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PER > SEC Filings for PER > Form 10-Q on 9-Aug-2013All Recent SEC Filings

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Form 10-Q for SANDRIDGE PERMIAN TRUST


9-Aug-2013

Quarterly Report


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

Introduction

The following discussion and analysis is intended to help the reader understand the Trust's financial condition, results of operations, liquidity and capital resources. This discussion and analysis should be read in conjunction with the Trust's unaudited 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 2012 Form 10-K.

Overview

The Trust is a statutory trust created under the Delaware Statutory Trust Act. The business and affairs of the Trust are administered by the Trustee and, as necessary, the Delaware Trustee. The Trust's purpose is to hold the Royalty Interests, to distribute to the Trust unitholders cash that the Trust receives in respect of the Royalty Interests and the derivatives agreement (described in Note 5 to the unaudited financial statements contained in Part I, Item 1 of this Quarterly Report) and to perform certain administrative functions in respect of the Royalty Interests and the Trust units. Other than the foregoing activities, the Trust does not conduct any operations or activities. The Trustee has no involvement with, control or authority over, or responsibility for, any aspect of the operations on or relating to the properties in which the Trust has an interest. The Trust derives all or substantially all of its income and cash flow from the Royalty Interests and the derivatives agreement. The Trust is treated as a partnership for federal income tax purposes. The Trust's activities result in the Trust having nexus in Texas and, therefore, make it subject to Texas franchise tax. The Trust is required to pay Texas franchise tax each year at a maximum effective rate of 0.7% of its gross income apportioned to Texas in the prior year.

Properties. As of June 30, 2013, the Trust's properties consisted of Royalty Interests in (a) the Initial Wells, (b) 563 additional wells (equivalent to approximately 581 Trust Development Wells under the development agreement as described below) that were drilled and perforated for completion between April 1, 2011 and June 30, 2013, and (c) the equivalent of approximately 307 Trust Development Wells to be drilled within an AMI consisting of approximately 16,900 gross acres (15,500 net acres) in Andrews County, Texas.

SandRidge is obligated to drill, or cause to be drilled, the Trust Development Wells on or before March 31, 2016. SandRidge is not permitted to drill and complete any well within the AMI for its own account, subject to certain exceptions, until it has satisfied the drilling obligation to the Trust. SandRidge has granted to the Trust a lien covering its interest in the AMI (except its interest in the Initial Wells) in order to secure the estimated amount of the drilling costs for the Trust's interests in the undeveloped Underlying Properties, the balance of which is reduced as SandRidge fulfills its drilling obligation under the development agreement. At June 30, 2013, the amount potentially recoverable under the lien was approximately $101.6 million.

The Trust is not responsible for any costs related to the drilling of the Trust Development Wells or any other operating or capital costs related to the Underlying Properties. The following table presents the number of Initial Wells, Trust Development Wells drilled and Trust Development Wells to be drilled as of June 30, 2013 and December 31, 2012.

                                                                     Trust
                                                 Trust            Development
                                              Development         Wells To Be
                        Initial Wells      Wells Drilled(1)         Drilled         Total
   June 30, 2013                   517                   581               307       1,405
   December 31, 2012               517                   454               434       1,405

(1) SandRidge is credited for having drilled one full Trust Development Well if a well is drilled and perforated for completion to the Grayburg/San Andres formation and SandRidge's net revenue interest in the well is equal to 69.3%. For wells in which SandRidge has a net revenue interest greater or less than 69.3%, SandRidge will receive proportionate credit for such well. In certain circumstances, SandRidge may also receive Trust Development Well credit for horizontal wells drilled to such formation.

Distributions. The Trust makes quarterly cash distributions of substantially all of its cash receipts, after deducting amounts for the Trust's administrative expenses and cash reserves withheld by the Trustee, property tax and Texas franchise tax, on or about 60 days following the completion of each quarter. The Trust's subordinated units are entitled to receive pro rata distributions from the Trust each quarter if and to the extent there is sufficient cash to provide a cash distribution on the common units that is at least equal to the Subordination Threshold. If there is not sufficient cash to fund such a distribution on all of the common units (including the common units SandRidge owns), the distribution to be made with respect to the subordinated units is reduced or eliminated for such quarter in order to make a distribution, to the extent possible, to all of the common units (including the common units held by SandRidge) up to the Subordination Threshold. However, there is no minimum distribution. If the cash available for distribution on all of the Trust units in any quarter exceeds the Incentive Threshold for the corresponding quarter, SandRidge, as holder of the Trust's subordinated units, is entitled to 50% of the amount by which the cash available for distribution exceeds the Incentive Threshold.


