Business Context and Reporting Period
Company: VOC Energy Trust (VOC)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2011
Structure: VOC is a Delaware statutory trust formed in November 2010. It holds a term net profits interest (NPI) entitling it to 80% of the net proceeds from oil and natural gas properties in Kansas and Texas owned by VOC Brazos Energy Partners, L.P. The trust has no employees and is managed by The Bank of New York Mellon Trust Company, N.A. The trust units commenced trading on the NYSE on May 10, 2011.
Key Financial Metrics
| Metric | 2011 Value |
|---|---|
| Total Assets | $133,619,263 |
| Net Profits Income | $24,852,638 |
| Distributable Income | $24,140,000 |
| Distributions per Unit | $1.42 |
| General & Administrative Expenses | $415,491 |
| Proved Reserves (Trust Share) | 8,011 MBoe (7,312 MBbl Oil / 4,200 MMcf Gas) |
| Standardized Measure of Discounted Future Net Cash Flows | $258,274,125 |
| Units Outstanding | 17,000,000 |
Note: The trust reports on a modified cash basis. Income is recorded when distributions are received. The trust received no income in 2010 as the NPI conveyance occurred in May 2011.
Material Changes vs. Prior Period
- Revenue Recognition: The trust recognized $24.9 million in net profits income in 2011, compared to $0 in 2010. This reflects the commencement of operations following the May 10, 2011 conveyance of the net profits interest.
- Asset Base: Total assets increased from $1,000 in 2010 to $133.6 million in 2011, driven by the capitalization of the investment in the net profits interest ($140.6 million gross, less $7.3 million accumulated amortization).
- Reserve Changes: Proved reserves attributable to the trust decreased from 8,515 MBoe (as of Dec 31, 2010) to 8,011 MBoe (as of Dec 31, 2011). This decline was primarily due to production of 684 MBoe, partially offset by revisions and extensions of 180 MBoe.
- Underlying Property Performance: For the underlying properties (100% interest basis), the excess of revenues over direct operating expenses increased to $53.6 million in 2011 from $44.9 million in 2010. This was driven by higher average oil prices ($89.41/Bbl in 2011 vs. $73.71/Bbl in 2010), despite a decrease in oil volumes sold.
Guidance, Outlook, Risks, and Unusual Items
Outlook and Guidance
VOC Brazos does not provide public projections for future sales or earnings. However, based on reserve reports, annual production from the underlying properties is expected to decline at an average annual rate of 7.1% over the next 20 years without additional development. VOC Brazos expects to incur approximately $20.0 million in development expenditures through 2015 to offset natural decline.
Hedge Contracts
VOC Brazos has entered into fixed price swap contracts to hedge crude oil price risk through June 30, 2014. These contracts cover approximately 54% of expected oil production for 2011-2013. The weighted average hedge prices range from $99.01 to $102.15 per barrel. While these contracts stabilize cash flow during price drops, they limit upside potential if market prices exceed the fixed hedge price.
Risks and Contingencies
- Depleting Assets: The trust holds a finite life interest. It will terminate on the later of December 31, 2030, or when 10.6 MMBoe have been produced from the underlying properties. Distributions include a return of capital component.
- Commodity Price Volatility: Distributions are highly sensitive to oil and natural gas prices. Lower prices reduce net proceeds and may lead to the abandonment of marginal wells.
- Counterparty Risk: The trust relies on hedge counterparties to make payments. A default by a counterparty could materially reduce cash distributions.
- Bankruptcy Risk: In the event of VOC Brazos' bankruptcy, the trust's status as a secured creditor in Kansas is uncertain. If the conveyance is not deemed a fully vested real property interest, the trust could become an unsecured creditor.
- Environmental Regulation: Operations are subject to stringent environmental laws. Changes in regulations regarding hydraulic fracturing or greenhouse gas emissions could increase costs or restrict production.
Investor Verification Checklist
- Reserve Accuracy: Verify the independent reserve report by Cawley, Gillespie & Associates, Inc., as actual production may differ from estimates.
- Hedge Settlements: Monitor the settlement of hedge contracts, as payments made by VOC Brazos to counterparties reduce net proceeds available to the trust.
- Development Expenditures: Track VOC Brazos' capital expenditure program, as these costs are deducted from gross proceeds before the trust receives its 80% share.
- Production Decline: Assess the actual production decline rate against the projected 7.1% annual decline to evaluate future distribution sustainability.
- Related Party Transactions: Note that 38% of oil production was sold to MV Purchasing, LLC, an affiliate of VOC Brazos, in 2011.