Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
__________________________
Form 10-Q
__________________________
(Mark One)
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þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2020
OR
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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 | | 30-0709968 |
(State or other jurisdiction of incorporation or organization) | | (I.R.S. Employer Identification No.) |
The Bank of New York Mellon Trust Company, N.A., Trustee 601 Travis Street, 16th Floor, Houston, Texas | | 77002 |
(Address of principal executive offices) | | (Zip Code) |
Registrant’s telephone number, including area code:
(512) 236-6555
Former name, former address and former fiscal year, if changed since last report: Not applicable
_________________________________
Securities registered pursuant to Section 12(b) of the Act: None
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 every Interactive Data File required to be submitted 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 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, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
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| Large accelerated filer | | o | | Accelerated filer | | o |
| Non-accelerated filer | | x | | Smaller reporting company | | x |
| | | | Emerging growth company | | o |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
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 August 6, 2020, 49,725,000 units of Beneficial Interest in SandRidge Mississippian Trust II were outstanding.
SANDRIDGE MISSISSIPPIAN TRUST II
FORM 10-Q
Quarter Ended June 30, 2020
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| PART I. FINANCIAL INFORMATION | |
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ITEM 1. | Financial Statements (Unaudited) | |
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ITEM 2. | | |
ITEM 3. | | |
ITEM 4. | | |
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| PART II. OTHER INFORMATION | |
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ITEM 1. | | |
ITEM 1A. | | |
ITEM 6. | | |
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 “Trustee’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 2 of Part I and elsewhere herein regarding the Trust’s or SandRidge’s plans and objectives for future operations, 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 Trust’s Annual Report on Form 10-K for the fiscal year ended December 31, 2019 (the “2019 Form 10-K”) and in Part II, Item 1A of this Quarterly Report, 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 SandRidge’s business or the Trust’s 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.
PART I. Financial Information
ITEM 1. Financial Statements
SANDRIDGE MISSISSIPPIAN TRUST II
STATEMENTS OF ASSETS AND TRUST CORPUS
(In thousands, except unit data)
| | | | | | | | | | | |
| June 30, 2020 | | December 31, 2019 |
| ASSETS | (Unaudited) | | |
Cash and cash equivalents | $ | 2,697 | | | $ | 2,697 | |
Investment in royalty interests | 467,146 | | | 467,146 | |
Less: accumulated amortization and impairment | (462,346) | | | (452,453) | |
Net investment in royalty interests | 4,800 | | | 14,693 | |
Total assets | $ | 7,497 | | | $ | 17,390 | |
| TRUST CORPUS | | | |
Trust corpus, 49,725,000 units issued and outstanding at June 30, 2020 and December 31, 2019 | $ | 7,497 | | | $ | 17,390 | |
The accompanying notes are an integral part of these financial statements.
SANDRIDGE MISSISSIPPIAN TRUST II
STATEMENTS OF DISTRIBUTABLE INCOME (Unaudited)
(In thousands, except per unit data)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | | | Six Months Ended June 30, | | | | | | | |
| 2020 | | 2019 | | 2020 | | 2019 | | | | | |
Revenues | | | | | | | | | | | | |
Royalty income | $ | 1,544 | | | $ | 2,797 | | | $ | 3,305 | | | $ | 5,985 | | | | | | |
Total revenues | 1,544 | | | 2,797 | | | 3,305 | | | 5,985 | | | | | | |
Expenses | | | | | | | | | | | | |
Post-production expenses | 323 | | | 418 | | | 702 | | | 817 | | | | | | |
Production taxes | 89 | | | 173 | | | 188 | | | 368 | | | | | | |
Trust administrative expenses | 430 | | | 528 | | | 973 | | | 937 | | | | | | |
| Cash reserves (used) withheld for current Trust expenses, net of amounts withheld (used) | (47) | | | (58) | | | 9 | | | 6 | | | | | | |
Total expenses | 795 | | | 1,061 | | | 1,872 | | | 2,128 | | | | | | |
Distributable income available to unitholders | $ | 749 | | | $ | 1,736 | | | $ | 1,433 | | | $ | 3,857 | | | | | | |
Distributable income per unit (49,725,000 units) | $ | 0.015 | | | $ | 0.035 | | | $ | 0.029 | | | $ | 0.078 | | | | | | |
The accompanying notes are an integral part of these financial statements.
SANDRIDGE MISSISSIPPIAN TRUST II
STATEMENTS OF CHANGES IN TRUST CORPUS (Unaudited)
(In thousands, except per unit data)
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | | | Six Months Ended June 30, | | | | | | |
| 2020 | | 2019 | | 2020 | | 2019 | | | | |
Trust corpus, beginning of period | $ | 11,475 | | | $ | 40,728 | | | $ | 17,390 | | | $ | 42,147 | | | | | |
Amortization of investment in royalty interests | (369) | | | (1,571) | | | (1,215) | | | (3,087) | | | | | |
| Impairment of investment in royalty interests | (3,565) | | | (10,441) | | | (8,678) | | | (10,441) | | | | | |
Net cash reserves (used) withheld | (47) | | | (58) | | | 9 | | | 6 | | | | | |
Distributable income | 749 | | | 1,736 | | | 1,433 | | | 3,857 | | | | | |
Distributions paid to unitholders | (746) | | | (1,741) | | | (1,442) | | | (3,829) | | | | | |
Trust corpus, end of period | $ | 7,497 | | | $ | 28,653 | | | $ | 7,497 | | | $ | 28,653 | | | | | |
Distributions per unit (49,725,000 units) | $ | 0.015 | | | $ | 0.035 | | | $ | 0.029 | | | $ | 0.077 | | | | | |
The accompanying notes are an integral part of these financial statements.
SANDRIDGE MISSISSIPPIAN TRUST II
NOTES TO FINANCIAL STATEMENTS
(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 Trust’s common units (“Trust 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 units and 12,431,250 subordinated units, which subsequently converted to common units as a result of SandRidge having met its drilling obligation to the Trust in March 2015, to certain wholly owned subsidiaries of SandRidge. At June 30, 2020, SandRidge owned 18,675,000 Trust units, or approximately 37.6% of all Trust units.
The Trust is passive in nature and neither the Trust nor the Trustee has any control over, or responsibility for, any operating or capital costs related to the Underlying Properties. The business and affairs of the Trust are administered by the Trustee. The trust agreement generally limits the Trust’s business activities to owning the Royalty Interests and activities reasonably related thereto, including activities required or permitted by the terms of the conveyances related to the Royalty Interests.
The Trust makes quarterly cash distributions of substantially all of its cash receipts, after deducting amounts for the Trust’s 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.
Early Termination of the Trust. As described in the Trust’s annual and quarterly reports filed with the Securities and Exchange Commission (the “SEC”), the trust agreement governing the Trust requires the Trust to dissolve and commence winding up of its business and affairs if cash available for distribution for any four consecutive quarters, on a cumulative basis, is less than $5.0 million. As cash available for distribution for the four consecutive quarters ended December 31, 2019, on a cumulative basis, was approximately $4.392 million, the Trust commenced its winding up procedures beginning at the close of business on February 14, 2020. Accordingly, the Trustee is required to sell all of the Trust’s assets, either by private sale or public auction, and distribute any net proceeds of the sale to the Trust unitholders after payment, or reasonable provision for payment, of all Trust liabilities, which is expected to include the establishment of cash reserves in such amounts as the Trustee in its discretion deems appropriate for the purpose of making reasonable provision for all claims and obligations of the Trust, including any contingent, conditional or unmatured claims and obligations, in accordance with the Delaware Statutory Trust Act. The sale process will involve costs that will reduce the amounts of any distributions to unitholders during the winding up period. As required by the trust agreement, the Trustee has engaged a third-party advisor to assist with the marketing and sale of the Trust’s assets. As provided in the trust agreement, SandRidge has a right of first refusal with respect to any sale of assets to a third party. The Trustee expects to complete the sale of the Trust’s assets and distribute the net proceeds of the sale to the Trust unitholders by the end of 2020, and the Trust units are expected to be canceled shortly thereafter. Subject to the final terms of the sale of the Royalty Interests, including the effective date and the timing of the closing of the anticipated sale, the Trust currently expects that there will be no further regular quarterly distributions to Trust unitholders reflecting quarterly revenues generated from the Underlying Properties. The Trust will remain in existence until the filing of a certificate of cancellation with the Secretary of State of the State of Delaware following the completion of the winding up process. See Note 6 “Subsequent Events—Early Termination of the Trust” for further information regarding the sale process.
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 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.
SANDRIDGE MISSISSIPPIAN TRUST II
NOTES TO FINANCIAL STATEMENTS - CONTINUED
(Unaudited)
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 Trust’s financial statements are prepared on the modified cash basis as described above, most accounting pronouncements are not applicable to the Trust’s 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. As discussed in "Potential Early Termination of the Trust" in Note 1 above, it was determined at June 30, 2019 that it is more likely than not that the Trust's remaining assets will be sold and the Trust will be liquidated significantly before the end of its previously estimated useful life. As a result, during the six-month periods ended June 30, 2020 and 2019 the Trust recorded impairments to the carrying value of the Investment in Royalty Interests of $8.7 million and $10.4 million, respectively. The impairments resulted in non-cash charges to trust corpus and did not affect the Trust’s distributable income. As there are numerous uncertainties inherent in estimating quantities of proved reserves, these quantities are a significant unobservable input resulting in the fair value measurement being considered a level 3 measurement within the fair value hierarchy. For June 30, 2020 as the Trust assets now meet the criteria for Held for Sale, the impairment was determined by taking the estimated fair value less the estimated cost to sell the assets. Fair value was derived from the sale process that was conducted by the third-party advisor engaged by the Trust as required by the trust agreement. Following an evaluation period, a number of bids were received and the Trustee, with the assistance of the advisor, after considering the proposed price, financing conditions and other terms of each bid, selected what was determined to be the strongest bid. See Note 6 “Subsequent Events—Early Termination of the Trust” for further information regarding the sale process. Prior to this sale process, on a quarterly basis, the Trust evaluated the carrying value of the investment in royalty interests by comparing the undiscounted cash flows expected to be realized from the Royalty Interests to the carrying value. If the expected future undiscounted cash flows were less than the carrying value, the Trust recognized an impairment loss for the difference between the carrying value and the estimated fair value of the Royalty Interests, which was determined using future cash flows of the net oil, natural gas and natural gas liquids (“NGL”) reserves attributable to the Royalty Interests, discounted at a rate based upon the weighted average cost of capital of publicly traded royalty trusts. The weighted average cost of capital was based upon inputs that are readily available in the public market. The future cash flows of the net oil, natural gas and NGL reserves attributable to the Royalty Interests utilized the oil and natural gas futures prices readily available in the public market adjusted for differentials and estimated quantities of oil, natural gas and NGL reserves that geological and engineering data demonstrate, with reasonable certainty, to be recoverable in future years from known reservoirs under existing economic and operating conditions.
Distributable Income Per Unit. 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 rounding and the timing of the Trust’s payment of Trust administrative expenses.
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 2019 Form 10-K and reflect all adjustments that are, in the opinion of the Trustee, necessary to state fairly the information in the Trust’s unaudited interim financial statements. The accompanying statement of assets and trust corpus as of December 31, 2019 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 2019 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 Trust’s 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 Trust’s quarterly distribution to be paid in August 2020. A summary of the Trust’s distributions to unitholders during the three- and six-month periods ended June 30, 2020 and the year ended December 31, 2019 is as follows:
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| | | | | | | | Total | | Distribution |
| | Covered | | | | | | Distribution | | Per Common |
| | Production Period | | Date Declared | | Date Paid | | Paid | | Unit |
| Calendar Quarter 2020 | | | | | | | | | | |
First Quarter | | September 1, 2019 — November 30, 2019 | | January 23, 2020 | | February 28, 2020 | | $ | 696,150 | | | $ | 0.014 | |
Second Quarter | | December 1, 2019 — February 29, 2020 | | April 23, 2020 | | May 29, 2020 | | $ | 745,875 | | | $ | 0.015 | |
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| Calendar Quarter 2019 | | | | | | | | | | |
First Quarter | | September 1, 2018 — November 30, 2018 | | January 24, 2019 | | February 22, 2019 | | $ | 2,088,450 | | | $ | 0.042 | |
Second Quarter | | December 1, 2018 — February 28, 2019 | | April 25, 2019 | | May 24, 2019 | | $ | 1,740,375 | | | $ | 0.035 | |
Third Quarter | | March 1, 2019 — May 31, 2019 | | July 25, 2019 | | August 23, 2019 | | $ | 1,392,300 | | | $ | 0.028 | |
Fourth Quarter | | June 1, 2019 — August 31, 2019 | | October 24, 2019 | | November 22, 2019 | | $ | 646,425 | | | $ | 0.013 | |
4. Related Party Transactions
Trustee Administrative Fee. Under the terms of the trust agreement, the Trust pays the Trustee an annual administrative fee, which for 2019 totaled $155,000. The annual fee can be adjusted for inflation by no more than 3% in any year. The Trustee’s administrative fees paid during the three-month periods ended June 30, 2020 and 2019 totaled approximately $40,000 and $38,000, respectively. The Trustee’s administrative fees paid during the six-month periods ended June 30, 2020 and 2019 totaled approximately $79,000 and $77,000, respectively.
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, one of which has been filed to date. The Trust does not bear any expenses associated with such transactions.
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. 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 the administrative services agreement. The administrative services agreement, as amended, will terminate on the earliest to occur of: (i) the date the Trust is finally wound up and liquidated in accordance with the trust agreement, (ii) the date that all of the conveyances have been terminated, (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 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. During each of the three-month periods ended June 30, 2020 and 2019, the Trust paid administrative fees to SandRidge equal to $75,000. During each of the six-month periods ended June 30, 2020 and 2019, the Trust paid administrative fees to SandRidge equal to $150,000.
5. Commitments and Contingencies
SANDRIDGE MISSISSIPPIAN TRUST II
NOTES TO FINANCIAL STATEMENTS - CONTINUED
(Unaudited)
Loan Commitment. Pursuant to the trust agreement, if at any time the Trust’s cash on hand (including available cash reserves) is not sufficient to pay the Trust’s ordinary course administrative expenses as they become due, SandRidge will, at the Trustee’s 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 Trust’s business, and may not be used to satisfy Trust indebtedness, or to make distributions. If SandRidge loans funds pursuant to this commitment, no further distributions will be made to unitholders (except in respect of any previously determined quarterly cash distribution amount) until such loan is repaid. Any such loan will be on an unsecured basis, and the terms of such loan will be substantially the same as that which would be obtained in an arm’s length transaction between SandRidge and an unaffiliated third party. No such loan from SandRidge was outstanding at June 30, 2020 or December 31, 2019.
Risks and Uncertainties. The Trust’s revenue and distributions are substantially dependent upon the prevailing and future prices for oil, natural gas and NGL, each of which depends on numerous factors beyond the Trust’s control such as overall oil, natural gas and NGL production and inventories in relevant markets, economic conditions, the global political environment, regulatory developments and competition from other energy sources. Oil, natural gas and NGL prices historically have been volatile and may be subject to significant fluctuations in the future. Low levels of future production, continued low commodity prices and the absence of any derivative arrangements would continue to reduce the Trust’s revenues and distributable income available to unitholders.
The Trust is highly dependent on its Trustor, SandRidge, for multiple services, including the operation of the Trust wells, remittance of net proceeds from the sale of associated production to the Trust, administrative services such as accounting, tax preparation, bookkeeping and informational services performed on behalf of the Trust. The ability to operate the properties depends on the Trustor’s future financial condition and economic performance, access to capital, and other factors, many of which are out of the control of the Trustor. The reduced demand for crude oil in the global market resulting from the economic effects of the global outbreak of the novel form of coronavirus known as COVID-19, and the oversupply in crude oil attributable to the dispute over production levels between Russia and the members of the Organization of Petroleum Exporting Countries (“OPEC”), have had, and are likely to continue to have, a negative impact on the Trustor’s financial condition. This negative impact could affect the Trustor’s ability to operate the wells and provide services to the Trust.
Legal Proceedings. At times, the Trust may be involved in various lawsuits, claims and proceedings which are handled and defended in the ordinary course of business. The Trust may incur expenses defending litigation, and any such expenses may increase the Trust’s administrative expenses significantly. However, the Trust is entitled to contractual indemnification covering reasonable costs of investigation and attorney’s fees and expenses that the Trust believes will be applicable. The Trust will estimate and, if the Trustee deems it appropriate, begin reserving funds 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 may withhold estimated amounts from future distributions to cover future costs associated with the litigation if determined necessary.
6. Subsequent Events
Distribution to Unitholders. On July 23, 2020, the Trust announced that there would be no cash distribution in August 2020 with respect to production for the three-month period from March 1, 2020 to May 31, 2020. Distributable income for March 1, 2020 to May 31, 2020 was calculated as follows (in thousands, except for unit and per unit amounts):
| | | | | |
Revenues | |
Royalty income | $ | 709 | |
Total revenues | 709 | |
Expenses | |
Post-production expenses | 278 | |
Production taxes | 33 | |
Cash reserves withheld by Trustee (1) | 378 | |
Total expenses | 689 | |
Distributable income | 20 | |
Additional cash reserve (2) | 20 | |
| Distributable income available to unitholders | $ | — | |
| Distributable income per unit (49,725,000 units issued and outstanding) | $ | — | |
SANDRIDGE MISSISSIPPIAN TRUST II
NOTES TO FINANCIAL STATEMENTS - CONTINUED
(Unaudited)
____________________
(1) Includes amounts withheld for payment of future Trust administrative expenses.
(2) Cash reserve increase for the payment of future known, anticipated or contingent expenses or liabilities.
COVID-19 and Oil Price Volatility. The amount of cash received or expected to be received by the Trust (and its ability to pay future distributions) has been and will be significantly and negatively impacted by prevailing low commodity prices, which have declined since the beginning of 2020 attributable primarily to the economic effects of the dispute over production levels between Russia and the members of OPEC, and the COVID-19 pandemic and could remain low for an extended period of time or decline further. Continued low oil, NGL and natural gas prices will reduce revenues to the Trust, which will reduce the amount of cash available for distribution to unitholders and in certain periods could result in no distributions to unitholders, and could diminish the value of the Royalty Interests, which would reduce the amount of proceeds the Trust would receive from a sale of the Trust’s assets in connection with the early termination of the Trust. Other important factors that could cause actual results to differ materially include expenses of the Trust and reserves for anticipated future expenses, and the effect, impact, potential duration or other implications of the COVID-19 pandemic.
Early Termination of the Trust. As discussed in “Early Termination of the Trust” in Note 1 above, winding up procedures for the Trust commenced at the close of business on February 14, 2020. Accordingly, the Trustee is required to sell all of the Trust’s assets, either by private sale or public auction. Any net proceeds of the sale will be distributed to the Trust unitholders after payment, or reasonable provision for payment, of all Trust liabilities, which is expected to include the establishment of cash reserves deemed appropriate by the Trustee for the payment of all claims and obligations of the Trust, including any contingent, conditional or unmatured claims and obligations, in accordance with the Delaware Statutory Trust Act.
The sale process will involve costs that will reduce the amounts of any distributions to unitholders during the winding up period. As required by the trust agreement, the Trustee has engaged a third-party advisor to assist with the marketing and sale of the Trust’s assets. The advisor conducted a bid solicitation process that concluded in June 2020, and the Trustee, with the assistance of the advisor, after considering the proposed price, financing conditions and other terms of each bid, selected what was determined to be the strongest bid received. As provided in the trust agreement, SandRidge has a right of first refusal with respect to any sale of assets to a third party, and on July 16, 2020, the Trustee provided notice to SandRidge of the offer to purchase the assets of the Trust. On August 6, 2020, SandRidge notified the Trustee that SandRidge will exercise its right of first refusal and will purchase the Royalty Interests from the Trust for a purchase price of $5.25 million, subject to the execution of a definitive agreement and the closing of the transaction.
ITEM 2. Trustee’s Discussion and Analysis of Financial Condition and Results of Operations
Introduction
The following discussion and analysis is intended to help the reader understand the 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 Trust’s unaudited interim financial statements and the accompanying notes included in this Quarterly Report and the Trust’s audited financial statements and the accompanying notes included in the 2019 Form 10-K. All information regarding operations has been provided to the Trustee by SandRidge.
Overview
The Trust is a statutory trust created under the Delaware Statutory Trust Act. The business and affairs of the Trust are administered by the Trustee and, as necessary, the Delaware Trustee. The Trust’s purpose is to hold the Royalty Interests, to distribute to the Trust unitholders cash that the Trust receives in respect of the Royalty Interests and 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. The Trust is treated as a partnership for federal income tax purposes.
Commodity Price Volatility; COVID-19 Pandemic. The Trust’s quarterly cash distributions are highly dependent upon the prices realized from the sale of oil, natural gas and NGL. The markets for these commodities are volatile, as demonstrated by significant price swings experienced during 2019 and have declined in 2020 attributable primarily to the economic effects of the dispute over production levels between Russia and the members of the Organization of Petroleum Exporting Countries (“OPEC”), and the global outbreak of the novel form of coronavirus known as COVID-19. The spot price for WTI crude oil has decreased from $61.18 on January 2, 2020 to $42.06 on August 6, 2020. Crude oil reached a closing NYMEX price low of negative $37.63 per barrel in April 2020. The responses by federal, state and local governmental authorities to the pandemic have also resulted in significant business and operational disruptions, including business closures, supply chains disruptions, travel restrictions, stay-at-home orders and limitations on the availability of workforces. The full impact of COVID-19 is unknown and is rapidly evolving. The extent to which COVID-19 negatively impacts SandRidge or any third-party operator of the Underlying Properties will depend on the severity, location and duration of the effects and spread of COVID-19, the actions undertaken by federal, state and local governments and health officials to contain the virus or treat its effects, and how quickly and to what extent economic conditions improve and normal business and operating conditions resume. A prolonged period of low crude oil, NGL and natural gas prices will adversely affect SandRidge or third-party operators of the Underlying Properties. As a result, there can be no assurance that prices for oil, natural gas and NGL, and therefore the Trust’s quarterly cash distributions, will be maintained for any significant period of time. Continued low oil, NGL and natural gas prices will reduce revenues to the Trust, which will reduce the amount of cash available for distribution to unitholders and in certain periods could result in no distributions to unitholders, and could negatively affect the value of the Royalty Interests, which could reduce the amount of proceeds the Trust would receive from a sale of the Trust’s assets in connection with the early termination of the Trust.
Impairment of Investment in Royalty Interests. During the six-month periods ended June 30, 2020 and 2019, the Trust recorded impairments to the carrying value of the Investment in Royalty Interests of $8.7 million and $10.4 million, respectively. The impairments resulted in non-cash charges to trust corpus and did not affect the Trust’s distributable income. Material write-downs in subsequent periods may occur if the fair value and selling costs differ from estimated values relative to the carrying value of the investment in royalty interests. 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.
Properties. As of June 30, 2020, the Trust’s properties consisted of Royalty Interests in oil and natural gas wells located in northern Oklahoma and southern Kansas.
Distributions. The Trust makes quarterly cash distributions of substantially all of its cash receipts, after deducting amounts for the Trust’s administrative expenses, property tax and cash reserves withheld by the Trustee, on or about the 60th day following the completion of each quarter.