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The following table sets forth the Subordination Threshold and Incentive Threshold for each remaining calendar quarter through the first quarter of 2017, as set out in the trust agreement.

                                     Subordination        Incentive
               Period(1)             Threshold(2)        Threshold(2)

               2013
               Second quarter (3)   $          0.53     $         0.80
               Third quarter                   0.56               0.84
               Fourth quarter                  0.58               0.87

               2014
               First quarter                   0.61               0.91
               Second quarter                  0.63               0.95
               Third quarter                   0.65               0.98
               Fourth quarter                  0.66               0.98

               2015
               First quarter                   0.64               0.96
               Second quarter                  0.61               0.92
               Third quarter                   0.56               0.85
               Fourth quarter                  0.54               0.81

               2016
               First quarter                   0.53               0.80
               Second quarter                  0.52               0.78
               Third quarter                   0.51               0.77
               Fourth quarter                  0.50               0.75

               2017
               First quarter                   0.49               0.74

(1) Due to the timing of the payment of production proceeds to the Trust, each distribution covers production from a three-month period consisting of the first two months of the most recently ended quarter and the final month of the quarter preceding it.

(2) Each of the Subordination Threshold (80% of quarterly target distribution) and Incentive Threshold (120% of quarterly target distribution) terminates after the fourth full calendar quarter following SandRidge's completion of its drilling obligation.

(3) A distribution of $0.585 per unit was declared on July 25, 2013 and is expected to be paid on or about August 29, 2013. See Note 6 to the financial statements contained in Item 1 of this report for further discussion.

Pursuant to Internal Revenue Code ("IRC") Section 1446, withholding tax on income effectively connected to a United States trade or business allocated to foreign partners should be made at the highest marginal rate. Under IRC
Section 1441, withholding tax on fixed, determinable, annual, periodic income from United States sources allocated to foreign partners should be made at 30% of gross income 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, currently 39.6% for individuals, on the distribution made to foreign partners.

Results of Trust Operations

The primary factors affecting the Trust's revenues and costs are the quantity of oil and natural gas production attributable to the Royalty Interests, the prices received for such production and amounts paid or received as net settlements under the derivatives agreement and the Trust's derivative contracts with unaffiliated third parties. Royalty income, post-production expenses, certain taxes and derivative settlements are recorded on a cash basis when net revenue distributions are received by the Trust from SandRidge and net derivative settlements are received from the Trust's derivative counterparty. Information regarding the Trust's production, pricing and costs for the three and six-month periods ended June 30, 2013 and 2012 is presented below.


Table of Contents
                                                    Three Months Ended            Six Months Ended
                                                         June 30,                     June 30,
                                                  2013(1)        2012(2)       2013(3)        2012(4)
Production Data
Oil (MBbls)(5)                                          325           346           700            689
Natural gas (MMcf)                                       94            91           189            176
Combined equivalent volumes (MBoe)                      341           362           731            718
Average daily combined equivalent volumes
(MBoe/d)                                                3.8           4.0           4.0            3.9
Well Data
Initial and Trust Development Wells producing
- average                                               868           680           863            653

Revenues (in thousands)
Royalty income                                   $   24,384      $ 32,373      $ 54,989       $ 61,539
Derivative settlements                                2,701            47         6,449          1,894

Total revenue                                    $   27,085      $ 32,420      $ 61,438       $ 63,433

Expenses (in thousands)
Post-production expenses                         $       30      $     25      $     52       $     65
Property taxes                                           -             -          1,767            162
Production taxes                                      1,140         1,542         2,572          2,943
Franchise taxes                                          -            155           442            155
Trust administrative expenses                           236           303           788            902
Cash reserves withheld (used) for current
Trust expenses, net of amounts used
(withheld)                                            1,166            79          (688 )          447

Total expenses                                   $    2,572      $  2,104      $  4,933       $  4,674

Distributable income available to unitholders    $   24,513      $ 30,316      $ 56,505       $ 58,759


