Permianville Royalty Trust 10-K

Item 5. Market for Registrant’s Common Equity, Related Unitholder Matters and Issuer Purchases of Equity Securities. The Trust Units trade on the New York Stock Exchange under the symbol “PVL.” At December 31, 2023, there were 33,000,000 Trust Units outstanding. On March 20, 2024, there were five unitholders of record. This number does not include owners for whom Trust Units may be held in “street” name. Distributions Each month, the Trustee determines the amount of funds available for distribution to the Trust unitholders. Available funds are the excess cash, if any, received by the Trust from the Net Profits Interest and other sources (such as interest earned on any amounts reserved by the Trustee) that month, over the Trust’s incurred expenses for that month. Available funds are reduced by any cash the Trustee decides to hold as a reserve against future liabilities. The holders of Trust Units as of the applicable record date (generally the last business day of each calendar month) are entitled to monthly distributions payable on or before the tenth business day after the record date (or the next succeeding business day). For further information on distributions to Trust unitholders, see Note 5 of the Notes to Financial Statements in Part II, Item 8 of this Form 10-K. Equity Compensation Plans The Trust does not have any employees and does not maintain any equity compensation plans. Recent Sales of Unregistered Securities There were no equity securities sold by the Trust during the year ended December 31, 2023. Purchases of Equity Securities There were no purchases of Trust Units by the Trust or any affiliated purchaser during the fourth quarter of 2023. Item 6. [Reserved] 47 Item 7. Trustee’s Discussion and Analysis of Financial Condition and Results of Operations. This discussion contains forward-looking statements. Please refer to “Forward-Looking Statements” for an explanation of these types of statements. Overview Permianville Royalty Trust, previously known as Enduro Royalty Trust, a statutory trust created in May 2011, completed its initial public offering in November 2011. The Trust’s only asset and source of income is the Net Profits Interest, which entitles the Trust to receive 80% of the net profits from oil and natural gas production from the Underlying Properties. The Net Profits Interest is passive in nature and neither the Trust nor the Trustee has any management control over or responsibility for costs relating to the operation of the Underlying Properties. Additionally, third parties operate substantially all of the wells on the Underlying Properties and, therefore, the Sponsor is not in a position to control the timing of development efforts, associated costs, or the rate of production of the reserves. The Trust is required to make monthly cash distributions of substantially all of its monthly cash receipts, after deducting the Trust’s administrative expenses, to holders of record (generally the last business day of each calendar month) on or before the tenth business day after the record date. The Net Profits Interest is entitled to a share of the profits from and after July 1, 2011 attributable to production occurring on or after June 1, 2011. The amount of Trust revenues and cash distributions to Trust unitholders depends on, among other things: ● oil and natural gas sales prices; ● volumes of oil and natural gas produced and sold attributable to the Underlying Properties; ● production and development costs; ● price differentials; ● potential reductions or suspensions of production; ● the amount and timing of Trust administrative expenses; and ● the establishment, increase, or decrease of reserves for approved development expenses or future liabilities of the Trust. Generally, the Sponsor receives cash payment for oil production 30 to 60 days after it is produced and for natural gas production 60 to 90 days after it is produced. 2023 Recap and 2024 Outlook The average NYMEX oil and natural gas prices experienced significant volatility in 2023, with the average NYMEX oil price declining from $94.57 per Bbl in calendar year 2022 to $77.65 per Bbl in calendar year 2023, a decline of 18%. Meanwhile, the price range varied from a low of $66.74 per Bbl in March 2023 to a high of $93.68 per Bbl in September 2023, before declining during the fourth quarter in response to increasing conflict in the Middle East. Natural gas prices faced even greater challenges in 2023 after seeing some of the highest prices in prior years in 2022. The average NYMEX natural gas price declined from $6.41 per MMBtu in calendar year 2022 to $2.54 per MMBtu in calendar year 2023, a decline of 60%. Prices for natural gas experienced similar volatility, ranging from a low of $1.77 per MMBtu in June 2023 to a high of $3.77 per MMBtu in January 2023. The year-over-year decline in commodity prices also drove a significant reduction in third-party operator drilling activity on the Underlying Properties, which led to a 45% decrease in development expenses for the production months of 2023 compared to 2022. 48 The Sponsor believes that the outlook for the oil and gas industry remains mixed, with oil prices having ended 2023 within a range consistent with prior years, but with natural gas prices currently facing levels generally below operator-targeted forward prices for capital deployment. In addition, mergers and acquisitions have continued to change the makeup of the companies deploying capital in the sector. As larger public companies continue to acquire smaller public companies and private operators, these larger companies are likely to react differently to commodity price volatility than smaller operators have in historical cycles. This merger and acquisition activity has also affected the operators of the Underlying Properties, with several of the largest and/or most active operators for the Underlying Properties announcing merger events in 2023. Nevertheless, the capital spending activity or operating performance for the Underlying Properties under new third-party operatorship in the future may not be consistent with such activity or performance experienced under previous third-party operators in prior years. As discussed further under “—Sale of 2023 Divestiture Properties” below, the Sponsor leveraged the volatility in commodity prices to negotiate and subsequently close the sale of certain acreage and associated production in the Permian Basin that constituted part of the Underlying Properties , generating $0.146920 per Trust Unit of distributable proceeds from properties that in the prior three years had generated cumulative net profits of $0.00831 per Trust Unit. Given the commodity price volatility as well as the recent merger activity in the industry, the operators of the Underlying Properties continue to evaluate planned capital expenditures during 2024. Based on currently available information, the Sponsor anticipates 2024 capital expenditures on the Underlying Properties to range from $5.0 million to $9.0 million, or $4.0 million to $7.2 million net to the Trust’s 80% Net Profits Interest. This would represent a decrease from 2023 levels, partly due to lower projected natural gas prices, which could reduce capital activity on the Haynesville area of the Underlying Properties, but somewhat offset by continued activity strength in the portion of the Underlying Properties located in the Permian region. The expected range is also wider compared to 2023 given the volatility and recent third-party operator merger activity. The Sponsor indicates that it continues to have access to adequate capital and liquidity to fund such capital expenditures as they come due. In addition to continued capital expenditure participation, the Sponsor believes there could be further opportunity in 2024 for prospective divestitures, as operators of some of the Underlying Properties look to consolidate non-operated interests and acreage given recent merger and acquisition activity in the industry. Capex Drilling Activity Update Presented below is a summary of the current status of certain notable capital projects recently undertaken on the Underlying Properties pursuant to the capital expenditure program described above. The following table is not intended to be a comprehensive list reflecting all capital expenditures to date. In addition, there can often be a several-month delay from the time of capital expenditures to the time of production and cash flows attributable to the Underlying Properties, especially given the non-operated nature of the Underlying Properties. Operator Region Number of Wells Underlying Properties Working Interest Project Capex Cumulative Total (in thousands) Status Large Cap E&P 1 Midland 5 6.6 % D&C New Drills 2,002 2 Producing, Awaiting First Revenues; 3 Drilling In-Process Large Cap E&P 2 Conventional Permian N/A (Field) 0.8 % New Drills / Workovers 168 In-process/ Continual Program Large Private E&P Haynesville 6 3.5 % D&C New Drills - Pre-Drill PE-Backed Private 1 Delaware 4 5.4 % D&C New Drills 793 Producing Awaiting Revenues PE-Backed Private 2 Delaware 5 1.0 % D&C New Drills 547 Drilling In-Process Large Cap E&P 3 Delaware 4 3.4 % D&C New Drills 678 Drilling In-Process Large Cap E&P 4 Conventional Permian 5 3.7 % New Drills / Workovers 498 Drilling In-Process 49 T he Sponsor expects that a majority of the projects above that are still in process or awaiting first revenues will be completed and will begin producing during 2024. Sale of 2023 Divestiture Properties On May 3, 2023, the Sponsor notified the Trustee that the Sponsor had entered into an agreement to divest certain acreage and associated production in the Permian Basin (the “2023 Divestiture Properties”) that constituted part of the Underlying Properties and were therefore burdened by the Trust’s Net Profits Interest, for a total purchase price of approximately $6.7 million. On July 19, 2023, at a special meeting of Trust unitholders, the unitholders approved the foregoing transaction and the release of the Trust’s Net Profits Interest in the 2023 Divestiture Properties. On August 9, 2023, the Sponsor completed the sale of the 2023 Divestiture Properties, and the Trustee, on behalf of the Trust, reconveyed, terminated and released to the Sponsor the Net Profits Interest with respect to the 2023 Divestiture Properties. The total proceeds received by the Sponsor from the sale of the 2023 Divestiture Properties, after preliminary closing adjustments, were approximately $6.5 million, inclusive of the escrow funded by the buyer and partial expense reimbursement associated with the proxy solicitation. The Sponsor deducted the final transaction expenses from the sales proceeds, along with an escrow amount of $250,000 to cover possible indemnification obligations under the purchase and sale agreement (the “Indemnification Escrow Amount”), to arrive at final net proceeds, based upon the Trust’s Net Profits Interest. On September 20, 2023, the Trust announced a special cash distribution to Trust unitholders of $0.069670 per Trust Unit, payable on October 13, 2023 to Trust unitholders of record on October 2, 2023, reflecting 50% of the Trust’s share of the net proceeds, after accounting for the Indemnification Escrow Amount. The