Notes to Financial Statements (Unaudited)
(Prepared on a modified basis of cash receipts and disbursements)
September 30, 2017
(1) Formation
of the Trust and Organization
BP Prudhoe Bay Royalty Trust (the Trust), a grantor trust, was created as a Delaware business trust pursuant
to a Trust Agreement dated February 28, 1989 (the Trust Agreement) among The Standard Oil Company (Standard Oil), BP Exploration (Alaska) Inc. (BP Alaska), The Bank of New York Mellon, as trustee, and BNY
Mellon Trust of Delaware (successor to The Bank of New York (Delaware)), as
co-trustee.
Standard Oil and BP Alaska are indirect wholly-owned subsidiaries of BP p.l.c. (BP). On December 15,
2010, The Bank of New York Mellon resigned as trustee and was replaced by The Bank of New York Mellon Trust Company, N.A., a national banking association, as successor trustee (the Trustee).
On February 28, 1989, Standard Oil conveyed an overriding royalty interest (the Royalty Interest) to the Trust. The Trust was formed for the
sole purpose of owning and administering the Royalty Interest. The Royalty Interest represents the right to receive a per barrel royalty (the Per Barrel Royalty) of 16.4246% on the lesser of (a) the first 90,000 barrels of the
average actual daily net production of oil and condensate per quarter or (b) the average actual daily net production of oil and condensate per quarter from BP Alaskas working interests as of February 28, 1989 in the Prudhoe Bay field
situated on the North Slope of Alaska (the 1989 Working Interests). Trust Unit holders are subject to the risk that production will be interrupted or discontinued or fall, on average, below 90,000 barrels per day in any quarter. BP has
guaranteed the performance of BP Alaska of its payment obligations with respect to the Royalty Interest.
Effective January 1, 2000, BP Alaska and
all other Prudhoe Bay working interest owners cross-assigned interests in the Prudhoe Bay field pursuant to the Prudhoe Bay Unit Alignment Agreement. BP Alaska retained all rights, obligations, and liabilities associated with the Trust.
The trustees of the Trust are The Bank of New York Mellon Trust Company, N.A. and BNY Mellon Trust of Delaware, a Delaware banking corporation. BNY Mellon
Trust of Delaware serves as
co-trustee
in order to satisfy certain requirements of the Delaware Statutory Trust Act. The Bank of New York Mellon Trust Company, N.A. alone is able to exercise the rights and
powers granted to the Trustee in the Trust Agreement.
The Per Barrel Royalty in effect for any day is equal to the price of West Texas Intermediate crude
oil (the WTI Price) for that day less scheduled Chargeable Costs (adjusted for inflation) and Production Taxes (based on statutory rates then in effect).
The Trust is passive, with the Trustee having only such powers as are necessary for the collection and distribution of revenues, the payment of Trust
liabilities, and the protection of the Royalty Interest. The Trustee, subject to certain conditions, is obligated to establish cash reserves and borrow funds to pay liabilities of the Trust when they become due. The Trustee
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BP Prudhoe Bay Royalty Trust
Notes to Financial Statements (Unaudited)
(Prepared on a modified basis of cash receipts and disbursements)
September 30, 2017
may sell Trust properties only (a) as authorized by a vote of the Trust Unit holders, (b) when necessary to provide for the payment of specific liabilities of the Trust then due
(subject to certain conditions) or (c) upon termination of the Trust. Each Trust Unit issued and outstanding represents an equal undivided share of beneficial interest in the Trust. Royalty payments are received by the Trust and distributed to
Trust Unit holders, net of Trust expenses, in the month succeeding the end of each calendar quarter. The Trust will terminate (i) upon a vote of holders of not less than 60% of the outstanding Trust Units, or (ii) at such time the net
revenues from the Royalty Interest for two successive years are less than $1,000,000 per year (unless the net revenues during such period are materially and adversely affected by certain events).
In order to ensure that the Trust has the ability to pay future expenses, the Trust established a cash reserve account, which the Trustee believes is
sufficient to pay approximately one years current and expected liabilities and expenses of the Trust.
