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Item 7. Management’s Discussion and Analysis

2023-02-23 compared with 2022-02-24 · 50 added, 46 removed, 149 unchanged (39% of the section changed)

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This discussion, which presents our results of operations for the fiscal years ended December 31, 2021, and December 31, 2020, should be read in conjunction with our Consolidated Financial Statements and the accompanying notes.

The following discussion summarizes our results of operations and liquidity and capital resources for the fiscal years ended December 31, 2022 and 2021 and should be read in conjunction with our Consolidated Financial Statements and the accompanying notes included elsewhere in this Annual Report.

A discussion of results of operations and liquidity and capital resources for fiscal year 2020 has been omitted from this report but may be found at “Item 7 –

Management’s Discussion and Analysis of Financial Condition and Results of Operations”

of our Annual Report on Form 10-K for the fiscal year ended December 31, 2021, filed with the SEC on February 24, 2022, and is incorporated by reference in this report from such prior Annual Report on Form 10-K.

We intend for this discussion to provide the reader with information that will assist in understanding our financial statements, the changes in certain key items in those financial statements from period to period, and the primary factors that accounted for those changes.

2022 Overview

Our results during 2021 to a large extent benefitted from industrywide increases in realized oil and natural gas sales prices and increases in Royalty Properties sales volumes from continued drilling activity in the Permian Basin, offset partially by decreases in drilling activity and NPI oil sales volumes in the Bakken and a decrease in NPI natural gas sales due to the divestiture of the Hugoton NPI in 2020.

Our results during 2022, to a large extent, benefitted from industrywide increases in realized oil and natural gas sales prices.

Increases in Royalty Properties and NPI sales volumes were largely a result of continued drilling activity in the Permian Basin.

Significant results include the following:

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Distributions of $131.9 million to our limited partners;

Acquisition of mineral and royalty interests representing approximately 4,600 net royalty acres located in 27 counties across New Mexico, Oklahoma, Texas and Wyoming in exchange for 1,580,000 common units representing limited partnership interests in the Partnership valued at $31.3 million and issued pursuant to the Partnership's registration statement on Form S-4;

Acquisition of overriding royalty interests in the Bakken Trend totaling approximately 6,400 net royalty acres located in Dunn, McKenzie, McLean and Mountrail Counties, North Dakota in exchange for 725,000 common units representing limited partnership interests in the Partnership valued at $12.2 million and issued pursuant to the Partnership's registration statement on Form S-4;

First payments on 725 gross and four net new wells completed on our Royalty Properties and 45 gross and less than one net new well completed on our NPI Properties.

The wells were located in 51 counties and parishes in eight states with the majority of the activity concentrated in the Permian Basin and Bakken.

Acquisition of mineral, royalty and overriding royalty interests representing approximately 2,100 net royalty acres located in 12 counties across Texas and New Mexico in exchange for 816,719 common units representing limited partnership interests in the Partnership valued at $20.4 million and issued pursuant to the Partnership's registration statement on Form S-4;

Acquisition of mineral and royalty interests representing approximately 3,600 net royalty acres located in 13 counties across Colorado, Louisiana, Ohio, Oklahoma, Pennsylvania, West Virginia and Wyoming in exchange for 570,000 common units representing limited partnership interests in the Partnership valued at $14.8 million and issued pursuant to the Partnership's registration statement on Form S-4;

First payments on 1,808 gross and ten net new wells completed on our Royalty Properties and 112 gross and two net new wells completed on our NPI Properties.

The wells were located in 63 counties and parishes in 12 states with the majority of the activity concentrated in the Permian Basin, Rockies, and South Texas.

Included in these totals are wells in which we own both a royalty interest and a net profits interest.

Wells with such overlapping interests are counted in both categories;

Total lease bonus of $0.8 million includes consummation of 16 leases and pooling elections of our mineral interest in undeveloped properties located in eight counties in four states.

Total lease bonus of $8.7 million includes consummation of 31 leases and pooling elections of our mineral interest in undeveloped properties located in 17 counties in four states.

Of the total, $7.3 million was attributable to a record lease bonus executed in Reagan County, Texas.

Critical Accounting Estimates

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The pricing of oil and natural gas sales from the Royalty Properties and NPI is primarily determined by supply and demand in the marketplace and can fluctuate considerably.

As a royalty owner, we have extremely limited involvement and no operational control over the volumes and method of sale of oil and natural gas produced and sold from the Royalty Properties and NPI.

As a royalty owner, we have no operational control over the volumes and method of sale of oil and natural gas produced and sold from the Royalty Properties and NPI.

