continue to make quarterly distributions to unitholders to the extent there is available cash after payment of Trust expenses and additions to cash reserves. The Trust will remain in existence until the filing of a certificate of cancellation with the Secretary of State of theState of Delaware following the completion of the winding up process. The Trust's reserves and quarterly cash distributions are highly dependent upon the prices realized from the sale of oil, natural gas and NGL. The markets for these commodities are volatile. Oil, natural gas and NGL prices declined significantly in the fourth quarter of 2018 and experienced substantial fluctuations during 2019. Meanwhile, crude oil prices have declined sharply in the first quarter of 2020, from$61.17 per Bbl onJanuary 2, 2020 to$30.24 per Bbl onMarch 9, 2020 . A buildup in inventories, lower global demand, or other factors could cause prices forU.S. oil, natural gas and NGL to weaken further.
Results of Trust Operations
Results of the
The primary factors affecting the Trust's revenues and costs are the quantity of oil, natural gas and NGL production attributable to the Royalty Interests and the prices received for such production. Royalty income, post-production expenses and certain taxes are recorded on a cash basis when the Trust receives net revenue distributions from SandRidge. Information regarding the Trust's revenues, expenses, production and pricing for the years endedDecember 31, 2019 and 2018 is presented below. 39 -------------------------------------------------------------------------------- Year Ended December 31, 2019(1) 2018(2) Production data Oil (MBbls) 42 74 NGL (MBbls) 187 185 Natural gas (MMcf) 1,926 2,331 Combined equivalent volumes (MBoe)(3) 549 648 Average daily combined equivalent volumes (MBoe/d) 1.5 1.8 Well data Initial and Trust Development Wells producing - average 121 147 Revenues (in thousands) Royalty income $ 10,147 $ 14,640 Total revenue 10,147 14,640 Expenses (in thousands) Post-production expenses 1,659 1,800 Property taxes 61 97 Production taxes 608 896 Trust administrative expenses 1,521 1,266
Cash reserves withheld, net of amounts used for current Trust expenses
421 262
Total expenses 4,270 4,321
Distributable income available to unitholders $ 5,877 $ 10,319
Average prices
Oil (per Bbl) $ 57.07 $ 59.71
NGL (per Bbl) $ 19.29 $ 28.27
Combined oil and NGL (per Bbl) $ 26.18 $ 37.27
Natural gas (per Mcf) $ 2.14 $ 2.12
Combined equivalent (per Boe) $ 18.39 $ 22.55
Average prices - including impact of post-production expenses
Natural gas (per Mcf) $ 1.28 $ 1.35
Combined equivalent (per Boe) $ 15.37 $ 19.77
Expenses (per Boe)
Post-production $ 3.02 $ 2.78
Production taxes $ 1.11 $ 1.38
____________________
(1) Production volumes and related revenues and expenses for the year ended
December 31, 2019 (included in SandRidge's 2019 net revenue distributions to the
Trust) represent oil, natural gas and NGL production from September 1, 2018 to
August 31, 2019 .
(2) Production volumes and related revenues and expenses for the year ended
December 31, 2018 (included in SandRidge's 2018 net revenue distributions to the
Trust) represent oil, natural gas and NGL production from September 1, 2017 to
August 31, 2018 .
(3) Barrel of oil equivalent, determined using the ratio of six Mcf of natural
gas to one Bbl of oil, which approximates the relative energy content of oil as
compared to natural gas.
Comparison of Results of the
Revenues Royalty Income. Royalty income is a function of production volumes sold attributable to the Royalty Interests and associated prices received. Royalty income received during the year endedDecember 31, 2019 totaled$10.1 million compared to$14.6 million received during the year endedDecember 31, 2018 . The approximately$4.5 million decrease in royalty income consisted of approximately$2.8 million attributable to a decrease in total volumes produced, and by approximately$1.7 million attributable to a decrease in prices received. The average number of producing wells decreased by 26 during the year endedDecember 31, 2019 compared to the year endedDecember 31, 2018 as wells that could not economically produce due to continued depressed pricing were shut-in. 40 --------------------------------------------------------------------------------
Expenses
Post-Production Expenses. The Trust bears post-production expenses attributable to production from the Royalty Interests. Post-production expenses generally consist of costs incurred to gather, store, compress, transport, process, treat, dehydrate and market the natural gas produced. Post-production expenses for the year endedDecember 31, 2019 totaled approximately$1.7 million compared to approximately$1.8 million for the year endedDecember 31, 2018 . Production Taxes. Production taxes are calculated as a percentage of oil, natural gas and NGL revenues, excluding the effects of derivative settlements and net of any applicable tax credits. Production taxes for the year endedDecember 31, 2019 totaled$0.6 million , or$1.11 per Boe, and were approximately 6.0% of royalty income. Production taxes for the year endedDecember 31, 2018 totaled$0.9 million , or$1.38 per Boe, and were approximately 6.1% of royalty income. Distributable Income Distributable income for the year endedDecember 31, 2019 was$5.9 million , which included a net addition of approximately$0.4 million to the cash reserve for the payment of future Trust expenses reflecting approximately$2.0 million withheld in aggregate from 2019 cash distributions to unitholders partially offset by approximately$1.6 million used to pay Trust expenses during the period. Distributable income for the year endedDecember 31, 2018 was$10.3 million , which included a net addition of approximately$0.3 million to the cash reserve for the payment of future Trust expenses reflecting approximately$1.6 million withheld in aggregate from 2018 cash distributions to unitholders partially offset by approximately$1.4 million used to pay Trust expenses during the period.
Liquidity and Capital Resources
The Trust has no source of liquidity or capital resources other than cash flow generated from the Royalty Interests and borrowings to fund administrative expenses, including any amounts borrowed under SandRidge's loan commitment described in Note 5 to the financial statements contained in Item 8 of this report. The Trust's primary uses of cash are distributions to Trust unitholders, payment of Trust administrative expenses, including any reserves established by the Trustee for future liabilities, payment of applicable taxes and payment of expense reimbursements to SandRidge for out-of-pocket expenses incurred on behalf of the Trust. See Item 3 of this report for a description of the impact of legal proceedings on the Trust's administrative expenses. The Trust is not obligated to pay any operating expenses or capital costs related to the wells. Administrative expenses include payments to the Trustee and the Delaware Trustee as well as a quarterly fee of$75,000 to SandRidge 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 sale of production attributable to the Royalty Interests that quarter, over the Trust's expenses for the quarter. If at any time the Trust's cash on hand (including available cash reserves) is not sufficient to pay the Trust's ordinary course administrative expenses as they become due, the Trust may borrow funds from the Trustee or other lenders, including SandRidge, to pay such expenses. The Trustee has not loaned and does not intend to lend funds to the Trust. If such funds are borrowed, no further distributions will be made to Trust unitholders (except in respect of any previously determined quarterly distribution amount) until the borrowed funds have been repaid, except that if SandRidge loans such funds, SandRidge may permit the Trust to make distributions prior to SandRidge being repaid. There was no such loan outstanding at eitherDecember 31, 2019 or 2018. Commencing with the distribution to unitholders paid in the first quarter of 2019, the Trustee has withheld the greater of$50,000 or 3.5% of the funds otherwise available for distribution each