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ROYT > SEC Filings for ROYT > Form 10-Q on 9-Nov-2012All Recent SEC Filings

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Form 10-Q for PACIFIC COAST OIL TRUST


9-Nov-2012

Quarterly Report


Item 2. Trustee's Discussion and Analysis of Financial Condition and Results of Operations.

Overview

Introduction.

The Trust is a statutory trust formed in January 2012 under the Delaware Statutory Trust Act. The business and affairs of the Trust are managed by the Trustee. The Trust's purpose is to hold the Conveyed Interests (described below), to distribute to the Trust unitholders cash that the Trust receives in respect of the Conveyed Interests, subject to the effects of the commodity derivative contracts described in Note 4 to the financial statements contained in Part I, Item 1 of this Quarterly Report, and to perform certain administrative functions in respect of the Conveyed Interests and the Trust units. The Trust does not conduct any operations or activities. The Trustee has no authority over or responsibility for, and no involvement with, any aspect of the oil and gas operations or other activities on the Underlying Properties. Wilmington Trust, National Association, as the Delaware Trustee (the "Delaware Trustee"), has only minimal rights and duties as are necessary to satisfy the requirements of the Delaware Statutory Trust Act. The Trust derives all or substantially all of its income and cash flow from the Conveyed Interests, subject to the effects of the commodity derivative contracts. The Trust is treated as a grantor trust for U.S. federal income tax purposes.

The Trust was created to acquire and hold net profits and royalty interests in certain oil and natural gas properties located in California and further described below for the benefit of the Trust unitholders pursuant to an agreement among Pacific Coast Energy Company, LP, a privately-held Delaware limited partnership ("PCEC"), the Trustee and the Delaware Trustee. The Conveyed Interests (as defined below) represent undivided interests in underlying properties consisting of PCEC's interests in its oil and natural gas properties located onshore in California (the "Underlying Properties"). The Conveyed Interests were conveyed by PCEC to the Trust concurrent with the initial public offering of the Trust's common units in May 2012.

Concurrent with the initial public offering, on May 8, 2012, the Trust and PCEC entered into a Conveyance of Net Profits Interests and Overriding Royalty Interest (the "Conveyance"), pursuant to which PCEC conveyed to the Trust net profits interest and an overriding royalty interest (the "Conveyed Interests") in certain oil and natural gas properties in California (the "Underlying Properties"). The Conveyed Interests entitle the Trust to receive 80% of the net profits from the sale of oil and natural gas production from the proved developed reserves as of December 31, 2011 on the Underlying Properties (the "Developed Properties") and either 25% of the net profits from the sale of oil and natural gas production from all other development potential on the Underlying Properties (the "Remaining Properties") or a 7.5% royalty interest from the sale of oil and natural gas production from the Remaining Properties located in PCEC's Orcutt properties (the "Royalty Interest Proceeds").

The Trust calculates the net profits and royalties for the Developed Properties and Remaining Properties monthly. For any monthly period during which costs for the Remaining Properties exceed gross proceeds, the Trust would be entitled to receive the Royalty Interest Proceeds, and the Trust would continue to receive such proceeds until the first day of the month following the day on which cumulative gross proceeds for the Remaining Properties exceed the cumulative total excess costs for the Remaining Properties (such occurrence being herein called an "NPI Payout"). Due to significant planned capital expenditures associated with the Remaining Properties for the benefit of the Trust, PCEC expects the Trust to receive payments associated with the Remaining Properties in the form of Royalty Interest Proceeds until the NPI Payout occurs in approximately 2020. In any monthly period following an NPI Payout, the Trust is entitled to receive Royalty Interest Proceeds if costs for the Remaining Properties exceed gross proceeds.

