Introduction
The following discussion and analysis are intended to help the reader understand the financial condition, results of operations, liquidity and capital resources ofSandRidge Permian Trust (the "Trust"). This discussion and analysis should be read in conjunction with the Trust's unaudited interim financial statements and the accompanying notes included in this Quarterly Report and the Trust's audited financial statements and the accompanying notes included in the 2020 Form 10-K. All information regarding operations was provided to the Trustee by Avalon.
15 Overview The Trust is a statutory trust formed under the Delaware Statutory Trust Act pursuant to a trust agreement, as amended and restated (the "Trust Agreement"), by and amongSandRidge Energy, Inc. ("SandRidge"), as Trustor,The Bank of New York Mellon Trust Company, N.A. , as Trustee (the "Trustee"), and TheCorporation Trust Company , as Delaware Trustee (the "Delaware Trustee"). The Trust held overriding royalty interests (the "Royalty Interests") in specified oil and natural gas properties located inAndrews County, Texas (the "Underlying Properties "), until the sale of the Royalty Interests inJune 2021 , effectiveJuly 1, 2021 (the "Asset Sale"), as discussed below in "Early Termination of the Trust and Going Concern-Liquidation of the Trust." The Royalty Interests were conveyed by SandRidge to the Trust concurrent with the initial public offering of the Trust's common units ("Trust units") inAugust 2011 pursuant to the terms set forth in conveyancing documents effectiveApril 1, 2011 (the "Conveyances"). As consideration for conveyance of the Royalty Interests, the Trust remitted the proceeds of the offering, along with 4,875,000 Trust units and 13,125,000 subordinated units of the Trust ("subordinated units") to certain wholly-owned subsidiaries of SandRidge. Pursuant to a development agreement between the Trust and SandRidge, SandRidge was obligated to drill, or cause to be drilled, 888 development wells within an area of mutual interest located inAndrews County, Texas byMarch 31, 2016 . SandRidge fulfilled this obligation inNovember 2014 . As no additional development wells will be drilled, the production attributable to the Royalty Interests is expected to decline each quarter during the remainder of its life. As a result of SandRidge fulfilling its drilling obligation, in accordance with the terms of the Trust Agreement, the subordinated units converted to Trust units inJanuary 2016 . AtOctober 31, 2018 , SandRidge owned 13,125,000 Trust units, or 25% of all Trust units. OnNovember 1, 2018 , SandRidge sold all of its interests in theUnderlying Properties and all of its Trust units (the "Sale Transaction") to Avalon Energy LLC, aTexas limited liability company ("Avalon"). The Conveyances permitted SandRidge to sell all or any part of its interest in theUnderlying Properties , where theUnderlying Properties were sold subject to and burdened by the Royalty Interests. In connection with the Sale Transaction, Avalon and its affiliates assumed all of SandRidge's obligations under the Conveyances and the Trust Agreement and the administrative services agreement between SandRidge and the Trust (the "Administrative Services Agreement") pursuant to which SandRidge and Avalon have provided accounting, tax preparation, bookkeeping and informational services to the Trust. In addition, SandRidge assigned its rights to Avalon under the registration rights agreement between SandRidge and the Trust. As ofJune 30, 2021 , Avalon held 13,125,000 Trust units, or 25% of all Trust units. In connection with the Sale Transaction, Avalon obtained a revolving line of credit fromWashington Federal Bank, National Association , formerly known as Washington Federal, National Association ("WaFed") pursuant to the terms of a Loan Agreement and related security documents (the "WaFed Loan"). Avalon used the proceeds of the WaFed Loan to fund a portion of the purchase price for the interests in theUnderlying Properties and Trust units acquired in the Sale Transaction. Until the release of WaFed's liens as described under "Early Termination of the Trust and Going Concern-Sale of Assets by Avalon to Montare" below, the WaFed Loan was secured by a first lien mortgage on Avalon's interest in theUnderlying Properties and a pledge of theAvalon Trust units (the "WaFed Collateral"). The Royalty Interests are not part of the WaFed Collateral. The Trust is passive in nature and neither the Trust nor the Trustee has any control over, or responsibility for, any operating or capital costs related to theUnderlying Properties . The business and affairs of the Trust are administered by the Trustee. The Trust Agreement generally limits the Trust's business activities to owning the Royalty Interests and activities reasonably related thereto, including activities required or permitted by the terms of
the Conveyances. The Trust makes quarterly cash distributions of substantially all of its cash receipts, after deducting amounts for the Trust's administrative expenses, property tax andTexas franchise tax and cash reserves determined and withheld by the Trustee in its sole discretion, on or about the 60th day following the completion of each calendar quarter. Due to the timing of the payment of production proceeds to the Trust attributable to the Royalty Interests, each distribution covers production from a three-month period consisting of the first two months of the most recently ended calendar quarter and the final month of the previous calendar quarter. As the effective date of the Asset Sale wasJuly 1, 2021 , the Trust will receive no further income from oil and gas production. Therefore, the Trust will not receive any further proceeds from such production afterJune 30, 2021 and will not make any further regular quarterly cash distributions to the Trust unitholders following the distribution to be made inAugust 2021 with respect to the quarterly period endedJune 30, 2021 . 16
Early Termination of the Trust and Going Concern
Avalon's Financial Condition. As previously reported in the Trust's Form 8-K filed onApril 23, 2020 , Avalon informed the Trustee that during 2019, Avalon repaired 29 producing Trust Wells (although not required to do so under the terms of the Conveyances) to increase production. Avalon reported that the working capital expended in this effort, combined with higher-than-expected lease operating expenses ("LOE") and declining oil prices, contributed to an operating loss for Avalon in 2019 and in 2020. Despite Avalon's efforts to reduce LOE (including shutting in some oil and gas wells subject to the Royalty Interests ("Trust Wells") that were not capable of producing oil and natural gas in paying quantities, as permitted under the Conveyances, alternating production to reduce electrical and other field operating costs, and staff lay-offs). Furthermore, Avalon informed the Trustee that it was likely to shut in additional Trust Wells, to further reduce LOE. The reduced demand for crude oil in the global market resulting from the economic effects of the COVID-19 pandemic and the dramatic reduction from mid-February to lateApril 2020 in the benchmark price of crude oil has had a further negative impact on Avalon's financial condition resulting in Avalon shutting in additional non-economic Trust Wells (which were not necessary to hold the leasehold interests burdened by the Trust's Royalty Interests). Avalon shut in 139 Trust Wells and 114 Trust Wells during the twelve-month periods endedDecember 31, 2019 and 2020, respectively. No Trust Wells were shut in during the six-month period ended
June 30, 2021 .
Given Avalon's financial condition, in early 2020 theBoard of Managers of Avalon decided to explore strategic alternatives with respect to its assets, including theUnderlying Properties and theAvalon Trust units. After a number of discussions regarding a possible transaction with potential strategic partners during the first half of 2020, onJuly 30, 2020 , Avalon entered into a letter agreement withMontare Resources I, LLC , aTexas limited liability company ("Montare"), agreeing to negotiate exclusively with Montare regarding a possible sale of Avalon assets, including theUnderlying Properties , to Montare and supporting Montare in any transaction negotiated with the Trust with respect to the acquisition of all Trust units not owned by Montare. On the same date, Avalon and WaFed entered into an amendment to the WaFed Loan that extended the date on which Avalon was obligated to provide a reserve report to WaFed (regarding the redetermination of the borrowing base) toSeptember 15, 2020 and required Avalon to pay off the WaFed Loan byOctober 15, 2020 . In addition, WaFed and Montare entered into a Participation Agreement with respect to the WaFed Loan whereby Montare purchased an undivided participation interest in the WaFed Loan along with the right to purchase the WaFed Loan in the event Avalon does not meet the conditions of the amended WaFed Loan. As a result of its operating loss in 2019, Avalon's independent public accounting firm included a going concern paragraph in its audit report on Avalon's financial statements for the fiscal year endedDecember 31, 2019 . TheMay 2020 Quarterly Payment. InApril 2020 , Avalon also informed the Trustee that Avalon had been using its commercially reasonable efforts to preserve the oil and gas leases burdened by the Royalty Interests so that in the future, assuming that oil prices returned to a profitable level, the Trust would still hold itsRoyalty Interests, and Trust unitholders might have the opportunity to receive future quarterly distributions. Avalon also informed the Trustee that it believed that continuing production from those Trust Wells required to preserve such leases was preferable to stopping production, as the failure to continue production would result in a termination of Avalon's working interest in such Trust Wells and, therefore, the Royalty Interests, which would have a material adverse effect on the Trust's financial condition. Avalon reported to the Trustee that Avalon therefore used revenues it received during the production period fromDecember 1, 2019 toFebruary 29, 2020 to pay the operating expenses necessary to maintain production from the Trust Wells and to pay oil and gas lessor royalties, as the proceeds attributable to Avalon's net revenue interest in theUnderlying Properties were insufficient to cover all such costs. Avalon had anticipated that revenues from production during the quarterly production period commencingMarch 1, 2020 would be sufficient to fund the quarterly payment to the Trust for the quarter endedMarch 31, 2020 in the amount of approximately$4.65 million (the "May 2020 Quarterly Payment"); however, revenues from production during that quarterly production period were insufficient to generate the cash needed to make theMay 2020 Quarterly Payment to the Trust due to the sharp drop in crude oil prices during the first quarter of 2020. Consequently, the Trustee was unable to make any quarterly distribution to unitholders at the end ofMay 2020 . In accordance with Section 5.02 of the Conveyances, the unpaidMay 2020 Payment amount due and owing to the Trust has been accruing interest sinceMay 15, 2020 at the rate of interest per annum publicly announced from time to time byThe Bank of New York Mellon Trust Company, N.A. as its "prime rate" in effect at its principal office in New
York City until paid to the Trust. OnMarch 1, 2021 , the Trust and Avalon entered into a repayment agreement setting forth the terms by which Avalon agreed to pay theMay 2020 Quarterly Payment to the Trust, together with accrued interest (the "Repayment Agreement"). Beginning with the quarterly distribution paid to Trust unitholders on or aboutFebruary 26, 2021 (the "February Distribution"), Avalon agreed to apply towards the payment of theMay 2020 Quarterly Payment the full amount of each quarterly cash distribution, if any, to which Avalon, as a unitholder of the Trust, was entitled (each such cash distribution, a "Company Distribution Amount"), until theMay 2020 Quarterly Payment, together with accrued interest, is paid in full to the Trust, subject to any obligations Avalon may have to repay the WaFed Loan as provided in the Repayment Agreement. Promptly following the February Distribution, Avalon deposited its portion of the February Distribution, which was$984,375 , into a repayment account established by the Trustee on behalf of the Trust (the "Repayment Account"), as an initial payment toward theMay 2020 Quarterly Payment, and that amount was included in the calculation of the quarterly distribution made inMay 2021 .
