UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2015
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 001-35508
SANDRIDGE MISSISSIPPIAN TRUST II
(Exact name of registrant as specified in its charter)
Delaware |
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30-0709968 |
(State or other jurisdiction of |
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(I.R.S. Employer |
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The Bank of New York Mellon |
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78701 |
(Address of principal executive offices) |
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(Zip Code) |
Registrants telephone number, including area code:
(512) 236-6531
Former name, former address and former fiscal year, if changed since last report: Not applicable
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 x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
Large accelerated filer o |
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Accelerated filer x |
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Non-accelerated filer o |
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Smaller reporting company o |
(Do not check if a smaller reporting company) |
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
As of October 30, 2015, 37,293,750 Common Units and 12,431,250 Subordinated Units of Beneficial Interest in SandRidge Mississippian Trust II were outstanding.
SANDRIDGE MISSISSIPPIAN TRUST II
Quarter Ended September 30, 2015
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Trustees Discussion and Analysis of Financial Condition and Results of Operations |
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19 | ||
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All references to we, us, our, or the Trust refer to SandRidge Mississippian Trust II. References to SandRidge refer to SandRidge Energy, Inc., and where the context requires, its subsidiaries. The royalty interests conveyed by SandRidge from its interests in certain properties in the Mississippian formation in northern Oklahoma and southern Kansas and held by the Trust are referred to as the Royalty Interests.
DISCLOSURES REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q (Quarterly Report) includes forward-looking statements about the Trust, SandRidge and other matters discussed herein that are subject to risks and uncertainties within the meaning of Section 27A of the Securities Act of 1933, as amended (the Securities Act), and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act). All statements other than statements of historical fact included in this document, including, without limitation, statements under Trustees Discussion and Analysis of Financial Condition and Results of Operations in Item 2 of Part I and elsewhere herein regarding the Trusts or SandRidges plans and objectives for future operations, including information regarding target distributions, are forward-looking statements. Actual outcomes and results may differ materially from those projected. Forward-looking statements are generally accompanied by words such as estimate, target, project, predict, believe, expect, anticipate, potential, could, may, foresee, plan, goal, should, intend or other words that convey the uncertainty of future events or outcomes. We have based these forward-looking statements on our current expectations and assumptions about future events. These statements are based on certain assumptions made by us in light of our experience and our perception of historical trends, current conditions and expected future developments as well as other factors we believe are appropriate under the circumstances. However, whether actual results and developments will conform with our expectations and predictions is subject to a number of risks and uncertainties, including the risk factors discussed in Item 1A of the Trusts Annual Report on Form 10-K for the fiscal year ended December 31, 2014 (the 2014 Form 10-K), which could affect the future results of the energy industry in general, and the Trust and SandRidge in particular, and could cause those results to differ materially from those expressed in such forward-looking statements. The actual results or developments anticipated may not be realized or, even if substantially realized, they may not have the expected consequences to or effects on SandRidges business or the Trusts results. Such statements are not guarantees of future performance and actual results or developments may differ materially from those projected in such forward-looking statements. The Trust undertakes no obligation to publicly update or revise any forward-looking statements.
SANDRIDGE MISSISSIPPIAN TRUST II
STATEMENTS OF ASSETS AND TRUST CORPUS
(In thousands, except unit data)
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September 30, |
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December 31, |
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(Unaudited) |
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ASSETS |
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Cash and cash equivalents |
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$ |
2,240 |
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$ |
2,573 |
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Investment in royalty interests |
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467,146 |
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467,146 |
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Less: accumulated amortization and impairment |
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(330,691 |
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(104,793 |
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Net investment in royalty interests |
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136,455 |
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362,353 |
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Total assets |
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$ |
138,695 |
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$ |
364,926 |
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TRUST CORPUS |
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Trust corpus, 37,293,750 common units and 12,431,250 subordinated units issued and outstanding at September 30, 2015 and December 31, 2014 |
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$ |
138,695 |
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$ |
364,926 |
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The accompanying notes are an integral part of these financial statements.
SANDRIDGE MISSISSIPPIAN TRUST II
STATEMENTS OF DISTRIBUTABLE INCOME
(In thousands, except unit and per unit data)
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Three Months Ended |
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Nine Months Ended |
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2015 |
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2014 |
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2015 |
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2014 |
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(Unaudited) |
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Revenues |
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Royalty income |
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$ |
8,098 |
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$ |
20,076 |
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$ |
29,104 |
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$ |
66,672 |
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Derivative settlements, net |
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2,509 |
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(542 |
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8,492 |
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1,210 |
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Total revenues |
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10,607 |
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19,534 |
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37,596 |
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67,882 |
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Expenses |
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Post-production expenses |
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624 |
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722 |
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1,698 |
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2,290 |
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Property taxes |
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177 |
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369 |
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Production taxes |
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143 |
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319 |
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512 |
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953 |
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Trust administrative expenses |
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184 |
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239 |
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1,381 |
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1,147 |
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Cash reserves withheld (used) for current Trust expenses, net of amounts (used) withheld |
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290 |
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236 |
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(194 |
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60 |
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Total expenses |
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1,241 |
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1,516 |
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3,574 |
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4,819 |
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Distributable income available to unitholders |
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9,366 |
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18,018 |
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34,022 |
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63,063 |
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Distributable income per common unit (37,293,750 units issued and outstanding) |
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$ |
0.251 |
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$ |
0.483 |
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$ |
0.912 |
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$ |
1.603 |
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Distributable income per subordinated unit (12,431,250 units issued and outstanding) |
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$ |
0.000 |
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$ |
0.000 |
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$ |
0.000 |
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$ |
0.264 |
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The accompanying notes are an integral part of these financial statements.
SANDRIDGE MISSISSIPPIAN TRUST II
STATEMENTS OF CHANGES IN TRUST CORPUS
(In thousands)
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Nine Months Ended September 30, |
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2015 |
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2014 |
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(Unaudited) |
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Trust corpus, beginning of period |
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$ |
364,926 |
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$ |
396,566 |
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Amortization of investment in royalty interests |
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(21,192 |
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(24,993 |
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Impairment of investment in royalty interests |
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(204,706 |
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Net cash reserves (used) withheld |
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(194 |
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60 |
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Distributable income |
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34,022 |
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63,063 |
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Distributions paid or payable to unitholders |
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(34,161 |
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(63,125 |
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Trust corpus, end of period |
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$ |
138,695 |
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$ |
371,571 |
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The accompanying notes are an integral part of these financial statements.
SANDRIDGE MISSISSIPPIAN TRUST II
(Unaudited)
1. Organization of Trust
SandRidge Mississippian Trust II (the Trust) is a statutory trust formed under the Delaware Statutory Trust Act pursuant to a trust agreement, as amended and restated, by and among SandRidge Energy, Inc. (SandRidge), as Trustor, The Bank of New York Mellon Trust Company, N.A., as Trustee (the Trustee), and The Corporation Trust Company, as Delaware Trustee (the Delaware Trustee).
The Trust holds Royalty Interests in specified oil and natural gas properties located in the Mississippian formation in Alfalfa, Grant, Kay, Noble and Woods counties in northern Oklahoma and Barber, Comanche, Harper and Sumner counties in southern Kansas (the Underlying Properties). The Royalty Interests were conveyed by SandRidge to the Trust concurrent with the initial public offering of the Trusts common units in April 2012. As consideration for conveyance of the Royalty Interests, the Trust remitted the proceeds of the offering, along with 7,393,750 Trust common units and 12,431,250 Trust subordinated units, to certain wholly owned subsidiaries of SandRidge. At September 30, 2015, SandRidge owned 6,243,750 Trust common units and 12,431,250 Trust subordinated units, or approximately 37.6% of all Trust units.
The Royalty Interests entitle the Trust to receive 80% of the proceeds (after deducting post-production costs and any applicable taxes) from the sale of oil, natural gas liquids (NGL) and natural gas production attributable to SandRidges net revenue interest in 54 wells producing at December 31, 2011 and 13 additional wells awaiting completion at that time (together, the Initial Wells), and 70% of the proceeds (after deducting post-production costs and any applicable taxes) from the sale of oil, NGLs and natural gas production attributable to SandRidges net revenue interest in 206 horizontal oil and natural gas development wells drilled thereafter (the Trust Development Wells) within an area of mutual interest (AMI). Pursuant to a development agreement entered into between the Trust and SandRidge, SandRidge was obligated to drill, or cause to be drilled, the Trust Development Wells by December 31, 2016. SandRidge fulfilled this obligation in March 2015.