Revenues from Royalty Properties and NPI are recorded under the cash receipts approach as directly received from the remitters’

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Comparison of the years ended December 31, 2022 and 2021

The increase in oil sales volumes attributable to our Royalty Properties during 2021 is primarily a result of higher suspense releases on new wells in the Permian Basin and Bakken region, partially offset by lower suspense releases on new wells in the Rockies and natural production declines in the Permian Basin, Bakken region, and Mid-Continent.

The increase in natural gas sales volumes attributable to our Royalty Properties during 2021 is primarily a result of higher suspense releases on new wells in the Permian Basin and Mid-Continent and increased production in the Bakken region and Barnett Shale, partially largely offset by lower suspense releases on new wells in the Rockies, natural production declines in the Mid-Continent, and decreased production in other areas of Texas and the Southeast region.

The decrease in oil sales volumes attributable to our NPI properties during 2021 is primarily a result of lower suspense releases for new wells in the Bakken region and Permian Basin and natural production declines across all regions.

The decrease in natural gas sales volumes attributable to our NPI properties during 2021 is primarily the result of the absence of 2021 production from the Hugoton Field due to the Hugoton NPI divestiture in the third quarter of 2020 and decreased production in Mid-Continent, partially offset by increased production in the Bakken region and increased Fayetteville Shale production due to higher prior period adjustments in the second quarter of 2021.

The increase in oil sales volumes attributable to our Royalty Properties during 2022 is primarily a result of higher suspense releases on new wells in the Permian Basin and South Texas, higher suspense releases on new wells and increased production from acquired wells in the Rockies, and increased production in the Bakken region.

The increase in natural gas sales volumes attributable to our Royalty Properties during 2022 is primarily a result of higher suspense releases on new wells in the Permian Basin, South Texas, and the Southeast and higher suspense releases on new wells and increased production from acquired wells in the Rockies, partially offset by natural production declines in the Barnett Shale.

The increase in oil sales volumes attributable to our NPI properties during 2022 is primarily a result of increased production and higher suspense releases on new wells in the Permian Basis and higher suspense releases on new wells in the Bakken region, partially offset by natural production declines in the Bakken region.

The increase in natural gas sales volumes attributable to our NPI properties during 2022 is primarily a result of the increased production and higher suspense releases on new wells in the Permian Basin, partially offset by natural production declines in the Bakken region and decreased Fayetteville Shale production due to higher prior period adjustments.

The increase in lease bonus revenue from 2021 to 2022 is primarily attributable to receipt of approximately $7.3 million from a lease executed on September 30, 2022, wherein the Partnership leased 243 net acres in two tracts of land in Reagan County, Texas for $30,000 per acre and a 25% royalty.

Production taxes and operating expenses increased 70% from 2021 to 2022.

The increase is primarily a result of higher production taxes attributable to higher oil and natural gas sales prices, partially offset by lower ad valorem taxes.

Depreciation, depletion and amortization decreased 12% from 2020 to 2021.

We adjust our depletion rate each quarter for significant changes in our estimates of oil and natural gas reserves, including acquisitions and divestitures.

General and administrative expenses decreased 31% from 2020 to 2021.

The decrease is primarily a result of lower compensation expenses due to the forgiveness of the Operating Partnership’s $0.9 million and $0.8 million Paycheck Protection Program loans in the second and third quarter of 2021, respectively, which were applied as non-recurring credits of compensation costs previously reimbursed between the Partnership and the Operating Partnership.

The remainder of the decrease is attributable to non-recurring Hugoton and Huffman NPI divestiture transaction and severance costs of $1.0 million in 2020 and lower information technology project costs.

These decreases were partially offset by higher compensation expenses due to the reduction of overhead billed to two NPIs which were divested in 2020.

The increase is primarily a result of higher proportionate production taxes due to higher oil and natural gas sales volumes and sales prices and higher ad valorem taxes.

Depreciation, depletion and amortization increased 82% from 2021 to 2022.

We adjust our depletion rate each quarter for significant changes in our estimates of oil and natural gas reserves, including acquisitions.

General and administrative expenses increased 58% from 2021 to 2022.

The increase is primarily attributable to higher compensation expenses due to market adjustments and forgiveness of the Operating Partnership’s $0.9 million and $0.8 million Paycheck Protection Program loans in the second and third quarters of 2021, respectively, which were applied as non-recurring credits of compensation costs previously reimbursed between the Partnership and the Operating Partnership partially offset by lower 2022 information technology project costs.

Net cash provided by operating activities increased 109% from 2021 to 2022.

The increase is primarily a result of higher Royalties revenue receipts, net of production taxes and operating expenses paid and lower compensation expenses paid due to the forgiveness of the Operating Partnership’s $0.9 million and $0.8 million Paycheck Protection Program loans in the second and third quarter of 2021, respectively, which were applied as non-recurring credits of compensation costs previously reimbursed between the Partnership and the Operating Partnership.