17 OnJune 23, 2021 , Avalon directed the Trustee, beginning with the three-month period endedJune 30, 2021 , to offset the amounts owed to Avalon Energy by the Trust under the Administrative Services Agreement as partial payment of the outstanding balance of theMay 2020 Quarterly Pament to the Trust. Section 3.02 of the Administrative Services Agreement provides that in the event Avalon or any of its affiliates owes the Trust a sum certain in an uncontested amount under any other agreement, then any such amount may, in the sole discretion of Avalon, be aggregated and the Trust and Avalon will discharge their obligations by netting those amounts against any amounts owed by the Trust to Avalon under the Administrative Services Agreement. As a result, approximately$300,000 was credited toward the payment of theMay 2020 Quarterly Payment. OnJune 24, 2021 , the Trust and Montare entered into an assignment agreement (the "Assignment") effective as ofJune 30, 2021 , pursuant to which Montare agreed to pay the Trust approximately$3.2 million representing payment in full of the remaining unpaid portion of theMay 2020 Quarterly Payment, together with accrued interest, in exchange for the assignment by theTrust of the Trust's rights and obligations under the Repayment Agreement, which amount was paid contemporaneously with the execution of the Assignment. The Trustee will distribute the cash received from Montare, less any amounts withheld to pay expenses of the Trust, to the Trust unitholders on the quarterly cash distribution date inAugust 2021 . Subsequent Distributions. As a result of improving oil prices, the Trust was able to make quarterly distributions for the three-month periods endedJune 30, 2020 (which primarily relates to production attributable to the Trust's Royalty Interests fromMarch 1, 2020 toMay 31, 2020 ) andSeptember 30, 2020 (which primarily relates to production attributable to the Trust's Royalty Interests fromJune 1, 2020 toAugust 31, 2020 ) of approximately$652,000 and$1,732,000 . There was no distribution for the three-month period endedDecember 31, 2020 (which relates to production attributable to the Royalty Interests fromSeptember 1, 2020 toNovember 30, 2020 ) as costs, charges and expenses attributable to theUnderlying Properties exceeded the revenue received from the sale of oil, natural gas and other hydrocarbons produced from theUnderlying Properties . The Trust also made a quarterly distribution for the three-month period endedMarch 31, 2021 (which relates in part to production attributable to the Royalty Interests fromDecember 1, 2020 toFebruary 28, 2021 ) of approximately$1,470,000 (of which approximately$143,000 relates to production). The Trust has announced a quarterly distribution for the three-month period endedJune 30, 2021 (which relates in part to production attributable to the Royalty Interests fromMarch 1, 2021 toMay 31, 2021 ) of approximately$9,500,000 (of which approximately$380,000 relates to production). See "-Liquidation of the Trust" below for further details of this distribution. Sale of Assets by Avalon to Montare. OnAugust 26, 2020 , Montare, Avalon and certain of their respective affiliates entered into a Contribution and Support Agreement, pursuant to which Avalon, among other things, (i) agreed, subject to certain conditions, to contribute all of the assets held by Avalon and its affiliates, including theUnderlying Properties and theAvalon Trust units, to Montare in exchange for interests in Montare or an affiliate thereof (the "Contribution Transaction"), (ii) agreed to support Montare's acquisition of all of the issued and outstanding Trust units not owned by Avalon by means of a transaction with the Trust or as otherwise determined by Montare in its sole discretion (the "Montare Transaction"), and any related actions taken by Montare with respect to the Montare Transaction, including by exercising any of Avalon's rights under the Trust Agreement, (iii) granted exclusivity and an irrevocable proxy to Montare to vote all Trust units beneficially owned by Avalon in connection with the Montare Transaction, and (iv) to not take any action that, directly or indirectly, is detrimental to or hinders Montare's ability to consummate the Montare Transaction. The consummation of the Contribution Transaction is subject to certain conditions, including Montare's determination in its sole and absolute discretion that all conditions necessary for the consummation of the Montare Transaction have been satisfied or waived. After preliminary discussions between Montare and the Trust regarding the Montare Transaction ended (as previously reported by Avalon and Montare in Amendment No. 3 to their joint Schedule 13D filed onSeptember 8, 2020 and by the Trust in its Form 8-K filed onSeptember 8, 2020 ), Montare and Avalon amended the Contribution and Support Agreement effectiveOctober 12, 2020 . As amended, the Contribution and Support Agreement contemplates a sale of Avalon assets having a value of less than$5.0 million , in accordance with the terms of the Trust Agreement, to Montare free from and unburdened by the applicable portion of the Royalty Interests held by the Trust. OnOctober 12, 2020 , Montare and Avalon entered into a Purchase and Sale Agreement, effective as ofSeptember 1, 2020 , whereby Avalon sold wells and related assets associated with certainUnderlying Properties to Montare, unburdened by the applicable portion of the Royalty Interests held by the Trust, for approximately$4.9 million in accordance with Avalon's contractual rights set forth in the Trust Agreement and the Conveyances (the "Montare Sale"). Prior to the Montare Sale, Avalon engaged an independent petroleum engineering firm to determine the fair value of substantially all wells burdened by the Trust's Royalty Interests (the "Trust Wells"). A copy of the independent petroleum engineering firm's valuation report has been provided to the Trustee. Avalon informed the Trustee that Avalon then sold to Montare those Trust Wells having a collective value of approximately$4.9 million , retaining ownership of the 65 most valuable Trust Wells burdened by Royalty Interests. The wells sold to Montare include 483 shut-in wells and 338 other wells with negative present value and 428 wells with positive present value. The wells sold to Montare represented approximately 76% of production attributable to the Trust's Royalty Interests for the month endedMay 31, 2020 (the most recent month prior to the sale for which production data was available). The Royalty Interests released by the Trust in connection with the Montare Sale represented approximately 32% of the fair value of the Royalty Interests atSeptember 1, 2020 . 18