The Trust is passive in nature and neither the Trust nor the Trustee has any control over, or responsibility for, costs relating to the operation of the Underlying Properties. The business and affairs of the Trust are administered by the Trustee. The trust agreement generally limits the Trusts business activities to owning the Royalty Interests and entering into derivative contracts on a limited basis and activities reasonably related thereto, including activities required or permitted by the terms of the conveyances related to the Royalty Interests. 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 Trust makes quarterly cash distributions of substantially all of its cash receipts, after deducting amounts for the Trusts administrative expenses, property tax and cash reserves withheld by the Trustee, on or about the 60th day following the completion of each quarter. 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.
The common and subordinated units have identical rights and privileges, except with respect to their rights to receive distributions. The subordinated units, all of which are held by SandRidge, constitute 25% of the Trust units issued and outstanding. The 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 no less than 80% of the target distribution for the corresponding quarter (Subordination Threshold). If there is not sufficient cash to fund such a distribution on all of the common units, the distribution made with respect to the subordinated units is reduced or eliminated for such quarter in order to make a distribution, to the extent possible, of up to the Subordination Threshold amount on all of the common units. In exchange for agreeing to subordinate a portion of its Trust units, and in order to provide additional financial incentive to SandRidge to satisfy its drilling obligation, SandRidge is entitled to receive incentive distributions equal to 50% of the amount by which the cash available for distribution on all of the Trust units in any quarter exceeds 120% of the target distribution for such quarter (Incentive Threshold). On April 1, 2016, the day following the end of the fourth full calendar quarter subsequent to SandRidges satisfaction of its drilling obligation, the subordinated units will automatically convert into common units on a one-for-one basis and SandRidges right to receive incentive distributions in respect of subsequent periods will terminate. Distributions made on common units in respect of subsequent periods will no longer have the benefit of the Subordination Threshold, nor will the common units be subject to the Incentive Threshold, and all Trust unitholders will share on a pro rata basis in the Trusts distributions.
The Trust will dissolve and begin to liquidate on December 31, 2031 (the Termination Date) and will soon thereafter wind up its affairs and terminate. At the Termination Date, 50% of the Royalty Interests will revert automatically to SandRidge. The remaining 50% of the Royalty Interests will be sold at that time, with the net proceeds of the sale, as well as any remaining Trust cash reserves,
SANDRIDGE MISSISSIPPIAN TRUST II
NOTES TO FINANCIAL STATEMENTS - CONTINUED
(Unaudited)
distributed to the unitholders on a pro rata basis. SandRidge has a right of first refusal to purchase the Royalty Interests retained by the Trust at the Termination Date. The Trust will not dissolve until the Termination Date unless any of the following occurs: (a) the Trust sells all of the Royalty Interests; (b) cash available for distribution for any four consecutive quarters, on a cumulative basis, is less than $5.0 million; (c) Trust unitholders approve an earlier dissolution of the Trust; or (d) the Trust is judicially dissolved. In the case of any of the foregoing, the Trustee would then sell all of the Trusts assets, either by private sale or public auction, and distribute the net proceeds of the sale to the Trust unitholders after payment, or reasonable provision for payment, of all Trust liabilities.
2. Basis of Presentation and Summary of Significant Accounting Policies
Basis of Accounting. The financial statements of the Trust differ from financial statements prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) as the Trust records revenues when cash is received (rather than when earned) and expenses when paid (rather than when incurred) and may also establish cash reserves for contingencies, which would not be accrued in financial statements prepared in accordance with GAAP. This comprehensive basis of accounting other than GAAP corresponds to the accounting permitted for royalty trusts by the Securities and Exchange Commission (SEC) as specified by Staff Accounting Bulletin Topic 12:E, Financial Statements of Royalty Trusts. Amortization of investment in royalty interests, calculated on a unit-of-production basis, and any impairments are charged directly to trust corpus. Distributions to unitholders are recorded when declared.
Significant Accounting Policies. Most accounting pronouncements apply to entities whose financial statements are prepared in accordance with GAAP, which may require such entities to accrue or defer revenues and expenses in a period other than when such revenues are received or expenses are paid. Because the Trusts financial statements are prepared on the modified cash basis as described above, most accounting pronouncements are not applicable to the Trusts financial statements.
The Trust is treated for federal and applicable state income tax purposes as a partnership. For U.S. federal income tax purposes, a partnership is not a taxable entity and incurs no U.S. federal income tax liability. With respect to state taxation, a partnership is typically treated in the same manner as it is for U.S. federal income tax purposes.
Impairment of Investment in Royalty Interests. On a quarterly basis, the Trust evaluates the carrying value of the Investment in Royalty Interests by comparing the undiscounted cash flows expected to be realized from the Royalty Interest to the carrying value. If the expected future undiscounted cash flows are less than the carrying value, the Trust recognizes an impairment loss for the difference between the carrying value and the estimated fair value of the Royalty Interest. During the three-month period ended September 30, 2015, the Trust recorded a $204.7 million impairment in the carrying value of the Investment in Royalty Interests. The impairment resulted in a non-cash charge to trust corpus and did not affect the Trusts distributable income. See Risks and Uncertainties in Note 5 below for further discussion.
Distributable Income Per Common and Subordinated Unit. The Trust calculates distributable income per common and subordinated unit using the two-class method. In accordance with this method, undistributed earnings in the accompanying unaudited statements of distributable income have been allocated to the common and subordinated units based upon the subordinated units contractual participation rights as if all of the distributable income for the periods presented had been distributed. Distributable income per unit amounts as calculated for the periods presented in the accompanying unaudited statements of distributable income may differ from declared distribution amounts per unit due to the timing of the Trusts receipt or payment of settlements on novated derivative contracts. See Note 4 for discussion of the Trusts derivative contracts. After the conversion of the Trusts subordinated units to common units and payment of the distribution in respect of the fourth full calendar quarter subsequent to SandRidges satisfaction of its drilling obligation, all Trust unitholders will share on a pro rata basis in the Trusts distributable income.
Interim Financial Statements. The accompanying unaudited interim financial statements have been prepared in accordance with the accounting policies stated in the audited financial statements contained in the 2014 Form 10-K and reflect all adjustments that are, in the opinion of the Trustee, necessary to state fairly the information in the Trusts unaudited interim financial statements. The accompanying statement of assets and trust corpus as of December 31, 2014 has been derived from audited financial statements. The unaudited interim financial statements should be read in conjunction with the audited financial statements and notes thereto included in the 2014 Form 10-K.
SANDRIDGE MISSISSIPPIAN TRUST II
NOTES TO FINANCIAL STATEMENTS - CONTINUED
(Unaudited)
3. Distributions to Unitholders
The Trust makes quarterly cash distributions of substantially all of its cash receipts, after deducting amounts for the Trusts administrative expenses, property tax and cash reserves withheld by the Trustee, on or about the 60th day following the completion of each quarter. Distributions cover a three-month production period. See Note 6 for discussion of the Trusts quarterly distribution to be paid in November 2015. A summary of the Trusts distributions to unitholders during the nine-month period ended September 30, 2015 and the year ended December 31, 2014 is as follows:
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Total |
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Covered |
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Distribution |
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Distribution Per Unit |
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Production Period |
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Date Declared |
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Date Paid |
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Paid |
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Common |
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Subordinated |
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(in millions) |
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Calendar Quarter 2015 |
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First Quarter |
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September 1, 2014 November 30, 2014 |
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January 29, 2015 |
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February 27, 2015 |
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$ |
14.0 |
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$ |
0.375 |
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$ |
0.000 |
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Second Quarter |
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December 1, 2014 February 28, 2015 |
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April 30, 2015 |
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May 29, 2015 |
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$ |
10.8 |
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$ |
0.290 |
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$ |
0.000 |
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Third Quarter |
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March 1, 2015 May 31, 2015 |
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July 30, 2015 |
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August 28, 2015 |
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$ |
9.4 |
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$ |
0.251 |
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$ |
0.000 |
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Total |
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Covered |
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Distribution |
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Distribution Per Unit |
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Production Period |
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Date Declared |
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Date Paid |
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Paid |
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Common |
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Subordinated |
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(in millions) |
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Calendar Quarter 2014 |
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First Quarter |
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September 1, 2013 November 30, 2013 |
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January 30, 2014 |
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February 28, 2014 |
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$ |
24.2 |
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$ |
0.568 |
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$ |
0.239 |
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Second Quarter |
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December 1, 2013 February 28, 2014 |
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April 24, 2014 |
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May 30, 2014 |
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$ |
20.8 |
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$ |
0.559 |
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$ |
0.000 |
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Third Quarter |
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March 1, 2014 May 31, 2014 |
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July 31, 2014 |
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August 29, 2014 |
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$ |
18.1 |
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$ |
0.486 |
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$ |
0.000 |
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Fourth Quarter |
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June 1, 2014 August 31, 2014 |
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October 30, 2014 |
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November 26, 2014 |
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$ |
15.0 |
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$ |
0.402 |
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$ |
0.000 |
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4. Related Party Transactions
Trustee Administrative Fee. Under the terms of the trust agreement, the Trust pays an annual administrative fee of $150,000 to the Trustee, which will be adjusted for inflation by no more than 3% in any year beginning in January 2018. The Trustees administrative fees paid during each of the three-month periods ended September 30, 2015 and 2014, totaled approximately $38,000. The Trustees administrative fees paid during each of the nine-month periods ended September 30, 2015 and 2014, totaled approximately $113,000.
Registration Rights Agreement. The Trust is party to a registration rights agreement pursuant to which the Trust has agreed to register the offering of the Trust units held by SandRidge and certain of its affiliates and permitted transferees upon request by SandRidge. The holders have the right to require the Trust to file no more than five registration statements in aggregate, none of which has been filed to date. The Trust does not bear any expenses associated with such transactions.
Development Agreement. The Trusts development agreement with SandRidge obligated SandRidge to drill, or cause to be drilled, the Trust Development Wells by December 31, 2016. Additionally, SandRidge agreed not to drill and complete, or allow another person within its control to drill and complete, any other well in the AMI other than the Trust Development Wells until SandRidge had fulfilled its drilling obligation. The Development Agreement terminated upon SandRidges fulfillment of its drilling obligation during March 2015.
A wholly owned subsidiary of SandRidge granted to the Trust a lien (Drilling Support 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 Trusts interests in the undeveloped Underlying Properties. The initial amount recoverable by the Trust pursuant to the Drilling Support Lien could not exceed approximately $269.1 million. As of March 31, 2015, SandRidge had drilled and perforated for completion approximately 206 equivalent Trust Development Wells, thus fulfilling its drilling obligation. Accordingly, the Drilling Support Lien automatically terminated at that time.
Administrative Services Agreement. The Trust is party to an administrative services agreement with SandRidge that obligates the Trust to pay SandRidge an annual administrative services fee for accounting, tax preparation, bookkeeping and informational services performed by SandRidge on behalf of the Trust. Additionally, the administrative services agreement designates SandRidge as the Trusts hedge manager, pursuant to which SandRidge has authority to administer the derivative contracts underlying the derivatives agreement (described below), and, on behalf of the Trust, to administer the Trusts derivative contracts with unaffiliated third parties. For its services under the administrative services agreement, SandRidge receives an annual fee of $300,000, which is payable in equal quarterly installments and will remain fixed for the life of the Trust. SandRidge is also entitled to receive reimbursement for its out-of- pocket fees, costs and expenses incurred in connection with the provision of any of the services under this agreement. The administrative services agreement will terminate on the earliest to occur of: (i) the date the Trust shall have
SANDRIDGE MISSISSIPPIAN TRUST II
NOTES TO FINANCIAL STATEMENTS - CONTINUED
(Unaudited)
dissolved and commenced winding up in accordance with the trust agreement, (ii) the date that all of the Royalty Interests have been terminated or are no longer held by the Trust, (iii) pertaining to services to be provided with respect to any Underlying Properties transferred by SandRidge, the date that either SandRidge or the Trustee may designate by delivering 90-days prior written notice, provided that SandRidges drilling obligation has been completed and the transferee of such Underlying Properties assumes responsibility to perform the services in place of SandRidge and (iv) a date mutually agreed to by SandRidge and the Trustee. There were no amounts paid to SandRidge for administrative fees during the three-month period ended September 30, 2015. During the three-month period ended September 30, 2014, the Trust paid administrative fees to SandRidge equal to $75,000. During the nine-month periods ended September 30, 2015 and 2014, the Trust paid administrative fees to SandRidge equal to $225,000 and $300,000, respectively.
Derivatives Agreement. The Trust is party to a derivatives agreement with SandRidge that provides the Trust with the economic effect of certain derivative contracts for production through December 31, 2015 that were previously entered into by SandRidge with third parties. Under the derivatives agreement, SandRidge pays the Trust amounts it receives from its counterparties and the Trust pays SandRidge any amounts that SandRidge is required to pay such counterparties. Substantially concurrent with the execution of the derivatives agreement and again in 2013, SandRidge novated certain of the derivative contracts underlying the derivatives agreement to the Trust that covered production through December 31, 2014. As a party to these contracts, the Trust received payment directly from the counterparties, and was required to pay any amounts owed directly to the counterparties. To secure its obligations under these novated contracts, the Trust entered into a collateral agency agreement and granted the counterparties a lien on the Royalty Interests. Under the collateral agency agreement, the Trust paid a $15,000 annual fee to the collateral agent. The Trusts derivative contracts consist of fixed price swaps, under which the Trust receives a fixed price and pays a floating price over specified periods for contracted volumes.
The following table presents, as of September 30, 2015, the notional amount and weighted average fixed price of the open contracts underlying the derivatives agreement.
Oil Contracts Underlying the Derivatives Agreement
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Notional |
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Weighted Avg. |
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October 2015 December 2015 |
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69 |
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$ |
90.30 |
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5. Commitments and Contingencies
Loan Commitment. Pursuant to the trust agreement, if at any time the Trusts cash on hand (including available cash reserves) is not sufficient to pay the Trusts ordinary course administrative expenses as they become due, SandRidge will, at the Trustees request, loan funds to the Trust necessary to pay such expenses. Any funds loaned by SandRidge pursuant to this commitment will be limited to the payment of current accounts payable or other obligations to trade creditors in connection with obtaining goods or services or the payment of other current liabilities arising in the ordinary course of the Trusts business, and may not be used to satisfy Trust indebtedness, or to make distributions. If SandRidge loans funds pursuant to this commitment, unless SandRidge agrees otherwise, no further distributions will be made to unitholders (except in respect of any previously determined quarterly cash distribution amount) until such loan is repaid. Any such loan 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 arms length transaction between SandRidge and an unaffiliated third party. There was no such loan outstanding with SandRidge at September 30, 2015 or December 31, 2014.
Risks and Uncertainties. The Trusts revenue and distributions are substantially dependent upon the prevailing and future prices for oil and natural gas, each of which depends on numerous factors beyond the Trusts control such as overall oil and natural gas production and inventories in relevant markets, economic conditions, the global political environment, regulatory developments and competition from other energy sources. Oil and natural gas prices historically have been volatile and may be subject to significant fluctuations in the future. The Trusts derivative arrangements serve to mitigate a portion of the effect of this price volatility through December 31, 2015. See Note 4 for a discussion of the Trusts open oil commodity derivative contracts. Low levels of future production and continued low commodity prices will continue to reduce the Trusts revenues and distributable income available to unitholders and will likely result in continued distributions to common unitholders below the Subordination Threshold.
Legal Proceedings. On May 11, 2015, the U.S. District Court for the Western District of Oklahoma issued an order dismissing all claims against the Trust in a putative class action lawsuit filed by unitholders of the Trust and stockholders of SandRidge, in which the plaintiffs asserted a variety of federal securities claims against the Trust, SandRidge and certain of SandRidges current and former
SANDRIDGE MISSISSIPPIAN TRUST II
NOTES TO FINANCIAL STATEMENTS - CONTINUED
(Unaudited)
officers and directors, among other defendants. As a result of the order, the Trust is no longer a party in the lawsuit. However, the dismissal was based on a procedural defect, and thus was made without prejudice to the plaintiffs rights, if any, to refile their claims against the Trust once the defect is cured.
