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 audited financial statements and the accompanying notes relating to the Trust and theUnderlying Properties included in Part II, Item 8 of this AnnualReport and The Underlying Properties and the Royalty Interests and Discussion and Analysis of Results from theUnderlying Properties included in Part I, Item 1 of this Annual Report.
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 Wash play and (b) 118 Development Wells that have since been drilled in the Colony Granite Wash play on properties within the AMI. Chesapeake was obligated to drill, cause to be drilled or participate as a non-operator in the drilling of the Development Wells from drill sites in the AMI on or prior toJune 30, 2016 . Additionally, based on 40 -------------------------------------------------------------------------------- Chesapeake's assessment of the ability of a Development Well to produce in paying quantities, Chesapeake was obligated to either complete and tie into production or plug and abandon each Development Well. As ofJune 30, 2016 , Chesapeake had fulfilled its drilling obligation under the development agreement. The Operator retained an interest in each of the Producing Wells and Development Wells, and Diversified currently operates approximately 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 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 the Operator'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 the Operator'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 the Operator 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 endingJune 30, 2031 . During the year endedDecember 31, 2022 , four distributions were paid. See Liquidity and Capital Resources below and Note 5 to the financial statements contained in Part II, Item 8 of this Annual Report for more information regarding the distributions.
The amount of Trust revenues and cash distributions to Trust unitholders fluctuates from quarter to quarter depending on several factors, including:
•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
Below is a discussion of changes in our results of operations for 2022 compared to 2021. A discussion of changes in our results of operations for 2021 compared to 2020 has been omitted from this Form 10-K, but may be found in Part II, Item 7. Trustee's Discussion and Analysis of Financial Condition and Results of Operations of our Form 10-K for the year endedDecember 31, 2021 as filed with theSEC onMarch 22, 2022 . The quarterly payments to the Trust with respect to the Royalty Interests are based on the amount of proceeds actually received by the Operator during the preceding calendar quarter. Proceeds from production are typically received by the Operator approximately one month after the month of production. Due to the timing of the payment of production proceeds, quarterly distributions made by the Operator 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. The Operator is required to make the Royalty Interest payments to the Trust within 35 days of the end of each calendar quarter. During the year endedDecember 31, 2022 , the Trust received payments on the Royalty Interests representing royalties attributable to proceeds from sales of oil, natural gas and NGL forSeptember 1, 2021 throughAugust 31, 2022 . During the year endedDecember 31, 2021 , the payments received by the Trust represented royalties attributable to proceeds from sales of oil, natural gas and NGL forSeptember 1, 2020 throughAugust 31, 2021 . The Trust's revenues and distributable income available to unitholders have been favorably affected throughout 2022 by a slight increase in production and higher commodity prices. Due to natural declines, the Trust expects production to decline in the future and expects distributable income to be adversely affected. 41 -------------------------------------------------------------------------------- During the year endedDecember 31, 2022 the Trust recognized no impairments of the Royalty Interests. During the year endedDecember 31, 2021 the Trust recognized impairments of$0.8 million of the Royalty Interests as a result of lower commodity prices. See Note 2 to the financial statements contained in Part II, Item 8 of this Annual Report for further discussion of the impairment analysis.
Distributable Income. The Trust's distributable income was
The$6.5 million increase from 2021 to 2022 was primarily due to an increase in the average realized prices received from sales of oil, natural gas and NGL with a slight revenue increase attributable to an increase in production volumes in the production period fromSeptember 1, 2021 toAugust 31, 2022 (the "2022 production period") as compared to the production period fromSeptember 1, 2020 toAugust 31, 2021 (the "2021 production period"). See Royalty Income below for information regarding average prices received and sales volumes. On a per unit basis, cash distributions during the year endedDecember 31, 2022 and attributable to the 2022 production period were$0.2778 per common unit as compared to$0.1399 per common unit for the year endedDecember 31, 2021 and attributable to the 2021 production period. Distributable income for the production periods described above was calculated as follows: Years Ended December 31, 2022 2021 ($ in thousands, except per unit data) Revenues: Royalty income(1) $ 15,842$ 8,697 Total revenues 15,842 8,697 Expenses: Production taxes (1,111) (590) Trust administrative expenses(2) (1,272) (1,370) Total expenses (2,383) (1,960) Cash withheld to increase cash reserves(3) (471) (197) Distributable income available to unitholders $
12,988
Distributable income per common unit (46,750,000 units) $ 0.2778
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(1)Net of certain post-production expenses.
