CHESAPEAKE GRANITE WASH TRUST 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 theUnderlying 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 endedDecember 31, 2020 . Recent Developments COVID-19 Pandemic and Impact on Global Demand forOil and Natural Gas The global spread of COVID-19 created significant volatility, uncertainty, and economic disruption during 2020. The pandemic has reached more than 200 countries and territories and has resulted in widespread adverse impacts on the global economy and on Tapstone and Tapstone's customers and other parties with whom it has business relations. To date, Tapstone has experienced limited operational impacts as a result of COVID-19 or the related governmental restrictions. While we cannot predict the full impact that COVID-19 or the current significant disruption and volatility in the oil and natural gas markets will have on Tapstone's business, cash flows, liquidity, financial condition and results of operations. For additional discussion regarding risks associated with the COVID-19 pandemic, see Part II, Item 7. Trustee's Discussion and Analysis of Financial Condition and Results of Operations in our 2020 Form 10-K and Item 1A "Risk Factors" in our 2020 Form 10-K. Winter Weather Event InMay 2021 , Tapstone, pursuant to certain royalty trust conveyances between Tapstone and the Trust, will deposit$500,000 of proceeds received by Tapstone associated with theFebruary 2021 production period in a separate escrow account. Significant demand, coupled with freeze related natural gas production curtailment resulted in supply shortages prompting natural gas prices to spike in mid-February in the centralUnited States (the "Winter Weather Event"). Natural gas produced from theUnderlying Properties and other Tapstone assets inFebruary 2021 realized a significant increase in prices for natural gas during such period, causing the related natural gas production revenues generated from theUnderlying Properties (the "Winter Weather Event Proceeds") to significantly increase, which is not expected to be a normal or recurring event. To ensure the proper allocation of the Winter Weather Event Proceeds to Tapstone's mineral interest owners, including the Trust, from this event, Tapstone will deposit$500,000 , an estimate of the amount at issue, in an escrow account (the "Escrowed Funds") to avoid possible allocation controversy while it reviews the allocation between mineral ownership of theUnderlying Properties . Interest on the Escrowed Funds attributable to the Royalty Interests will be paid to the Trust upon completion of the review process. The Winter Weather Event Proceeds attributable to the Royalty Interests may be materially greater or less than the amount of Escrowed Funds and will be recognized as Royalty Income in a future period. Tapstone expects to conclude its allocation review process and submit the Winter Weather Event Proceeds (together with any interest thereon) attributable to the Royalty Interests to the Trust byJuly 31, 2021 , for distribution to Trust unitholders byAugust 30, 2021 . Overview The Trust is a statutory trust formed inJune 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 forU.S. federal income tax purposes. Concurrent with the Trust's initial public offering inNovember 2011 , Chesapeake conveyed the Royalty Interests to the Trust effectiveJuly 1, 2011 , which included interests in (a) 69 Producing Wells in the Colony Granite 10 -------------------------------------------------------------------------------- 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 toJune 30, 2016 . As ofJune 30, 2016 , Chesapeake fulfilled its drilling obligation under the development agreement. Chesapeake retained an interest in each of the Producing Wells and Development Wells, which were acquired by Tapstone pursuant to the Assignment Agreement, and Tapstone 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 theUnderlying 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 Tapstone'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 Tapstone'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 Tapstone or Tapstone 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 endingJune 30, 2031 . During the three months endedMarch 31, 2021 , a distribution was paid onMarch 1, 2021 . 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 •the Trust's expenses. 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 Tapstone during the preceding calendar quarter. Proceeds from production are typically received by Tapstone in the month following the month of production. Due to the timing of the payment of production proceeds, quarterly distributions made by Tapstone 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. Tapstone is required to make the Royalty Interest payments to the Trust within 35 days after the end of each calendar quarter. During the three months endedMarch 31, 2021 , the Trust received payments on the Royalty Interests representing royalties attributable to proceeds from sales of oil, natural gas and NGL forSeptember 1, 2020 toNovember 30, 2020 . The Trust's revenues and distributable income available to unitholders were adversely affected throughout 2020 and to date in 2021 by natural declines in production and commodity price volatility including, with respect to theCurrent 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$0.8 million impairment of the Royalty Interests in the Current Period. In the three months endedMarch 31, 2020 , 11 -------------------------------------------------------------------------------- the Trust recognized no impairments of the Royalty Interests.See Investment in Royalty Interests in Note 2 to the financial statements contained in Item 1 of Part I of this Quarterly Report for further discussion. Distributable Income Three Months Ended March 31, 2021 2020 Change ($ in thousands, except per unit data) Distributable income available to unitholders $ 294$ 1,733 (83) % Distributable income per common unit $ 0.0063$ 0.0371 (83) % The$1.44 million decrease in distributable income during theCurrent Quarter was primarily due to a decrease in sales volumes of oil, natural gas and NGL and the average realized price per boe in the production period fromSeptember 1, 2020 toNovember 30, 2020 (the "Current Production Quarter ") as compared to the production period fromSeptember 1, 2019 toNovember 30, 2019 (the "PriorProduction Quarter "). Royalty Income Three Months Ended March 31, 2021 2020 Change ($ in thousands, except per unit data) Royalty income(a) $ 954$ 2,016 (53) % Estimated production from trust properties: Oil sales volumes (MBbl) 10 20 (50) % Natural gas sales volumes (MMcf) 340 511 (33) % Natural gas liquids sales volumes (MBbl) 31 42 (26) % Total sales volumes (Mboe) 98 147 (33) % Average prices received for production(b): Oil ($/Bbl) $ 33.37$ 51.06 (35) % Natural gas ($/Mcf) $ 0.68$ 0.81 (16) % Natural gas liquids ($/Bbl) $ 12.47$ 14.17 (12) % Total average price received ($/boe) $ 9.75$ 13.69 (29) %
_____________________________________________________
(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 theCurrent Production Quarter compared to the PriorProduction Quarter resulted in a decrease of approximately$0.39 million in royalty income. Additionally, lower sales volumes in theCurrent Production Quarter decreased royalty income by approximately$0.67 million , for a total decrease in royalty income of approximately$1.06 million in theCurrent Production Quarter compared to the PriorProduction Quarter . The 49 mboe decrease in total sales attributable to the Royalty Interests for theCurrent Production Quarter compared to the PriorProduction Quarter is primarily due to natural declines in production from the Producing Wells and Development Wells. 12 --------------------------------------------------------------------------------
Production Taxes
Three Months Ended
March 31,
2021 2020 Change
($ in thousands, except per unit data)
Production tax expenses(income) $ 56 $ (164) 134 %
Production taxes per boe $ 0.57 $ (1.12) 151 %
Production taxes are calculated as a percentage of oil, natural gas and NGL
revenues, net of any applicable tax credits. The increase in production taxes in
the Current Quarter compared to the Prior Period relates to tax refunds received
in the Prior Period related to taxes paid from 2010 to 2017.