On June 9, 2015, the Duane & Virginia Lanier Trust, on behalf of itself and all other similarly situated unitholders of the Trust, filed a putative class action complaint in the U.S. District Court for the Western District of Oklahoma against the Trust, SandRidge and certain current and former executive officers of SandRidge, among other defendants ( the Securities Litigation). The complaint asserts a variety of federal securities claims on behalf of a putative class of (a) purchasers of common units of SandRidge Mississippian Trust I in or traceable to its initial public offering on or about April 7, 2011, and (b) purchasers of common units of the Trust in or traceable to its initial public offering on or about April 17, 2012. The claims are based on allegations that SandRidge and certain of its current and former officers and directors, among other defendants, including the Trust, are responsible for making false and misleading statements, and omitting material information, concerning a variety of subjects, including oil and gas reserves. The plaintiffs seek class certification, an order rescinding the Trusts initial public offering and an unspecified amount of damages, plus interest, attorneys fees and costs.
Regardless of the outcome of the litigation, the Trust may incur expenses in defending the litigation, and any such expenses may increase the Trusts administrative expenses significantly. However, the Trust is entitled to contractual indemnification covering reasonable costs of investigation and attorneys fees and expenses that the Trust believes will be applicable. The Trust will estimate and financially provide for potential losses that may arise out of litigation to the extent that such losses are probable and can be reasonably estimated. Significant judgment will be required in making any such estimates and any final liabilities of the Trust may ultimately be materially different than any estimates. The Trust is currently unable to assess the probability of loss or estimate a range of any potential loss the Trust may incur in connection with the Securities Litigation, and has not established any reserves relating to the Securities Litigation. The Trust may withhold estimated amounts from future distributions to cover future costs associated with the litigation if determined necessary. The Trust has not yet fully analyzed any rights it may have to indemnities that may be applicable or any claims it may make in connection with the Securities Litigation.
6. Subsequent Events
Distribution to Unitholders. On October 29, 2015, the Trust declared a cash distribution of $0.223 per common unit covering production for the three-month period from June 1, 2015 to August 31, 2015. The distribution will be paid on or about November 27, 2015 to record holders as of November 13, 2015. Distributable income for June 1, 2015 to August 31, 2015 was calculated as follows (in thousands, except for unit and per unit amounts):
Revenues |
|
|
| |
Royalty income |
|
$ |
6,865 |
|
Derivative settlements, net |
|
2,703 |
| |
Total revenues |
|
9,568 |
| |
Expenses |
|
|
| |
Post-production expenses |
|
646 |
| |
Production taxes |
|
126 |
| |
Cash reserves withheld by Trustee(1) |
|
474 |
| |
Total expenses |
|
1,246 |
| |
Distributable income available to unitholders |
|
$ |
8,322 |
|
Distributable income per common unit (37,293,750 units issued and outstanding) |
|
$ |
0.223 |
|
Distributable income per subordinated unit (12,431,250 units issued and outstanding) |
|
$ |
0.000 |
|
(1) Includes amounts withheld for payment of future Trust administrative expenses.
Because income available for distribution on all outstanding Trust units was $0.167 per unit, which was below the Subordination Threshold of $0.640 for the period, no distribution will be paid to holders of subordinated units for the period.
ITEM 2. Trustees Discussion and Analysis of Financial Condition and Results of Operations
Introduction
The following discussion and analysis is intended to help the reader understand the financial condition, results of operations, liquidity and capital resources of SandRidge Mississippian Trust II (the Trust). This discussion and analysis should be read in conjunction with the Trusts unaudited interim financial statements and the accompanying notes included in this Quarterly Report and the Trusts audited financial statements and the accompanying notes included in the 2014 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 Trusts 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 Trusts derivative contracts (described in Note 4 to the unaudited interim 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 Trusts derivative contracts. The Trust is treated as a partnership for federal income tax purposes.
Commodity Price Volatility. The Trusts quarterly cash distributions are highly dependent upon the prices realized from the sale of oil, NGLs and natural gas. The markets for these commodities are volatile and experienced significant pricing declines during the latter half of 2014 and into 2015. Although distributions relating to production through December 31, 2015 are partially supported by hedging arrangements, no such arrangements are in place for production attributable to periods thereafter, and consequently distributions for production periods beginning January 1, 2016 or later should be expected to be lower than distributions for recent periods. The Trust received net settlement proceeds of approximately $2.5 million and paid approximately $0.5 million during the three-month periods ended September 30, 2015 and 2014, respectively. The Trust received net settlement proceeds of approximately $8.5 million and $1.2 million during the nine-month periods ended September 30, 2015 and 2014, respectively.
During the three-month period ended September 30, 2015, the Trust recognized a $204.7 million impairment in the carrying value of the Investment in Royalty Interests. The impairment resulted in a non-cash charge to trust corpus and did not affect the Trusts distributable income. There were no impairments in the carrying value of the Investment in Royalty Interests during 2014. Further material write-downs in subsequent quarters may occur if the trailing 12-month commodity prices continue to fall as compared to the commodity prices used in prior quarters. See Impairment of Investment in Royalty Interests in Note 2 to the unaudited interim financial statements contained in Part I, Item 1 of this Quarterly Report for further discussion of the impairments.
As of March 31, 2015, SandRidge had fulfilled its drilling obligation to the Trust. Accordingly, on April 1, 2016, the subordinated units will automatically convert into common units and distributions made on common units in respect of subsequent periods will no longer have the benefit of the Subordination Threshold.
Properties. As of September 30, 2015, the Trusts properties consisted of Royalty Interests in the Initial Wells and 173 additional wells (equivalent to approximately 206 Trust Development Wells under the development agreement as described below) that were drilled and perforated for completion between December 31, 2011 and March 31, 2015 in northern Oklahoma and southern Kansas.
SandRidge was obligated to drill, or cause to be drilled, the Trust Development Wells on or before December 31, 2016. SandRidge was not permitted to drill and complete any well within the AMI for its own account until it had satisfied the drilling obligation to the Trust. As of March 31, 2015, SandRidge had fulfilled its drilling obligation to the Trust by drilling and perforating for completion approximately 206 equivalent Trust Development Wells.
The Trust was not responsible for any costs related to the drilling of the Trust Development Wells and is not responsible for 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 September 30, 2015 and December 31, 2014.
|
|
Initial Wells |
|
Trust |
|
Trust |
|
Total |
|
September 30, 2015 |
|
67 |
|
206 |
|
|
|
273 |
|
December 31, 2014 |
|
67 |
|
199 |
|
7 |
|
273 |
|
(1) SandRidge was credited for having drilled one full Trust Development Well if a well was drilled and perforated for completion with a perforated length between 3,500 feet and 4,500 feet within the Mississippian formation and SandRidges net revenue interest in the well was equal to 47.4%. For wells with a perforated length of less than 3,500 feet or greater than 4,500 feet and for wells in which SandRidge had a net revenue interest greater or less than 47.4%, SandRidge received proportionate credit for such well.
Distributions. The Trust makes quarterly cash distributions of substantially all of its cash receipts, after deducting amounts for the Trusts administrative expenses, property tax and cash reserves withheld by the Trustee, on or about the 60th day following the completion of each quarter. The Trusts 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 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 Trusts subordinated units, is entitled to 50% of the amount by which the cash available for distribution exceeds the Incentive Threshold.
The following table sets forth the approximate Subordination Threshold and Incentive Threshold for each remaining calendar quarter through the end of the subordination period, as set out in the trust agreement.
Period(1) |
|
Subordination |
|
Incentive |
| ||
|
|
|
|
|
| ||
2015 |
|
|
|
|
| ||
Third quarter (3) |
|
$ |
0.64 |
|
$ |
0.96 |
|
Fourth quarter |
|
0.64 |
|
0.96 |
| ||
|
|
|
|
|
| ||
2016 |
|
|
|
|
| ||
First quarter |
|
0.67 |
|
1.00 |
| ||
Second quarter |
|
0.64 |
|
0.96 |
| ||
(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 and Incentive Threshold terminates after the fourth full calendar quarter following SandRidges completion of its drilling obligation. Amounts have been rounded to two decimal places and are presented as set forth in the trust agreement. Actual distributions are declared and paid based upon a calculation carried out to three decimal places.
(3) A distribution of $0.223 per common unit was declared on October 29, 2015 and is expected to be paid on or about November 27, 2015. Because income available for distribution on the Trust common units was below the Subordination Threshold of $0.640 for the period, no distribution will be paid to the holders of subordinated units for the period. See Note 6 to the unaudited interim financial statements contained in Part I, 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.