Acquisition for Units

On December 31, 2021, pursuant to a non-taxable contribution and exchange agreement with Gemini 5 Thirty, LP, a Texas limited partnership (“Gemini”), the Partnership acquired mineral and royalty interests representing approximately 4,600 net royalty acres located in 27 counties across New Mexico, Oklahoma, Texas and Wyoming in exchange for 1,580,000 common units representing limited partnership interests in the Partnership valued at $31.3 million and issued pursuant to the Partnership's registration statement on Form S-4.

We believe that the acquisition is considered complimentary to our business.

The increase is primarily a result of higher Royalties revenue receipts, net of production taxes and operating expenses, higher NPI payment receipts, and higher lease bonus receipts, partially offset by higher general and administrative expenses and ad valorem taxes paid.

Acquisitions for Units

On September 30, 2022, pursuant to a non-taxable contribution and exchange agreement with Excess, the Partnership acquired mineral, royalty and overriding royalty interests totaling approximately 2,100 net royalty acres located in 12 counties across Texas and New Mexico in exchange for 816,719 common units representing limited partnership interests in the Partnership valued at $20.4 million and issued pursuant to the Partnership's registration statement on Form S-4.

We believe that the acquisition is considered complementary to our business.

The transaction was accounted for as an acquisition of assets under U.S.

Accordingly, the cost of the acquisition was allocated on a relative fair value basis and transaction costs were capitalized as a component of the cost of the assets acquired.

At closing, in addition to conveying mineral and royalty interests to the Partnership, Gemini delivered funds to the Partnership in an amount equal to their cash receipts during the period from October 1, 2021 through December 31, 2021 of $1.9 million.

The contributed cash, net of capitalized transaction costs paid, of $1.6 million is included in net cash contributed in acquisitions on the consolidated statement of cash flows for the year ended December 31, 2021.

On June 30, 2021, pursuant to a contribution and exchange agreement with JSFM, LLC, a Wyoming limited liability company (“JSFM”), the Partnership acquired overriding royalty interests in the Bakken Trend totaling approximately 6,400 net royalty acres located in Dunn, McKenzie, McLean and Mountrail Counties, North Dakota in exchange for 725,000 common units representing limited partnership interests in the Partnership valued at $12.2 million and issued pursuant to the Partnership's registration statement on Form S-4.

We believe that the acquisition is considered complimentary to our business.

Contributed cash delivered at closing, net of capitalized transaction costs paid, of $0.9 million are included in net cash contributed in acquisitions on the consolidated statement of cash flows for the year ended December 31, 2022.

On March 31, 2022, pursuant to a non-taxable contribution and exchange agreement with multiple unrelated third parties, the Partnership acquired mineral and royalty interests representing approximately 3,600 net royalty acres located in 13 counties across Colorado, Louisiana, Ohio, Oklahoma, Pennsylvania, West Virginia and Wyoming in exchange for 570,000 common units representing limited partnership interests in the Partnership valued at $14.8 million and issued pursuant to the Partnership’s registration statement on Form S-4.

We believe that the acquisition is considered complementary to our business.

The transaction was accounted for as an acquisition of assets under U.S.

Accordingly, the cost of the acquisition was allocated on a relative fair value basis and transaction costs were capitalized as a component of the cost of the assets acquired.

At closing, in addition to conveying overriding royalty interests to the Partnership, JSFM delivered funds to the Partnership in an amount equal to their cash receipts during the period from April 1, 2021 through June 30, 2021 of $0.4 million.

The contributed cash and final settlement net cash receipts, net of capitalized transaction costs paid, of $0.7 million are included in the net cash contributed in acquisition on the consolidated statement of cash flows for the year ended December 31, 2021.

Net Profits Interest Divestiture

On September 30, 2020, the Partnership and affiliates of its General Partner closed the divestiture of our Hugoton net profits interest located in Texas County, Oklahoma and Stevens County, Kansas to a third party.

In accordance with the full cost method of accounting, as the divestiture did not represent a significant portion of the Partnership’s reserves, gross divestiture proceeds of $5.7 million were credited to the oil and natural gas properties full cost pool as of December 31, 2020.

Transaction costs of $0.5 million are included in general and administrative expenses on the consolidated income statement for the year ended December 31, 2020.

Contributed cash delivered at closing and final settlement net cash received, net of capitalized transaction costs paid, of $0.8 million are included in net cash contributed in acquisitions on the consolidated statement of cash flows for the year ended December 31, 2022.