(2)Includes the annual change in cash advance resulting in an increase in
administrative expenses totaling
(3)The Trustee may increase or decrease the targeted amount of the cash reserve 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. Without limiting the foregoing, the Trustee reviewed the adequacy and sufficiency of the existing cash reserve in 2021 and determined to withhold funds otherwise available for distribution to the unitholders each quarter to increase existing cash reserves by a total of approximately$3,200,000 over a period of several quarters, commencing with the distribution to unitholders for the fourth quarter 2021 (payable in 2022). As ofDecember 30, 2022 $1,265,828 has been so withheld to increase cash reserves. 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. Royalty Income. Royalty income to the Trust for the year endedDecember 31, 2022 , and attributable to the 2022 production period, totaled$15.8 million based upon sales of production attributable to the Royalty Interests of 60 mbbls of oil, 1,236 mmcf of natural gas and 153 mbbls of NGL. Total production attributable to the Royalty Interests for the 2022 production period was 419 mboe. Average prices received for oil, natural gas and NGL production, including the impact of certain post-production expenses and excluding production taxes, during the 42 --------------------------------------------------------------------------------
2022 production period were
Royalty income to the Trust for the year endedDecember 31, 2021 , and attributable to the 2021 production period, totaled$8.7 million based upon sales of production attributable to the Royalty Interests of 48 mbbls of oil, 1,310 mmcf of natural gas and 151 mbbls of NGL. Total production attributable to the Royalty Interests for the 2021 production period was 417 mboe. Average prices received for oil, natural gas and NGL production, including the impact of certain post-production expenses and excluding production taxes, during the 2021 production period were$53.32 per bbl of oil,$2.39 per mcf of natural gas and$20.05 per bbl of NGL, respectively. The increase in the average price received per boe in the 2022 production period compared to the 2021 production period resulted in a$7.1 million increase in royalty income. The slight increase in sales volumes resulted in a de minimis increase in royalty income, for a net increase in royalty income of$7.1 million . Production Taxes. Production taxes are calculated as a percentage of oil, natural gas and NGL revenues, net of any applicable tax credits. Production taxes for the year endedDecember 31, 2022 , and attributable to the 2022 production period, totaled$1.1 million , or$2.65 per boe, or approximately 7.0% of royalty income, as compared to$0.6 million , or$1.41 per boe, or approximately 6.8% of royalty income for the year endedDecember 31, 2021 , and attributable to the 2021 production period. The increase in production taxes per boe from 2021 to 2022 was primarily due to increased commodity prices.