Litigation. As described in more detail in Item 1 of Part II, Legal Proceedings, claims brought against the Trust in a putative class action against SandRidge and others were dismissed in the second quarter of 2015. However, the dismissal was based on a procedural defect, and thus was made without prejudice to the plaintiffs rights, if any, to refile their claims against the Trust once the defect is cured. Regardless of the outcome of the litigation, the Trust may incur expenses in defending the litigation, and any such expenses may increase the Trusts administrative expenses significantly. However, the Trust is entitled to contractual indemnification covering reasonable costs of investigation and attorneys fees and expenses that the Trust believes will be applicable.
Results of Trust Operations
The primary factors affecting the Trusts revenues and costs are the quantity of oil, NGLs 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. 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 or paid to the Trusts derivative counterparties. Information regarding the Trusts production, pricing and costs for the three- and nine-month periods ended September 30, 2015 and 2014 is presented below.
|
|
Three Months Ended |
|
Nine Months Ended |
| ||||||||
|
|
2015(1) |
|
2014(2) |
|
2015(3) |
|
2014(4) |
| ||||
Production Data |
|
|
|
|
|
|
|
|
| ||||
Oil (MBbls) |
|
88 |
|
122 |
|
244 |
|
442 |
| ||||
NGL (MBbls) |
|
80 |
|
34 |
|
228 |
|
99 |
| ||||
Natural gas (MMcf) |
|
1,189 |
|
1,423 |
|
3,477 |
|
4,588 |
| ||||
Combined equivalent volumes (MBoe) |
|
366 |
|
392 |
|
1,051 |
|
1,306 |
| ||||
Average daily combined equivalent volumes (MBoe/d) |
|
4.0 |
|
4.3 |
|
3.8 |
|
4.8 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Well Data |
|
|
|
|
|
|
|
|
| ||||
Initial and Trust Development Wells producing - average |
|
225 |
|
236 |
|
233 |
|
232 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Revenues (in thousands) |
|
|
|
|
|
|
|
|
| ||||
Royalty income |
|
$ |
8,098 |
|
$ |
20,076 |
|
$ |
29,104 |
|
$ |
66,672 |
|
Derivative settlements |
|
2,509 |
|
(542 |
) |
8,492 |
|
1,210 |
| ||||
Total revenue |
|
$ |
10,607 |
|
$ |
19,534 |
|
$ |
37,596 |
|
$ |
67,882 |
|
|
|
|
|
|
|
|
|
|
| ||||
Expenses (in thousands) |
|
|
|
|
|
|
|
|
| ||||
Post-production expenses |
|
$ |
624 |
|
$ |
722 |
|
$ |
1,698 |
|
$ |
2,290 |
|
Property taxes |
|
|
|
|
|
177 |
|
369 |
| ||||
Production taxes |
|
143 |
|
319 |
|
512 |
|
953 |
| ||||
Trust administrative expenses |
|
184 |
|
239 |
|
1,381 |
|
1,147 |
| ||||
Cash reserves withheld (used) for current Trust expenses, net of amounts (used) withheld |
|
290 |
|
236 |
|
(194 |
) |
60 |
| ||||
Total expenses |
|
$ |
1,241 |
|
$ |
1,516 |
|
$ |
3,574 |
|
$ |
4,819 |
|
Distributable income available to unitholders |
|
$ |
9,366 |
|
$ |
18,018 |
|
$ |
34,022 |
|
$ |
63,063 |
|
|
|
|
|
|
|
|
|
|
| ||||
Average Prices |
|
|
|
|
|
|
|
|
| ||||
Oil (per Bbl) |
|
$ |
48.88 |
|
$ |
99.57 |
|
$ |
60.42 |
|
$ |
97.62 |
|
NGL (per Bbl) |
|
$ |
15.63 |
|
$ |
35.59 |
|
$ |
20.05 |
|
$ |
37.12 |
|
Combined oil and NGL (per Bbl) |
|
$ |
33.05 |
|
$ |
85.72 |
|
$ |
40.91 |
|
$ |
86.58 |
|
Natural gas (per Mcf) |
|
$ |
2.14 |
|
$ |
4.77 |
|
$ |
2.82 |
|
$ |
4.32 |
|
Combined equivalent (per Boe) |
|
$ |
22.13 |
|
$ |
51.18 |
|
$ |
27.69 |
|
$ |
51.06 |
|
|
|
|
|
|
|
|
|
|
| ||||
Average Prices including impact of derivative settlements and post-production expenses |
|
|
|
|
|
|
|
|
| ||||
Oil (per Bbl)(5) |
|
$ |
77.38 |
|
$ |
96.13 |
|
$ |
95.94 |
|
$ |
100.55 |
|
NGL (per Bbl) |
|
$ |
15.63 |
|
$ |
35.59 |
|
$ |
20.05 |
|
$ |
37.12 |
|
Combined oil and NGL (per Bbl) |
|
$ |
47.99 |
|
$ |
83.02 |
|
$ |
59.26 |
|
$ |
88.98 |
|
Natural gas (per Mcf) |
|
$ |
1.62 |
|
$ |
4.26 |
|
$ |
2.33 |
|
$ |
3.82 |
|
Combined equivalent (per Boe) |
|
$ |
27.27 |
|
$ |
48.28 |
|
$ |
34.31 |
|
$ |
50.30 |
|
|
|
|
|
|
|
|
|
|
| ||||
Expenses (per Boe) |
|
|
|
|
|
|
|
|
| ||||
Post-production |
|
$ |
1.70 |
|
$ |
1.84 |
|
$ |
1.62 |
|
$ |
1.75 |
|
Production taxes |
|
$ |
0.39 |
|
$ |
0.81 |
|
$ |
0.49 |
|
$ |
0.73 |
|
(1) Production volumes and related revenues and expenses for the three-month period ended September 30, 2015 (included in SandRidges August 2015 net revenue distribution to the Trust) represent production from March 1, 2015 to May 31, 2015.
(2) Production volumes and related revenues and expenses for the three-month period ended September 30, 2014 (included in SandRidges August 2014 net revenue distribution to the Trust) represent production from March 1, 2014 to May 31, 2014.
(3) Production volumes and related revenues and expenses for the nine-month period ended September 30, 2015 (included in SandRidges February 2015, May 2015 and August 2015 net revenue distributions to the Trust) represent production from September 1, 2014 to May 31, 2015.
(4) Production volumes and related revenues and expenses for the nine-month period ended September 30, 2014 (included in SandRidges February 2014, May 2014 and August 2014 net revenue distributions to the Trust) represent production from September 1, 2013 to May 31, 2014.
(5) Includes impact of derivative settlements attributable to production from March 1, 2015 to May 31, 2015 for the three-month period ended September 30, 2015 and from March 1, 2014 to May 31, 2014 for the three-month period ended September 30, 2014. Includes impact of derivative settlements attributable to production from September 1, 2014 to May 31, 2015 for the nine-month period ended September 30, 2015 and from September 1, 2013 to May 31, 2014 for the nine-month period ended September 30, 2014.
Three Months Ended September 30, 2015 Compared to the Three Months Ended September 30, 2014
Revenues
Royalty Income. Royalty income received during the three-month period ended September 30, 2015 totaled $8.1 million compared to $20.1 million received during the three-month period ended September 30, 2014. Royalty income is a function of production volumes sold attributable to the Royalty Interests and associated prices received. Approximately $2.8 million of the total decrease in royalty income was attributable to the decrease in total volumes produced, caused by a reduction in the average number of producing wells and natural declines in production, and approximately $9.2 million was attributable to a decrease in prices received. The average number of producing wells decreased by 11 during the three-month period ended September 30, 2015 compared to the three-month period ended September 30, 2014 because wells that could not economically produce due to continued depressed pricing were shut-in. Royalty income received during the three-month period ended September 30, 2015 was based upon production attributable to the Royalty Interests of 88 MBbls of oil, 80 MBbls of NGLs and 1,189 MMcf of natural gas, or 366 MBoe of combined production, for the period from March 1, 2015 to May 31, 2015. Royalty income received during the three-month period ended September 30, 2014 was based upon production attributable to the Royalty Interests of 122 MBbls of oil, 34 MBbls of NGLs and 1,423 MMcf of natural gas, or 392 MBoe of combined production, for the period from March 1, 2014 to May 31, 2014. During the 2015 period, NGL production volumes were higher than in the 2014 period as a result of a contractual change to the Trusts gathering agreement. The average price received for oil decreased to $48.88 per Bbl during the three-month period ended September 30, 2015 from $99.57 per Bbl during the same period in 2014, while the average price received for NGLs decreased to $15.63 per Bbl during the three-month period ended September 30, 2015 from $35.59 per Bbl during the same period in 2014. The average price received for natural gas decreased to $2.14 per Mcf during the three-month period ended September 30, 2015 from $4.77 per Mcf during the same period in 2014.
