drilling operations or well recompletions in the near term, the Subject Interests are depleting assets; Hilcorp has informed the Trust that it is unable to estimate the productive life of the
Subject Interests. The reduction in proved reserve quantities is a common measure of depletion. Hilcorps (or a future operators) capital investments in the Subject Interests will affect the quantity of proved reserves and can offset any
reduction in proved reserves. Lower commodity prices may also cause Hilcorp to reduce drilling operations, workover, and/or recompletions, thus reducing the volume of natural gas and oil produced from the Subject Interests. Hilcorp did not conduct
any new drill projects within the Subject Interests in 2022 or 2021; however, it did conduct eight recompletions and workovers in 2022.
On February 17, 2023, the Trust announced that Hilcorp had provided the Trust with its 2023 capital project plan for the Subject
Interests (the 2023 Plan), and Hilcorp has estimated its 2023 capital expenditures for the Subject Interests to be $4.4 million.
Hilcorp informed the Trust that its 2023 Plan will allocate approximately $3.7 million of the 2023 Plans budget toward 25 well
recompletions and workovers scheduled to be completed in the Mesaverde, Pictured Cliffs and Fruitland Coal formations. Approximately $0.5 million of the 2023 Plans budget will be allocated to facilities projects related to natural gas
compression, and approximately $0.2 million will be spent for permitting costs for potential future new drill projects. Hilcorp further informed the Trust that its planned project status for 2023 is subject to revision if Hilcorp revises its
assumptions underlying the 2023 Plan, in which event the actual capital costs may vary from these estimates.
Under the terms of the
Conveyance, production costs are deducted from Gross Proceeds in calculating Royalty Income. Production costs generally means costs incurred on an accrual basis by Hilcorp in operating the Subject Interests, including both capital and non-capital costs. For example, these costs include development drilling, production and processing costs, applicable taxes and operating charges. However, Hilcorp informed the Trust that, for wells operated by
Hilcorp, it generally did not intend to accrue lease operating expenses to the Trust. If production costs exceed Gross Proceeds in any month, the excess is recovered out of future Gross Proceeds prior to the making of further payment to the Trust,
but the Trust is not otherwise liable for any production costs or other costs or liabilities attributable to the Subject Interests or the minerals produced therefrom. If at any time the Trust receives more than the amount due under the Royalty, it
is not obligated to return such overpayment, but the amounts payable to it for any subsequent period are reduced by such amount, plus interest, at a rate specified in the Conveyance. The Trust and the Trustee has very limited authority to control
the amount and timing of production costs.
Distributable Income. In addition to Royalty Income, the Trust receives interest
income, typically from interest paid on cash deposits. General and administrative expenses constitute the Trusts primary expense and include, among other items, the Trustees fees, audit, consulting and legal fees and reporting costs.
The Trustee is authorized to determine in its discretion the amount of cash reserves needed to pay liabilities and contingencies of the
Trust. Total cash reserves were $1.0 million as of December 31, 2021 and 2022. The Trustee does not anticipate any increase or decrease to the cash reserves in 2023.
Hilcorp
The sale of San Juan Basin
assets, including the Subject Interests, from Burlington to Hilcorp closed on July 31, 2017. Hilcorp has advised the Trust that for certain months (since the closing of its purchase of the assets), it has reported estimates of cash revenues and
expenses based on the best information available to it at the time, instead of reporting actual amounts. Hilcorp further has informed the Trust that it believes that its estimates have been prepared in accordance with the Conveyance, and the Trust
and its advisors continue to review such estimates for compliance with the Conveyance.
Gross Proceeds and Production Cost
Estimates. Hilcorps process of reconciling actual revenue and severance taxes to previously reported estimates (which the Trust refers to as true-ups) were still occurring and
being reported in 2022. At the beginning of 2021, Hilcorp informed the Trust that it planned to refine further its estimating and reporting processes and that Hilcorp would review prior periods to ensure greater accuracy and consistency, both for
prior periods as well as future reporting periods. As part of that review process, Hilcorp informed the Trust that it may reverse and rebook revenue for certain periods. Thus, distributions to the Trust from Hilcorp in certain months during 2021 and
2022 were subject to adjustments based upon prior months true-ups and rebooking, plus interest.
Hilcorp has informed the Trust that it completed the transition to its new accounting system and began to report actual, not estimated,
revenue and expenses for operated wells beginning with the June 2021 production month (August 2021 reporting month) and that it has reversed and rebooked revenue for certain prior periods. The true-ups of
revenues for non-operated properties for the 2021 distribution periods were completed in the February and March 2022 reporting months. In 2022, Hilcorp made total actualizations and other adjustments resulting
in $10,951,453 additional Royalty Income paid to the Trust. Of this amount, $1,391,619 was revenue related to prior period non-operated property true-ups, revenue for
granted audit exceptions, and interest, and $9,559,834 associated with Hilcorp process reviews and adjustments. Hilcorp has continued to inform the Trustee that it has implemented additional controls to enhance the reporting process to reduce the
need for future corrections. As of December 31, 2022, Hilcorp has informed the Trust that it believes that all prior month actualizations have occurred, and it does not expect to need to report any further actualizations in future distribution
reports.
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