UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

 

FORM 10-Q

 

 

(Mark One)

☑

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

or

 

☐

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2021

or

For the transition period from                  to                 

Commission File Number 1-10243

 

 

BP PRUDHOE BAY ROYALTY TRUST

(Exact Name of Registrant as Specified in its Charter)

 

 

 

Delaware   13-6943724
(State or other jurisdiction of
incorporation or organization) 		  (I.R.S. Employer
Identification No.)

The Bank of New York Mellon Trust Company, N.A.

601 Travis Street, Floor 16

Houston, Texas

(Address of principal executive offices)

77002

(Zip Code)

(713) 483-6020

(Registrant’s telephone number, including area code)

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Trading Symbol(s)

 

Name of each exchange on which registered

Units of Beneficial Interest   BPT   New York Stock Exchange

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☑    No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit such files).    Yes  ☐    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large Accelerated filer   ☐    Accelerated filer   ☑
Non-accelerated filer   ☐    Smaller reporting company   ☐
     Emerging growth company   ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)    Yes  ☐    No  ☑

As of May 7, 2021, 21,400,000 Units of Beneficial Interest were outstanding.

 

 

 

TABLE OF CONTENTS

 

          Page  

PART I—FINANCIAL INFORMATION

     1  

    Item 1.

   Financial Statements      1  

    Item 2.

   Trustee’s Discussion and Analysis of Financial Condition and Results of Operations.      9  

    Item 3.

   Quantitative and Qualitative Disclosures About Market Risk.      13  

    Item 4.

   Controls and Procedures.      13  

PART II —OTHER INFORMATION

     14  

    Item 1.

   Legal Proceedings      14  

    Item 1A.

   Risk Factors      14  

    Item 2.

   Unregistered Sales of Equity Securities and Use of Proceeds.      14  

    Item 3.

   Defaults Upon Senior Securities.      14  

    Item 4.

   Mine Safety Disclosures.      14  

    Item 5.

   Other Information.      14  

    Item 6.

   Exhibits.      14  

 

1

PART I—FINANCIAL INFORMATION

 

Item 1.

Financial Statements

BP Prudhoe Bay Royalty Trust

Statement of Assets, Liabilities and Trust Corpus

(Prepared on a modified cash basis)

(In thousands, except unit data)

 

     March 31,
2021 		    December 31,
2020 		 

Assets

    

Cash and cash equivalents (Note 3)

   $ 191     $ 266  
  

 

 

   

 

 

 

Total Assets

   $ 191     $ 266  
  

 

 

   

 

 

 

Liabilities and Trust Corpus

    

Accrued expenses

   $ 713     $ 139  

Royalty deposit liability (Note 7)

     69       68  
  

 

 

   

 

 

 

Total Liabilities

     782       207  

Trust Corpus (deficit) (40,000,000 units of beneficial interest authorized, 21,400,000 units issued and outstanding)

     (591 )      59  
  

 

 

   

 

 

 

Total Liabilities and Trust Corpus (Deficit)

   $ 191     $ 266  
  

 

 

   

 

 

 

See accompanying notes to financial statements (unaudited).

 

1

BP Prudhoe Bay Royalty Trust

Statements of Cash Earnings and Distributions

(Prepared on a modified cash basis)

(In thousands, except unit data)

 

     Three Months Ended
March 31, 		 
     2021     2020  

Royalty revenues

   $ —       $ 9,337  

Interest income (expense)

     (1 )      7  

Less: Trust administrative expenses

     (75 )      (253 ) 
  

 

 

   

 

 

 

Cash earnings (loss)

   $ (76 )    $ 9,091  
  

 

 

   

 

 

 

Cash distributions

   $ —       $ 9,078  
  

 

 

   

 

 

 

Cash distributions per unit

   $ —       $ 0.4242  
  

 

 

   

 

 

 

Units outstanding

     21,400,000       21,400,000  
  

 

 

   

 

 

 

See accompanying notes to financial statements (unaudited).

 

2

BP Prudhoe Bay Royalty Trust

Statements of Changes in Trust Corpus

(Prepared on a modified cash basis)

(In thousands)

 

     Three Months Ended
March 31, 		 
     2021     2020  

Trust Corpus at beginning of period

   $ 59     $ 898  

Cash earnings (loss)

     (76 )      9,091  

Increase in accrued expenses

     (574 )      (436 ) 

Cash distributions

     —         (9,078 ) 
  

 

 

   

 

 

 

Trust Corpus (deficit) at end of period

   $ (591 )    $ 475  
  

 

 

   

 

 

 

See accompanying notes to financial statements (unaudited).

 

3

BP Prudhoe Bay Royalty Trust

Notes to Financial Statements (Unaudited)

(Prepared on a modified cash basis)

March 31, 2021

 

(1)

Formation of the Trust and Organization

BP Prudhoe Bay Royalty Trust (the “Trust”), a grantor trust, was created as a Delaware business trust pursuant to a Trust Agreement dated February 28, 1989 (the “Trust Agreement”), among The Standard Oil Company (“Standard Oil”), BP Exploration (Alaska) Inc. (“BP Alaska”) (now known as Hilcorp North Slope, LLC (“HNS”)), The Bank of New York Mellon, as trustee, and BNY Mellon Trust of Delaware (successor to The Bank of New York (Delaware)), as co-trustee. On December 15, 2010, The Bank of New York Mellon resigned as trustee and was replaced by The Bank of New York Mellon Trust Company, N.A., a national banking association, as successor trustee (the “Trustee”). At the time of the formation of the Trust, Standard Oil and BP Alaska were indirect, wholly-owned subsidiaries of BP p.l.c. (“BP”).