Pursuant to Internal Revenue Code (“IRC”) Section 1446, withholding tax on income effectively connected to a United States trade or business allocated to non-U.S. persons (“ECI”) should be made at the highest marginal rate. Under IRC Section 1441, withholding tax on fixed, determinable, annual, periodic income from United States sources allocated to non-U.S. persons 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 on the distribution made to non-U.S. persons. The Tax Cuts and Jobs Act (the “TCJA”) enacted in December 2017 treats a non-U.S. holder’s gain on the sale of Trust units as ECI to the extent such holder would have had ECI if the Trust had sold all of its assets at fair market value on the date of the exchange. The TCJA also requires the transferee of units to withhold 10% of the amount realized on the sale of exchange of units (generally, the purchase price) unless the transferor certifies that it is not a nonresident alien individual or foreign corporation. Pending the finalization of proposed regulations under IRC Section 1446, the IRS has suspended this new withholding obligation with respect to publicly traded partnerships such as the Trust, which is classified as a partnership for federal and state income tax purposes.
Early Termination of the Trust. As discussed in “Early Termination of the Trust” in Note 1 to the unaudited interim financial statements contained in Part I, Item 1 of this Quarterly Report, winding up procedures for the Trust commenced at the close of business on February 14, 2020. Accordingly, the Trustee is required to sell all of the Trust’s assets, either by private sale or public auction. Any net proceeds of the sale will be distributed to the Trust unitholders after payment, or reasonable provision for payment, of all Trust liabilities, which is expected to include the establishment of cash reserves deemed appropriate by the Trustee for the payment of all claims and obligations of the Trust, including any contingent, conditional or unmatured claims and obligations, in accordance with the Delaware Statutory Trust Act.
The sale process will involve costs that will reduce the amounts of any distributions to unitholders during the winding up period. As required by the trust agreement, the Trustee has engaged a third-party advisor to assist with the marketing and sale of the Trust’s assets. The advisor conducted a bid solicitation process that concluded in June 2020, and the Trustee, with the assistance of the advisor, after considering the proposed price, financing conditions and other terms of each bid, selected what was determined to be the strongest bid received. As provided in the trust agreement, SandRidge has a right of first refusal with respect to any sale of assets to a third party, and on July 16, 2020, the Trustee provided notice to SandRidge of the offer to purchase the assets of the Trust. On August 6, 2020, SandRidge notified the Trustee that SandRidge will exercise its right of first refusal and will purchase the Royalty Interests from the Trust for a purchase price of $5.25 million, subject to the execution of a definitive agreement and the closing of the transaction.
The Trustee expects to complete the sale of the Trust’s assets and distribute the net proceeds of the sale to the Trust unitholders by the end of 2020, and the Trust units are expected to be canceled shortly thereafter. As provided in the trust agreement, if SandRidge actually completes the purchase of the Royalty Interests, the proposed third-party purchaser will be entitled to receive reimbursement from SandRidge and the Trust for such proposed third-party purchaser’s reasonable and documented expenses incurred in connection with its review and analysis of the subject properties and bid preparation, up to a maximum amount representing 5% of the sale price, with the Trust obligated to pay 50% of such reimbursement. Subject to the final terms of the sale of the Royalty Interests, including the effective date and the timing of the closing of the anticipated sale, the Trust currently expects that there will be no further regular quarterly distributions to Trust unitholders reflecting quarterly revenues generated from the Underlying Properties. The Trust will remain in existence until the filing of a certificate of cancellation with the Secretary of State of the State of Delaware following the completion of the winding up process.
As previously disclosed, beginning with the distribution to unitholders paid in the first quarter of 2019, the Trustee had been withholding the greater of $50,000 or 3.5%, increasing to $195,000 for the fourth quarter 2019 distribution, of the funds otherwise available for distribution each quarter to gradually increase existing cash reserves for the payment of future known, anticipated or contingent expenses or liabilities by a total of $625,000. The targeted reserve amount has been funded; however, because the amount of distributable income for the three months ended June 30, 2020 was only $20,000, the Trustee, in its discretion, elected to withhold that amount for inclusion in the cash reserve for future liabilities. Any cash reserves remaining after the payment of all expenses and liabilities and any further additions to cash reserves as the Trustee in its discretion deems appropriate for the purpose of making reasonable provision for all claims and obligations of the Trust, including any contingent, conditional or unmatured claims and obligations, will be distributed to unitholders prior to the completion of the winding up process.
Results of Trust Operations
The primary factors affecting the Trust’s revenues and costs are the quantity of oil, natural gas and NGL production attributable to the Royalty Interests and the prices received for such production. Royalty income, post-production expenses and certain taxes are recorded on a cash basis when net revenue distributions are received by the Trust from SandRidge. Information regarding the Trust’s production, pricing and costs for the three- and six-month periods ended June 30, 2020 and 2019 is presented below.
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| | Three Months Ended June 30, | | | | Six Months Ended June 30, | | | | | | | |
| | 2020(1) | | 2019(2) | | 2020(3) | | 2019(4) | | | | | |
| Production Data | | | | | | | | | | | | | |
| Oil (MBbls) | | 8 | | | 11 | | | 17 | | | 23 | | | | | | |
| NGL (MBbls) | | 45 | | | 48 | | | 82 | | | 92 | | | | | | |
| Natural gas (MMcf) | | 378 | | | 458 | | | 823 | | | 971 | | | | | | |
| Combined equivalent volumes (MBoe) | | 116 | | | 136 | | | 236 | | | 277 | | | | | | |
| Average daily combined equivalent volumes (MBoe/d) | | 1.3 | | | 1.5 | | | 1.3 | | | 1.5 | | | | | | |
| Well Data | | | | | | | | | | | | | |
| Initial and Trust Development Wells producing - average | | 98 | | | 121 | | | 102 | | | 125 | | | | | | |
| Revenues (in thousands) | | | | | | | | | | | | | |
| Royalty income | | $ | 1,544 | | | $ | 2,797 | | | $ | 3,305 | | | $ | 5,985 | | | | | | |
| Total revenue | | 1,544 | | | 2,797 | | | 3,305 | | | 5,985 | | | | | | |
Expenses (in thousands) | | | | | | | | | | | | | |
| Post-production expenses | | $ | 323 | | | $ | 418 | | | $ | 702 | | | $ | 817 | | | | | | |
| Production taxes | | 89 | | | 173 | | | 188 | | | 368 | | | | | | |
| Trust administrative expenses | | 430 | | | 528 | | | 973 | | | 937 | | | | | | |
| Cash reserves (used) withheld for current Trust expenses, net of amounts withheld (used) | | (47) | | | (58) | | | 9 | | | 6 | | | | | | |
| Total expenses | | 795 | | | 1,061 | | | 1,872 | | | 2,128 | | | | | | |
| Distributable income available to unitholders | | $ | 749 | | | $ | 1,736 | | | $ | 1,433 | | | $ | 3,857 | | | | | | |
| Average Prices | | | | | | | | | | | | | |
| Oil (per Bbl) | | $ | 55.55 | | | $ | 49.46 | | | $ | 55.00 | | | $ | 57.44 | | | | | | |
| NGL (per Bbl) | | $ | 12.39 | | | $ | 17.59 | | | $ | 14.16 | | | $ | 23.16 | | | | | | |
| Combined oil and NGL (per Bbl) | | $ | 18.84 | | | $ | 23.66 | | | $ | 20.98 | | | $ | 29.33 | | | | | | |
| Natural gas (per Mcf) | | $ | 1.42 | | | $ | 3.02 | | | $ | 1.48 | | | $ | 2.60 | | | | | | |
| Combined equivalent (per Boe) | | $ | 13.25 | | | $ | 20.54 | | | $ | 13.95 | | | $ | 21.54 | | | | | | |
| Average Prices – including impact of post-production expenses | | | | | | | | | | | | | |
| Natural gas (per Mcf) | | $ | 0.57 | | | $ | 2.11 | | | $ | 0.63 | | | $ | 1.75 | | | | | | |
| Combined equivalent (per Boe) | | $ | 10.47 | | | $ | 17.45 | | | $ | 10.98 | | | $ | 18.59 | | | | | | |
| Expenses (per Boe) | | | | | | | | | | | | | |
| Post-production | | $ | 2.78 | | | $ | 3.09 | | | $ | 2.97 | | | $ | 2.95 | | | | | | |
| Production taxes | | $ | 0.76 | | | $ | 1.27 | | | $ | 0.80 | | | $ | 1.33 | | | | | | |
____________________
1.Production volumes and related revenues and expenses for the three-month period ended June 30, 2020 (included in SandRidge’s May 2020 net revenue distribution to the Trust) represent production from December 1, 2019 to February 29, 2020.
2.Production volumes and related revenues and expenses for the three-month period ended June 30, 2019 (included in SandRidge’s May 2019 net revenue distribution to the Trust) represent production from December 1, 2018 to February 28, 2019.
3.Production volumes and related revenues and expenses for the six-month period ended June 30, 2020 (included in SandRidge’s February and May 2020 net revenue distribution to the Trust) represent production from September 1, 2019 to February 29, 2020.
4.Production volumes and related revenues and expenses for the six-month period ended June 30, 2019 (included in SandRidge’s February and May 2019 net revenue distribution to the Trust) represent production from September 1, 2018 to February 28, 2019.
Three Months Ended June 30, 2020 Compared to the Three Months Ended June 30, 2019
Revenues
Royalty Income. Royalty income is a function of production volumes sold attributable to the Royalty Interests and associated prices received. Royalty income received during the three-month period ended June 30, 2020 totaled $1.5 million compared to $2.8 million received during the three-month period ended June 30, 2019. The approximate $1.3 million decrease in royalty income consisted of approximately $0.8 million attributable to a decrease in prices received and approximately $0.5 million attributable to a decrease in total volumes produced. The average number of producing wells in the three-month period ended June 30, 2020 decreased by 23 from 121 in the three-month period ended June 30, 2019, because wells that could not economically produce due to continued declining production and current pricing were shut-in.
Expenses
Production Taxes. Production taxes are calculated as a percentage of oil and natural gas revenues, net of any applicable tax credits. Production taxes for the three-month period ended June 30, 2020 totaled approximately $89,000, or $0.76 per Boe, and were approximately 5.8% of royalty income. Production taxes for the three-month period ended June 30, 2019 totaled approximately $173,000, or $1.27 per Boe, and were approximately 6.2% of royalty income.
Distributable Income
Distributable income for the three-month period ended June 30, 2020 was $0.7 million, which included a net reduction to the cash reserve for payment of future Trust expenses of approximately $47,000, reflecting approximately $430,000 used to pay Trust expenses during the period partially offset by approximately $383,000 withheld from the May 2020 cash distribution to unitholders. Distributable income for the three-month period ended June 30, 2019 was $1.7 million, which included a net reduction to the cash reserve for payment of future Trust expenses of approximately $58,000, reflecting approximately $528,000 used to pay Trust expenses during the period partially offset by approximately $470,000 withheld from the May 2019 cash distribution to unitholders.
Six Months Ended June 30, 2020 Compared to the Six Months Ended June 30, 2019
Revenues
Royalty Income. Royalty income is a function of production volumes sold attributable to the Royalty Interests and associated prices received. Royalty income received during the six-month period ended June 30, 2020 totaled $3.3 million compared to $6.0 million received during the six-month period ended June 30, 2019. The approximate $2.7 million decrease in royalty income consisted of approximately $1.7 million attributable to a decrease in prices received and approximately $1.0 million attributable to a decrease in total volumes produced. The average number of producing wells in the six-month period ended June 30, 2020 decreased by 23 from 125 in the six-month period ended June 30, 2019, because wells that could not economically produce due to continued declining production and current pricing were shut-in.
Expenses
Production Taxes. Production taxes are calculated as a percentage of oil and natural gas revenues, net of any applicable tax credits. Production taxes for the six-month period ended June 30, 2020 totaled approximately $188,000, or $0.80 per Boe, and were approximately 5.7% of royalty income. Production taxes for the six-month period ended June 30, 2019 totaled approximately $368,000, or $1.33 per Boe, and were approximately 6.2% of royalty income.
Distributable Income
Distributable income for the six-month period ended June 30, 2020 was $1.4 million, which included a net addition to the cash reserve for payment of future Trust expenses of approximately $9,000, reflecting approximately $982,000 withheld in aggregate from the February 2020 and May 2020 cash distributions to unitholders partially offset by approximately $973,000 used to pay Trust expenses during the period. Distributable income for the six-month period ended June 30, 2019 was $3.9 million, which included a net addition to the cash reserve for payment of future Trust expenses of approximately $6,000, reflecting approximately $943,000 withheld in aggregate from the February 2019 and May 2019 cash distributions to unitholders partially offset by approximately $937,000 used to pay Trust expenses during the period.
Liquidity and Capital Resources
The Trust has no source of liquidity or capital resources other than cash flow generated from the Royalty Interests and borrowings to fund administrative expenses, including any amounts borrowed under SandRidge’s loan commitment described in Note 5 to the unaudited interim financial statements contained in Part I, Item 1 of this Quarterly Report. The Trust’s primary uses of cash are distributions to Trust unitholders, including, if applicable, 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 Trust does not have any capital requirements related to drilling wells or any other operating or capital costs 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 Trust’s expenses for the quarter. If at any time the Trust’s cash on hand (including available cash reserves) is not sufficient to pay the Trust’s ordinary course administrative expenses as they become due, the Trust may borrow funds from the Trustee or other lenders, including 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. No such loan was outstanding at June 30, 2020 or December 31, 2019.
Commencing with the distribution to unitholders paid in the first quarter of 2019, the Trustee had been withholding, the greater of $50,000 or 3.5%, increasing to $195,000 for the fourth quarter 2019 distribution, of the funds otherwise available for distribution each quarter to gradually increase cash reserves for the payment of future known, anticipated or contingent expenses or liabilities by a total of $625,000. The targeted reserve amount has been funded; however, because the amount of distributable income for the three months ended June 30, 2020 was only $20,000, the Trustee, in its discretion, elected to withhold that amount for inclusion in the cash reserve for future liabilities. Any cash reserves remaining after the payment of all expenses and liabilities and any further additions to cash reserves as the Trustee in its discretion deems appropriate for the purpose of making reasonable provision for all claims and obligations of the Trust, including any contingent, conditional or unmatured claims and obligations, will be distributed to unitholders prior to the completion of the winding up process. These cash reserves, if needed, are expected to be sufficient to fund the Trust's expenses for the next 12 months.
The Trust is highly dependent on its Trustor, SandRidge, for multiple services, including the operation of the Trust wells, remittance of net proceeds from the sale of associated production to the Trust, administrative services such as accounting, tax preparation, bookkeeping and informational services performed on behalf of the Trust, and potentially for loans to pay Trust administrative expenses. The ability to operate the properties depends on the Trustor’s future financial condition and economic performance, access to capital, and other factors, many of which are out of the control of the Trustor. The reduced demand for crude oil in the global market resulting from the economic effects of the COVID-19 pandemic and the oversupply in crude oil attributable to the dispute over production levels between Russia and the members of OPEC, have had, and are likely to continue to have, negative impact on the Trustor’s financial condition. This negative impact could affect the Trustor’s ability to operate the wells and provide services to the Trust.
2020 Trust Distributions to Unitholders. During the six-month period ended June 30, 2020, the Trust's distribution to unitholders were as follows:
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| | | | | | | | Total | |
| | Covered | | | | | | Distribution | |
| | Production Period | | Date Declared | | Date Paid | | Paid | |
| Calendar Quarter 2020 | | | | | | | | | |
First Quarter | | September 1, 2019 — November 30, 2019 | | January 23, 2020 | | February 28, 2020 | | $ | 696,150 | | |
Second Quarter | | December 1, 2019 — February 29, 2020 | | April 23, 2020 | | May 29, 2020 | | $ | 745,875 | | |
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Future Trust Distributions to Unitholders. During the three-month production period from March 1, 2020 to May 31, 2020, average oil prices decreased significantly compared to the three-month period ended February 29, 2020. Combined sales volumes
were lower than the previous period. On July 23, 2020, the Trust announced that there would be no cash distribution in August 2020 with respect to production for the three-month period from March 1, 2020 to May 31, 2020. See “Distribution to Unitholders” in Note 6 to the unaudited interim financial statements contained in Part I, Item 1 of this Quarterly Report for additional discussion of this future distribution. See also “Overview—Commodity Price Volatility; COVID-19 Pandemic” for discussion of the effects of continued low oil, NGL and natural gas prices on cash available for distribution to unitholders in future periods. In addition, as discussed above under “Overview—Early Termination of the Trust,” subject to the final terms of the sale of the Royalty Interests, including the effective date and the timing of the closing of the anticipated sale, the Trust currently expects that there will be no further regular quarterly distributions to Trust unitholders reflecting quarterly revenues generated from the Underlying Properties.
As the Trust cannot acquire or cause additional wells to be drilled on its behalf, the Trust’s production is expected to decline each quarter during the remainder of its life.
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk
As a “smaller reporting company” as defined in Item 10 of Regulation S-K, the Trust is not required to provide information required by this Item.
ITEM 4. Controls and Procedures
Disclosure Controls and Procedures
The Trustee conducted an evaluation of the Trust’s 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 SEC’s 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 Trustee’s 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 Trust’s 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 Trust’s independent reserve engineers.