As previously reported by the Trust in its Form 8-K filedOctober 14, 2020 , Avalon notified theTrust of the Montare Sale onOctober 13, 2020 . As required by the terms of the Trust Agreement, an officer of Avalon certified to the Trust that (i) the gross purchase price received by Avalon for the sale of the specified Trust Wells was less than$5 million and (ii) the cash proceeds received by the Trust in respect of the Royalty Interests to be released in connection with such sale represents Fair Value (as defined in the Trust Agreement) to the Trust for such Royalty Interests. The Montare Sale was completed onOctober 13, 2020 , and all of the approximately$4.9 million of proceeds that Avalon received from such sale were paid to the Trust inOctober 2020 as fair value for the Royalty Interests required to be released by the Trustee in connection with the Montare Sale in accordance with Section 3.02 of the Trust Agreement. OnFebruary 26, 2021 , the Trust distributed net sales proceeds of approximately$3.9 million , which represented the amount paid to the Trust by Avalon as fair value for the Royalty Interests required to be released less approximately$884,000 withheld by the Trustee toward its targeted cash reserve, to Trust unitholders in accordance with the terms of the Conveyances granting the Royalty Interests to the Trust. As provided in the Trust Agreement, the sales proceeds of approximately$4.9 million received by the Trust from Avalon is not included in the calculation of the cash available for distribution from royalty payments by Avalon and, therefore, did not affect the timing of the dissolution of the Trust. OnOctober 30, 2020 , Avalon and WaFed entered into the third amendment to the WaFed Loan that (i) extends the date by which Avalon is required to provide a reserve report of an independent petroleum engineer to WaFed (regarding the redetermination of the WaFed Loan borrowing base) toApril 15, 2021 , (ii) requires Avalon to pay off the WaFed Loan byApril 15, 2021 , and (iii) provides a partial release of Trust Wells located on certain of theUnderlying Properties in connection with the Montare Sale. In addition, WaFed and Montare modified the Participation Agreement, and Montare purchased an additional interest in the WaFed Loan. EffectiveApril 15, 2021 , Avalon and WaFed entered into a fourth amendment to the WaFed Loan. This amendment (i) extends the date by which Avalon is obligated to provide a reserve report of an independent petroleum engineer to WaFed (regarding the redetermination of the borrowing base) toDecember 15, 2021 , (ii) provides a partial waiver of violations of financial covenants toDecember 15, 2021 , and (iii) requires Avalon to pay off the loan on the earlier to occur of the date that the Contribution and Support Agreement by and between Montare and Avalon is consummated orDecember 15, 2021 . In addition, Montare and WaFed modified the Participation Agreement with Montare purchasing an additional interest in the WaFed Loan and agreeing to further purchases of additional interests in the future. OnJune 30, 2021 , Montare and Avalon entered into an Amended and Restated Contribution and Support Agreement that amends and restates in its entirety the Contribution and Support Agreement, as amended. See "Subsequent Events" in Note 7 to the unaudited interim financial statements contained in Part I, Item 1 of this report for additional information regarding the Contribution Transaction. In addition, onJune 30, 2021 , Montare and WaFed entered into an Amended and Restated Participation Agreement pursuant to which Montare acquired the remaining balance of the WaFed Loan. As a result, WaFed has released all of its liens on the Avalon assets, including the 13,125,000 Trust units representing 25% of all Trust units. Liquidation of the Trust. The Trust Agreement requires the Trust to dissolve and commence winding up of its business and affairs if cash available for distribution for any four consecutive quarters, on a cumulative basis, is less than$5.0 million . Cash available for distribution for the four consecutive quarters endedDecember 31, 2020 , on a cumulative basis, totaled approximately$2.4 million , due in part to Avalon's inability to make theMay 2020 Quarterly Payment to the Trust. Because Avalon's inability to make theMay 2020 Quarterly Payment contributed to the insufficient cumulative cash available for distribution over the four-quarter period, the Trustee and Avalon submitted to an arbitration panel, in accordance with the Trust Agreement, the question of whether the Trust nonetheless remains required to dissolve following the end of that period. OnFebruary 25, 2021 , the arbitration panel determined that the existence of the unpaidMay 2020 Quarterly Payment does not alter the requirement of the Trust to terminate under the provisions of the Trust Agreement. As a result, the Trust was required to dissolve and commence winding up beginning as of the close of business onFebruary 26, 2021 , which raises substantial doubt regarding the Trust's ability to continue as a going concern within one year from the issuance of the unaudited interim financial statements contained in Part I, Item 1 of this report. Accordingly, the Trustee was 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. 19
InApril 2021 , the Trustee commenced a sale process that was marketed with the assistance of an independent oil and gas advisory firm. As a result of that process, the Trustee received several offers from third parties and, after one bidder withdrew its offer, the Trustee selected the offer from the highest remaining bidder, Montare. As provided in the Trust Agreement, Avalon Energy had a right of first refusal with respect to any sale of assets to a third party. OnJune 17, 2021 , Avalon notified the Trustee that Avalon would waive its right of first refusal in connection with the sale to Montare. OnJune 18, 2021 , the Trust and Montare entered into a Purchase and Sale Agreement (the "Agreement") for the sale of all of the remaining Royalty Interests held by the Trust for a purchase price of$6,000,000 . The sale closed onJune 18, 2021 , with an effective date ofJuly 1, 2021 . Accordingly, as the Trust retained control of the Royalty Interests throughJune 30, 2021 , the Trust is entitled to receive all proceeds from the oil and natural gas production attributable to the Royalty Interests for the three-month period endedJune 30, 2021 (which relates to production attributable to the Royalty Interests fromMarch 1, 2021 toMay 31, 2021 ). The Assignment of Overriding Royalty Interests assigning all of the Trust's right, title and interest in and to the Royalty Interests effectiveJuly 1, 2021 was filed in the Property Records ofAndrews County, Texas onJune 22, 2021 . Montare is entitled to receive all proceeds from the oil and natural gas production attributable to the Royalty Interests from and afterJuly 1, 2021 , for the production period commencing onJune 1, 2021 . Therefore, the Trust will not receive any further proceeds from such production afterJune 30, 2021 and will not make any further regular quarterly cash distributions to the Trust unitholders following the distribution to be made inAugust 2021 with respect to the quarterly period endedJune 30, 2021 . Under the Trust Agreement, the Trustee is required to distribute to the Trust unitholders on the quarterly cash distribution date inAugust 2021 the net proceeds of the sale, after payment of expenses related to the sale, and less any amounts withheld as 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, as discussed above. See "Subsequent Distributions" in Note 4 to the unaudited interim financial statements contained in Part I, Item 1 of this report for further details on this distribution.
Properties. As of
Distributions. As a result of the sale of the Trust's remaining Royalty Interests to Montare, the Trust will receive no further income from oil and gas production. Cash reserves remaining after the distribution on or beforeAugust 27, 2021 will be used by the Trustee to complete the winding up process of the Trust, which includes, but is not limited to, the preparation and filing of this Form 10-Q, the filing of a Form 15 with theSecurities and Exchange Commission ("SEC") to deregister the Trust as a reporting company, notification to theOTC Markets Group of the Trust's deregistration with theSEC and notice to stop trading of the Trust's common units, and preparation and issuance of Forms K-1 for all holders of the Trust's common units. If any cash reserves remain following the payment of the Trust's estimated remaining expenses and liabilities, the Trustee will make a final distribution to unitholders of such amount. The Trust will remain in existence until the winding up process is completed, after which the Trustee will file a certificate of cancellation with the Secretary of State of theState of Delaware . Trust unitholders are responsible for all federal and state tax liabilities associated with distributions they receive from the Trust. Pursuant to Internal Revenue Code ("IRC") Section 1446, withholding tax on income effectively connected to aUnited States trade or business allocated to non-U.S. persons ("ECI") should be made at the highest marginal rate. Under IRC Section 1441, withholding tax on fixed, determinable, annual, periodic income fromUnited States sources allocated to non-U.S. persons should be made at a 30% rate unless the rate is reduced by treaty. This is intended to be a qualified notice to nominees and brokers as provided for under Treasury Regulation Section 1.1446-4(b) by the Trust, and while specific relief is not specified for IRC Section 1441 income, this disclosure is intended to suffice. Nominees and brokers should withhold at the highest marginal rate on the distribution made to non-U.S. persons. The Tax Cuts and Jobs Act (the "TCJA") enacted inDecember 2017 treats a non-U.S. holder's gain on the sale of Trust units as ECI to the extent such holder would have had ECI if the Trust had sold all of its assets at fair market value on the date of the sale of such Trust units. The TCJA also requires a transferee of Trust units to withhold 10% of the amount realized on the sale or exchange of such units (generally, the purchase price) unless the transferor certifies that it is not a non-resident alien individual or foreign corporation or another exception is available. Pursuant to final Treasury Regulations issued onOctober 7, 2020 , this new withholding obligation will become applicable to transfers of units in publicly traded partnerships such as the Trust (which is classified as a partnership for federal and state income tax purposes) occurring on or afterJanuary 1, 2022 . 20 Results of Trust Operations
Historically, the primary factors affecting the Trust's revenues and costs were the quantity of oil, natural gas and NGL production from the Trust Wells, the prices received for such production and post-production costs (primarily transportation). Royalty income, post-production expenses and certain taxes are recorded on a cash basis when net revenue distributions attributable to the Royalty Interests are received by the Trust from Avalon. Information regarding the revenue from the production and sale of oil, natural gas and NGL attributable to the Royalty Interests, the prices received by Avalon from marketing such hydrocarbons and the costs associated with the production of such hydrocarbons for the three- and six-month periods endedJune 30, 2021 and 2020 is presented below. Three Months Ended Six Months Ended June 30, June 30, 2021(1) 2020(2) 2021(3) 2020(4) Production Data Oil (MBbls) 29 - 46 93 NGL (MBbls) 3 - 5 10 Natural gas (MMcf) 11 - 18 39
Combined equivalent volumes (MBoe) 34 - 54 110 Well Data Trust Wells producing - average 62 990 62 1,020 Revenues (in thousands) Royalty income
6,000 - 6,000 - Proceeds from missed royalty payment