On December 31, 2021, pursuant to a non-taxable contribution and exchange agreement with Gemini, the Partnership acquired mineral and royalty interests representing approximately 4,600 net royalty acres located in 27 counties across New Mexico, Oklahoma, Texas and Wyoming in exchange for 1,580,000 common units representing limited partnership interests in the Partnership valued at $31.3 million and issued pursuant to the Partnership's registration statement on Form S-4.

We believe that the acquisition is considered complementary to our business.

The transaction was accounted for as an acquisition of assets under U.S.

Accordingly, the cost of the acquisition was allocated on a relative fair value basis and transaction costs were capitalized as a component of the cost of the assets acquired.

Contributed cash delivered at closing, net of capitalized transaction costs paid, of $1.6 million is included in net cash contributed in acquisitions on the consolidated statement of cash flows for the year ended December 31, 2021.

Final settlement net cash received, net of capitalized transaction costs, of $0.4 million is included in the net cash contributed in acquisitions on the consolidated statement of cash flows for the year ended December 31, 2022.

On June 30, 2021, pursuant to a non-taxable contribution and exchange agreement with JSFM, the Partnership acquired overriding royalty interests in the Bakken Trend totaling approximately 6,400 net royalty acres located in Dunn, McKenzie, McLean and Mountrail Counties, North Dakota in exchange for 725,000 common units representing limited partnership interests in the Partnership valued at $12.2 million and issued pursuant to the Partnership’s registration statement on Form S-4.

We believe that the acquisition is considered complementary to our business.

The transaction was accounted for as an acquisition of assets under U.S.

Accordingly, the cost of the acquisition was allocated on a relative fair value basis and transaction costs were capitalized as a component of the cost of the assets acquired.

Contributed cash delivered at closing and final settlement net cash received, net of capitalized transaction costs paid, of $0.7 million are included in net cash contributed in acquisitions on the consolidated statement of cash flows for the year ended December 31, 2021.

Texas Margin Tax

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(as defined in Section 514 of the Internal Revenue Code of 1986, as amended).

We currently expect to have sufficient liquidity to fund our distributions to unitholders and operations despite potential material uncertainties that may impact us as a result of the spread of COVID-19 and any ongoing variants and continued oil and natural gas market volatility.

Although demand and market prices for oil and natural gas have recently increased due to the rising energy demand, we cannot predict events that may lead to future price volatility.

Our ability to fund future distributions to unitholders may be affected by the prevailing economic conditions in the oil and natural gas market and other financial and business factors, including the evolution of COVID-19 and any ongoing variants, which are beyond our control.

Although demand and market prices for oil and natural gas have remained strong due to the rising energy use and worldwide shortage of oil due to sanctions implemented on Russia, we cannot predict events that may lead to future price volatility.

If market conditions were to change due to declines in oil prices or uncertainty created by COVID-19 or any ongoing variants and our revenues were reduced significantly or our operating costs were to increase significantly, our cash flows and liquidity could be reduced.

Despite recent improvements, the current economic environment is volatile, and therefore, we cannot predict the ultimate impact on our liquidity or cash flows.

Despite recent improvements, the current economic environment is volatile, and therefore, we cannot predict the ultimate impact that COVID-19 or the ongoing military conflict between Russia and Ukraine will have on our liquidity or cash flows.

Liquidity and Working Capital

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Distributions to limited partners and the General Partner related to cash receipts were as follows:

February 1, 2021

January 31, 2022

February 10, 2022

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August 11, 2022

November 1, 2021

October 31, 2022

November 10, 2022

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Approximately 79% of these receipts reflect oil sales during September 2022 through November 2022 and natural gas sales during August 2022 through October 2022, and approximately 21% from prior sales periods.

The average indicated prices for oil and natural gas sales during the 2021 fourth quarter attributable to the Royalty Properties were $68.46/bbl and $4.15/mcf, respectively.

The average indicated prices for oil and natural gas sales attributable to the Royalty Properties during the 2022 fourth quarter were $76.32/bbl and $6.50/mcf, respectively.

Cash receipts attributable to the Partnership's NPI during the 2022 fourth quarter totaled $9.5 million.

Approximately 52% of these receipts reflect oil sales and natural gas sales during August 2022 through October 2022, and approximately 48% from prior sales periods.

The average indicated prices for oil and natural gas sales during the 2021 fourth quarter attributable to the NPI were $68.11/bbl and $4.20/mcf, respectively.

The average indicated prices for oil and natural gas sales attributable to the NPI were $78.76/bbl and $6.63/mcf, respectively.

General and Administrative Costs

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Through December 31, 2022, the reimbursement amounts actually paid or accrued were less than the limitation.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The consolidated financial statements are set forth herein commencing on page F-1.

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis