OVERVIEW
You should read the following discussion in conjunction with Part II, Item 8.
"Financial Statements and Supplementary Data" and Part I, Items 1. and 2.
"Business and Properties" of this Form 10-K. The results of operations reported
and summarized below are not necessarily indicative of future operating results.
Unless otherwise specified, all references to "Notes" refer to Notes to
Financial Statements located in Part II, Item 8. "Financial Statements and
Supplementary Data" of this Form 10-K. A glossary of definitions for some of the
oil and gas industry terms used in this Form 10-K is provided beginning on page
49. Additionally, please refer to the section above entitled "Forward-Looking
Statements" in this Form 10-K. The information below has been furnished to the
Trustee by Highlander Oil & Gas Assets LLC (HOGA).
On June 3, 2013, Freeport-McMoRan Inc. (FCX) and McMoRan Exploration Co. (MMR)
completed the transactions contemplated by the Agreement and Plan of Merger,
dated as of December 5, 2012 (the merger agreement), by and among MMR, FCX, and
INAVN Corp., a Delaware corporation and indirect wholly owned subsidiary of FCX
(Merger Sub). Pursuant to the merger agreement, Merger Sub merged with and into
MMR, with MMR surviving the merger as an indirect wholly owned subsidiary of FCX
(the merger).
FCX's oil and gas assets are held through its wholly owned subsidiary, FCX Oil &
Gas LLC (FM O&G). As a result of the merger, MMR and McMoRan are both indirect
wholly owned subsidiaries of FM O&G.
The Royalty Trust is a statutory trust created as contemplated by the merger
agreement by FCX under the Delaware Statutory Trust Act pursuant to a trust
agreement entered into on December 18, 2012 (inception), by and among FCX, as
depositor, Wilmington Trust, National Association, as Delaware trustee, and
certain officers of FCX, as regular trustees. On May 29, 2013, Wilmington Trust,
National Association, was replaced by BNY Trust of Delaware, as Delaware trustee
(the Delaware Trustee), through an action of the depositor. Effective June 3,
2013, the regular trustees were replaced by The Bank of New York Mellon Trust
Company, N.A., a national banking association, as trustee (the Trustee).
The Royalty Trust was created to hold a 5% gross overriding royalty interest
(collectively, the overriding royalty interests) in future production from each
of McMoRan's Inboard Lower Tertiary/Cretaceous exploration prospects located in
the shallow waters of the Gulf of Mexico and onshore in South Louisiana that
existed as of December 5, 2012, the date of the merger agreement (collectively,
the subject interests). The subject interests were "carved out" of the mineral
interests acquired by FCX pursuant to the merger and were not considered part of
FCX's purchase consideration of MMR. McMoRan has informed the Trustee that it
has no plans to pursue, has relinquished, has allowed to expire or has sold all
of its subject interests.
In connection with the merger, on June 3, 2013, (1) FCX, as depositor, McMoRan
Oil & Gas LLC (McMoRan), as grantor, the Trustee and the Delaware Trustee
entered into the amended and restated royalty trust agreement to govern the
Royalty Trust and the respective rights and obligations of FCX, the Trustee, the
Delaware Trustee, and the Royalty Trust unitholders with respect to the Royalty
Trust (the royalty trust agreement); and (2) McMoRan, as grantor, and the
Royalty Trust, as grantee, entered into the master conveyance of overriding
royalty interests (the master conveyance) pursuant to which McMoRan conveyed to
the Royalty Trust the overriding royalty interests in future production from the
subject interests. Other than (a) its formation, (b) its receipt of
contributions and loans from FCX for administrative and other expenses as
provided for in the royalty trust agreement, (c) its payment of such
administrative and other expenses, (d) its repayment of loans from FCX, (e) its
receipt of the conveyance of the overriding royalty interests from McMoRan
pursuant to the master conveyance, (f) its receipt of royalties from McMoRan or
HOGA, and (g) its cash distributions to unitholders, if any, the Royalty Trust
has not conducted any activities. The Trustee has no involvement with, control
over, or responsibility for, any aspect of any operations on or relating to the
subject interests.
On February 5, 2019, McMoRan completed the sale of all of its rights, title and
interest in and to the onshore Highlander subject interest pursuant to a
purchase and sale agreement with Highlander Oil & Gas Assets LLC (HOGA) (the
Highlander Sale). The onshore Highlander subject interest was sold subject to
the overriding royalty interest in future production held by the Royalty Trust.
As a result of the Highlander Sale, HOGA has a 72 percent working interest and
an approximate 48 percent net revenue interest in the onshore Highlander subject
interest. The Royalty Trust continues to hold a 3.6 percent overriding royalty
interest in the onshore Highlander subject interest. McMoRan was
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the operator of the onshore Highlander subject interest through May 31, 2019.
HOGA qualified and was designated as the operator on June 1, 2019.