Trust Administrative Expenses. Trust administrative expenses, including
additional cash reserves, for the years ended
Liquidity and Capital Resources
The Trust's principal sources of liquidity and capital are cash flows generated from the Royalty Interests. 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 the Operator for out-of-pocket expenses incurred on behalf of the Trust. Administrative expenses include payments to the Trustee and the Delaware Trustee as well as a quarterly fee of$50,000 to the Administrative Servicer pursuant to the 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 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 year endedDecember 31, 2022 , four distributions were paid. The 2022 first quarter distribution of$0.0667 per common unit to common unitholders consisting of proceeds attributable to production fromSeptember 1, 2021 throughNovember 30, 2021 , was made onMarch 3, 2022 to record unitholders as ofFebruary 21, 2022 . The 2022 second quarter distribution of$0.0540 per common unit, consisting of proceeds attributable to production fromDecember 1, 2021 throughFebruary 28, 2022 , was made onMay 31, 2022 to record unitholders as ofMay 20, 2022 . The 2022 third quarter distribution of$0.0849 per common unit, consisting of proceeds attributable to production fromMarch 1, 2022 throughMay 31, 2022 , was made onAugust 29, 2022 to record unitholders as ofAugust 19, 2022 . The 2022 fourth quarter distribution of$0.0722 per common unit, consisting of proceeds attributable to production fromJune 1, 2022 throughAugust 31, 2022 , was made onDecember 1, 2022 to record unitholders as ofNovember 21, 2022 . 43 --------------------------------------------------------------------------------
The following is a summary of distributable income and distributable income per
common unit by quarter for the years ended
2022 Q1 Q2 Q3 Q4 Total
Distributable income $ 3,120 $ 2,524 $ 3,968 $ 3,376 $ 12,988
Distributable income per common unit $ 0.0667 $ 0.0540 $ 0.0849 $ 0.0722 $ 0.2778
2021 Q1 Q2 Q3 Q4 Total
Distributable income $ 294 $ 2,182 $
1,744
OnFebruary 3, 2023 , the Trust announced that a cash distribution of$0.0757 per common unit consisting of proceeds attributable to production fromSeptember 1, 2022 toNovember 30, 2022 , to common unitholders of record, as of February 20, 2023 would be paid on March 1, 2023. See Note 6 to the financial statements contained in Part II, Item 8 of this Annual Report for additional information regarding the distribution paid onMarch 1, 2023 to record unitholders as ofFebruary 20, 2023 . 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. Without limiting the foregoing, the Trustee reviewed the adequacy and sufficiency of the existing cash reserve in 2021 and determined to withhold funds otherwise available for distribution to the unitholders each quarter to increase existing cash reserves by a total of approximately$3,200,000 over a period of several quarters, commencing with the distribution to unitholders for the fourth quarter 2021 (payable in 2022). As ofDecember 30, 2022 $1,265,828 has been so withheld to increase cash reserves. 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. 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) is not sufficient to pay the Trust's ordinary course expenses as they become due, the Operator will loan funds to the Trust necessary to pay such expenses. Any funds loaned by the Operator 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 the Operator loans funds pursuant to this commitment, unless the Operator agrees otherwise, no further distributions will be made to unitholders (except in respect of any previously determined quarterly cash distribution amount) until such loan is repaid. InMarch 2019 , the Trust's cash on hand (including cash reserves) was insufficient to pay the Trust's ordinary course expenses as they became due. As ofDecember 31, 2022 andDecember 31, 2021 , there were no loans outstanding.
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
Basis of Accounting. 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 that would not be accrued in financial statements prepared in
accordance with
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GAAP. This non-GAAP, other comprehensive basis of accounting corresponds to the accounting principles permitted for royalty trusts by theSEC as specified by Staff Accounting Bulletin Topic 12:E, Financial Statements of Royalty Trusts. The financial statements of the Trust, as prepared on a modified cash basis, reflect the Trust's assets, trust corpus, earnings and distributions as follows: Investment in Royalty Interests. The conveyance of the Royalty Interests to the Trust was accounted for as a transfer of properties between entities under common control and thus the Trust recorded the Royalty Interests at the historical cost of Chesapeake ("Investment in Royalty Interests"), which was based on an allocation of the historical net book value of Chesapeake's full cost pool according to the fair value of the Royalty Interests relative to the fair value of Chesapeake's proved reserves. The carrying value of the Trust's Investment in Royalty Interests will not necessarily be indicative of the fair value of such Royalty Interests. This investment 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 significant revisions are known. On a quarterly basis, the Trust evaluates the carrying value of the Investment in Royalty Interests under the full cost accounting method prescribed by theSEC . 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 PV-10 for the Trust's proved reserves. Any write-downs resulting from the ceiling test will be non-cash charges to Trust corpus and will not affect distributable income. Revenues and Expenses. Revenues received by the Trust are net of existing royalties and overriding royalties associated with the Operator's interests and are reduced by certain post-production expenses, production taxes and other allowable expenses, such as the Trust's administrative expenses, in order to determine distributable income. The Royalty Interests are not burdened by field and lease operating expenses.
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