The Trust will make monthly cash distributions of all of its monthly cash receipts, after deduction of fees and expenses for the administration of the Trust, to holders of its Trust units as of the applicable record date (generally the last business day of each calendar month) on or before the 10th business day after the record date. Actual cash distributions to the Trust unitholders will fluctuate monthly based upon the quantity of oil and natural gas produced from the Underlying Properties, the prices received for oil and natural gas production, costs to develop and produce the oil and natural gas and other factors. Because payments to the Trust will be generated by depleting assets with the production from the Underlying Properties diminishing over time, a portion of each distribution will represent, in effect, a return of a unitholder's original investment. Oil and natural gas production from proved reserves attributable to the Underlying Properties will decline over time.


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Properties.

The Underlying Properties consist of (i) the proved developed reserves as of December 31, 2011 on the Underlying Properties (the "Developed Properties,") and
(ii) all other development potential on the Underlying Properties (the "Remaining Properties"). Production from the Developed Properties that will be attributable to the Trust is produced from wells that, because they have already been drilled, require limited additional capital expenditures. Production from the Remaining Properties that will be attributable to the Trust will require capital expenditures for the drilling of wells and installation of infrastructure. PCEC will supply required capital on behalf of the Trust during this period; however, because the costs initially incurred will exceed gross proceeds, the Remaining Properties will have negative net profits during the drilling and development period. During this period of negative net profits, instead of being paid net profits, the Trust will be paid a 7.5% overriding royalty on the portion of the Remaining Properties located on PCEC's Orcutt properties. Once revenues from the Remaining Properties have paid back PCEC for the cumulative costs it has advanced on behalf of the Trust, the net profits interests on the Remaining Properties will be paid out in place of the royalty interests, as described below. The net profits interests and royalty interest conveyed to the Trust are referred to herein as the "Net Profits Interests" and "Royalty Interest," respectively. These interests, collectively the "Conveyed Interests," entitle the Trust to receive the following:

Developed Properties

80% of the net profits from the sale of oil and natural gas production from the Developed Properties.

Remaining Properties

7.5% of the proceeds (free of any production or development costs but bearing the proportionate share of production and property taxes and post-production costs) attributable to the sale of all oil and natural gas production from the Remaining Properties located on PCEC's Orcutt properties, including but not limited to PCEC's interest in such production (the "Royalty Interest Proceeds"), or

25% of the net profits from the sale of oil and natural gas production from all of the Remaining Properties.

The Trust calculates the net profits and royalties for the Developed Properties and the Remaining Properties separately. Any excess costs for either the Developed Properties or the Remaining Properties will not reduce net profits calculated for the other. The amount of Royalty Interest Proceeds paid will be taken into account in the net profits interest calculation for the Remaining Properties. If at any time cumulative costs for the Developed Properties or the Remaining Properties exceed cumulative gross proceeds associated with such properties, neither the Trust nor the Trust unitholders would be liable for the excess costs, but the Trust would not receive any net profits from the Developed Properties or the Remaining Properties, as the case may be, until future cumulative net profits for such properties exceed the cumulative total excess costs for such properties.

The Net Profits Interests will be entitled to a share of the profits from and after April 1, 2012 attributable to production from the Underlying Properties from and after April 1, 2012. In addition, from and after April 1, 2012, if the Remaining Properties are not entitled to a share of such net profits because costs exceed gross profits, the Royalty Interest will be entitled to the Royalty Interest Proceeds until the NPI Payout occurs.

The Trust is not subject to any pre-set termination provisions based on a maximum volume of oil or natural gas to be produced or the passage of time. The Trust will dissolve upon the earliest to occur of the following: (1) the Trust, upon approval of the holders of at least 75% of the outstanding Trust units, sells the Net Profits Interest, (2) the annual cash available for distribution to the Trust is less than $2 million for each of any two consecutive years,
(3) the holders of at least 75% of the outstanding Trust units vote in favor of dissolution or (4) the Trust is judicially dissolved.

