Hugoton Royalty Trust: Form 10-Q for the period ended Jun 30, 2024

The following discussion should be read in conjunction with the Trustee’s discussion and analysis contained in the Trust’s 2023 Annual Report on Form 10-K, as well as the condensed financial statements and notes thereto included in this Quarterly Report on Form 10-Q. The Trust’s Annual Report on Form 10-K, Quarterly Reports on Form 10‑Q, Current Reports on Form 8-K and all amendments to those reports are available on the Trust’s website at www.hgt-hugoton.com (http://www.hgt-hugoton.com).

Distributable Income

Quarter

For the quarter ended June 30, 2024, net profits income was $0 compared to $1,008,161 for second quarter 2023. This was primarily the result of lower gas prices ($3.2 million) and decreased gas production ($0.8 million), partially offset by net excess costs activity ($1.8 million), decreased taxes, transportation and other costs ($0.7 million), increased oil production ($0.2 million), higher oil prices ($0.1 million), decreased development costs ($0.1 million), and decreased production expenses ($0.1 million). See “Net Profits Income” below.

After adding interest income of $1,832, deducting administration expense of $113,723, and utilizing $111,891 of the cash reserve for the payment of Trust expenses, distributable income for the quarter ended June 30, 2024, was $0 or $0.000000 per unit of beneficial interest. Administration expense for the quarter decreased $782 compared to the prior year quarter, primarily related to the timing of receipt and payment of Trust expenses and terms of professional services. Changes in interest income are attributable to fluctuations in net profits income, cash reserve and interest rates. For second quarter 2023, distributable income was $920,760 or $0.023019 per unit.

Distributions to unitholders for the quarter ended June 30, 2024, were:

Six Months

For the six months ended June 30, 2024, net profits income was $0 compared with $11,467,914 for the same 2023 period primarily due to lower gas prices ($15.6 million), decreased gas production ($1.6 million), increased production expenses ($0.5 million), increased overhead ($0.2 million), and lower oil prices ($0.1 million), partially offset by decreased taxes, transportation, and other costs ($2.7 million), net excess costs activity ($2.0 million), decreased development costs ($1.0 million), and increased oil production ($0.8 million). See “Net Profits Income” below.

After adding interest income of $6,510 and deducting administration expense of $342,146, distributable income for the six months ended June 30, 2024, was $0, or $0.000000 per unit of beneficial interest. Administration expense for the six months ended June 30, 2024, decreased $73,896 as compared to the same 2023 period, primarily related to the timing of receipt and payment of Trust expenses and terms of professional services. Changes in interest income are attributable to fluctuations in net profits income, cash reserve and interest rates. For the six months ended June 30, 2023, distributable income was $11,096,520 or $0.277413 per unit.

Net Profits Income

Net profits income is recorded when received by the Trust, which is the month following receipt by XTO Energy, and generally two months after oil and gas production. Net profits income is generally affected by three major factors:

1. oil and gas sales volumes,

2. oil and gas sales prices, and

3. costs deducted in the calculation of net profits income.

The following is a summary of the calculation of net profits income received by the Trust:

(a) Because of the two-month interval between time of production and receipt of net profits income by the Trust, (1) gas and oil sales for the quarter ended June 30 generally represent production for the period February through April and (2) gas and oil sales for the six months ended June 30 generally represent production for the period November through April.

(b) Gas and oil sales volumes are allocated to the net profits interests by dividing Trust net cash inflows by average sales prices. As gas and oil prices change, the Trust’s allocated production volumes are impacted as the quantity of production necessary to cover expenses changes inversely with price. As such, the underlying property production volume changes may not correlate with the Trust’s allocated production volumes in any given period. Therefore, comparative discussion of gas and oil sales volumes is based on the underlying properties.

(c) See Note 4 to Condensed Financial Statements.

The following are explanations of significant variances on the underlying properties from second quarter 2023 to second quarter 2024 and from the first six months of 2023 to the comparable period in 2024:

Sales Volumes

Gas

Gas sales volumes decreased 17 percent for second quarter 2024 and decreased 14 percent for the six-month period as compared with the same 2023 periods primarily because of timing of cash receipts and natural production decline, partially offset by gas sales from new wells in Major County, Oklahoma.

Oil

Oil sales volumes increased nine percent for second quarter 2024 and increased 17 percent for the six-month period as compared with the same 2023 periods primarily because of oil sales from new wells in Major County, Oklahoma, partially offset by timing of cash receipts and natural production decline.

The estimated rate of natural production decline on the underlying oil and gas properties is approximately six to eight percent a year.

Sales Prices

Gas

The second quarter 2024 average gas price was $2.38 per Mcf, a 42 percent decrease from the second quarter 2023 average gas price of $4.10 per Mcf. For the six-month period, the average gas price decreased 57 percent to $3.12 per Mcf in 2024 from $7.34 per Mcf in 2023.

Oil

The second quarter 2024 average oil price was $76.59 per Bbl, a four percent increase from the second quarter 2023 average oil price of $73.91 per Bbl. The year-to-date average oil price decreased three percent to $74.16 per Bbl in 2024 from $76.54 per Bbl in 2023.

Costs

Taxes, Transportation and Other

Taxes, transportation and other costs decreased 33 percent for second quarter 2024 and decreased 45 percent for the six-month period as compared with the same 2023 periods primarily because of decreased gas production taxes and gas deductions due to lower revenues.

Production Expense

Production expense decreased one percent for second quarter 2024 primarily because of decreased repairs and maintenance costs, partially offset by increased labor costs, pipeline costs, and plug and abandonment expenses. Production expense increased six percent for the six-month period as compared with the same 2023 periods primarily because of increased labor costs, plug and abandonment expenses, and pipeline costs, partially offset by decreased repairs and maintenance costs and field costs.

Development Costs

Development costs decreased 10 percent for second quarter 2024 and decreased 50 percent for the six-month period primarily due to the timing of drilling costs related to non-operated wells in Major County, Oklahoma. Changes in oil or natural gas prices could impact future development plans on the underlying properties.

As previously disclosed, XTO Energy advised the Trustee that it elected to participate in the development of four non-operated wells in Major County, Oklahoma. XTO Energy advised the Trustee that the total development costs for the four non-operated wells was anticipated to be approximately $10 million underlying ($8 million net to the Trust). Two wells were completed in second quarter of 2023, the third was completed in fourth quarter 2023, and the fourth was completed in first quarter 2024. No assurances can be made as to the estimated costs of the non-operated wells or timing of receipt of costs for completing the wells.

Overhead

Overhead decreased one percent for second quarter 2024 and increased four percent for the six-month period. Overhead is charged by XTO Energy and other operators for administrative expenses incurred to support operations of the underlying properties. Overhead fluctuates based on changes in the active well count and drilling activity on the underlying properties, as well as an annual cost level adjustment based on an industry index.

Excess Costs

If monthly costs exceed revenues for any conveyance, these excess costs must be recovered, with accrued interest, from future net proceeds of that conveyance and cannot reduce net profits income from another conveyance. Underlying cumulative excess costs for the Kansas, Oklahoma and Wyoming conveyances remaining as of June 30, 2024, totaled $8.0 million ($6.4 million net to the Trust), including accrued interest of $0.5 million ($0.4 million net to the Trust). For further information on excess costs, see Note 4 to Condensed Financial Statements.

Contingencies

For information on contingencies, see Note 3 to Condensed Financial Statements.