On February 28, 1989, Standard Oil conveyed an overriding royalty interest (the “Royalty Interest”) to the Trust. The Trust was formed for the sole purpose of owning and administering the Royalty Interest. The Royalty Interest represents the right to receive a per barrel royalty (the “Per Barrel Royalty”) of 16.4246% on the lesser of (a) the first 90,000 barrels of the average actual daily net production of oil and condensate per quarter or (b) the average actual daily net production of oil and condensate per quarter from BP Alaska’s working interests as of February 28, 1989 in the Prudhoe Bay field situated on the North Slope of Alaska (the “1989 Working Interests”). Trust Unit holders are subject to the risk that production will be interrupted or discontinued or fall, on average, below 90,000 barrels per day in any quarter. BP has guaranteed the performance of BP Alaska of its payment obligations with respect to the Royalty Interest and that guarantee remains in place with respect to the performance of HNS of such payment obligations.

Effective January 1, 2000, BP Alaska and all other Prudhoe Bay working interest owners cross-assigned interests in the Prudhoe Bay field pursuant to the Prudhoe Bay Unit Alignment Agreement. BP Alaska retained all rights, obligations, and liabilities associated with the Trust.

The trustees of the Trust are The Bank of New York Mellon Trust Company, N.A and BNY Mellon Trust of Delaware, a Delaware banking corporation. BNY Mellon Trust of Delaware serves as co-trustee in order to satisfy certain requirements of the Delaware Statutory Trust Act. The Bank of New York Mellon Trust Company, N.A. alone is able to exercise the rights and powers granted to the Trustee in the Trust Agreement.

The Per Barrel Royalty in effect for any day is equal to the price of West Texas Intermediate crude oil (the “WTI Price”) for that day less scheduled Chargeable Costs (adjusted for inflation) and Production Taxes (based on statutory rates then in existence).

The Trust is passive, with the Trustee having only such powers as are necessary for the collection and distribution of revenues, the payment of Trust liabilities, and the protection of the Royalty Interest. The Trustee, subject to certain conditions, is obligated to establish cash reserves and borrow funds to pay liabilities of the Trust when they become due. The Trustee may sell Trust properties only (a) as authorized by a vote of the Trust Unit holders, (b) when necessary to provide for the payment of specific liabilities of the Trust then due (subject to certain conditions) or (c) upon termination of the Trust. Each Trust Unit issued and outstanding represents an equal undivided share of beneficial interest in the Trust. Royalty payments are received by the Trust and distributed to Trust Unit holders, net of Trust expenses, in the month succeeding the end of each calendar quarter. The Trust will terminate (i) upon a vote of Trust unit holders of not less than 60% of the outstanding Trust Units, or (ii) at such time the net revenues from the Royalty Interest for two successive years are less than $1,000,000 per year (unless the net revenues during such period are materially and adversely affected by certain events).

 

4

BP Prudhoe Bay Royalty Trust

Notes to Financial Statements (Unaudited)

(Prepared on a modified cash basis)

March 31, 2021

 

(2)

Impact of COVID-19 Pandemic and Liquidity

A novel strain of coronavirus, SARS-CoV-2 (severe acute respiratory syndrome coronavirus 2), surfaced in late 2019 and has since spread around the world. In March 2020, the World Health Organization characterized the disease caused by the virus—COVID-19—as a pandemic. Due to the economic impacts of the COVID-19 pandemic, the markets have experienced a decline in oil prices in response to oil demand concerns and global storage considerations. As a result of lower oil prices, the Trust received no royalty payments for the quarters ended March 31, June 30, September 30, and December 31, 2020 and, as discussed in Note 8 to these financial statements, did not receive a royalty payment in April 2021 for the quarter ended March 31, 2021. If oil prices remain below the “break-even” WTI price of $60.72 per barrel necessary for the Trust to receive a positive Per Barrel Royalty with respect to a particular day’s production, the Trust’s operations will continue to be adversely impacted. As noted above, as a general matter, the Trust is expected to terminate at such time the net revenues from the Royalty Interest for two successive years are less than $1,000,000 per year.

In order to ensure that the Trust has the ability to pay future expenses, the Trust established a cash reserve account in July 1999. The cash reserve account was funded from periodic deductions from the royalty payments. These deductions were intended to result in an available cash balance in the cash reserve account that would be sufficient to pay approximately one year’s current and expected liabilities and expenses of the Trust.

As previously disclosed, the Trust has not received any royalty payments attributable to the four quarters of 2020 and the first quarter 2021. As a result, the Trust has not been able to make a quarterly deduction to replenish the funds on deposit in the cash reserve account since January of 2020.

Pursuant to Section 7.02 of the Trust Agreement, the Trustee, on December 18, 2020, notified HNS in writing that available assets in the trust created under the Trust Agreement were insufficient to pay current expenses that had been incurred on behalf of the Trust relating to the Trustee’s administration of the Trust. Pursuant to the indemnity provisions contained in Section 7.02 of the Trust Agreement, the Trustee made a demand for indemnity and reimbursement of expenses upon HNS in the amount of $537,835, representing the Trust’s unpaid expenses through December 18, 2020. HNS paid the requested funds to the Trustee on December 28, 2020, and the Trustee applied those funds to the Trust’s unpaid expenses in accordance with the Trust Agreement.