Commodity Derivative Contracts

The revenues derived from the Underlying Properties depend substantially on prevailing oil prices and, to a lesser extent, natural gas prices. As a result, commodity prices also affect the amount of cash flow available for distribution to the Trust unitholders. Lower prices may also reduce the amount of oil and natural gas that PCEC or the third-party operators can economically produce. PCEC has entered into hedge contracts to reduce the exposure of the revenues from oil production from the Underlying Properties to fluctuations in oil prices and to achieve more predictable cash flow. However, these contracts limit the amount of cash available for distribution if prices increase above the fixed hedge price. None of the Trust's exposure to natural gas prices is hedged.

PCEC has entered into commodity derivative contracts with Wells Fargo Bank, National Association in order to mitigate the effects of falling commodity prices through March 31, 2014. The Trust will be entitled to the effect of 2,000 barrels of daily swap volumes of Brent crude oil at $115.00 per barrel during the twenty-four months ending March 31, 2014, which represents


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approximately 70% of expected oil production from April 1, 2012 through March 31, 2014 from the proved developed reserves as of December 31, 2011, proportional to the Trust's interest in the Developed Properties.

The Trust will not bear any commodity derivative settlement costs paid by PCEC, or be entitled to any commodity derivative payments received by PCEC, for periods prior to April 2012.

The amounts received by PCEC from the commodity derivative contract counterparty upon settlement of the commodity derivative contracts will reduce the operating expenses related to the Underlying Properties in calculating net profits. In addition, the aggregate amounts paid by PCEC upon settlement of the commodity derivative contracts related to the Underlying Properties will reduce the amount of net profits paid to the Trust.

Results of Operations for the Three and Nine Months Ended September 30, 2012

For the three and nine months ended September 30, 2012, income from net profits interests received by the Trust amounted to $17,691,782 and $24,241,643, respectively. As the Trust was not formed until January 1, 2012 and the conveyance of the Net Profits Interest and Overriding Royalty Interest was not completed until May 8, 2012, the Trust did not receive or disburse funds during the quarter ended March 31, 2012. The net profits income received by the Trust during the three and nine months ended September 30, 2012 was primarily associated with net profits for oil and natural gas production during the months of May, June and July 2012 and April, May, June and July 2012, respectively.

The following table displays PCEC's underlying sales volumes and average prices for the Underlying Properties, representing the amounts included in the net profits calculation for distributions paid during the three and nine months ended September 30, 2012.

                                Developed Properties        Remaining Properties
                               Underlying      Average     Underlying      Average
                              Sales Volumes     Price     Sales Volumes     Price
Month of Production             (Boe) (a)     (per Boe)     (Boe) (b)     (per Boe)

May                                 110,680      100.82               -           -
June                                106,568       89.33           1,857       88.22
July                                107,019       93.53           5,110       92.54

Total - Third Quarter 2012          324,267       94.64           6,967       91.39

April                               110,620      111.17               -           -

Total - Second Quarter 2012         100,620      111.17               -           -



(a) Crude oil sales represented 98% of total sales volumes from the Developed Properties.

(b) Crude oil sales represented 100% of total sales volumes from the Remaining Properties.


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Computation of Net Profits and Royalty Income Received by the Trust

The Trust's net profits and royalty income consist of monthly net profits and royalty income attributable to the Conveyed Interests. Net profits and royalty income for the three and nine months ended September 30, 2012 were determined as shown in the following table. The Trust did not receive any income for the three months ended March 31, 2012.

                                                           Three Months               Inception
                                                               Ended            (May 8, 2012) through
                                                        September 30, 2012       September 30, 2012

Developed Properties - 80% Net Profits Interest
Gross profits:
Oil sales                                                        30,551,116                 42,798,368
Natural gas sales                                                   137,305                    187,551

Total                                                            30,688,421                 42,985,919

Costs:
Direct operating expenses:
Lease operating expenses                                          9,942,724                 13,112,493
Production and other taxes                                        1,043,059                  1,396,096
Development expenses                                                 88,919                    162,919

Total                                                            11,074,702                 14,671,508