3,528 - 3,528 - Total revenue 11,187 3 11,853 5,292 Expenses (in thousands) Post-production expenses 6 - 7 15 Production taxes 79 - 111 254 Property taxes - - (343 ) 1,676 Franchise taxes - 36 - 36
Trust administrative expenses 779 338 1,159 1,046
Cash reserves withheld for current Trust expenses, net of amounts (used) withheld (332 ) (371 ) 1,202 (1,945 ) Total expenses
532 3 2,136 1,082 Less proceeds from sale of Trust assets 6,000 - 1,126 - Less proceeds from missed royalty payment 3,528 - 3,528 - Distributable income available to unitholders
$ 1,127 $ -$ 5,063 $ 4,210 Average Prices - Oil (per Bbl)$ 50.78 -$ 45.26 $ 53.93 NGL (per Bbl)$ 21.47 -$ 19.69 $ 19.48 Natural gas (per Mcf)$ 1.14 -$ 1.11 $ 0.92 Total (per Boe)$ 45.47 -$ 40.82 $ 47.89 Average Prices - including impact of post-production expenses Natural gas (per Mcf)$ 0.63 -$ 0.69 $ 0.53 Total (per Boe)$ 45.29 -$ 40.69 $ 47.76 Expenses (per Boe) Post-production production$ 0.17 -$ 0.14 $ 0.14 Production taxes$ 2.34 -$ 2.05 $ 2.31
1. Production volumes and related revenues and expenses for the three-month
period ended
distribution to the Trust) represent production from
February 29, 2020 .
2. Related revenues and expenses for the three-month period ended
3. Production volumes and related revenues and expenses for the six-month period
ended
distributions to the Trust) represent production from
February 29, 2020 .
4. Production volumes and related revenues and expenses for the six-month period
ended
distributions to the Trust) represent production fromSeptember 1, 2019 toFebruary 29, 2020 . 21
Three Months Ended
Revenues Royalty Income. Royalty income is a function of production volumes sold by Avalon attributable to the Royalty Interests and associated prices received. There was no royalty income during the three-month period endedJune 30, 2020 as a result of Avalon's failure to pay proceeds owed to the Trust for the period fromDecember 1, 2019 toFebruary 29, 2020 in the amount of approximately$4.7 million . Royalty income received during the three-month period endedJune 30, 2021 totaled approximately$1.7 million , which amount included a portion of the proceeds owed to the Trust by Avalon under the terms of the Repayment Agreement. Expenses
Property Taxes. There were no property taxes paid during the three months ended
Production Taxes. Production taxes are calculated as a percentage of oil and natural gas revenues, net of any applicable tax credits. Production taxes for the three-month period endedJune 30, 2021 totaled approximately$0.1 million , or$2.34 per Boe, and were approximately 5.2% of royalty income. No production taxes were paid by the Trust for the three-month period endedJune 30, 2020 . Trust Administrative Expenses. Trust administrative expenses generally consist of fees paid to the Trustee and the Delaware Trustee, administrative services fees paid to Avalon, tax return and related form preparation fees, legal and accounting fees, and other expenses incurred as a result of being a publicly traded entity. Trust administrative expenses for the three-month period endedJune 30, 2021 totaled approximately$0.8 million compared to approximately$0.3 million for the three-month period endedJune 30, 2020 . The increase during the 2021 period primarily relates to the timing of administrative expense payments. 22 Distributable Income Distributable income for the three-month period endedJune 30, 2021 was$1.1 million , which included a net reduction of approximately$0.3 million as the result of the Trustee adding such amount to the cash reserve for the payment of future Trust expenses and reflecting approximately$0.8 million used to pay Trust expenses during the period, which amount was partially offset by approximately$0.4 million withheld from theMay 2020 cash distribution to unitholders. There was no distributable income for the three-month period endedJune 30, 2020 as Avalon was unable to pay the approximately$4.7 million it owed the Trust (as discussed in further detail in the section entitled "Early Termination of the Trust and Going Concern - TheMay 2020 Quarterly Payment" above), which reflected production fromDecember 1, 2019 toFebruary 29, 2020 .
Six Months Ended
Revenues Royalty Income. Royalty income received during the six-month period endedJune 30, 2021 totaled$2.3 million from production compared to$5.3 million received during the six-month period endedJune 30, 2020 . Sales volumes were lower than the previous period primarily due to the sale of certain assets by Avalon to Montare inOctober 2020 . Expenses Property Taxes. There were no property taxes paid during the six months endedJune 30, 2021 due to applicable taxes were paid during a prior period. InFebruary 2021 , Montare provided reimbursement for approximately$0.4 million of 2020 Ad Valorem Tax attributable to the assets sold by Avalon to Montare inOctober 2020 . Property taxes paid during the six months endedJune 30, 2020 were approximately$1.7 million , which related to 2019 property taxes. Production Taxes. Production taxes paid for the six-month period endedJune 30, 2021 totaled approximately$0.1 million , or$2.05 per Boe, and were approximately 5.0% of royalty income. Production taxes paid for the six-month period endedJune 30, 2020 totaled approximately$0.3 million , or$2.31 per Boe, and were approximately 4.8% of royalty income. Distributable Income
Distributable income for the six-month period endedJune 30, 2020 was$5.1 million , which included a net addition of approximately$1.2 million to the cash reserve for the payment of future Trust expenses, reflecting approximately$2.0 million withheld in the aggregate from theFebruary 2021 andMay 2021 cash distributions to unitholders partially offset by approximately$1.2 million used to pay Trust expenses during the period (offset by the$0.4 million Ad Valorem Tax reimbursement). Distributable income for the six-month period endedJune 30, 2020 was$4.2 million , which included a net reduction of approximately$1.6 million to the cash reserve for the payment of future Trust expenses, reflecting approximately$2.4 million used to pay Trust expenses during the period partially offset by approximately$0.8 million withheld from theFebruary 2020 cash distribution to unitholders.