Although HNS agreed to make an indemnity payment to reimburse the Trust for current administrative expenses incurred by the Trustee on behalf of the Trust through December 18, 2020, there can be no assurance that HNS will make any further indemnification payments and in such case, the Trustee will continue to review its options under the Trust Agreement and Support Agreement, including obtaining a loan for the Trust, selling a portion of the Trust assets, or selling all of the Trust assets, or enforcing such indemnity, if necessary.

The Trustee anticipates incurring significant additional expenses relating to continued compliance with the Trust’s Securities and Exchange Act and tax reporting requirements through the remainder of fiscal year 2021 and subsequent periods. As disclosed in the Trust’s report on Form 10-K for the year ended December 31, 2020, the Trustee is continuing to explore with HNS the options available to the Trust under the Trust Agreement to address the Trust’s continuing operational funding shortfall. These steps may include obtaining a loan for the Trust, selling a portion of the Trust assets, or selling all of the Trust assets and taking the necessary steps to terminate the Trust. In addition, the Trustee intends to increase the amount of the cash reserve, in the event that royalty payments are available to the Trust in the future. There can be no assurance that the Trust will be able to secure a loan or arrange for the sale of Trust assets, or that any loan or sale will be on terms that are acceptable to the Trust.

The uncertainty surrounding the receipt of future royalties necessary for the Trust to avoid termination, coupled with the Trust’s current liquidity position, raises substantial doubt regarding the Trust’s ability to continue as a going concern.

 

5

BP Prudhoe Bay Royalty Trust

Notes to Financial Statements (Unaudited)

(Prepared on a modified cash basis)

March 31, 2021

 

(3)

Basis of Accounting

The financial statements of the Trust are prepared on a modified cash basis and reflect the Trust’s assets, liabilities, corpus, earnings, and distributions, as follows:

 

  a.

Revenues are recorded when received (generally within 15 days of the end of the preceding quarter) and distributions to Trust Unit holders are recorded when paid.

 

  b.

Trust expenses (which include accounting, engineering, legal, and other professional fees, trustees’ fees, and out-of-pocket expenses) are recorded on an accrual basis.

 

  c.

Cash reserves may be established by the Trustee for certain contingencies that would not be recorded under generally accepted accounting principles.

While these statements differ from financial statements prepared in accordance with accounting principles generally accepted in the United States of America, the modified cash basis of reporting revenues and distributions is considered to be the most meaningful because quarterly distributions to the Trust Unit holders are based on net cash receipts. The accompanying modified cash basis financial statements contain all adjustments necessary to present fairly the assets, liabilities and corpus of the Trust as of March 31, 2021 and December 31, 2020, and the modified basis of cash earnings and distributions and changes in Trust corpus for the three-month periods ended March 31, 2021 and 2020. The adjustments are of a normal recurring nature and are, in the opinion of the Trustee, necessary to fairly present the results of operations.

As of March 31, 2021 and December 31, 2020 cash equivalents which represent the cash reserve consist of a Morgan Stanley ILF Treasury Fund and U.S. Treasury Bills with original maturities of ninety days or less.

Estimates and assumptions are required to be made regarding assets, liabilities and changes in Trust corpus resulting from operations when financial statements are prepared. Changes in the economic environment, financial markets and any other parameters used in determining these estimates could cause actual results to differ, and the difference could be material.

These unaudited financial statements should be read in conjunction with the financial statements and related notes in the Trust’s Annual Report on Form 10-K for the fiscal year ended December 31, 2020. The cash earnings and distributions for the interim periods presented are not necessarily indicative of the results to be expected for the full year.

 

(4)

Royalty Interest

At inception in February 1989, the Royalty Interest held by the Trust had a carrying value of $535,000,000. In accordance with generally accepted accounting principles, the Trust amortized the value of the Royalty Interest based on the units of production method. Such amortization was charged directly to the Trust corpus, and did not affect cash earnings. In addition, the Trust periodically evaluated impairment of the Royalty Interest by comparing the undiscounted cash flows expected to be realized from the Royalty Interest to the carrying value, pursuant to the Financial Accounting Standards Board Accounting Standards Codification (ASC) 360, Property, Plant, and Equipment. If the expected future undiscounted cash flows were less than the carrying value, the Trust recognized impairment losses for the difference between the carrying value and the estimated fair value of the Royalty Interest. By December 31, 2010, the Trust had recognized accumulated amortization of $359,473,000 and aggregate impairment write-downs of $175,527,000 reducing the carrying value of the Royalty Interest to zero.

 

6

BP Prudhoe Bay Royalty Trust

Notes to Financial Statements (Unaudited)

(Prepared on a modified cash basis)

March 31, 2021

 

(5)

Income Taxes

The Trust files its federal tax return as a grantor trust subject to the provisions of subpart E of Part I of Subchapter J of the Internal Revenue Code of 1986, as amended, rather than as an association taxable as a corporation. The Trust unit holders are treated as the owners of Trust income and corpus, and the entire taxable income of the Trust will be reported by the Trust unit holders on their respective tax returns.

If the Trust were determined to be an association taxable as a corporation, it would be treated as an entity taxable as a corporation on the taxable income from the Royalty Interest, the Trust unit holders would be treated as shareholders, and distributions to Trust unit holders would not be deductible in computing the Trust’s tax liability as an association.

 

(6)

Alaska Oil and Gas Production Tax

On April 14, 2013, Alaska’s legislature passed an oil-tax reform bill amending Alaska’s oil and gas production tax statutes, AS 43.55.10 et seq (the “Production Tax Statutes”) with the aim of encouraging oil production and investment in Alaska’s oil industry. On May 21, 2013, the Governor of Alaska signed the bill into law as chapter 10 of the 2013 Session Laws of Alaska (the “Act”). Among significant changes, the Act eliminated the monthly “progressivity” tax rate implemented by certain amendments to the Production Tax Statutes in 2006 and 2007, increased the base rate from 25% to 35% and added a stair-step per-barrel tax credit for oil production. This tax credit is based on the gross value at the point of production per barrel of taxable oil and may not reduce a producer’s tax liability below the “minimum tax” (which is a percentage, ranging from zero to 4%, of the gross value at the point of production of a producer’s taxable production during the calendar year based on the average price per barrel for Alaska North Slope crude oil for sale on the United States West Coast for the year) under the Production Tax Statutes. These changes became effective on January 1, 2014.

On January 15, 2014, the Trustee executed a letter agreement with BP Alaska dated January 15, 2014 (the “2014 Letter Agreement”) regarding the implementation of the Act with respect to the Trust. Pursuant to the 2014 Letter Agreement, Production Taxes for the Trust’s Royalty Production will equal the tax for the relevant quarter, minus the allowable monthly stair-step per-barrel tax credits for the Royalty Production during that quarter. If there is a “minimum tax”-related limitation on the amount of the stair-step per-barrel tax credits that could otherwise be claimed for any quarter during the year, any difference between that limitation as preliminarily determined on a quarterly basis and the actual limitation for the entire year will be reflected in the payment to the Trust for the first quarter Royalty Production in the following year.

On July 6, 2015, BP Alaska and the Trustee signed a letter agreement (the “2014 Letter Agreement Amendment”) amending the 2014 Letter Agreement to provide that if there is a “minimum tax”-related limitation on the amount of the stair-step per-barrel tax credits that could otherwise be claimed for any quarter during the year, any difference between that limitation as preliminarily determined on a quarterly basis and the actual limitation for the entire year will be reflected in the payment to the Trust for the fourth quarter Royalty Production payment for such year rather than in the payment to the Trust for the first quarter Royalty Production in the following year.

 

7

BP Prudhoe Bay Royalty Trust

Notes to Financial Statements (Unaudited)

(Prepared on a modified cash basis)

March 31, 2021

 

(7)

Royalty Revenue Adjustments

Certain of the royalty payments received by the Trust in 2020 were adjusted by BP Alaska (as predecessor to HNS) to compensate for underpayments or overpayments of the royalties due with respect to the quarters ended prior to the dates of such payments. Average net production of crude oil and condensate from the proved reserves allocated to the Trust was less than 90,000 barrels per day during certain quarters. Royalty payments by BP Alaska with respect to those quarters were based on estimates by BP Alaska of production levels because actual data was not available by the date on which payments were required to be made to the Trust. Subsequent recalculation by BP Alaska of royalty payments due based on actual production data resulted in the payment adjustments shown in the table below (in thousands).

 

     Payments
Received 		 
     Jan. 2020  

Royalty payment as calculated

   $ 9,321  

Adjustment for previous quarter’s underpayment (overpayment), plus accrued interest

     16  
  

 

 

 

Total payment received

   $ 9,337  
  

 

 

 

Due to a slight over estimation of the December 2019 production volume included in the 2019 fourth quarter royalty payment calculation, there was an overpayment by BP Alaska of $68,541, including interest through March 31, 2021, with respect to the 2019 fourth quarter royalty payment. This overpayment would be recovered by HNS in one or more future quarters with a sufficient positive royalty payment. In the event that there are no future, or insufficient, positive payments, it is expected that HNS would explore other options it may have under the Trust Agreement, the Conveyance or otherwise to recover the amount of the 2019 fourth quarter overpayment.

 

(8)

Subsequent Event

There was no royalty payment received by the Trust in April 2021 for the quarter ended March 31, 2021.

Subsequent events have been evaluated through the date of this report.

 

8

Item 2.

Trustee’s Discussion and Analysis of Financial Condition and Results of Operations.

Introduction

BP Prudhoe Bay Royalty Trust (the “Trust”), a grantor trust, was created as a Delaware business trust pursuant to a Trust Agreement dated February 28, 1989 (the “Trust Agreement”), among The Standard Oil Company (“Standard Oil”), BP Exploration (Alaska) Inc. (“BP Alaska”), The Bank of New York Mellon, as trustee, and BNY Mellon Trust of Delaware (successor to The Bank of New York (Delaware)), as co-trustee. On December 15, 2010, The Bank of New York Mellon resigned as trustee and was replaced by The Bank of New York Mellon Trust Company, N.A., a national banking association, as successor trustee (the “Trustee”). At the time of formation of the Trust, Standard Oil and BP Alaska were indirect, wholly-owned subsidiaries of BP p.l.c. (“BP”).