Average Prices
Oil (per Bbl)(5)                                 $    74.13      $  92.81      $  77.88       $  88.62
Natural gas (per Mcf)                            $     2.85      $   2.43      $   2.67       $   2.68
Combined equivalent (per Boe)                    $    71.52      $  89.53      $  75.21       $  85.65

Average Prices - including impact of
derivative settlements and post-production
expenses
Oil (per Bbl)(5)(6)                              $    83.28      $  93.60      $  87.01       $  92.59
Natural gas (per Mcf)                            $     2.53      $   2.16      $   2.40       $   2.31
Combined equivalent (per Boe)                    $    80.16      $  90.21      $  83.88       $  89.37

Expenses (per Boe)
Post-production                                  $     0.09      $   0.07      $   0.07       $   0.09
Production taxes                                 $     3.34      $   4.26      $   3.52       $   4.10

(1) Oil and natural gas volumes and related revenues and expenses for the three-month period ended June 30, 2013 (included in SandRidge's May 2013 net revenue distribution to the Trust) represent oil and natural gas production from December 1, 2012 to February 28, 2013.

(2) Oil and natural gas volumes and related revenues and expenses for the three-month period ended June 30, 2012 (included in SandRidge's May 2012 net revenue distribution to the Trust) represent oil and natural gas production from December 1, 2012 to February 29, 2012.

(3) Oil and natural gas volumes and related revenues and expenses for the six-month period ended June 30, 2013 (included in SandRidge's March 2013 and May 2013 net revenue distribution to the Trust) represent oil and natural gas production from September 1, 2012 to February 28, 2013.

(4) Oil and natural gas volumes and related revenues and expenses for the six-month period ended June 30, 2012 (included in SandRidge's February 2012 and May 2012 net revenue distributions to the Trust) represent oil and natural gas production from September 1, 2011 to February 29, 2012.

(5) Includes natural gas liquids.

(6) Includes impact of derivative settlements attributable to production from December 1, 2012 to February 28, 2013 for the three-month period ended June 30, 2013 and from December 1, 2011 to February 29, 2012 for the three-month period ended June 30, 2012. Includes impact of derivative settlements attributable to production from September 1, 2012 to February 28, 2013 for the six-month period ended June 30, 2013 and from September 1, 2011 to February 29, 2012 for the six-month period ended June 30, 2012.


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Three Months Ended June 30, 2013 Compared to the Three Months Ended June 30, 2012

Revenues

Royalty Income. Royalty income received during the three-month period ended June 30, 2013 totaled $24.4 million compared to $32.4 million received during the three-month period ended June 30, 2012. Royalty income is a function of production volumes sold attributable to the Royalty Interests and associated prices received. The decrease in royalty income was primarily attributable to a decrease in the average price received for oil production, excluding the impact of derivative settlements and post-production expenses, to $74.13 per Bbl during the three-month period ended June 30, 2013 from $92.81 per Bbl during the same period in 2012. Also contributing to the decrease in royalty income was a decrease in equivalent volumes produced as production from Trust Development Wells completed and brought on production during 2012 and early 2013 was more than offset by natural declines in production from the Initial Wells and older Trust Development Wells. The net revenue distribution from SandRidge received by the Trust during the three-month period ended June 30, 2013 included royalty income attributable to production for the three-month period from December 1, 2012 to February 28, 2013 of 325 MBbls of oil and 94 MMcf of natural gas, or 341 MBoe of combined production. The net revenue distribution from SandRidge received by the Trust during the three-month period ended June 30, 2012 included royalty income attributable to production for the three-month period from December 1, 2011 to February 29, 2012 of 346 MBbls of oil and 91 MMcf of natural gas, or 362 MBoe of combined production. The decreases in the average price received for oil production and total production were slightly offset by an increase in the average price received for natural gas production, excluding the impact of derivative settlements and post-production expenses, to $2.85 per Mcf during the three-month period ended June 30, 2013 from $2.43 per Mcf during the same period in 2012.