Forward-Looking Statements

Certain information included in this Quarterly Report and other materials filed, or to be filed, by the Trust with the Securities and Exchange Commission (as well as information included in oral statements or other written statements made or to be made by XTO Energy or the Trustee) contain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended, relating to the Trust, operations of the underlying properties and the oil and gas industry. Such forward-looking statements may concern, among other things, excess costs, continuation of the Trust as a going-concern, or alternatives to a going-concern, reserve-to-production ratios, future production, development activities and associated operating expenses, future development plans by area, increased density drilling, maintenance projects, development, production, regulatory and other costs, oil and gas prices and expectations for future demand, the impact of inflation and economic downturns on economic activity, government policy and its impact on oil and gas prices and future demand, the development and competitiveness of alternative energy sources, pricing differentials, proved reserves, future net cash flows, production levels, expense reserve budgets, availability of financing, arbitration, litigation, liquidity, financing, political and regulatory matters, such as tax and environmental policy, climate policy, trade barriers, sanctions, competition, war and other political or security disturbances. Such forward-looking statements are based on XTO Energy’s and the Trustee’s current plans, expectations, assumptions, projections and estimates and are identified by words such as “may,” “intends,” “plans,” “anticipates,” “believes,” “estimates,” “should,” “could,” “would,” and similar words that convey the uncertainty of future events. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict, including those detailed in Part I, Item 1A of the Trust’s Annual Report on Form 10-K for the year ended December 31, 2023, which is incorporated by this reference as though fully set forth herein. Therefore, actual financial and operational results may differ materially from expectations, estimates or assumptions expressed in, implied in, or forecasted in such forward-looking statements. XTO Energy and the Trustee assume no duty to update these statements as of any future date.

As of the end of the period covered by this report, the Trustee carried out an evaluation of the effectiveness of the Trust’s disclosure controls and procedures pursuant to Exchange Act Rules 13a-15 and 15d-15. Based upon that evaluation, the Trustee concluded that the Trust’s disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Trust in the reports that it files or submits under the Securities Exchange Act of 1934 and are effective in ensuring that information required to be disclosed by the Trust in the reports that it files or submits under the Securities Exchange Act of 1934 is accumulated and communicated to the Trustee to allow timely decisions regarding required disclosure. In its evaluation of disclosure controls and procedures, the Trustee has relied, to the extent considered reasonable, on information provided by XTO Energy. There has not been any change in the Trust’s internal control over financial reporting during the period covered by this report that has materially affected, or is reasonably likely to materially affect, the Trust’s internal control over financial reporting.

Except as set forth below, there have been no material changes in the risk factors disclosed under Part I, Item 1A of the Trust’s Annual Report on Form 10-K for the year ended December 31, 2023.

The Trust may not have sufficient cash to meet its obligations during the one-year period after the date that the financial statements are issued and intends to review alternatives to the Trust continuing as a going concern.

All three of the Trust’s conveyances are in excess costs resulting in no net proceeds to the Trust and a reduction in the Trust’s expense reserve, which have resulted in no unitholder distributions since July 2023. These conditions raise substantial doubt about the Trust’s ability to continue as a going concern as the Trust does not have sufficient cash to meet its obligations during the one-year period after the date the financial statements are issued. The Trust’s financial statements do not include any adjustments that might result from the outcome of this uncertainty. Pursuant to the Settlement Agreement, XTO Energy has advanced $500,000 to the Trust (which may be recouped, together with interest from what would otherwise be distributable net profits under any of the three conveyances; provided, however, that such recoupment does not leave the Trust with less than $250,000 of available cash). There are no assurances that even with such advance, the Trust will receive net profits income sufficient to pay its obligations during the one-year period after the date the financial statements are issued. The Trustee currently believes that financing is unlikely to be a viable option for the Trust moving forward. Nothing in the Trust Indenture obligates the Trustee to pay for the Trust’s expenses if the Trust’s cash reserves were to be completely depleted. As a result, the Trustee intends to review options for the Trust, which may include alternatives to the Trust continuing as a going concern such as seeking to terminate the Trust or marketing the Trust’s interests (which are Net Profits Interests burdened by excess costs) for a potential sale. If the Trust is unable to continue as a going concern, unitholders could incur significant losses on their investment in the Trust or lose their entire investment in the Trust altogether. For further information see Notes to Condensed Financial Statements - 1. Basis of Accounting – Liquidity and Going Concern.