Total income                                                     19,613,719                 28,314,411
Net Profits Interest                                                     80 %                       80 %

Income from Net Profits Interest                                 15,690,975                 22,651,529

Remaining Properties - 25% Net Profits Interest
Total Revenues:
Oil sales                                                           636,676                    636,676

Total                                                               636,676                    636,676
Overriding Royalty Interest                                          47,751                     47,751

Costs:
Direct operating expenses:
Lease operating expenses                                            200,133                    200,133
Development expenses                                             11,010,480                 13,061,480

Total                                                            11,210,613                 13,261,613

Total excess cost                                               (10,621,688 )              (12,672,688 )
Net Profits Interest                                                     25 %                       25 %

25% Net Profits Interest Accrued Deficit                         (2,655,422 )               (3,168,172 )

Total Trust Cash Flow
80% Net Profit Interest                                 $        15,690,975    $            22,651,529
25% Net Profit Interest                                                   -                          -
7.5% Overriding Royalty Interest                                     47,751                     47,751
Settlement of Hedge Contracts                                     2,203,056                  1,875,696
PCEC Operating and Service Fee                                     (250,000 )                 (333,333 )

Total                                                            17,691,782                 24,241,643

Trust general and administrative expenses and cash
withheld for expenses                                   $          (163,961 )  $              (450,361 )

Distributable income                                    $        17,527,821    $            23,791,282


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Three months ended September 30, 2012

Excess of revenues over direct operating expenses and development expenses from the Developed Properties was approximately $19.6 million for the three months ended September 30, 2012. Total capital expenditures included in the net profits calculation during the quarter were approximately $0.1 million. Total lease operating expenses included in the net profits calculation during the quarter were approximately $9.9 million. Net settlements related to hedge contracts and PCEC's Operating and Service Fee were $2.2 million and $0.2 million, respectively, for the three months ended September 30, 2012.

For the Remaining Properties, costs exceeded gross proceeds by $2.7 million for the three months ended September 30, 2012, therefore the Trust received $47,751 from the 7.5% Overriding Royalty attributable to the sale of all production from the Remaining Properties located on PCEC's Orcutt Properties. The deficit of the net profits interest on the Remaining Properties, including the 7.5% Overriding Royalty, was approximately $2.7 million for the three months ended September 30, 2012.

The total cash received by the Trust from PCEC for the three months ended September 30, 2012 was approximately $17.7 million.

The Trustee paid general and administrative expenses of $148,961 during the third quarter of 2012. Expenses paid during the third quarter primarily consisted of Trustee fees, legal fees and New York Stock Exchange listing fees. The Trust also withheld $15,000 as a reserve for future Trust expenses, resulting in distributable income of approximately $17.5 million.

Nine months ended September 30, 2012

Excess of revenues over direct operating expenses and development expenses from the Developed Properties was approximately $28.3 million for the nine months ended September 30, 2012. Total capital expenditures included in the net profits calculation during the nine months ended September 30, 2012 were approximately $0.2 million. Total lease operating expenses included in the net profits calculation during the nine months ended September 30, 2012 were approximately $13.1 million. Net settlements related to hedge contracts and PCEC's Operating and Service Fee were $1.9 million and $0.3 million, respectively, for the nine months ended September 30, 2012.

For the Remaining Properties, costs exceeded gross proceeds by $3.2 million for the nine months ended September 30, 2012, therefore the Trust received $47,751 from the 7.5% Overriding Royalty attributable to the sale of all production from the Remaining Properties located on PCEC's Orcutt Properties. The cumulative deficit of the net profits interest on the Remaining Properties, including the 7.5% Overriding Royalty, is approximately $3.2 million for the nine months ended September 30, 2012.

The total cash received by the Trust from PCEC for the nine months ended September 30, 2012 was approximately $24.2 million.

