Business Context and Reporting Period
Company: North European Oil Royalty Trust (a passive fixed investment trust)
Reporting Period: Quarterly period ended July 31, 2017 (Fiscal Q3 2017) and the nine months ended July 31, 2017.
Business Model: The Trust holds overriding royalty rights on gas, sulfur, and oil production in the Federal Republic of Germany, primarily from the Oldenburg concession. It receives royalties from operating subsidiaries of ExxonMobil and Royal Dutch/Shell, pays expenses, and distributes net funds to unit owners. The Trust does not engage in extractive operations.
Key Financial Metrics
| Metric | Q3 2017 | Q3 2016 | 9 Months 2017 | 9 Months 2016 |
|---|---|---|---|---|
| Total Royalty Income | $1,974,441 | $1,561,026 | $5,617,957 | $5,727,167 |
| Net Income | $1,840,694 | $1,388,796 | $5,015,620 | $5,062,847 |
| Net Income Per Unit | $0.20 | $0.15 | $0.55 | $0.55 |
| Distributions Per Unit | $0.20 | $0.15 | $0.54 | $0.55 |
| Total Expenses | $134,977 | $173,434 | $605,143 | $668,319 |
| Cash and Equivalents (End of Period) | $1,953,295 | $1,165,347 | $1,953,295 | $1,465,641 |
| Units Outstanding | 9,190,590 | 9,190,590 | 9,190,590 | 9,190,590 |
Liquidity: The Trust holds no debt. Cash increased by $787,948 during the nine-month period. Undistributed earnings at July 31, 2017, were $115,177.
Material Changes vs. Prior Period
- Quarterly Performance (Q3): Net income increased 32.54% and royalty income increased 26.48% compared to Q3 2016. This growth was driven by higher gas sales volumes (+11.88% under Mobil Agreement) and higher gas prices (+13.30%). Q3 2016 results were negatively impacted by $407,560 in prior period accounting adjustments, which did not occur in Q3 2017.
- Nine-Month Performance: Net income decreased slightly (-0.93%) and royalty income decreased (-1.91%) compared to the prior nine-month period. This decline was due to lower gas sales volumes, lower gas prices, and a weaker average Euro exchange rate. However, the decline was mitigated by the absence of the negative $369,580 accounting adjustment that impacted the prior year's nine-month results.
- Expense Reduction: Trust expenses decreased 22.17% in Q3 and 9.45% for the nine months. This was primarily due to the absence of biennial accounting examination costs (2017 is an alternate year) and reduced legal fees following the completion of pricing method examinations.
- Sulfur Royalties: No sulfur royalties were received in Q3 2017 as the selling price dropped below the base price. For the nine months, sulfur royalties totaled $84,405, compared to a net negative of $127,370 in the prior year due to error corrections.
Outlook, Risks, and Management Commentary
- Operational Changes: Vermilion Energy Inc. entered a Farm-In Agreement in 2016 and is committed to drilling 11 exploratory wells over five years, three of which are in areas subject to the Trust's royalties. The first well is expected to start in 2020. The Trust's royalty interest is not impacted by Vermilion's participation.
- Pricing Methodology: In August 2016, the Trust amended agreements to use the German Border Import gas Price (GBIP) as the base for royalty calculations, intended to be revenue neutral and reduce disputes. For 2016 and forward, the average GBIP is increased by 1% (Mobil) and 3% (OEG).
- Production Capacity: The Grossenkneten desulfurization plant capacity will be reduced in 2017 to promote efficiency, though operators state this will not impact current production levels. No major maintenance shutdown is planned for 2018.
- Risks: Key risks include fluctuations in gas production levels and prices, general economic conditions, currency exchange rates (Euro to USD), and the ability of operating companies to perform contractual obligations. The Trust does not hedge against foreign exchange or commodity price risks.
- Accounting Basis: Financial statements are prepared on a modified cash basis. Revenue is recognized when cash is received.
Investor Verification Checklist
- Gas Price Trends: Verify current German Border Import gas Prices (GBIP) and their impact on future royalty calculations.
- Exchange Rates: Monitor the Euro to U.S. Dollar exchange rate, as royalties are paid in Euros and converted immediately.
- Drilling Activity: Track Vermilion Energy's progress on the 11 exploratory wells, specifically the three within the Trust's royalty areas, to assess potential future production increases.
- Sulfur Pricing: Monitor sulfur selling prices relative to the agreed base price to determine eligibility for sulfur royalties.
- Biennial Audits: Note that 2017 is an alternate year for the biennial examination of royalty statements by German accountants; the next examination is scheduled for November 2017 covering 2015 and 2016.