(2) Basis of Accounting
The financial statements of the Trust are prepared on a modified cash basis and reflect the Trusts assets, liabilities, corpus, earnings, and
distributions, as follows:
a.
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Revenues are recorded when received (generally within 15 days of the end of the preceding quarter) and distributions to Trust Unit holders are recorded when paid.
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b.
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Trust expenses (which include accounting, engineering, legal, and other professional fees, trustees fees, and
out-of-pocket
expenses)
are recorded on an accrual basis.
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c.
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Cash reserves may be established by the Trustee for certain contingencies that would not be recorded under generally accepted accounting principles.
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While these statements differ from financial statements prepared in accordance with accounting principles generally accepted in the United States of America,
the modified cash basis of reporting revenues and distributions is considered to be the most meaningful because quarterly distributions to the Trust Unit holders are based on net cash receipts. These modified cash basis financial statements are
unaudited but, in the opinion of the Trustee, include all adjustments necessary to present fairly the assets, liabilities and corpus of the Trust as of September 30, 2017 and December 31, 2016, and the modified cash basis of earnings and
distributions and changes in Trust corpus for the three and nine-month periods ended September 30, 2017 and 2016. The adjustments are of a normal recurring nature and are, in the opinion of the Trustee, necessary to fairly present the results
of operations.
As of September 30, 2017 and December 31, 2016, cash equivalents which represent the cash reserve consist of a Morgan Stanley
ILF Treasury Fund and U.S. Treasury Bills with original maturities of ninety days or less.
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BP Prudhoe Bay Royalty Trust
Notes to Financial Statements (Unaudited)
(Prepared on a modified basis of cash receipts and disbursements)
September 30, 2017
Estimates and assumptions are required to be made regarding assets, liabilities and changes in Trust corpus
resulting from operations when financial statements are prepared. Changes in the economic environment, financial markets and any other parameters used in determining these estimates could cause actual results to differ, and the differences could be
material.
These unaudited financial statements should be read in conjunction with the financial statements and related notes in the Trusts Annual
Report on Form
10-K
for the fiscal year ended December 31, 2016. The cash earnings and distributions for the interim periods presented are not necessarily indicative of the results to be expected for the
full year.
(3) Royalty Interest
At inception in
February 1989, the Royalty Interest held by the Trust had a carrying value of $535,000,000. In accordance with generally accepted accounting principles, the Trust amortized the value of the Royalty Interest based on the units of production method.
Such amortization was charged directly to the Trust corpus, and did not affect cash earnings. In addition, the Trust periodically evaluated impairment of the Royalty Interest by comparing the undiscounted cash flows expected to be realized from the
Royalty Interest to the carrying value, pursuant to the Financial Accounting Standards Board Accounting Standards Codification 360,
Property, Plant, and Equipment
. If the expected future undiscounted cash flows were less than the carrying
value, the Trust recognized impairment losses for the difference between the carrying value and the estimated fair value of the Royalty Interest. By December 31, 2010, the Trust had recognized accumulated amortization of $359,473,000 and
aggregate impairment write-downs of $175,527,000 reducing the carrying value of the Royalty Interest to zero.
(4) Income Taxes
The Trust files its federal tax return as a grantor trust subject to the provisions of subpart E of Part I of Subchapter J of the Internal Revenue Code of
1986, as amended, rather than as an association taxable as a corporation. The Trust Unit holders are treated as the owners of Trust income and corpus, and the entire taxable income of the Trust will be reported by the Trust Unit holders on their
respective tax returns.
If the Trust were determined to be an association taxable as a corporation, it would be treated as an entity taxable as a
corporation on the taxable income from the Royalty Interest, the Trust Unit holders would be treated as shareholders, and distributions to Trust Unit holders would not be deductible in computing the Trusts tax liability as an association.
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BP Prudhoe Bay Royalty Trust
Notes to Financial Statements (Unaudited)
(Prepared on a modified basis of cash receipts and disbursements)
September 30, 2017
(5) Alaska Oil and Gas Production Tax
On April 14, 2013, Alaskas legislature passed an
oil-tax
reform bill amending Alaskas oil and gas
production tax statutes, AS 43.55.10 et seq. (the Production Tax Statutes) with the aim of encouraging oil production and investment in Alaskas oil industry. On May 21, 2013, the Governor of Alaska signed the bill into law as
chapter 10 of the 2013 Session Laws of Alaska (the Act). Among significant changes, the Act eliminated the monthly progressivity tax rate implemented by certain amendments to the Production Tax Statutes in 2006 and 2007, increased the
base rate from 25% to 35% and added a stair-step
per-barrel
tax credit for oil production. This tax credit is based on the gross value at the point of production per barrel of taxable oil and may not reduce a
producers tax liability below the minimum tax (which is a percentage, ranging from zero to 4%, of the gross value at the point of production of a producers taxable production during the calendar year based on the average
price per barrel for Alaska North Slope crude oil for sale on the United States West Coast for the year) under the Production Tax Statutes. These changes became effective on January 1, 2014.
On January 15, 2014, the Trustee executed a letter agreement with BP Alaska dated January 15, 2014 (the 2014 Letter Agreement) regarding
the implementation of the Act with respect to the Trust. Pursuant to the 2014 Letter Agreement, Production Taxes for the Trusts Royalty Production will equal the tax for the relevant quarter, minus the allowable monthly stair-step
per-barrel
tax credits for the Royalty Production during that quarter. If there is a minimum tax-related limitation on the amount of the stair-step
per-barrel
tax
credits that could otherwise be claimed for any quarter during the year, any difference between that limitation as preliminarily determined on a quarterly basis and the actual limitation for the entire year will be reflected in the payment to the
Trust for the first quarter Royalty Production in the following year.
On July 6, 2015, BP Alaska and the Trustee signed a letter agreement (the
2014 Letter Agreement Amendment) amending the 2014 Letter Agreement to provide that if there is a minimum tax-related limitation on the amount of the stair-step
per-barrel
tax credits
that could otherwise be claimed for any quarter during the year, any difference between that limitation as preliminarily determined on a quarterly basis and the actual limitation for the entire year will be reflected in the payment to the Trust for
the fourth quarter Royalty Production payment for such year rather than in the payment to the Trust for the first quarter Royalty Production in the following year.
(6) Royalty Revenue Adjustments
Certain of the royalty
payments received by the Trust in 2017 and 2016 were adjusted by BP Alaska to compensate for underpayments or overpayment of the royalties due with respect to the quarters ended prior to the dates of such payments. Average net production of crude
oil and condensate from the proved reserves allocated to the Trust was less than 90,000 barrels per day during certain quarters. Royalty payments by BP Alaska with respect to those
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BP Prudhoe Bay Royalty Trust
Notes to Financial Statements (Unaudited)
(Prepared on a modified basis of cash receipts and disbursements)
September 30, 2017
quarters were based on estimates by BP Alaska of production levels because actual data was not available by the date on which payments were required to be made to the Trust. Subsequent
recalculation by BP Alaska of the royalty payments due based on actual production data resulted in the payment adjustments shown in the table below (in thousands).
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Payments Received
(in thousands)
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Jan. 2017
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Jan. 2016
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Royalty payment as calculated
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$
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21,475
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$
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13,168
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Adjustment for previous quarters underpayment (overpayment), plus accrued
interest
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7
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(47
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)
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Total payment received
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$
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21,482
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$
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13,121
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(7) Subsequent Event
In
October 2017, the Trust received a payment of $14,666,898 from BP Alaska. This payment consisted of $14,626,890, representing the royalty payment due with respect to the Trusts Royalty Interest for the quarter ended September 30, 2017,
plus $40,008, representing the amount of an underpayment by BP Alaska, including interest on the underpayment, of the royalty payment due with respect to the quarter ended June 30, 2017. On October 20, 2017, after deducting Trust
administrative expenses, the Trustee distributed $14,426,063 to Unit holders of record on October 16, 2017.
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