Business Context and Reporting Period
Company: PermRock Royalty Trust (a Delaware statutory trust)
Reporting Period: Quarterly period ended June 30, 2018
Business Overview: The Trust holds an 80% Net Profits Interest in certain oil and natural gas properties (the "Underlying Properties") located in the Permian Basin, Texas. The Trust is passive; Boaz Energy II, LLC operates the properties and conveys 80% of net proceeds to the Trust. The Trust distributes all cash receipts, less administrative expenses and reserves, to unitholders monthly.
Capital Structure: As of August 14, 2018, 12,165,732 trust units were outstanding. Boaz Energy owns approximately 48.6% of the units (5,915,732 units).
Key Financial Metrics
| Metric | Three Months Ended June 30, 2018 | Six Months Ended June 30, 2018 |
|---|---|---|
| Net Profits Income | $7,932,940 | $7,932,940 |
| Total Income | $7,935,911 | $7,935,911 |
| Administration Expenses | $(264,370) | $(264,370) |
| Distributable Income | $7,671,541 | $7,671,541 |
| Distributable Income Per Unit | $0.630584 | $0.630584 |
| Cash and Short-Term Investments | $1,383,689 (as of June 30, 2018) | |
| Net Profits Interest Asset | $93,157,997 (as of June 30, 2018) | |
| Debt | None reported; Trust relies on a $1.0M Letter of Credit from Boaz Energy for liquidity. |
Material Changes and Operational Highlights
- Initial Public Offering (IPO): The Trust completed its IPO in May 2018, selling 6,250,000 units. Boaz Energy received net proceeds of approximately $99.6 million. The Net Profits Interest was conveyed to the Trust effective January 1, 2018, but no income was recognized prior to May 2018.
- Production Volumes (Jan-April 2018): The income reported for the quarter reflects production from January through April 2018 due to settlement timing.
- Oil: 217,906 Bbls
- Gas: 224,364 Mcf
- Revenue Composition: Total revenues from the Underlying Properties were $14,255,131, with oil revenue comprising the majority ($13,304,398). Total costs (including severance tax, production expenses, and development costs) were $4,338,955.
- Capital Expenditures: Boaz Energy revised its 2018 capital budget for the Underlying Properties. Q2 actuals were $966,937, and the budget for the second half of 2018 was revised to $1.2 million to fund additional non-operated wells.
Guidance, Outlook, and Risks
Outlook and Hedging
Boaz Energy has hedged approximately 100% of expected oil production for the remainder of 2018 and 76% for 2019 using put option contracts.
- 2018 Hedge: Strike price of $60.00 per barrel (400,000 Bbls).
- 2019 Hedge: Strike price of $50.00 per barrel (480,000 Bbls).
Management Commentary
The Trustee noted that the Trust is an "emerging growth company" and will take advantage of reduced reporting requirements. The Trust's liquidity is supported by cash flows and a $1.0 million Letter of Credit from Boaz Energy, which covers administrative expenses until a cash reserve is established (scheduled to begin retention in May 2019).
Risk Factors
- Commodity Price Volatility: Distributions are highly sensitive to oil and natural gas prices. After 2019, the Trust will have no price protection.
- Depleting Assets: The Underlying Properties are depleting assets. The Trust cannot acquire new properties to replace production, meaning distributions will decline over time.
- Boaz Energy Internal Controls: Boaz Energy identified a material weakness in its internal control over financial reporting. While this did not impact the Trust's financial statements, the Trust relies on Boaz Energy for operational data.
- Passive Nature: Unitholders have no control over operations, development decisions, or the operator (Boaz Energy).
- Environmental and Regulatory: Operations are subject to stringent environmental laws, including potential methane emission regulations, which could increase costs.
Investor Verification Checklist
- Production vs. Revenue Timing: Verify that reported income reflects production from two months prior (e.g., Q2 2018 income reflects Jan-April production) due to settlement lags.
- Hedge Expiration: Confirm the lack of hedging protection after December 31, 2019, and assess exposure to spot price volatility.
- Capital Expenditure Impact: Monitor Boaz Energy's revised capital budget ($1.2M for H2 2018) and its impact on net profits, as development costs are deducted before distribution.
- Boaz Energy Financial Health: Review Boaz Energy's ability to fund operations and maintain the Letter of Credit, given the disclosed material weakness in their internal controls.
- Depletion Rate: Assess the projected decline rate of proved reserves (estimated at 7.8% annually if development is not pursued) to understand long-term distribution sustainability.