Liquidity and Capital Resources
Capital Resources and Distributions. 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 Avalon's loan commitment described in Note 6 to the unaudited interim financial statements contained in Part I, Item 1 of this report. The Trust's primary uses of cash are distributions to Trust unitholders, the payment of Trust administrative expenses, establishing reserves (as determined by the Trustee) for future liabilities, the payment of applicable taxes and the payment of expense reimbursements to Avalon for out-of-pocket expenses incurred on behalf of the Trust. The Trust does not have any obligation to pay any costs associated with the operation of the Trust Wells. As a result of the sale of the Trust's remaining Royalty Interests to Montare effectiveJuly 1, 2021 , the Trust will receive no further income from oil and gas production. Administrative Expenses. Administrative expenses include payments to the Trustee and the Delaware Trustee as well as a quarterly fee of$75,000 paid to Avalon 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 sale of production attributable to the Royalty Interests less related production expenses and taxes during 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 Avalon, to pay such expenses. The Trustee does not intend to lend funds to the Trust. Pursuant to the Trust Agreement, 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, Avalon (as the assignee of SandRidge) will, at the Trustee's request, loan funds to the Trust necessary to pay such expenses. Any funds loaned by Avalon 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, or to make distributions. If Avalon 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) until such loan is repaid in full, with interest, unless Avalon consents to any further distributions. Any such loan will be on an unsecured basis, and the terms of such loan will be substantially the same as that which would be obtained in an arm's length transaction between Avalon and an unaffiliated third party. No such loan was outstanding atJune 30, 2021 orDecember 31, 2020 , and given Avalon's current financial condition, as further discussed under "Early Termination of the Trust and Going Concern-Avalon's Financial Condition" above, it is unlikely such
loan could be made. 23
Reserves. Commencing with the distribution to unitholders paid in the first quarter of 2019, the Trustee withheld the greater of$190,000 or 3.5% of the funds otherwise available for distribution to Trust unitholders each quarter to gradually increase cash reserves for the payment of future known, anticipated or contingent expenses or liabilities by a total of approximately$3,275,000 . In light of the fact that there would be no distribution from production for the three-month period endedDecember 31, 2020 (with respect to production attributable to the Trust's royalty interests fromSeptember 1, 2020 toNovember 30, 2020 ), the Trustee elected to withhold approximately$884,000 , the remaining amount needed to reach its targeted cash reserve, in connection with the distribution made inFebruary 2021 . 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 of the Trust eventually will be distributed to unitholders, together with interest earned on the funds. Reliance on Avalon. The Trust is highly dependent on Avalon for multiple services, including administrative services such as accounting, tax preparation, bookkeeping, regulatory filings and information services performed on behalf of the Trust, and potentially for loans to pay Trust administrative expenses. Avalon is a relatively new oil and gas company formed inAugust 2018 with no prior operating history. EffectiveAugust 1, 2021 , Avalon sold all of its assets to Montare pursuant to the terms of the Conveyance Transaction and, aside from its obligation to provide administrative services to the Trust, will be a holding company for the securities received as consideration for the sale of such assets.
2021 Trust Distributions to Unitholders. During the six-month period ended
Total Distribution Covered Distribution Per Common Production Period Date Declared Date Paid Paid Unit (in millions)
Calendar Quarter 2021 September 1, 2020 - November 30, First Quarter 2020 February 1, 2021 February 26, 2021 $ 3.9 $ 0.075 December 1, 2020 - February 28, Second Quarter 2021 April 27, 2021 May 28, 2021 $ 1.5 $ 0.028 OnFebruary 26, 2021 , the Trust paid a cash distribution of$0.075 per Trust unit reflecting the fair value to the Trust, less cash reserves withheld by the Trustee, received by the Trust for the portion of the Trust's Royalty Interests required to be released in connection with the Montare Sale. OnMay 28, 2021 , the Trust paid a cash distribution of$0.028 relating in part to oil and gas production attributable to the Trust's royalty interests fromDecember 1, 2020 toFebruary 28, 2021 , as well as to (1) a reimbursement by Montare of a portion of property taxes attributable to assets sold by Avalon to Montare inOctober 2020 and (2) the distribution Avalon received inMarch 2021 and returned to the Trust pursuant to the terms of the Repayment Agreement. Repayment Agreement. OnMarch 1, 2021 , as previously disclosed, the Trust and Avalon entered into the Repayment Agreement. Beginning with the February Distribution, Avalon agreed to apply towards the payment of theMay 2020 Quarterly Payment the full amount of each quarterly cash distribution, if any, to which Avalon, as a unitholder of the Trust, is entitled (each such cash distribution, a "Company Distribution Amount") until theMay 2020 Quarterly Payment, together with accrued interest, has been paid in full to the Trust, subject to any obligations Avalon may have to repay the revolving line of credit Avalon had previously obtained from WaFed pursuant to the terms of the WaFed Loan as provided in the Agreement. Promptly following the February Distribution, Avalon deposited its portion of the February Distribution, which was$984,375 , into the Repayment Account, as an initial payment toward theMay 2020 Quarterly Payment, and that amount was included in the calculation of the quarterly distribution for the three-month period endedMarch 31, 2021 . In addition, Avalon deposited the Company Distribution Amount of$367,500 relating to Avalon's portion of the quarterly distribution paid to Trust unitholders on or aboutMay 28, 2021 into the Repayment Account, which was included in the calculation of the quarterly distribution for the three-month period ended
June 30 2021. 24 OnJune 23, 2021 , Avalon directed the Trustee, beginning with the three-month period endedJune 30, 2021 , to offset the amounts owed to Avalon Energy by the Trust under the Administrative Services Agreement as partial payment of the outstanding balance of theMay 2020 Quarterly Pament to the Trust. Section 3.02 of the Administrative Services Agreement provides that in the event Avalon or any of its affiliates owes the Trust a sum certain in an uncontested amount under any other agreement, then any such amount may, in the sole discretion of Avalon, be aggregated and the Trust and Avalon will discharge their obligations by netting those amounts against any amounts owed by the Trust to Avalon under the Administrative Services Agreement. As a result, approximately$300,000 was credited toward the payment of theMay 2020 Quarterly Payment and will be included in the quarterly distribution for the three-month period endedJune 30, 2021 . OnJune 24, 2021 , the Trust and Montare entered into an assignment agreement (the "Assignment") pursuant to which Montare agreed to pay the Trust approximately$3.2 million representing payment in full of the remaining unpaid portion of theMay 2020 Quarterly Payment, together with accrued interest, in exchange for the assignment by theTrust of the Trust's rights and obligations under the Repayment Agreement, which amount was paid contemporaneously with the execution of the Assignment. The Trustee will distribute the cash received from Montare, less any amounts withheld to pay expenses of the Trust, to the Trust unitholders as part of the quarterly distribution for the three-month period endedJune 30, 2021 . As ofJune 30, 2021 , the outstanding balance of theMay 2020 Quarterly Payment, together with accrued interest, that Avalon owes the Trust is zero. Future Trust Distributions to Unitholders. During the three-month production period fromMarch 1, 2021 toMay 31, 2021 , combined sales volumes were slightly higher than the previous comparable period. OnJuly 30, 2021 , the Trust announced a distribution for the three-month period endedJune 30, 2021 of approximately$9.5 million , or$0.182 per unit. This amount reflects (a) the distribution for the three-month period endedJune 30, 2021 (which primarily relates to production attributable to the Trust's royalty interests fromMarch 1, 2021 toMay 31, 2021 ) of approximately$0.4 million , (b) approximately$3.5 million (reflecting payments to the Trust of approximately$0.3 million and approximately$3.2 million ) representing payment in full of the remaining unpaid portion of theMay 2020 Quarterly Payment, including accrued interest, and (c) the approximately$5.6 million of net proceeds received from the sale of the Trust's assets to Montare onJune 18, 2021 . The distribution is expected to occur on or beforeAugust 27, 2021 to holders of record as of the close of business onAugust 13, 2021 and was calculated as follows (in thousands, except for unit and per unit amounts): Revenues Royalty income$ 797 Total revenues 797 Expenses Post-production expenses 1 Production taxes 38
Cash reserves withheld by Trustee (1)
378
Total expenses
417
Distributable income to unitholders $
380
Company Distribution Amount (2)
368
Repayment ofMay 2020 Quarterly Payment (3)
3,160
Proceeds from sale of Trust assets
6,000
Expense of sale of Trust assets (375 ) Distributable income available to unitholders $
9,533
Distributable income per unit (52,500,000 units issued and outstanding)
(1) Includes amounts withheld for payment of future Trust administrative expenses.
(2) Represents the deposit of Avalon's portion of the
Trust unitholders, pursuant to the Repayment Agreement dated as of
2021 between Avalon and the Trust.
(3) Represents the payment by Montare of the remaining unpaid portion of the
missed
disclosed in the Trust's Current Report on Form 8-K dated
25
As a result of the Trust selling its remaining Royalty Interests to Montare effectiveJuly 1, 2021 , the Trust will receive no further income from oil and gas production. Cash reserves remaining after the distribution on or beforeAugust 27, 2021 will be used by the Trustee to complete the winding up process of the Trust, which includes, but is not limited to, the preparation and filing of this Form 10-Q, the filing of a Form 15 with theSEC to deregister the Trust as a reporting company, notification to theOTC Markets Group of the Trust's deregistration with theSEC and notice to stop trading of the Trust's common units, and preparation and issuance of Forms K-1 for all holders of the Trust's common units. If any cash reserves remain following the payment of the Trust's estimated remaining expenses and liabilities, the Trustee will make a final distribution to unitholders of such amount. The Trust will remain in existence until the winding up process is completed, after which the Trustee will file a certificate of cancellation with the Secretary of State of theState of Delaware .
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