MARINE PETROLEUM TRUST 10-K

ITEM 1A. RISK FACTORS Although various risk factors and specific cautionary statements are described elsewhere in this Annual Report on Form 10-K, the following is a summary of the principal risks associated with the Trust and an investment in units of the Trust. Oil and natural gas prices, which are subject to fluctuations, have declined substantially from historical highs and may remain depressed for the foreseeable future. The depression in oil and natural gas prices has resulted in, and is expected to continue to result in, lower royalty payments to Marine and lower cash distributions to its unitholders. Marine’s quarterly distributions are highly dependent upon the prices realized from the sale of oil and natural gas. Any sustained decline in Marine’s distributable income would cause a decrease in the value of cash distributions to its unitholders and could result in Marine being unable to make a cash distribution to its unitholders in one or more quarters, as well as result in a decrease of the market price of the units. Historically, oil and natural gas prices have been volatile and are likely to continue to be volatile in the future due to factors beyond Marine’s control. These factors include, but are not limited to: • political conditions worldwide, and in particular, political disruptions, terrorist activities, wars or other armed conflicts in oil producing regions; • worldwide economic conditions; • tariffs; • weather conditions; • technological innovation affecting extraction expenses; • the supply and price of domestic and foreign oil and natural gas; • the level of consumer demand; • the price and availability of alternative fuels; • the proximity to, and capacity of, transportation facilities; and • the effect of worldwide energy conservation measures. 3 Table of Contents In addition, a portion of Marine’s distributable income has historically been generated from distributions to Marine from its interest in Tidelands. Tidelands’ ability to make distributions to Marine is also substantially dependent on the prices it obtains for oil and natural gas, and Tidelands has not generated sufficient revenue in recent quarters to make distributions to its unitholders, including Marine. Tidelands may not be able to return to a level of profitability that allows it to make distributions to Marine in the future. The last distribution Marine received from Tidelands was in the fourth quarter of 2018. Moreover, government regulations, such as the regulation of natural gas transportation and price controls, can affect oil and natural gas prices in the long term. Lower prices may reduce the amount of oil and natural gas that is economical to produce and reduce distributable income available to Marine. As a result, a substantial decline in the production or price of oil and natural gas could result in Marine being unable to make distributions to unitholders in future quarters. The volatility of oil and gas prices reduces the predictability of future cash distributions to unitholders. Substantially all of the oil and natural gas produced from the leases are being sold under short-term or multi-month contracts at market clearing prices or on the spot market. Marine is unable to acquire royalty interests in any more leases. Marine’s overriding royalty interests apply only to existing leases and do not apply to new leases that the Interest Owners may acquire. Therefore, the Interest Owners are no longer obligated to assign any interest to Marine out of any lease that they acquire. In addition, Marine is not permitted to carry on any business, including making investments in additional oil and natural gas interests. Marine will continue to be entitled to receive payments on its existing leases, so long as the leases are active properties. Once the leases terminate or expire, any overriding royalties payable to Marine will terminate and Marine will not be able to acquire any additional or replacement royalty interests. Royalty interests are depleting assets and may deplete faster than expected or in their entirety. The net proceeds payable to Marine are derived from the sale of depleting assets. Accordingly, the portion of the distributions to unitholders that are attributable to depletion may be considered a return of capital as opposed to a return on investment. Distributions that are considered a return of capital will ultimately diminish the depletion tax benefits available to unitholders, which could reduce the market value of the units over time. The reduction in proved reserve quantities is a common measure of depletion. Future maintenance and development projects on the leases will likely affect the quantity of proved reserves. The timing and size of these projects will depend on the market prices of oil and natural gas. If operators of the leases do not implement additional maintenance and development projects, the future rate of production decline of proved reserves may be higher than the rate currently experienced by Marine. Eventually, the properties in the leases will stop producing in commercial quantities, and Marine will cease to be entitled to receive any distributions of net proceeds therefrom. The recent spread of COVID-19, or the novel coronavirus, and the measures taken to mitigate the impact of the COVID-19 pandemic could have an adverse effect on trust distributions. As the coronavirus pandemic and government responses are rapidly