Derivative Settlements. The Trust's derivatives agreement with SandRidge reduces the Trust's exposure to commodity price volatility attributable to a portion of production from the Royalty Interests through March 31, 2015 by the use of oil fixed price swaps. Net cash settlements received related to the Trust's derivatives during the three-month period ended June 30, 2013 were approximately $2.7 million, and included (i) approximately $1.4 million received related to the conveyed contracts for production attributable to the Royalty Interests from December 1, 2012 to February 28, 2013, (ii) approximately $0.8 million received from the counterparty to the novated contracts for production attributable to the Royalty Interests from January 1, 2013 to February 28, 2013 and
(iii) approximately $0.5 million received from the counterparty to the novated contracts for March 2013 production. Total net derivative settlements received by the Trust for production from December 1, 2012 to February 28, 2013 were $3.0 million, including $0.8 million received in February 2013 from the counterparty to the novated contracts, which effectively increased the average price received for oil production for the related period by $9.15 per Bbl to $83.28 per Bbl. Derivative settlements received during the three-month period ended June 30, 2013 related to March 2013 production will be included in the Trust's August 2013 quarterly distribution. Net cash settlements received related to the Trust's derivatives during the three-month period ended June 30, 2012 were approximately $47,000, and included net settlements received of approximately $216,000 related to production from December 1, 2011 to February 29, 2012 and net settlements paid of approximately $169,000 related to March 2012 production. Total net derivative settlements received by the Trust for production from December 1, 2011 to February 29, 2012, including $56,000 received in January 2012, were $272,000, which effectively increased the average price received for oil production for the related period by $0.79 per Bbl to $93.60 per Bbl.

Expenses

Post-Production Expenses. The Trust bears post-production expenses attributable to production from the Royalty Interests. Post-production expenses generally consist of costs incurred to gather, store, compress, transport, process, treat, dehydrate and market the oil and natural gas produced. Post-production expenses for the three-month period ended June 30, 2013 totaled approximately $30,000 compared to approximately $25,000 for the three-month period ended June 30, 2012.

Production Taxes. Production taxes are calculated as a percentage of oil and natural gas revenues, excluding the effects of derivative settlements and net of any applicable tax credits. Production taxes for the three-month period ended June 30, 2013 totaled approximately $1.1 million, or $3.34 per Boe, and were approximately 4.7% of royalty income. Production taxes for the three-month period ended June 30, 2012 totaled approximately $1.5 million, or $4.26 per Boe, and were approximately 4.8% of royalty income.

Texas Franchise Tax. There were no amounts paid relating to Texas franchise taxes during the three-month period ended June 30, 2013. The Trust paid its Texas franchise tax for the year ended December 2012 of approximately $0.4 million during the first quarter of 2013. The Trust paid its Texas franchise tax for the period ended December 31, 2011 of approximately $0.2 million during the three-month period ended June 30, 2012.

Trust Administrative Expenses. Trust administrative expenses generally consist of fees paid to the Trustee and the Delaware Trustee, administrative services fees paid to SandRidge, 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 ended June 30, 2013 totaled approximately $0.2 million compared to approximately $0.3 million for the three-month period ended June 30, 2012.


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Distributable Income

Distributable income for the three-month period ended June 30, 2013 was $24.5 million, which included a net addition to the cash reserve for payment of future Trust expenses of approximately $1.2 million (approximately $1.4 million withheld from the May 2013 cash distribution to unitholders partially offset by approximately $0.2 million used to pay Trust expenses during the period). Distributable income for the three-month period ended June 30, 2012 was $30.3 million, which included a net addition to the cash reserve for payment of future Trust expenses of approximately $79,000 (approximately $537,000 withheld from the May 2012 cash distribution to unitholders less approximately $458,000 used to pay Trust expenses during the period).

Six Months Ended June 30, 2013 Compared to the Six Months Ended June 30, 2012

Revenues

Royalty Income. Royalty income received during the six-month period ended June 30, 2013 totaled $55.0 million compared to $61.5 million received during the six-month period ended June 30, 2012. The decrease in royalty income was primarily attributable to a decrease in the average price received for oil production, excluding the impact of derivative settlements and post-production expenses, to $77.88 per Bbl during the six-month period ended June 30, 2013 from $88.62 per Bbl during the same period in 2012. The decrease in the average price received for oil production was slightly offset by an increase in production. The net revenue distributions from SandRidge received by the Trust during the six-month period ended June 30, 2013 included royalty income attributable to production for the six-month period from September 1, 2012 to February 28, 2013 of 700 MBbls of oil and 189 MMcf of natural gas, or 731 MBoe of combined production. The net revenue distributions from SandRidge received by the Trust during the six-month period ended June 30, 2012 included royalty income attributable to production for the six-month period from September 1, 2011 to February 29, 2012 of 689 MBbls of oil and 176 MMcf of natural gas, or 718 MBoe of combined production.