quarter to gradually increase cash reserves for the payment of future known, anticipated or contingent expenses or liabilities by a total of$625,000 . With the potential for an early termination of the Trust, inNovember 2019 the Trust announced that the withholding for each of the distributions paid to unitholders in the fourth quarter of 2019 and the first quarter of 2020 would be increased to$195,000 , to enable the Trustee to reach the targeted reserve amount. In 2019, the Trustee withheld an aggregate of approximately$384,000 from the funds otherwise available for distribution. InFebruary 2020 , the Trustee withheld approximately$195,000 from the funds otherwise available for distribution. In addition, during the winding up period following the dissolution of the Trust onFebruary 14, 2020 , the Trustee may make further additions to cash reserves as the Trustee in its discussion deems appropriate for the purpose of making reasonable provision for all claims and obligations of the Trust, in accordance with the Delaware Statutory Trust Act. These cash reserves, if needed, are expected to be sufficient to fund the Trust's expenses for the next 12 months. The Trust is highly dependent on its Trustor, SandRidge, for multiple services, including the operation of the Trust wells, remittance of net proceeds from the sale of associated production to the Trust, administrative services such as accounting, tax preparation, bookkeeping and informational services performed on behalf of the Trust. The ability to operate the properties depends on the Trustor's future financial condition and economic performance, access to capital, and other factors, many of which are out of the control of the Trustor. If the reduced demand for crude oil in the global market as a result of the economic 41 -------------------------------------------------------------------------------- effects of the outbreak of coronavirus, and the recent reduction in the benchmark price of crude oil, persist for the near future or longer, such factors could have a negative impact on the financial condition and economic performance of SandRidge, which could affect SandRidge's ability to operate the Trust wells and provide services to the Trust.
Trust Distributions to Unitholders. During the years ended
Covered Production Total
Period Date Declared Date Paid Distribution Paid
Calendar Quarter 2019
September 1, 2018 -
First Quarter November 30, 2018 January 24, 2019 February 22, 2019 $ 2,088,450
December 1, 2018 -
Second Quarter February 28, 2019 April 25, 2019 May 24, 2019 $ 1,740,375
March 1, 2019 - May 31,
Third Quarter 2019 July 25, 2019 August 23, 2019 $ 1,392,300
June 1, 2019 -
Fourth Quarter August 31, 2019 October 24, 2019 November 22, 2019 $ 646,425
Calendar Quarter 2018
September 1, 2017 -
First Quarter November 30, 2017 January 25, 2018 February 23, 2018 $ 2,884,050
December 1, 2017 -
Second Quarter February 28, 2018 April 26, 2018 May 25, 2018 $ 2,734,875
March 1, 2018 - May 31,
Third Quarter 2018 July 26, 2018 August 24, 2018 $ 2,237,625
June 1, 2018 -
Fourth Quarter August 31, 2018 October 25, 2018 November 23, 2018 $ 2,436,525
On February 28, 2020 , the Trust paid a cash distribution of $0.014 per Trust
unit covering production for the three-month period from September 1, 2019 to
November 30, 2019 . The distribution totaled $0.7 million and was made to Trust
unitholders of record as of February 14, 2020 .
Continued relatively low oil, natural gas and NGL prices will reduce proceeds to
which the Trust is entitled and may ultimately reduce the amount of oil, natural
gas and NGL that is economic to produce from the Underlying Properties . As the
Trust cannot acquire or cause additional wells to be drilled on its behalf, the
production from the Underlying Properties attributable to the Royalty Interests
is expected to decline each quarter during the remainder of the Trust's life.
Contractual Obligations. Pursuant to the terms of the administrative services
agreement with SandRidge, the Trust is obligated to pay SandRidge an annual
administrative services fee of $300,000 for accounting, tax preparation,
bookkeeping and informational services to be performed by SandRidge on behalf of
the Trust throughout the life of the Trust. Pursuant to the trust agreement, the
Trust pays the Trustee an annual administrative fee, which prior to January 1,
2018 was $150,000 . The annual fee can be adjusted for inflation by no more than
3% in any year through 2031. The annual administrative fee, which was adjusted
for inflation in July 2019 , currently is approximately $156,000 . In addition,
under the trust agreement the Trust is obligated to pay the Delaware Trustee an
annual fee of $2,400 , throughout the life of the Trust.