evolving, the extent of the impact on domestic sales of crude oil and natural gas remains unknown and is constantly evolving. Markets have experienced a sharp and rapid decline in the demand for crude oil and natural gas as the U.S. and global economy, and commodity prices, have been negatively impacted as economic activity has been curtailed in response to the COVID-19 pandemic. Official restrictions on non-essential activities, including “shelter in place” and “stay at home” orders, have been introduced throughout the U.S. and the world, which may impact oil and natural gas operators’ production activities, and the length of time such measures are in place may adversely affect us. Fewer businesses than normal are open and fewer people are going to work which has reduced the demand for oil and natural gas, and operators’ reliance on third-party suppliers, contractors, and service providers exposes them to possibility of delay or interruption of operations. At this time, the full extent to which COVID-19 will negatively impact the global economy and the oil and gas industry is uncertain, but pandemics or other significant public health events will most likely have a material adverse effect on operators’ business and financial condition which would likely have an adverse effect on trust distributions. 4 Table of Contents The market price for the units may not reflect the value of the royalty interests held by Marine. The public trading price for the units tends to be tied to the recent and expected levels of cash distributions on the units. The amounts available for distribution by Marine vary in response to numerous factors outside of Marine’s control, including prevailing prices for oil and natural gas produced from properties on the leases. The market price of the units is not necessarily indicative of the value that Marine would realize if it sold its interest in the properties on the leases to a third party buyer and distributed the net proceeds to its unitholders. In addition, the market price of the units is not necessarily reflective of the fact that Marine’s assets are depleting assets, and a portion of each cash distribution paid on the units should be considered by investors as a return of capital, with the remainder being considered as a return on investment. There is no guarantee that distributions made to a unitholder over the life of these depleting assets will equal or exceed the purchase price paid by the unitholder for the unit. In addition, the public stock markets have traditionally experienced price and trading volume volatility. This volatility has had a significant effect on the market prices of securities issued by many companies for reasons that may or may not be related to operating performance. If the public stock markets continue to experience price and trading volume volatility in the future, the market price of the units could be adversely affected. Our units have been thinly traded and an active trading market for our units may not develop. The trading volume of our units has historically been low. As a result, sales of small amounts of the units in the public market could cause the price of the units to fluctuate greatly, including in a materially adverse manner. In addition, a more active trading market for our units may not develop, or if it does develop, may not continue, and a unitholder may find it difficult to dispose of, or to obtain accurate quotations as to the market value of, our units. Operating risks for the working interest owners’ interests on the leases can adversely affect distributions. The occurrence of drilling, production or transportation accidents and other natural disasters on the properties underlying the leases can reduce distributions. These occurrences include blowouts, cratering, explosions, environmental and hurricane damage that may result in personal injuries, property damage, damage to productive formations or equipment and environmental damages. Any of these occurrences could have a material adverse effect on the amount of our distributions or the market value of the units. Failure to collect royalty payments from working interest owners could adversely affect Marine’s distributions to its unitholders. A significant portion of Marine’s royalties are attributable to a limited number of working interest owners. For the fiscal year ended June 30, 2020, three working interest owners accounted for approximately 100% of the royalty payments to Marine. Marine does not require working interest owners to pledge collateral or otherwise post security for royalty payments. At any time, Marine may encounter collection issues with one or more of the working interest owners, which could result in Marine not receiving payments for some or all of its royalty interests. Any reduction in royalty payments would reduce the distributable income to Marine’s unitholders. The owner of any properties in the leases may transfer any of the properties to another unrelated third party, which could reduce the amount of royalty payments that are received. The working interest owners may at any time transfer all or part of the property in a lease to another unrelated third party. Unitholders are not entitled to vote on any transfer, and Marine will not receive any proceeds of any such transfer. Following any transfer, the lease will continue to be subject to Marine’s royalty interest, but the net proceeds from the transferred property would be calculated separately and paid by the transferee. The transferee would be responsible for all of the obligations relating to calculating, reporting and paying to Marine its royalty interest on the transferred portion of the lease, and the transferor of the transferred property would have no continuing obligation to Marine for that property. Any such transferee may not be as financially sound as the current working interest owner. 5 Table of Contents The owner of any properties in the leases may abandon any property, terminating the related royalty interest Marine may hold. The current working interest owners or any transferee may abandon any well or property that is subject to Marine’s royalty interest if it believes that the well or property can no longer produce in commercially economic quantities or for any other reason. This would terminate Marine’s royalty interest relating to the abandoned well or property. The Trustee, Marine and the Trust’s unitholders do not control the operation or development of the properties in the leases and have little influence over their operation or development. The Trustee, Marine and the Trust’s unitholders have little, if any, influence or control over the operation or future development of the underlying properties of the leases. The properties underlying the leases are owned by independent working interest owners. The working interest owners manage the underlying properties and handle the receipt and payment of funds relating to the leases and payments to Marine for its royalty interests. The current working interest owners are under no obligation to continue operating the properties. The failure of a working interest owner to conduct its operations, discharge its obligations, cooperate with regulatory agencies or comply with laws, rules and regulations in a proper manner could have an adverse effect on net proceeds payable to Marine. The Trustee, Marine and the Trust’s unitholders do not have the right to replace an operator. Important reserve and other information with respect to the particular leases subject to Marine’s royalty interest is unreasonably difficult to obtain. The leasehold working interests that are subject to the rights held by Marine are owned, in most cases, in whole or in part by Arena, or other oil and natural gas exploration and production companies. Certain information with respect to the particular leases subject to Marine’s interests, including, but not limited to, (i) reserves, (ii) the availability of oil and natural gas, (iii) the average production cost (lifting cost) per unit, (iv) undeveloped acreage and (v) net wells and net acres, lies solely within the knowledge of these working interest owners. Marine does not have access to engineering data regarding these leaseholds and believes that such information would have been compiled principally by or for the working interest owners of these leaseholds and such information is unreasonably difficult for Marine to obtain. Terrorism and continued geopolitical hostilities could adversely affect Marine’s distributions to its unitholders or the market price of its units. Terrorist attacks and the threat of terrorist attacks, whether domestic or foreign, as well as military or other actions taken in response to such attacks or threats, could cause instability in the global financial, oil and natural gas markets. Terrorism and other geopolitical hostilities could adversely affect the Trust’s distributions to its unitholders or the market price of its units in unpredictable ways, including through the disruption of oil and natural gas supplies and markets, increased volatility in oil and natural gas prices, or the possibility that the infrastructure on which the operators of the underlying properties rely could be a direct target or an indirect casualty of an act of terror. Unitholders have limited voting rights. Voting rights as a unitholder are more limited than those of stockholders of most public corporations. For example, there is no requirement for annual meetings of unitholders or for an annual or other periodic re-election of the Trustee. Unlike corporations, which are generally governed by boards of directors that are elected by their equity holders, the Trust is administered by a corporate trustee in accordance with the Indenture and other organizational documents. The Trustee has extremely limited discretion in its administration of the Trust. The limited liability of the unitholders is uncertain. The unitholders are not protected from the liabilities of the Trust to the same extent that a shareholder would be protected from a corporation’s liabilities. The structure of the Trust as a trust does not include the interposition of a limited liability entity, such as a corporation or limited partnership, which would provide further limited liability protection to unitholders. While the Trust is liable for any excess liabilities incurred if the Trustee fails to ensure that 6 Table of Contents such liabilities are to be satisfied only out of the Trust’s assets, under the laws of the State of Texas, which are unsettled on this point, a unitholder may be jointly and severally liable for any liability of the Trust if (i) the satisfaction of such liabilities was not contractually limited to the assets of the Trust and (ii) the assets of the Trust and the Trustee are not adequate to satisfy such liability. As a result, unitholders may be exposed to personal liability. Marine’s royalty interest can be sold and the Trust can be terminated. The Trust may be terminated and the Trustee may sell Marine’s royalty interests if holders of 80% or more of the units of beneficial interest of the Trust approve the sale and vote to terminate the Trust. Following any such termination and liquidation, the net proceeds of any sale would be distributed to the unitholders and the unitholders would receive no further distributions from the Trust. Any such sale may not be on terms acceptable or favorable to all unitholders. The term of the Trust will expire on June 1, 2021 and there is no guarantee that it will be extended. The Indenture provides that the term of the Trust will expire on June 1, 2021, unless extended by the vote of the holders of a majority of the outstanding units of beneficial interest. Following the filing of this Annual Report, Marine expects to ask the unitholders to approve an amendment to the Indenture to extend the life of the Trust beyond the expiration date. However, there is no guarantee that unitholders will approve the extension, in which case, the Trust will terminate pursuant to the terms of the Indenture. The operators of the oil and natural gas leases are subject to extensive governmental regulation. Oil and natural gas operators have been, and in the future will be, affected by Federal, state and local laws and regulations and other political developments, such as price or gathering rate controls, drilling regulations, and environmental protection regulations, including the regulation of hydraulic fracturing. Although Marine is unable to predict changes to existing laws and regulations, such changes could significantly impact Marine’s overriding royalty interests. Cash held by the Trustee is not insured by the Federal Deposit Insurance Corporation. Currently, cash held by Marine that is reserved for the payment of accrued liabilities and estimated future expenses and distributions to unitholders is typically held in cash deposits, U.S. Treasury and agency bonds and money market accounts. Marine places such reserve cash with financial institutions that Marine considers credit worthy and limits the amount of credit exposure from any one financial institution. However, none of these accounts are insured by the Federal Deposit Insurance Corporation. In the event that any such financial institution becomes insolvent, Marine may be unable to recover any or all such cash from the insolvent financial institution. Any loss of such cash may have a material adverse effect on Marine’s cash balances and any distributions to unitholders. Financial information of Marine is not prepared in accordance with generally accepted accounting principles in the United States. The financial statements of Marine are prepared on a modified cash basis of accounting, which is a comprehensive basis of accounting that differs from generally accepted accounting principles in the United States (“GAAP”). Although the modified cash basis of accounting is permitted for royalty trusts by the U.S. Securities and Exchange Commission (the “SEC”), the financial statements of Marine differ from financial statements prepared in accordance with GAAP because royalty income is recognized in the month it is received rather than in the month of production, expenses are recorded in the month paid rather than in the month incurred and reserves may be established for contingencies that would not be recorded under GAAP. 7 Table of Contents If Marine becomes subject to the Texas franchise tax, the Trustee may have to withhold amounts from future distributions to pay the tax liability. The State of Texas imposes a franchise tax that applies to most business entities doing business in Texas. Trusts, however, other than business trusts (as defined in U.S. Treasury Regulation section 301.7701-4(b)), that meet certain statutory requirements are exempt from the franchise tax as “passive entities.” The Trustee does not expect that the Trust will be required to pay any amounts under the Texas franchise tax for the 2020 tax year based on the Trustee’s belief that the Trust is exempt from the franchise tax as a passive entity ( i.e. , the Trust is not a business trust, it receives at least 90% of its federal gross income from certain passive sources, and no more than 10% of its income is derived from an active trade or business). If it is subsequently determined that the Trust is not exempt from the franchise tax, the Trust will be required to reduce distributions by the amount required to satisfy and pay the Trust’s franchise tax liability for the years for which the applicable statute of limitations has not yet expired. In addition, the Trust would be required to timely pay franchise tax liability due with respect to current and future years in which the Trust fails to qualify for an exemption and has total revenues in excess of $1,180,000 (subject to adjustment pursuant to Texas Tax Code section 171.006). If the Trust is exempt from the Texas franchise tax as a passive entity, each unitholder that is subject to the Texas franchise tax as a taxable entity under the Texas Tax Code should generally include its share of the Trust’s revenue in its franchise tax computation. The Texas franchise tax does not apply to natural persons. Each unitholder is urged to consult its own tax advisor regarding its possible Texas franchise tax liability. ITEM 1B. UNRESOLVED STAFF COMMENTS Not applicable.