On August 27, 2019, BP announced that it had agreed to sell BP Alaska and its other assets and operations in Alaska for total consideration of $5.6 billion to Hilcorp Alaska, LLC and its affiliates, which are affiliates of Houston-based Hilcorp Energy Company (collectively “Hilcorp”). On June 30, 2020, Hilcorp completed its acquisition of BP’s entire upstream business in Alaska, including BP’s interest in BP Alaska, which owned all of BP’s upstream oil and gas interest in Alaska (including oil and gas leases in the Prudhoe Bay field), and on December 18, 2020, an affiliate of Hilcorp completed its acquisition of BP’s midstream business in Alaska. On July 1, 2020, BP Alaska, a Delaware corporation, converted to a Delaware limited liability company and changed its name to Hilcorp North Slope, LLC, a wholly-owned subsidiary of Hilcorp Alaska, LLC. Hilcorp and its affiliates employ approximately 1,400 full-time employees in Alaska. Under the terms of the Trust Agreement, HNS is the successor to BP Alaska. For purposes of this Quarterly Report on Form 10-Q, “HNS” means (i) at all times prior to June 30, 2020, BP Alaska, and (ii) at all times after and including June 30, 2020, Hilcorp North Slope, LLC (formerly known as BP Alaska).

The information in this report relating to the Prudhoe Bay Unit, the calculation of royalty payments and certain other matters has been furnished to the Trustee by HNS, and the Trustee is entitled to rely on the accuracy of such information in accordance with the Trust Agreement.

Forward-Looking Statements

Various sections of this report contain forward-looking statements (that is, statements anticipating future events or conditions and not statements of historical fact) within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Words such as “anticipate,” “expect,” “believe,” “intend,” “plan” or “project,” and “should,” “would,” “could,” “potentially,” “possibly” or “may,” and other words that convey uncertainty of future events or outcomes are intended to identify forward-looking statements. Forward-looking statements in this report are subject to a number of risks and uncertainties beyond the control of the Trustee. These risks and uncertainties include such matters as future changes in oil prices, oil production levels, production charges and costs, economic activity, domestic and international political events and developments, legislation and regulation, COVID-19, and certain changes in expenses of the Trust.

The actual results, performance and prospects of the Trust could differ materially from those expressed or implied by forward-looking statements. Descriptions of some of the risks that could affect the future performance of the Trust appear in Item 1A, “RISK FACTORS,” of the Trust’s Annual Report on Form 10-K for the fiscal year ended December 31, 2020 (the “2020 Annual Report”). There may be additional risks of which the Trustee is unaware or which are currently deemed immaterial.

In the light of these risks, uncertainties and assumptions, you should not rely unduly on any forward-looking statements. Forward-looking events and outcomes discussed in the 2020 Annual Report and in this report may not occur or may turn out differently. The Trustee undertakes no obligation to update forward-looking statements after the date of this report, except as required by law, and all such forward-looking statements in this report are qualified in their entirety by the preceding cautionary statements.

Liquidity and Capital Resources

The Trust is a passive entity. The Trustee’s activities are limited to collecting and distributing the revenues from the Royalty Interest and paying liabilities and expenses of the Trust. Generally, the Trust has no source of liquidity and no capital resources other than the revenue attributable to the Royalty Interest that it receives from time to time. See the discussion under “THE ROYALTY INTEREST” in Part I, Item 1 of the 2020 Annual Report for a description of the calculation of the Per Barrel Royalty, and the discussion under “THE PRUDHOE BAY UNIT AND FIELD – Reserve Estimates” in Part I, Item 1 of the 2020 Annual Report for information concerning the estimated future net revenues of the Trust. However, the Trust Agreement gives the Trustee power to borrow, establish a cash reserve, or dispose of all or part of the Trust property under limited circumstances. See the discussion under “THE TRUST – Sales of Royalty Interest; Borrowings and Reserves” in Part I, Item 1 of the 2020 Annual Report.

 

9

In July 1999, the Trustee established a cash reserve to provide liquidity to the Trust during any future periods in which the Trust does not receive a distribution from HNS. The Trustee draws funds from the cash reserve account during any quarter in which the quarterly distribution received by the Trust does not exceed the liabilities and expenses of the Trust, and replenishes the reserve from future quarterly distributions, if any. 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 Unit holders. The Trustee anticipates that it will keep this cash reserve program in place, to the extent that it receives a distribution from HNS, until termination of the Trust. In December 2018, the Trust announced that the Trustee had determined to gradually increase the Trustee’s existing cash reserve for the payment of future expenses and liabilities of the Trust, as permitted by the Trust Agreement. Commencing with the distribution to Unit holders payable in April 2019, the Trustee began withholding the greater of $33,750 or 0.17% of the funds otherwise available for distribution each quarter to gradually increase existing 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 Unit holders, together with interest earned on the funds. Any amounts set aside for the cash reserve are invested by the Trustee in U.S. government or agency securities secured by the full faith and credit of the United States, or mutual funds investing in such securities.

A novel strain of coronavirus, SARS-CoV-2 (severe acute respiratory syndrome coronavirus 2), surfaced in late 2019 and has since spread around the world. In March 2020, the World Health Organization characterized the disease caused by the virus—COVID-19—as a pandemic. Due to the economic impacts of the COVID-19 pandemic, the markets experienced a decline in oil prices in response to oil demand concerns and global storage considerations. As a result of, among other things, lower oil prices and the increase in Chargeable Costs, the Trust received no royalty payments for the quarters ended March 31, June 30, September 30, and December 31, 2020. As discussed in Note 8 to the financial statements, the Trust did not receive a Royalty Payment for the first quarter of 2021, because during such period, oil prices were below the “break-even” price of West Texas Intermediate crude oil (the “WTI Price”) of $60.72 needed for the Trust to receive a positive Per Barrel Royalty with respect to a particular day’s production (such price, the “Break-Even Price”).