Trust Administrative Expenses
Three Months Ended
March 31,
2021 2020 Change
($ in thousands)
Trust administrative expenses(a) $ 534 $ 377 42 %
_____________________________________________________
(a)Includes cash advances for administrative expenses. During the three months endedMarch 31, 2021 , the Trust incurred administrative expenses related to the periods fromNovember 1, 2020 toJanuary 31, 2021 . Trust administrative expenses primarily consist of the administrative fees paid to the Trustees and Chesapeake (now Tapstone following theDecember 11, 2020 acquisition of theUnderlying Properties ) as well as costs for accounting and legal services. The increase in expenses in theCurrent Quarter is primarily due to an increase in accounting fees related to the year-end audit of the Trust. 13
-------------------------------------------------------------------------------- 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 Tapstone 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 Tapstone 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 Tapstone. 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 Tapstone'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 endingJune 30, 2031 . The 2021 first quarter distribution of$0.0063 per common unit, consisting of proceeds attributable to production fromSeptember 1, 2020 throughNovember 30, 2020 , (net of administrative expenses incurred fromNovember 1, 2020 toJanuary 31, 2021 ) was made onMarch 1, 2021 to record unitholders as ofFebruary 19, 2021 . The Trust's quarterly income available for distribution was$0.0467 per common unit consisting of proceeds attributable to production fromDecember 1, 2020 toFebruary 28, 2021 (net of administrative expenses incurred fromFebruary 1, 2021 toApril 30, 2021 ). OnMay 5, 2021 , the Trust declared theMay 2021 Distribution, attributable to such production period. The distribution will be paid onJune 1, 2021 to common unitholders of record as ofMay 20, 2021 . All Trust unitholders share on a pro rata basis in the Trust's distributable income. Distributable income attributable to production fromDecember 1, 2020 toFebruary 28, 2021 was calculated as follows (in thousands, except for unit and per unit amounts): REVENUES: Royalty income(a)$ 2,546 EXPENSES: Production taxes (187) Trust administrative expenses(b) (95) Total expenses (282) Cash withheld to increase cash reserves(c) (82) Distributable income available to common unitholders$ 2,182 Distributable income per common unit(d)$ 0.0467
___________________________________________________
(a)Net of certain post-production expenses and is not inclusive of the Escrowed
Funds. During the period, we experienced the Winter Weather Event, and the
increased royalty income as a result thereof is not expected to be a normal or
recurring event.
14
--------------------------------------------------------------------------------
(b)Includes the cash advance for administrative expenses.
(c)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 March 31, 2021 ,
$667,075 has been withheld to increase cash reserves.
(d)Calculation of distributable income per common unit is based on 46,750,000
commons units issued and outstanding as of May 4, 2021 .
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, Tapstone will loan funds to the Trust
necessary to pay such expenses. Any funds loaned by Tapstone 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 Tapstone loans funds pursuant to this commitment, unless
Tapstone 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 March 31, 2021 and December 31, 2020 .
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 2020 Form 10-K.
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk
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 Tapstone. Tapstone's ability to perform its
obligations to the Trust will depend on its future results of operations,
financial condition, liquidity, 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 Tapstone's control and subject to the
continued impact of the COVID-19 pandemic and related economic turmoil.
15
--------------------------------------------------------------------------------
In the event of a bankruptcy of Tapstone, the Trust could lose the value of
all of the Royalty Interests if a bankruptcy court were to hold that the Royalty
Interests constitute an asset of the bankruptcy estate. Tapstone may also be
unable to provide support to the Trust through loans and performance of its
management duties.
ITEM 4. Controls and Procedures
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
Tapstone to the Trustee, 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 March 31, 2021 , 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 Tapstone, 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 Tapstone 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 March 31, 2021 that materially affected, or were
reasonably likely to materially affect, the Trust's internal control over
financial reporting.
16--------------------------------------------------------------------------------
© Edgar Online, source