Changes in Internal Control Over Financial Reporting
There were no changes in the Trust’s internal control over financial reporting during the quarter ended June 30, 2020, that have materially affected, or are reasonably likely to materially affect, the Trustee’s 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.
PART II. Other Information
ITEM 1. Legal Proceedings
At times, the Trust may be involved in various lawsuits, claims and proceedings which are handled and defended in the ordinary course of business. The Trust may incur expenses in defending the litigation, and any such expenses may increase the Trust’s administrative expenses significantly. However, the Trust is entitled to contractual indemnification covering reasonable costs of investigation and attorney’s fees and expenses that the Trust believes will be applicable. The Trust will estimate and, if the Trustee deems it appropriate, begin reserving funds 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.
ITEM 1A. Risk Factors
Except as provided below, there have been no material changes to the risk factors contained in Item 1A of the 2019 Form 10-K.
The COVID-19 pandemic could materially adversely affect proceeds to the Trust and cash distributions to unitholders.
The recent outbreak of the novel form of coronavirus known as COVID-19 and its development into a global pandemic is negatively impacting worldwide economic and commercial activity and financial markets, as well as global demand for crude oil, NGL and natural gas. The economic effects of the COVID-19 pandemic, combined with the dispute over production levels between Russia and the members of the Organization of Petroleum Exporting Countries (“OPEC”), which resulted in an oversupply of crude oil and exacerbated the decline in crude oil prices, have created uncertainty in the oil industry and led to an immediate and steep decrease in oil prices, which reached a closing NYMEX price low of negative $37.63 per barrel of crude oil in April 2020. The West Texas Intermediate spot price of crude oil has declined from $61.18 per barrel on January 2, 2020 to $42.06 per barrel on August 6, 2020. The responses by federal, state and local governmental authorities to the pandemic have also resulted in significant business and operational disruptions, including business closures, supply chains disruptions, travel restrictions, stay-at-home orders and limitations on the availability of workforces. The full impact of COVID-19 is unknown and is rapidly evolving. The extent to which COVID-19 negatively impacts SandRidge or any third-party operator of the Underlying Properties will depend on the severity, location and duration of the effects and spread of COVID-19, the actions undertaken by federal, state and local governments and health officials to contain the virus or treat its effects, and how quickly and to what extent economic conditions improve and normal business and operating conditions resume. A prolonged period of low crude oil, NGL and natural gas prices will adversely affect SandRidge or third-party operators of the Underlying Properties. If commodity prices for crude oil, NGL and natural gas remain at reduced levels, quarterly cash distributions to unitholders will be substantially lower than historical distributions, and in certain periods there may be no distribution to unitholders. Continued low oil and natural gas prices may ultimately reduce the amount of oil and natural gas that is economically viable to produce from the Underlying Properties. As a result, SandRidge or any third-party operator of any of the Underlying Properties could determine during periods of low commodity prices to shut-in or curtail production from wells on the Underlying Properties, or even plug and abandon marginal wells that otherwise may have been allowed to continue to produce for a longer period under conditions of higher prices. Specifically, SandRidge or any third-party operator may abandon any well or property if it reasonably believes that the well or property can no longer produce oil or natural gas in commercially paying quantities, which could result in termination of the portion of the Royalty Interest relating to the abandoned well, and SandRidge would have no obligation to drill a replacement well. Continued low commodity prices for crude oil, NGL and natural gas also could diminish the value of the Royalty Interests, which would reduce the amount of proceeds the Trust would receive from a sale of the Trust’s assets in connection with the early termination of the Trust.
To the extent COVID-19 adversely affects production from the Underlying Properties or SandRidge’s business, results of operations and financial condition, it may also have the effect of heightening many of the other risks described in the Trust’s 2019 Form 10-K.
The ability or willingness of OPEC and other oil exporting nations to set and maintain production levels has a significant impact on oil and natural gas commodity prices, which could reduce the amount of cash available for distribution to Trust unitholders.
OPEC is an intergovernmental organization that seeks to manage the price and supply of oil on the global energy market. Actions taken by OPEC members, including those taken alongside other oil exporting nations, have a significant impact on global oil supply and pricing. For example, OPEC and certain other oil exporting nations have previously agreed to take measures, including production cuts, to support crude oil prices. In March 2020, members of OPEC and Russia considered extending and potentially increasing these oil production cuts. However, those negotiations were unsuccessful. As a result, Saudi Arabia announced an immediate reduction in export prices and Russia announced that all previously agreed upon oil production cuts would expire on April 1, 2020. These actions led to an immediate and steep decrease in oil prices, which reached a closing NYMEX price low of negative $37.63 per barrel of crude oil in April 2020. There can be no assurance that OPEC members and other oil exporting nations will agree to future production cuts or other actions to support and stabilize oil prices, nor can there be any assurance that they will not further reduce oil prices or increase production. Uncertainty regarding future actions to be taken by OPEC members or other oil exporting countries could lead to increased volatility in the price of oil, which could adversely affect the financial condition and economic performance of the operators of the underlying properties and may reduce the net proceeds to which the Trust is entitled, which could materially reduce or completely eliminate the amount of cash available for distribution to Trust unitholders.
ITEM 6. Exhibits
The following exhibits are filed or furnished as part of this Quarterly Report:
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| | Incorporated by Reference | | | | | | | | |
Exhibit No. | Exhibit Description | Form | | SEC File No. | | Exhibit | | Filing Date | | Filed or Furnished Herewith |
| 3.1 |
| S-1
| | 333-178894
| | 3.1 | | 01/05/2012
| | |
| 3.2 |
| 8-K
| | 001-35508
| | 4.1 | | 04/24/2012
| | |
| 3.3 |
| 10-Q
| | 001-35508
| | 3.4 | | 08/13/2012
| | |
| 31.1 | | | | | | | | | | * |
| 32.1 | | | | | | | | | | * |
| | | | | | | | | | |
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 | | |
| | | Sarah Newell | | |
| | | Vice President | | |
Date: August 13, 2020 | | | | | |
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.