Because the Trust did not receive any royalty payments attributable to the four quarters during 2020 or the first quarter of 2021, the Trust has been unable to make a quarterly deduction to replenish the funds on deposit in the cash reserve account since the January 2020 distribution made for royalty payments attributed to the fourth quarter of 2019. In December 2020, the remaining funds on deposit in the cash reserve were insufficient to pay the Trustee’s fees and administrative fees, expenses, charges and costs, including accounting, engineering, legal, financial advisory, and other professional fees incurred in connection with the Trust (“Administrative Expenses”). Subsequently, the Trustee made a demand for indemnity and reimbursement of expenses upon HNS in accordance with the Trust Agreement in the amount of $537,835, representing the Trust’s current unpaid expenses through December 18, 2020. On December 28, 2020, HNS paid the requested funds to the Trustee and the Trustee applied those funds to the Trust’s current unpaid Administrative Expenses in accordance with the Trust Agreement. Although HNS agreed to make an indemnity payment to reimburse the Trust for current Administrative Expenses incurred by the Trustee on behalf of the Trust through December 18, 2020, there can be no assurance that HNS will make any further indemnification payments and in such case, the Trustee will continue to review its options under the Trust Agreement and Support Agreement, including obtaining a loan for the Trust, selling a portion of the Trust assets, selling all of the Trust assets, or enforcing such indemnity, if necessary.

At March 31, 2021, the cash balance of the cash reserve account was $191,000. The Trust has incurred additional Administrative Expenses in excess of the cash balance of the reserve fund and anticipates incurring additional Administrative Expenses. The Trust is exploring the options available under the Trust Agreement to address the Trust’s continuing operational shortfall. These steps may include obtaining a loan for the Trust, selling a portion of the Trust assets, or selling all of the Trust assets and taking the necessary steps to terminate the Trust. The Trustee has engaged a firm with expertise in the oil industry to provide financial advisory, investment banking, valuation, and consulting services to assist the Trust in identifying a potential lender or potential purchaser of Trust assets, and to advise the Trust with respect to the timing of its potential termination pursuant to the Trust Agreement. These efforts are ongoing and there can be no assurance that the Trust will be able to secure a loan or arrange for the sale of Trust assets, or if it can, that the loan or sale will be on terms that are acceptable to the Trust.

Although the Trust did not receive Royalty Payments attributable to any quarter in 2020 or the first quarter of 2021, in part due to the decline in WTI prices, the increase in Chargeable Costs and the payment of Production Taxes, coupled with decreased Royalty Production from the Prudhoe Bay Field, significantly reduce the likelihood of any material Royalty Payments to Unit holders for the remainder of 2021 or in subsequent periods.

The Trustee expects to retain in reserve future Royalty Payments, if any, made in fiscal year 2021 or subsequent periods for future Administrative Expenses of at least $1,270,000 and potentially more in an amount sufficient to pay Trust fees and expenses for at least one year plus anticipated expenses in connection with the termination of the Trust. In order to comply with the Trust Agreement’s termination process and requirements, the Trust is likely to incur significant additional expenditures. Accordingly, even if the Trust receives royalty revenues during 2021 or 2022, it is unlikely that Unit holders will receive Royalty Payments on outstanding Units during such periods, since the Trust would need to withhold sufficient funds from such Royalty Payments to replenish the cash reserve and ensure there are sufficient funds on hand to provide for an orderly termination of Trust in accordance with its terms, before distributing any funds to the Unit Holders.

 

10

If the Trust does not receive any additional royalty revenues in 2021 or thereafter, or obtain alternative funding, the Trust’s ability to meet its obligations would be adversely affected, which raises substantial doubt about its ability to continue as a going concern. As a general matter, the Trust is expected to terminate at such time the net revenues from the Royalty Interest for two successive years are less than $1,000,000 per year.

Results of Operations

Relatively modest changes in oil prices significantly affect the Trust’s revenues and results of operations. Crude oil prices are subject to significant changes in response to fluctuations in the domestic and world supply and demand and other market conditions as well as the world political situation as it affects OPEC and other producing countries. The effect of changing economic conditions on the demand and supply for energy throughout the world and future prices of oil cannot be accurately projected.

Royalty revenues are generally received on the Quarterly Record Date (generally the fifteenth day of the month) following the end of the calendar quarter in which the related Royalty Production occurred. The Trustee, to the extent possible, pays all expenses of the Trust for each quarter on the Quarterly Record Date on which the revenues for the quarter are received. For the statement of cash earnings and distributions, revenues and Trust expenses are recorded on a cash basis and, as a result, distributions to Unit holders in the three-month periods ended March 31, 2021 and 2020, respectively, are attributable to HNS’s operations during the three-month periods ended December 31, 2020 and 2019, respectively.

“Royalty Production” for each day in a calendar quarter is 16.4246% of the first 90,000 barrels of the actual average daily net production of oil and condensate for the quarter from the proved reserves allocated to the Trust. When HNS’s average net production of oil and condensate per quarter from the 1989 Working Interests exceeds 90,000 barrels a day, the principal factors affecting the Trust’s revenues and distributions to Unit holders are changes in WTI Prices, scheduled annual increases in Chargeable Costs, changes in the Consumer Price Index and changes in Production Taxes. However, it is likely that the Trust’s revenues in future periods also will be affected by increases and decreases in production from the 1989 Working Interests. HNS’s net production of oil and condensate allocated to the Trust from proved reserves was less than 90,000 barrels per day on an annual basis during 2018, 2019 and 2020. The Trustee has been advised that HNS expects that average net production allocated to the Trust from the proved reserves will be less than 90,000 barrels a day on an annual basis in future years.

During 2020 and the first quarter of 2021, WTI Prices were below the level necessary for the Trust to receive a Per Barrel Royalty. Whether the Trust will be entitled to future distributions during the remainder of 2021 will depend on, among other things, WTI Prices prevailing during the remainder of the year.

On January 1, 2021, the “break-even” WTI price (the price at which all taxes and prescribed deductions are equal to the WTI price) for the Trust to receive a positive Per Barrel Royalty with respect to a particular day’s production was $60.72. From the beginning of the first quarter of 2021 through May 7, 2021, the closing WTI crude oil spot price fluctuated between a high of $66.09 per barrel on March 5, 2021, and a low of $47.62 per barrel on January 4, 2021. The closing WTI crude oil spot price on May 7, 2021, was $64.90 per barrel. The quarterly royalty payment by HNS to the Trust is the sum of the individual revenues attributed to the Trust as calculated each day during the quarter. Any single calculation of a calendar day will not reflect the value of the dividend paid to the Trust for the quarter, nor will it reflect the estimated future value of the Trust. However, if a low oil price environment should occur for a protracted period, quarterly royalty payments are likely to be insignificant or be zero.

HNS estimates Royalty Production from the 1989 Working Interests for purposes of calculating quarterly royalty payments to the Trust because complete actual field production data for the preceding calendar quarter generally is not available by the Quarterly Record Date. To the extent that average net production from the 1989 Working Interests is below 90,000 barrels per day, calculation by HNS of actual Royalty Production data may result in revisions of prior Royalty Production estimates. Revisions by HNS of its Royalty Production calculations may result in quarterly royalty payments by HNS which reflect adjustments for overpayments or underpayments of royalties with respect to prior quarters. Such adjustments, if material, may adversely affect certain Unit holders who buy or sell Units between the Quarterly Record Dates for the Quarterly Distributions affected.

The Quarterly Distributions received by the Trust from HNS in January 2020 were adjusted by HNS to compensate for the underpayment of royalties due to the Trust with respect to the quarter ended December 31, 2019. See Note 7 of Notes to Financial Statements (Unaudited) in Item 1. Because the statements of cash earnings and distributions of the Trust are prepared on a modified cash basis, royalty revenues for the three-month period ended March 31, 2020, reflect the amount of the adjustments with respect to the earlier fiscal period.

The following table summarizes the factors which determined the Per Barrel Royalty used to calculate the payment received by the Trust in January 2020 and the lack of a payment in January 2021. See Note 1 of Notes to Financial Statements (Unaudited) in Part I, Item 1. The information in the table has been furnished to the Trust by HNS.

 

11

       Data for Quarter  

Royalty

Payment in

Month

   Based on Data
for Quarter
Ended 		     Average
WTI Price 		     Chargeable
Costs 		     Cost
Adjustment
Factor 		     Adjusted
Chargeable
Costs 		     Average
Production
Taxes 		     Average Per
Barrel
Royalty 		    Average Net
Production
(mb/d) 		 

Jan 2021

     12/31/2020      $ 42.66      $ 26.50        2.00      $ 53.10      $ 1.39      $ (11.84 )      74.8  

Jan 2020

     12/31/2019      $ 55.22      $ 23.75        1.981      $ 47.04      $ 1.96      $ 8.02       77.0  

Three Months Ended March 31, 2021 Compared to Three Months Ended March 31, 2020

Royalty Production

Trust royalty revenues received for the three-month period ended March 31, 2021, is based on the Royalty Production during the fourth quarter of the year ended December 31, 2020. The following table shows the changes between the fourth quarter ended December 31, 2020 and the fourth quarter ended December 31, 2019, in the factors that determined the Per Barrel Royalties used to calculate the royalty payment received by the Trust during the quarter ended March 31, 2020, and the lack of a royalty payment for the three-months ended March 31, 2021.

 

            Increase (decrease)        
     Three Months
Ended
12/31/2020 		     Amount      Percent     Three Months
Ended
12/31/2019 		 

Average WTI Price

   $ 42.66      ($ 14.36 )       (25.18 %)    $ 57.02  

Adjusted Chargeable Costs

   $ 53.10      $ 6.06        12.88 %    $ 47.04  

Average Production Taxes

   $ 1.39      ($ 0.57 )       (29.08 %)    $ 1.96  

Average Per Barrel Royalty

   ($ 11.84 )     ($ 19.86 )       (247.63 %)    $ 8.02  

Average Net Production (mb/d)

     74.8        (2.2 )       (2.86 %)      77.0  

The average WTI price for the fourth quarter of 2020 was down 25.2% compared to the average WTI price for the 2019 fourth quarter. The increase in the Consumer Price Index used to calculate the Cost Adjustment Factor, as well as the scheduled increase in Chargeable Costs from $23.75 in calendar 2019 to $26.50 in calendar 2020, resulted in a 12.9% percent increase in Adjusted Chargeable Costs during the three months ended December 31, 2020. The 247.6% decrease in the average Per Barrel Royalty for the period to a negative value resulted primarily from the decrease in WTI prices and the increase in Adjusted Chargeable Costs. As provided in the Trust Agreement, the payment with respect to the Royalty Interest for any calendar quarter may not be less than zero. Production Taxes remained low for the quarter because, as has occurred in each quarter since the second quarter of 2015, Production Taxes were calculated on the basis of the minimum tax under the Act and the 2014 Letter Agreement. See Note 6 of Notes to Financial Statements (Unaudited) in Item 1 above.