Currently, only the onshore Highlander subject interest has any reserves
classified as proved, probable or possible and has established commercial
production. The Royalty Trust has no ability to direct or influence the
exploration or development of the subject interests. In addition, none of FCX,
McMoRan or HOGA is under any obligation to fund or to commit any other resources
to the exploration or development of the subject interests. To the extent that
HOGA does not fund further exploration and development of the onshore Highlander
subject interest, or if for any other reason sufficient production from the
onshore Highlander subject interest is not maintained in commercial quantities,
Royalty Trust unitholders will not realize any additional value from their
investment in the royalty trust units.
The royalty trust units are quoted on the OTC Pink tier of the OTC markets. The
OTC Pink is a significantly more limited market than the national securities
exchanges, which could adversely affect the market price, trading volume,
liquidity and resale price of the royalty trust units.
For information regarding the OTC Pink, see Part I, Item IA. "Risk Factors -
There is a limited public market for the royalty trust units, which could affect
the market price, trading volume and resale price of the royalty trust units" of
this Form 10-K.
North American Natural Gas and Crude Oil Market Prices
Market prices for natural gas and crude oil can fluctuate significantly. During
the period from January 2010 through December 31, 2019, the NYMEX natural gas
price fluctuated from a low of $1.61 per MMBtu in 2016 to a high of $6.49 per
MMBtu in 2014. During 2019, the NYMEX natural gas price fluctuated from a low of
$2.03 per MMBtu to a high of $3.72 per MMBtu. On December 31, 2019, the NYMEX
natural gas price was $2.19 per MMBtu. Natural gas prices have declined sharply
during the first quarter of 2020, and could decline further, due to current
economic conditions. On March 18, 2020, the NYMEX natural gas price was $1.60
per MMBtu. Crude oil and natural gas prices are affected by numerous factors
beyond either McMoRan's or HOGA's control as described further in Part I, Item
1A. "Risk Factors" of this Form 10-K.
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The following graph presents the NYMEX natural gas prices from January 2009
through December 31, 2019.
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OPERATIONAL ACTIVITIES
Oil and Gas Activities
For additional information regarding McMoRan's and HOGA's current oil and gas
activities in relation to the subject interests, see Part I, Items 1. and 2.
"Business and Properties - The Subject Interests - Exploratory and Development
Drilling" and Part I, Item 1A. "Risk Factors" of this Form 10-K.
Production
For information regarding McMoRan's and HOGA's production, see "Results of
Operations" in this section of this Form 10-K.
Acreage Position
For information regarding McMoRan's and HOGA's acreage position, see Part I,
Items 1. and 2. "Business and Properties - The Subject Interests - Acreage" of
this Form 10-K.
RESULTS OF OPERATIONS
Royalty Income. The onshore Highlander subject interest began commercial
production on February 25, 2015. Prior to this date there had been no commercial
production of hydrocarbons from any of the subject interests. As of December 31,
2019, only the onshore Highlander subject interest had established commercial
production. During the year ended December 31, 2019, the Royalty Trust received
royalties of $1,386,064 from McMoRan and HOGA related to 582,484 Mcf of natural
gas production attributable to the onshore Highlander subject interest with
average post-production costs of $0.33 per Mcf and an average receipt price of
$2.71 per Mcf. During the year ended December 31, 2018, the Royalty Trust
received royalties of $1,462,796 from McMoRan related to 576,120 Mcf of natural
gas production attributable to the onshore Highlander subject interest with
average post-production costs of $0.31 per Mcf and an average receipt price of
$2.85 per Mcf. Lower royalty income in 2019 as compared to 2018 is primarily due
to lower natural gas prices during 2019, partially offset by increased
production from the installation of a second pipeline from the onshore
Highlander subject interest allowing for higher production volumes.
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Administrative Expenses. For the years ended December 31, 2019 and 2018, the
Royalty Trust paid administrative expenses of $588,987 and $630,551,
respectively. Administrative expenses, which consisted primarily of audit, legal
and trustee expenses incurred in connection with the administration of the
Royalty Trust, were lower in 2019 as compared to 2018 primarily because of the
timing of payments for professional fees.
LIQUIDITY AND CAPITAL RESOURCES
Pursuant to the royalty trust agreement, FCX has agreed to pay annual trust
expenses up to $350,000, with no right of repayment or interest due, to the
extent the Royalty Trust lacks sufficient funds to pay administrative expenses.
No such contributions were made during the years ended December 31, 2019 or
2018. In addition to such annual contributions, FCX has agreed to lend money, on
an unsecured, interest-free basis, to the Royalty Trust to fund the Royalty
Trust's ordinary administrative expenses as set forth in the royalty trust
agreement. All funds the Trustee borrows to cover expenses or liabilities,
whether from FCX or from any other source, must be repaid before the Royalty
Trust unitholders will receive any distributions. No loans or repayments were
made during the years ended December 31, 2019 or 2018.