The Trustee paid general and administrative expenses of $385,351 during the nine months ended September 30, 2012. Expenses paid during the nine month period primarily consisted of Trustee fees, legal fees and New York Stock Exchange listing fees. The Trust withheld $65,010 as a reserve for future Trust expenses during the nine months ended, resulting in distributable income of approximately $23.8 million.

Liquidity and Capital Resources

Other than Trust administrative expenses, including any reserves established by the Trustee for future liabilities, the Trust's only use of cash is for distributions to Trust unitholders. Available funds are the excess cash, if any, received by the Trust from the Conveyed Interests and other sources (such as interest earned on any amounts reserved by the Trustee) in that month, over the Trust's expenses paid for that month. Available funds are reduced by any cash the Trustee determines to hold as a reserve against future expenses.

The Trustee may create a cash reserve to pay for future liabilities of the Trust. If the Trustee determines that the cash on hand and the cash to be received are, or will be, insufficient to cover the Trust's liabilities, the Trustee may cause the Trust to borrow funds to pay liabilities of the Trust. The Trustee may also cause the Trust to mortgage its assets to secure payment of the indebtedness. If the Trustee causes the Trust to borrow funds, the Trust unitholders will not receive distributions until the borrowed funds are repaid. As of September 30, 2012 the Trust has reserved $65,010 for future Trust expenses.

Each month, the Trustee will pay Trust obligations and expenses and distribute to the Trust unitholders the remaining proceeds received from the Conveyed Interests. The cash held by the Trustee as a reserve against future liabilities or for distribution at the next distribution date may be invested in a limited number of permitted investments. Alternatively, cash held for distribution at the next distribution date may be held in a noninterest bearing account.


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PCEC has provided the Trust with a $1.0 million letter of credit to be used by the Trust in the event that its cash on hand (including available cash reserves) is not sufficient to pay ordinary course administrative expenses as they become due. Further, if the Trust requires more than the $1.0 million under the letter of credit to pay administrative expenses, PCEC has agreed to loan funds to the Trust necessary to pay such expenses. Any funds provided under the letter of credit or loaned by PCEC may only be used for the payment of current accounts or other obligations to trade creditors in connection with obtaining goods or services or for the payment of other accrued current liabilities arising in the ordinary course of the Trust's business, and may not be used to satisfy Trust indebtedness. If the Trust draws on the letter of credit or PCEC loans funds to the Trust, no further distributions will be made to Trust unitholders (except in respect of any previously determined monthly cash distribution amount) until such amounts drawn or borrowed, including interest thereon, are repaid. Any loan made by PCEC will be on an unsecured basis, and the terms of such loan will be substantially the same as those which would be obtained in an arm's-length transaction between PCEC and an unaffiliated third party.

The Trustee has no current plans to authorize the Trust to borrow money. During the quarter and nine months ended September 30, 2012, there were no borrowings.

Distributions Paid and Declared After Quarter End

On October 12, 2012, the distribution of $0.14987 per Trust Unit, which was declared on September 18, 2012, was paid to Trust unitholders owning Trust Units as of September 28, 2012.

On October 19, 2012, the Trust declared a distribution of $0.13939 per unit to unitholders of record as of October 31, 2012. The distribution is payable to Trust unitholders on November 14, 2012.

Off-Balance Sheet Arrangements

The Trust has no off-balance sheet arrangements and does not have any transactions, arrangements or other relationships with unconsolidated entities or persons that could materially affect the Trust's liquidity or the availability of capital resources.

New Accounting Pronouncements

As the Trust's financial statements are prepared on the modified cash basis, most accounting pronouncements are not applicable to the Trust's financial statements. No new accounting pronouncements have been adopted or issued that would impact the financial statements of the Trust.

Critical Accounting Policies and Estimates

Please see Note 2 to the Trust's Statement of Assets and Trust Corpus as of January 3, 2012 included in the Trust's Prospectus filed with the Securities and Exchange Commission pursuant to Rule 424(b)(1) on May 4, 2012 for information regarding the Trust's critical accounting policies and estimates.


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