Derivative Settlements. The Trusts derivatives agreement with SandRidge reduces the Trusts exposure to commodity price volatility attributable to a portion of production from the Royalty Interests through December 31, 2015, including the effects of amendments executed in May 2014, by the use of oil fixed price swaps. During the three-month period ended September 30, 2015 the Trust received approximately $2.5 million related to the conveyed derivative contracts for production attributable to the Royalty Interests from March 1, 2015 to May 31, 2015 which effectively increased the average price received for oil production for the related period by $28.50 per Bbl to $77.38 per Bbl. Net cash settlements paid related to the Trusts derivatives during the three-month period ended September 30, 2014 were approximately $542,000, and included (i) approximately $205,000 paid related to the conveyed contracts for production attributable to the Royalty Interests from March 1, 2014 to May 31, 2014, (ii) approximately $165,000 paid to the counterparty to the novated contracts for production attributable to the Royalty Interests from April 1, 2014 to May 31, 2014 and (iii) approximately $172,000 paid to the counterparty to the novated contracts for June 2014 production. Total net derivative settlements paid by the Trust for production from March 1, 2014 to May 31, 2014 were $418,000, including the impact of $48,000 paid in May 2014 to the counterparty to the novated contracts for March 2014 production, which effectively decreased the average price received for oil production for the related period by $3.44 per Bbl to $96.13 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 natural gas produced. Post-production expenses for the three-month period ended September 30, 2015 decreased to approximately $0.6 million from approximately $0.7 million for the three-month period ended September 30, 2014 due to decreased natural gas production.
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 September 30, 2015 totaled approximately $0.1 million, or $0.39 per Boe, and were approximately 1.8% of royalty income. Production taxes for the three-month period ended September 30, 2014 totaled approximately $0.3 million, or $0.81 per Boe, and were approximately 1.6% of royalty income.
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 each of the three-month periods ended September 30, 2015 and 2014 totaled approximately $0.2 million.
Distributable Income
Distributable income for the three-month period ended September 30, 2015 was $9.4 million, which included a net addition to the cash reserve for payment of future Trust expenses of approximately $0.3 million (approximately $0.5 million withheld from the August 2015 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 September 30, 2014 was $18.0 million, which included a net addition to the cash reserve for payment of future Trust expenses of approximately $236,000 (approximately $475,000 withheld from the August 2014 cash distribution to unitholders partially offset by approximately $239,000 used to pay Trust expenses during the period).
Distributions to Holders of Common and Subordinated Units. Holders of Trust common units received greater distributions than holders of Trust subordinated units during the three-month periods ended September 30, 2015 and 2014 as a result of the Trusts subordination provisions. Because income available for distribution on the Trust common units for the August 2015 and 2014 distributions was below the respective Subordination Thresholds, no distributions were paid to the subordinated units for those periods. As a result of the subordination provisions, holders of common units received approximately $2.3 million and $4.5 million more in distributions for the three-month periods ended September 30, 2015 and 2014, respectively, than such holders would have received had the subordination provisions not existed.
Nine Months Ended September 30, 2015 Compared to the Nine Months Ended September 30, 2014
Revenues
Royalty Income. Royalty income received during the nine-month period ended September 30, 2015 totaled $29.1 million compared to $66.7 million received during the nine-month period ended September 30, 2014. Approximately $19.4 million of the total decrease in royalty income was attributable to the decrease in total volumes produced caused by natural declines in production and approximately $18.2 million was attributable to a decrease in prices received. Royalty income received during the nine-month period ended September 30, 2015 was based upon production attributable to the Royalty Interests of 244 MBbls of oil, 228 MBbls of NGLs and 3,477 MMcf of natural gas, or 1,051 MBoe of combined production, for the period from September 1, 2014 to May 31, 2015. Royalty income received during the nine-month period ended September 30, 2014 was based upon production attributable to the Royalty Interests of 442 MBbls of oil, 99 MBbls of NGLs and 4,588 MMcf of natural gas, or 1,306 MBoe of combined production, for the period from September 1, 2013 to May 31, 2014. During the 2015 period, NGL production volumes were higher than in the 2014 period as a result of a contractual change to the Trusts gathering agreement. The average price received for oil decreased to $60.42 per Bbl during the nine-month period ended September 30, 2015 from $97.62 per Bbl during the same period in 2014, while the average price received for NGLs decreased to $20.05 per Bbl during the nine-month period ended September 30, 2015 from $37.12 per Bbl during the same period in 2014. The average price received for natural gas decreased to $2.82 per Mcf during the nine-month period ended September 30, 2015 from $4.32 per Mcf during the same period in 2014.
Derivative Settlements. Net cash settlements received related to the Trusts derivatives during the nine-month period ended September 30, 2015 were approximately $8.5 million, and included (i) approximately $6.3 million received related to the conveyed contracts for production from September 1, 2014 to May 31, 2015 and (ii) approximately $2.2 million received from the counterparty to the novated contracts for production attributable to the Royalty Interests from October 1, 2014 to December 31, 2014. Total net derivative settlements received by the Trust for production from September 1, 2014 to May 31, 2015 were $8.6 million, including approximately $0.1 million received in November 2014 from the counterparty to the novated contracts for September 2014 production, which effectively increased the average price received for oil production for the related period by $35.52 per Bbl to $95.94 per Bbl. Net cash settlements received related to the Trusts derivatives during the nine-month period ended September 30, 2014 were approximately $1.2 million, and included (i) approximately $0.8 million received related to the conveyed contracts for production attributable to the Royalty Interests from September 1, 2013 to May 31, 2014, (ii) approximately $0.6 million received from the counterparty to the novated contracts for production attributable to the Royalty Interests from October 1, 2013 to May 31, 2014 and (iii) approximately $0.2 million paid to the counterparty to the novated contracts for June 2014 production. Total net derivative settlements received by the Trust for production from September 1, 2013 to May 31, 2014 were $1.3 million, including the impact of $0.1 million paid in November 2013 to the counterparty to the novated contracts for September 2013 production, which effectively increased the average price received for oil production for the related period by $2.93 per Bbl to $100.55 per Bbl.
Expenses
Post-Production Expenses. Post-production expenses for the nine-month period ended September 30, 2015 decreased to approximately $1.7 million from approximately $2.3 million for the nine-month period ended September 30, 2014 due to decreased natural gas production.
Property Taxes. The Trust paid approximately $0.2 million of its $0.4 million 2014 property tax assessment during the nine-month period ended September 30, 2015. The Trust paid approximately $0.4 million of its $0.7 million 2013 property tax assessment during the nine-month period ended September 30, 2014.
Production Taxes. Production taxes for the nine-month period ended September 30, 2015 totaled approximately $0.5 million, or $0.49 per Boe, and were approximately 1.8% of royalty income. Production taxes for the nine-month period ended September 30, 2014 totaled approximately $1.0 million, or $0.73 per Boe, and were approximately 1.4% of royalty income.
Trust Administrative Expenses. Trust administrative expenses for the nine-month period ended September 30, totaled approximately $1.4 million compared to approximately $1.1 million for the nine-month period ended September 30, 2014.
Distributable Income
Distributable income for the nine-month period ended September 30, 2015 was $34.0 million, which included a net reduction to the cash reserve for payment of future Trust expenses of approximately $0.2 million (approximately $1.6 million used to pay Trust expenses during the period partially offset by approximately $1.4 million withheld from the February 2015, May 2015 and August 2015 cash distributions to unitholders). Distributable income for the nine-month period ended September 30, 2014 was $63.1 million, which included a net addition to the cash reserve for payment of future Trust expenses of approximately $0.1 million (approximately $1.6 million withheld from the February 2014, May 2014 and August 2014 cash distributions to unitholders partially offset by approximately $1.5 million used to pay Trust expenses during the period).
Distributions to Holders of Common and Subordinated Units. Holders of Trust common units received greater distributions than holders of Trust subordinated units during the nine-month periods ended September 30, 2015 and 2014 as a result of the Trusts subordination provisions. Because income available for distribution on all Trust units for the related quarterly periods was below the Subordination Threshold, no distributions or reduced distributions were paid to the subordinated units for those periods. As a result of the subordination provisions, holders of common units received approximately $8.5 million and $12.8 million more in distributions for the nine-month periods ended September 30, 2015 and 2014, respectively, than such holders would have received had the subordination provisions not existed.
Liquidity and Capital Resources
The Trusts principal sources of liquidity and capital are cash flow generated from the Royalty Interests and the Trusts derivative contracts, and borrowings to fund administrative expenses, including any amounts borrowed under SandRidges loan commitment described in Note 5 to the unaudited interim financial statements contained in Part I, Item 1 of this Quarterly Report. The Trusts primary uses of cash are distributions to Trust unitholders, including, if applicable, incentive distributions to SandRidge during the subordination period, payment of amounts owed under the Trusts derivative contracts, payment of Trust administrative expenses, including any reserves established by the Trustee for future liabilities, payment of applicable taxes and payment of expense reimbursements to SandRidge for out-of-pocket expenses incurred on behalf of the Trust. The incentive distribution provisions will terminate concurrently with the subordination provisions. Under the conveyances granting the Royalty Interests, the Trust does not have any operating or capital cost requirements related to the wells.
Administrative expenses include payments to the Trustee and the Delaware Trustee as well as a quarterly fee of $75,000 to SandRidge pursuant to an administrative services agreement. Each quarter, the Trustee determines the amount of funds available for distribution. Available funds are the excess cash, if any, received by the Trust from the sale of production attributable to the Royalty Interests that quarter over the Trusts expenses for the quarter, subject in all cases to the subordination and incentive provisions. If at any time the Trusts cash on hand (including available cash reserves) is not sufficient to pay the Trusts ordinary course administrative expenses as they become due, the Trust may borrow funds from the Trustee or other lenders, including SandRidge, to pay such expenses. The Trustee does not intend to lend funds to the Trust. If such funds are borrowed, no further distributions will be made to unitholders (except in respect of any previously determined quarterly distribution amount) until the borrowed funds have been repaid, except that if SandRidge loans such funds, SandRidge may permit the Trust to make distributions prior to SandRidge being repaid. There was no such loan outstanding at September 30, 2015 or December 31, 2014.
Under the derivatives agreement, SandRidge pays the Trust amounts it receives from its counterparties and the Trust pays SandRidge any amounts that SandRidge is required to pay such counterparties. Additionally, during the terms of the contracts novated to the Trust by SandRidge, the Trust received payment directly from its counterparties to the contracts and was required to pay any amounts owed under those contracts directly to the counterparties. Future payments by the Trust to SandRidge, if any, reduce, and could eliminate, distributions paid to unitholders.
2015 Trust Distributions to Unitholders. During the nine-month period ended September 30, 2015, the Trusts distributions to unitholders were as follows:
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Covered Production |
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Date Declared |
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Date Paid |
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Total |
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|
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(in millions) |
| |
Calendar Quarter 2015 |
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|
|
|
|
|
|
|
| |
First Quarter |
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September 1, 2014 November 30, 2014 |
|
January 29, 2015 |
|
February 27, 2015 |
|
$ |
14.0 |
|
Second Quarter |
|
December 1, 2014 February 28, 2015 |
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April 30, 2015 |
|
May 29, 2015 |
|
$ |
10.8 |
|
Third Quarter |
|
March 1, 2015 May 31, 2015 |
|
July 30, 2015 |
|
August 28, 2015 |
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$ |
9.4 |
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Future Trust Distributions to Unitholders. During the three-month production period from June 1, 2015 to August 31, 2015, total sales volumes were lower than initial Trust estimates and oil, NGLs and natural gas experienced continued depressed pricing. The decrease in revenue caused by lower commodity prices during the period was partially offset by net cash settlements received under the derivatives agreement of approximately $2.7 million. On October 29, 2015, the Trust declared a cash distribution of $0.223 per common unit covering production for the period. The distribution will be paid on or about November 27, 2015 to record unitholders as of November 13, 2015 and was calculated as follows (in thousands, except for unit and per unit amounts):
Revenues |
|
|
| |
Royalty income |
|
$ |
6,865 |
|
Derivative settlements, net |
|
2,703 |
| |
Total revenues |
|
9,568 |
| |
Expenses |
|
|
| |
Post-production expenses |
|
646 |
| |
Production taxes |
|
126 |
| |
Cash reserves withheld by Trustee(1) |
|
474 |
| |
Total expenses |
|
1,246 |
| |
Distributable income available to unitholders |
|
$ |
8,322 |
|
Distributable income per common unit (37,293,750 units issued and outstanding) |
|
$ |
0.223 |
|
Distributable income per subordinated unit (12,431,250 units issued and outstanding) |
|
$ |
0.000 |
|
(1) Includes amounts withheld for payment of future Trust administrative expenses.
Although distributions relating to production through December 31, 2015 are partially supported by hedging arrangements, no such arrangements are in place for production attributable to periods thereafter, and consequently distributions for production periods beginning January 1, 2016 or later should be expected to be dramatically lower than distributions for recent periods.
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk
This discussion provides information about commodity derivative contracts, the benefits and obligations of which SandRidge has passed to the Trust pursuant to a derivatives agreement. Under the derivatives agreement, SandRidge pays the Trust amounts it receives from counterparties under certain of its derivative contracts with third parties, and the Trust pays SandRidge any amounts that SandRidge is required to pay the counterparties under such derivative contracts. The commodity derivative contracts underlying the derivatives agreement are settled in cash and do not require the actual delivery of a commodity at settlement. Fixed price swap contracts are settled based upon New York Mercantile Exchange prices. The contracts underlying the derivatives agreement may not cover all of the future sales volumes of oil production through December 31, 2015. Except in limited circumstances involving the novation of an existing hedge, the Trust does not have the ability to enter into additional hedges. See Note 4 to the unaudited interim financial statements contained in Part I, Item 1 of this Quarterly Report for notional and price information of the Trusts open oil derivative contracts. The Trust received net settlement proceeds of approximately $8.5 million and $1.2 million related to the derivatives agreement and the Trusts derivative contracts with counterparties during the nine-month periods ended September 30, 2015 and 2014, respectively.
Commodity Price Risk. Because the Trusts primary asset and source of income is the Royalty Interests, which generally entitle the Trust to receive a portion of the net proceeds from sales of production from the Underlying Properties, the Trusts most significant market risk relates to the prices received for oil, NGLs and natural gas production. Revenue derived from the Royalty Interests, and therefore the amount of cash flow available for distribution to the Trust unitholders, depends substantially on prevailing oil, NGL and natural gas prices. Lower prices may also reduce the amount of oil, NGLs and natural gas that can be economically produced from the Underlying Properties. The derivative contracts described above are intended to mitigate a portion of the variability of oil prices received for the Trusts share of production from the Underlying Properties through December 31, 2015.
Credit Risk. A portion of the Trusts liquidity is concentrated in the derivative contracts described above. The use of derivative contracts, including the arrangement between the Trust and SandRidge, involves the risk that SandRidge or its counterparties will be unable to meet their obligations under the contracts. The Trusts counterparty under the derivatives agreement is SandRidge, whose counterparties are institutions with an investment grade credit rating. SandRidge is not required to pay the Trust to the extent of payment defaults by SandRidges counterparties.
ITEM 4. Controls and Procedures
Disclosure Controls and Procedures
The Trustee conducted an evaluation of the Trusts disclosure controls and procedures, as defined in Rules 13a-15 and 15d-15 under the Exchange Act, designed to ensure that information required to be disclosed by the Trust in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms and such information is accumulated and communicated as appropriate to allow timely decisions regarding required disclosure. Based on this evaluation, the Trustee has concluded that the disclosure controls and procedures of the Trust are effective as of the end of the period covered by this report. In its evaluation of disclosure controls and procedures, the Trustee has relied, to the extent considered reasonable, on information provided by SandRidge.
Due to the nature of the Trust as a passive entity and in light of the contractual arrangements pursuant to which the Trust was created, including the provisions of (i) the trust agreement, (ii) the administrative services agreement, (iii) the development agreement and (iv) the conveyances granting the Royalty Interests, the Trustees disclosure controls and procedures related to the Trust necessarily rely on (A) information provided by SandRidge, including information relating to results of operations, the costs and revenues attributable to the Trusts interests under the conveyance and other operating and historical data, plans for future operating and capital expenditures, reserve information, information relating to projected production, and other information relating to the status and results of operations of the Underlying Properties and the Royalty Interests, and (B) conclusions and reports regarding reserves by the Trusts independent reserve engineers.
Changes in Internal Control Over Financial Reporting
There were no changes in the Trusts internal control over financial reporting during the quarter ended September 30, 2015, that have materially affected, or are reasonably likely to materially affect, the Trustees internal control over financial reporting. The Trustee notes for purposes of clarification that it has no authority over, has not evaluated and makes no statement concerning, the internal control over financial reporting of SandRidge.
On May 11, 2015, the U.S. District Court for the Western District of Oklahoma issued an order dismissing all claims against the Trust in a putative class action lawsuit filed by unitholders of the Trust and stockholders of SandRidge, in which the plaintiffs asserted a variety of federal securities claims against the Trust, SandRidge and certain of SandRidges current and former officers and directors, among other defendants. As a result of the order, the Trust is no longer a party in the lawsuit. However, the dismissal was based on a procedural defect, and thus was made without prejudice to the plaintiffs rights, if any, to refile their claims against the Trust once the defect is cured.
On June 9, 2015, the Duane & Virginia Lanier Trust, on behalf of itself and all other similarly situated unitholders of the Trust, filed a putative class action complaint in the U.S. District Court for the Western District of Oklahoma against the Trust, SandRidge and certain current and former executive officers of SandRidge, among other defendants (the Securities Litigation). The complaint asserts a variety of federal securities claims on behalf of a putative class of (a) purchasers of common units of SandRidge Mississippian Trust I in or traceable to its initial public offering on or about April 7, 2011, and (b) purchasers of common units of the Trust in or traceable to its initial public offering on or about April 17, 2012. The claims are based on allegations that SandRidge and certain of its current and former officers and directors, among other defendants, including the Trust, are responsible for making false and misleading statements, and omitting material information, concerning a variety of subjects, including oil and gas reserves. The plaintiffs seek class certification, an order rescinding the Trusts initial public offering and an unspecified amount of damages, plus interest, attorneys fees and costs.
Regardless of the outcome of the litigation, the Trust may incur expenses in defending the litigation, and any such expenses may increase the Trusts administrative expenses significantly. However, the Trust is entitled to contractual indemnification covering reasonable costs of investigation and attorneys fees and expenses that the Trust believes will be applicable. The Trust will estimate and financially provide for potential losses that may arise out of litigation to the extent that such losses are probable and can be reasonably estimated. Significant judgment will be required in making any such estimates and any final liabilities of the Trust may ultimately be materially different than any estimates. The Trust is currently unable to assess the probability of loss or estimate a range of any potential loss the Trust may incur in connection with the Securities Litigation, and has not established any reserves relating to the Securities Litigation. The Trust may withhold estimated amounts from future distributions to cover future costs associated with the litigation if determined necessary. The Trust has not yet fully analyzed any rights it may have to indemnities that may be applicable or any claims it may make in connection with the Securities Litigation.
A risk factor relating to the Trust is found below. This description includes material changes to the description of the risk factors previously disclosed in the Trusts Annual Report Part I, Item 1A of the 2014 Form 10-K.
The conveyance of certain properties to the Trust could be adversely affected if SandRidge becomes the subject of a bankruptcy case.
Approximately 120 of the 206 Development Wells SandRidge drilled for the Trust were drilled on properties covered by leases that were intended to be subject to certain of the conveyances related to the Royalty Interests but that were inadvertently omitted from the exhibits to such conveyances. The Trust has recorded corrected conveyances with respect to such leases in the appropriate jurisdictions. SandRidge has fulfilled the drilling obligations and has duly made payments to the Trust on all wells contributed and drilled, based on the parties intent and understanding that the omitted leases were burdened by the Royalty Interest conveyed to the Trust upon its creation. If SandRidge were to become the subject of a bankruptcy case or proceeding, however, it is possible that the corrected conveyance of the Royalty Interest in such leases might be challenged as a voidable transfer that should be set aside. If a court were to make a determination in a bankruptcy proceeding that the corrected conveyance was a voidable transfer, the Trusts rights to such properties could be adversely affected.
See the Exhibit Index accompanying this Quarterly Report.
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.
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SANDRIDGE MISSISSIPPIAN TRUST II | |||
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By: |
THE BANK OF NEW YORK MELLON TRUST COMPANY, N.A., Trustee | ||
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By: |
/s/ Sarah Newell | |
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Sarah Newell | |
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Vice President | |
Date: November 6, 2015
The Registrant, SandRidge Mississippian Trust II, has no principal executive officer, principal financial officer, board of directors or persons performing similar functions. Accordingly, no additional signatures are available, and none have been provided. In signing the report above, the Trustee does not imply that it has performed any such function or that any such function exists pursuant to the terms of the trust agreement under which it serves.
EXHIBIT INDEX
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Incorporated by Reference |
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Exhibit |
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Exhibit Description |
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Form |
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SEC |
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Exhibit |
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Filing Date |
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Filed |
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3.1 |
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Certificate of Trust of SandRidge Mississippian Trust II |
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S-1 |
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333-178894 |
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3.1 |
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01/05/2012 |
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3.2 |
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Amended and Restated Trust Agreement of SandRidge Mississippian Trust II, dated as of April 23, 2012, by and among SandRidge Energy, Inc., The Bank of New York Mellon Trust Company, N.A., and The Corporation Trust Company. |
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8-K |
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001-35508 |
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4.1 |
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04/24/2012 |
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3.3 |
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Amendment No. 1 to Amended and Restated Trust Agreement of SandRidge Mississippian Trust II, dated June 18, 2012, by the Bank of New York Mellon Trust Company, N.A. |
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10-Q |
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001-35508 |
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3.4 |
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08/13/2012 |
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31.1 |
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Section 302 Certification |
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* |
32.1 |
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Section 906 Certification |
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* |
Exhibit 31.1
Certification
I, Sarah Newell, certify that:
1. I have reviewed this quarterly report on Form 10-Q of SandRidge Mississippian Trust II, for which The Bank of New York Mellon Trust Company, N.A., acts as Trustee;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition and results of operations of the registrant as of, and for, the periods presented in this report;
4. I am responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and I have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under my supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to me by others within those entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under my supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with the basis of accounting described in Note 2;
(c) Evaluated the effectiveness of the registrants disclosure controls and procedures and presented in this report my conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrants internal control over financial reporting that occurred during the registrants most recent fiscal quarter (the registrants fourth quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrants internal control over financial reporting; and
5. I have disclosed, based on my most recent evaluation, to the registrants auditors:
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrants ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves any persons who have a significant role in the registrants internal control over financial reporting.
In giving the foregoing certifications in paragraphs 4 and 5, I have relied to the extent I consider reasonable on information provided to me by SandRidge Energy, Inc.
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/s/ Sarah Newell |
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Sarah Newell |
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Vice President |
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The Bank of New York Mellon Trust Company, N.A., |
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as Trustee of SandRidge Mississippian Trust II |
Date: November 6, 2015
Exhibit 32.1
Securities and Exchange Commission
100 F Street, N.E.
Washington, D.C. 20549
RE: Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350)
Ladies and Gentlemen:
In connection with the Quarterly Report of SandRidge Mississippian Trust II (the Trust) on Form 10-Q for the quarterly period ended September 30, 2015 as filed with the Securities and Exchange Commission on the date hereof (the Report), the undersigned, not in its individual capacity but solely as the Trustee of the Trust, certifies pursuant to 18 U.S.C. § 1350, that to its knowledge:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934, as amended; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Trust.
The above certification is furnished solely pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350) and is not being filed as part of the Report or as a separate disclosure document.
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/s/ Sarah Newell |
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Sarah Newell |
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Vice President |
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The Bank of New York Mellon Trust Company, N.A., |
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as Trustee of SandRidge Mississippian Trust II |
November 6, 2015