Pursuant to the royalty trust agreement, FCX also agreed to provide and maintain
a $1.0 million stand-by reserve account or an equivalent letter of credit for
the benefit of the Royalty Trust to enable the Trustee to draw on such reserve
account or letter of credit to pay obligations of the Royalty Trust if its funds
are inadequate to pay its obligations at any time. Currently, with the consent
of the Trustee, FCX may reduce the reserve account or substitute a letter of
credit with a different face amount for the original letter of credit or any
substitute letter of credit. In connection with this arrangement, FCX has
provided $1.0 million in the form of a reserve fund cash account to the Royalty
Trust. As of December 31, 2019, the Royalty Trust had not drawn any funds from
the reserve account, and FCX had not requested a reduction of such reserve
account.
In connection with the completion of the Highlander Sale, HOGA assumed all
administrative and reporting responsibilities with respect to the Royalty Trust,
including those described in Article III of the royalty trust agreement.
As of December 31, 2019, only the onshore Highlander subject interest had
established commercial production. Royalties are paid to the Royalty Trust on
the last day of the month following the month in which production payments are
received by McMoRan or HOGA in accordance with the terms of the master
conveyance. In accordance with the master conveyance, the Royalty Trust received
royalties from McMoRan and HOGA of $1,386,064 and $1,462,796 during the years
ended December 31, 2019 and 2018, respectively, due to production from the
onshore Highlander subject interest.
Royalties received by the Royalty Trust must first be used to (i) satisfy
Royalty Trust administrative expenses and (ii) reduce Royalty Trust
indebtedness. The Royalty Trust had no indebtedness outstanding as of
December 31, 2019. Additionally, the Trustee has established a minimum cash
reserve of $250,000. As a result, distributions will be made to Royalty Trust
unitholders only when royalties received less administrative expenses incurred
and repayment of any indebtedness exceeds the $250,000 minimum cash reserve.
Distributable income totaled $806,028 and $838,155 for the years ended
December 31, 2019 and 2018. On January 17, 2020, the Royalty Trust declared a
cash distribution of $0.000705 per unit payable on February 13, 2020, to
unitholders of record on January 30, 2020. These distributions are not
necessarily indicative of future distributions. The Royalty Trust's only other
sources of liquidity are mandatory annual contributions, any loans and the
required standby reserve account or letter of credit from FCX. As a result, any
material adverse change in FCX's, McMoRan's or HOGA's financial condition or
results of operations could materially and adversely affect the Royalty Trust
and the underlying royalty trust units. See Part I, Item 1A. "Risk Factors" of
this Form 10-K for more information.
OFF- BALANCE SHEET ARRANGEMENTSThe Royalty Trust has no off-balance sheet arrangements. The Royalty Trust has
not guaranteed the debt of any other party, nor does the Royalty Trust have any
other arrangements or relationships with other entities that could potentially
result in unconsolidated debt, losses or contingent obligations.
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CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The financial statements of the Royalty Trust are prepared on the modified cash
basis of accounting and are not intended to present the Royalty Trust's
financial position and results of operations in conformity with GAAP. This other
comprehensive basis of accounting corresponds to the accounting permitted for
royalty trusts by the SEC.
The carrying value of the Royalty Trust's overriding royalty interests in the
subject interests (defined in Note 2 to the Notes to Financial Statements
located in Part II, Item 8. "Financial Statements and Supplementary Data" of
this Form 10-K) is amortized using the units of production method based on
estimated proved reserves, on an individual subject interest basis, once
production has been achieved for the respective subject interests. Such non-cash
amortization is charged directly to the Trust Corpus as royalties are received,
and does not affect distributable cash or the determination of distributable
cash per royalty trust unit.
The Royalty Trust evaluates the carrying values of the overriding royalty
interests in the subject interests for impairment if conditions indicate that
potential uncertainty exists regarding the Royalty Trust's ability to recover
its recorded amounts related to the overriding royalty interests. Indications of
potential impairment with respect to the overriding royalty interests can
include, among other things, subject interest lease expirations, reductions in
estimated reserve quantities or resource potential, changes in estimated future
oil and gas prices, exploration costs, and/or drilling plans, and other matters
that arise that could negatively impact the carrying values of the overriding
royalty interests. If an impairment event occurs and it is determined that the
carrying value of the Royalty Trust's overriding royalty interests in the
subject interests may not be recoverable, an impairment will be recognized as
measured by the amount by which the carrying amount of the overriding royalty
interests in the subject interests exceeds the fair value of these assets, which
would be measured by discounting projected cash flows. The related impairment
amounts are recorded as a reduction to the overriding royalty interests with an
offsetting reduction to the Trust Corpus in the period such impairment is
determined, see Note 3. No impairment charges were recorded during the years
ended December 31, 2019 and 2018.
NEW ACCOUNTING STANDARDSThe Royalty Trust does not expect recently issued accounting standards to have a
significant impact on its future financial statements and disclosures.
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GULF COAST ULTRA DEEP ROYALTY TRUST 