Derivative Settlements. Net cash settlements received related to the Trust's derivatives during the six-month period ended June 30, 2013 were approximately $6.4 million, and included (i) approximately $2.7 million received related to the conveyed contracts for production attributable to the Royalty Interests from September 1, 2012 to February 28, 2013, (ii) approximately $3.2 million received from the counterparty to the novated contracts for production attributable to the Royalty Interests from October 1, 2012 to February 28, 2013 and
(iii) approximately $0.5 million received from the counterparty to the novated contracts for March 2013 production. Total net derivative settlements received by the Trust for production from September 1, 2012 to February 28, 2013 were $6.4 million, including $0.5 million received in November 2012 from the counterparty to the novated contracts, which effectively increased the average price received for oil production for the related period by $9.13 per Bbl to $87.01 per Bbl. Net cash settlements received related to the Trust's derivatives during the six-month period ended June 30, 2012 were approximately $1.9 million and included net settlements received of approximately $2.1 million related to production from September 1, 2011 to February 29, 2012 and net settlements paid of approximately $0.2 million related to March 2012 production. Total net derivative settlements received by the Trust for production from September 1, 2011 to February 29, 2012 were $2.7 million, including $0.6 million received in 2011, and effectively increased the average price received for oil production for the related period by $3.97 per Bbl to $92.59 per Bbl.

Expenses

Post-Production Expenses. Post-production expenses for the six-month period ended June 30, 2013 totaled approximately $52,000 compared to approximately $65,000 for the six-month period ended June 30, 2012.

Property Taxes. Property taxes paid during the six-month period ended June 30, 2013 totaled approximately $1.8 million compared to approximately $0.2 million for the six-month period ended June 30, 2012. The total payments made related to 2012 property taxes were $2.2 million ($0.4 million paid in October 2012 and $1.8 million in paid in January 2013) compared to $0.4 million in payments made related to 2011 property taxes ($0.2 million paid in November 2011 and $0.2 million paid in February 2012). The net increase in expense is attributable to several factors including the number of days the Royalty Interests were owned by the Trust during 2012 compared to 2011, changes in the producing reserves associated with the Royalty Interests and changes in commodity prices used to value the associated reserves.

Production Taxes. Production taxes for the six-month period ended June 30, 2013 totaled approximately $2.6 million, or $3.52 per Boe, and were approximately 4.7% of royalty income. Production taxes for the six-month period ended June 30, 2012 totaled approximately $2.9 million, or $4.10 per Boe, and were approximately 4.8% of royalty income.


Table of Contents

Texas Franchise Tax. The Trust paid its Texas franchise tax for the period ended December 31, 2012 of approximately $0.4 million, or approximately 0.4% of 2012 royalty income, during the six-month period ended June 30, 2013. The Trust paid its Texas franchise tax for the period ended December 31, 2011 of approximately $0.2 million, or approximately 0.4% of 2011 royalty income, during the six-month period ended June 30, 2012.

Trust Administrative Expenses. Trust administrative expenses for the six-month period ended June 30, 2013 totaled approximately $0.8 million compared to approximately $0.9 million for the six-month period ended June 30, 2012.

Distributable Income.

Distributable income for the six-month period ended June 30, 2013 was $56.5 million, which included a net reduction to the cash reserve for payment of future Trust expenses of approximately $0.7 million (approximately $3.0 million used to pay Trust expenses during the period partially offset by approximately $2.3 million withheld from the March 2013 and May 2013 cash distributions to unitholders). Distributable income for the six-month period ended June 30, 2012 was $58.8 million, which included a net addition to the cash reserve for payment of future Trust expenses of approximately $0.4 million (approximately $1.3 million withheld from the February 2012 and May 2012 cash distributions to unitholders less approximately $0.9 million used to pay Trust expenses during the period).

Liquidity and Capital Resources

The Trust's principal sources of liquidity and capital are cash flow generated from the Royalty Interests and derivative contracts. The Trust's primary uses of cash are distributions to Trust unitholders, including, if applicable, incentive distributions to SandRidge, payment of amounts owed under the Trust's derivative . . .

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