The average net production from the 1989 Working Interest for the two reporting periods declined by 2.9%. This decrease was due to the naturally declining production rate from the Prudhoe Bay field.

The following table shows the changes to the Trust’s revenues received and distributions paid during the quarter ended March 31, 2021, as compared to the same period in 2020 resulting from the factors in the table above, as well as changes in the Trust’s Administrative Expenses.

 

            Increase (decrease)        
     Three Months
Ended
3/31/2021 		     Amount      Percent     Three Months
Ended
3/31/2020 		 
     (Dollar amounts in thousands)  

Royalty revenues

     —        ($ 9,337 )       (100.00 %)    $ 9,337  

Cash earnings (loss)

   $ (76 )     ($ 9,167 )       (100.84 %)    $ 9,091  

Cash distributions

     —        ($ 9,078 )       (100.00 %)    $ 9,078  

Administrative Expenses (paid)

   $ 75      ($ 178 )       (70.36 %)    $ 253  

The period-to-period  decreases in royalty revenues, cash earnings and cash distributions are due to the substantial decline in the average Per Barrel Royalty as a result of the decline in average WTI Price, the increase in Adjusted Chargeable Costs and the decline

 

12

in average net production that prevailed during the three months ended March 31, 2021, compared to the same period in 2020. The decrease in Administrative Expenses paid during the three months ended March 31, 2021, reflects the near depletion of the cash reserve. As a result, the Trust has limited cash on hand to pay accrued Administrative Expenses. Accrued Administrative Expenses for the three months ended March 31, 2021, were $713,000, an increase of $574,000 from the prior year’s quarter. The increase in accrued Administrative Expenses relates to the Trust’s efforts to address the diminished amount of cash available to fund expenses and lack of royalty revenues attributable to the 2020 calendar year and first quarter of 2021, as well as an increase in professional fees, and timing differences in accruals of expenses. The decrease in the Trust corpus is primarily due to the increase in accrued expenses for the period and the lack of royalty revenues.

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk.

The Trust is a passive entity and except for the Trust’s ability to borrow money as necessary to pay liabilities of the Trust that cannot be paid out of cash on hand, the Trust is prohibited from engaging in borrowing transactions. The Trust periodically holds short-term investments acquired with funds held by the Trust pending distribution to Unit holders and funds held in reserve for the payment of Trust expenses and liabilities. Because of the short-term nature of these investments and limitations on the types of investments which may be held by the Trust, the Trust is not subject to any material interest rate risk. The Trust does not engage in transactions in foreign currencies which could expose the Trust or Unit holders to any foreign currency related market risk or invest in derivative financial instruments. It has no foreign operations and holds no long-term debt instruments.

 

Item 4.

Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

The Bank of New York Mellon Trust Company, N.A., as Trustee of the Trust, is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) promulgated under the Exchange Act. The Trust’s internal control over financial reporting is defined as a process designed by or under the supervision of the Trustee to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Trust’s financial statements for external reporting purposes in accordance with the modified cash basis of accounting. The Trust’s internal control over financial reporting includes policies and procedures that pertain to maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of assets; provide reasonable assurances that transactions are recorded as necessary to permit preparation of financial statements in accordance with the modified cash basis of accounting, and that receipts and expenditures are being made only in accordance with authorizations of the Trustee; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Trust’s assets that could have a material effect on the Trust’s financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projection of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

The Trustee conducted an evaluation of the effectiveness of the Trust’s internal control over financial reporting based on the criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO criteria”). Based on the Trustee’s evaluation under the COSO criteria, the Trustee concluded that the Trust’s internal control over financial reporting was effective as of March 31, 2021.

Changes in Internal Control Over Financial Reporting

There has not been any change in the Trust’s internal control over financial reporting identified in connection with the Trustee’s evaluation of the Trust’s internal control over financial reporting that occurred during the Trust’s last fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Trust’s internal control over financial reporting.

 

13

PART II —OTHER INFORMATION

 

Item 1.

Legal Proceedings.

None.

 

Item 1A.

Risk Factors

There have been no changes from the risk factors disclosed in the Trust’s annual report on Form 10-K for the year December 31, 2020.

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds.

None.

 

Item 3.

Defaults Upon Senior Securities.

None.

 

Item 4.

Mine Safety Disclosures.

Not applicable

 

Item 5.

Other Information.

None.

 

Item 6.

Exhibits.

 

31*

Rule 13a-14(a) Certification

 

32*

Section 1350 Certification

 

101

Explanatory note: An Interactive Data File is not submitted with this filing pursuant to Item 601(101) of Regulation S-K, because the Trust does not prepare its financial statements in accordance with generally accepted accounting principles as used in the United States. See Note 3 of Notes to Financial Statements (Unaudited) in Part I, Item 1.

 

*

Filed herewith.

 

14

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

BP PRUDHOE BAY ROYALTY TRUST
By:   THE BANK OF NEW YORK MELLON TRUST COMPANY, N.A., as Trustee
By:  

/s/ Elaina C. Rodgers

  Elaina C. Rodgers
  Vice President

Date: May 10, 2021

The Registrant is a trust and has no officers or persons performing similar functions. No additional signatures are available and none have been provided.

 

 

15

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