Critical Accounting Policies and Estimates
The financial statements of the Trust are significantly affected by its basis of accounting and estimates related to the Royalty Interests and proved reserves, as summarized below. Basis of Accounting. The financial statements of the Trust differ from financial statements prepared in accordance with accounting principles generally accepted inthe United States of America ("GAAP") as the Trust records revenues when cash is received (rather than when earned) and expenses when paid (rather than when incurred) and may also establish cash reserves for contingencies, which would not be accrued in financial statements prepared in accordance with GAAP. This comprehensive basis of accounting other than GAAP corresponds to the accounting permitted for royalty trusts by theSEC as specified by Staff Accounting Bulletin Topic 12:E, Financial Statements of Royalty Trusts. Amortization of investment in royalty interests, calculated on a unit-of-production basis, and any impairment are charged directly to trust corpus. Distributions to unitholders are recorded when declared. Because the Trust's financial statements are prepared on a modified cash basis, most accounting pronouncements are not applicable to the Trust's financial statements. 42 -------------------------------------------------------------------------------- Proved Reserves. The proved oil, natural gas and NGL reserves attributable to the Royalty Interests are estimated by independent petroleum engineers. Estimates of proved reserves are based on the quantities of oil, natural gas and NGL that geological and engineering data demonstrate, with reasonable certainty, to be recoverable in future years from known reservoirs under existing economic and operating conditions; however, there are numerous uncertainties inherent in estimating quantities of proved reserves and in projecting future revenues, rates of production and timing of development expenditures, including many factors beyond the Trust's control. Estimating reserves is very complex and relies on assumptions and subjective interpretations of available geologic, geophysical, engineering and production data, and the accuracy of reserve estimates is a function of the quality and quantity of available data, engineering and geological interpretation and judgment. In addition, as a result of volatility of changing market conditions, commodity prices will vary from period to period, causing estimates of proved reserves to vary, as well as causing estimates of future net revenues to vary. Estimates of proved reserves are key components of the Trust's most significant financial estimates as discussed further below. Amortization of Investment in Royalty Interests. Amortization of investment in royalty interests is calculated on a units-of-production basis, whereby the Trust's cost basis is divided by the proved reserves attributable to the Royalty Interests to derive an amortization rate per reserve unit. The rate used to record amortization is dependent upon the estimate of total proved reserves attributable to the Royalty Interests, which incorporates various assumptions and future projections. If the estimates of total proved reserves decline significantly, the rate at which the Trust records amortization would increase, reducing trust corpus. Such a decline in reserves may result from lower commodity prices, which may make it uneconomic for SandRidge to produce from theUnderlying Properties or from other factors, including changes to estimates for other reasons. Changes in reserve quantity estimates are dependent on future economic and operational conditions and cannot be predicted. Impairment of Investment in Royalty Interests. The investment in royalty interests is assessed to determine whether net capitalized cost is impaired whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Potential impairments of the investment in royalty interests are determined by comparing the net capitalized costs of investment in royalty interests to undiscounted future net revenues attributable to the Trust's interest in the proved oil, natural gas and NGL reserves of theUnderlying Properties . The Trust provides a write-down to the extent that the net capitalized costs exceed the fair value of the Royalty Interests, which is determined using future cash flows of the oil, natural gas and NGL reserves attributable to the Royalty Interests, discounted at a rate based upon the weighted average cost of capital of publicly traded royalty trusts. Different pricing assumptions or discount rates could result in a different calculated impairment. The Trust recorded impairments in the carrying value of the Investment in Royalty Interests of$19.9 million during the year endedDecember 31, 2019 . The impairments resulted in a non-cash charges to trust corpus and did not affect the Trust's distributable income. No impairment was recorded in 2018. Material write-downs in subsequent periods may occur if commodity prices decline.
Refer to Note 2 to the financial statements included in Item 8 of this report for the Trust's significant accounting policies.
Off-balance sheet arrangements
As of
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
As a "smaller reporting company" as defined in Item 10(f)(1) of Regulation S-K, the Trust is not required to provide information required by this Item.
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