remaining 50% of the Trust’s share of the net proceeds was temporarily retained by the Sponsor as a source of payment of the Trust’s proportionate share of any post-closing purchase price adjustments, with any amount remaining (less any amounts in dispute) after such adjustments to be paid to the Trust within five business days after finalization of the settlement statement and included in a distribution to Trust unitholders. On November 6, 2023, the Trust announced a special cash distribution to Trust unitholders of $0.077250 per Trust Unit, payable on November 22, 2023 to Trust unitholders of record on November 16, 2023, reflecting the remaining 50% of the Trust’s share of the net proceeds (net of the Indemnification Escrow Amount). Within 12 months after the closing of the sale, any remaining amount from the Indemnification Escrow Amount (less any amounts in dispute) will be released to the Trust and included in a distribution to Trust unitholders. Results of Operations The following table displays oil and natural gas sales volumes and average prices from the Underlying Properties, representing the amounts included in the net profits calculation for the distributions paid during the years ended December 31, 2023 and 2022. Underlying Properties Sales Volumes Average Price Month of Distribution Oil (Bbls) Natural Gas (Mcf) Oil (per Bbl) Natural Gas (per Mcf) 2023: January 37,419 250,486 $ 94.66 $ 7.20 February 36,796 222,785 $ 85.39 $ 6.89 March 38,056 217,262 $ 80.01 $ 5.19 April 34,720 204,419 $ 78.48 $ 4.23 May 38,896 191,223 $ 75.01 $ 4.71 June 39,651 241,119 $ 75.60 $ 3.84 July 38,120 195,616 $ 71.94 $ 2.85 August 64,721 604,148 $ 86.52 $ 2.75 September 43,894 204,848 $ 71.99 $ 1.32 October 33,806 227,756 $ 69.15 $ 2.01 November 33,461 222,906 $ 73.07 $ 2.02 Total—2023 (1) 439,540 2,782,568 $ 78.84 $ 3.79 50 Underlying Properties Sales Volumes Average Price 2022: January 40,878 280,503 $ 68.90 $ 3.78 February 40,779 214,181 $ 78.30 $ 4.28 March 44,180 325,962 $ 76.45 $ 5.31 April 40,390 290,847 $ 73.25 $ 4.96 May 47,114 266,091 $ 74.79 $ 4.09 June 40,553 331,076 $ 86.55 $ 5.00 July 40,102 380,958 $ 98.77 $ 4.84 August 41,122 301,477 $ 105.29 $ 4.52 September 37,350 297,117 $ 107.77 $ 5.37 October 37,873 287,116 $ 110.92 $ 6.85 November 43,632 237,538 $ 106.32 $ 7.56 December 42,594 144,367 $ 97.06 $ 7.05 Total—2022 496,567 3,357,233 $ 89.96 $ 5.21 (1) The year ended December 31, 2023 does not include sales volumes for December as the Trust did not make a distribution in that month, as the Net Profits Interest calculation for the corresponding production period was negative. Computation of Income from Net Profits Interest Received by the Trust In connection with the closing of the initial public offering in November 2011, Enduro contributed the Net Profits Interest to the Trust in exchange for 33,000,000 newly issued Trust Units. The Net Profits Interest entitles the Trust to receive 80% of the net profits from the sale and production of oil and natural gas attributable to the Underlying Properties that are produced during the term of the Conveyance, which commenced on July 1, 2011. The Trust’s Income from Net Profits Interest consists of monthly net profits attributable to the Net Profits Interest. Net profits income for the years ended December 31, 2023 and 2022 were determined as shown in the following table: Year Ended December 31, 2023 2022 Gross profits: Oil sales $ 34,653,097 $ 44,669,834 Natural gas sales 10,555,426 17,479,475 Total 45,208,523 62,149,309 Costs: Direct operating expenses: Lease operating expenses 22,136,000 21,914,000 Compression, gathering and transportation 1,696,000 3,276,000 Production, ad valorem and other taxes 2,963,000 4,750,000 Development expenses 6,729,000 12,143,000 Total 33,524,000 42,083,000 Gross proceeds from sale/lease of undeveloped acreage 306,250 130,030 Net profits attributable to Underlying Properties $ 11,990,773 $ 20,196,339 Percentage allocable to Net Profits Interest 80 % 80 % Income from Net Profits Interest $ 9,592,619 $ 16,157,071 Capex Reserve – Release (Holdback) for anticipated 2022-2023 capital expenditures 1,000,000 (1,000,000 ) Less: Trust general and administrative expenses and cash withheld for expenses (1,327,790 ) (1,676,571 ) Distributable income generated by properties prior to divestiture $ 9,264,829 $ 13,480,500 Income from sale of Net Profits Interest 4,848,281 - Distributable income $ 14,113,110 $ 13,480,500 51 As reflected in the Net Profits Interest calculation for November 2023, direct operating and development expenses exceeded revenues, thereby causing net profits attributable to the Underlying Properties to be negative and resulting in a Net Profits Interest shortfall of approximately $1.2 million. As a result, there was no distribution to Trust unitholders in the month of December 2023. The shortfall of $1.2 million was carried forward to be deducted from future net profits to be generated by the Underlying Properties, and the corresponding revenues and associated direct operating and development expenses are excluded from the calculation of distributable income for the year ended December 31, 2023 detailed in the table above as well as the related sales volumes detailed below. As a result, only eleven months of results are included in the results for the year ended December 31, 2023. The following table displays oil and natural gas sales volumes and average prices from the Underlying Properties, representing the amounts included in the net profits calculation for distributions paid during the years ended December 31, 2023 and 2022: Year Ended December 31, 2023 2022 Underlying Properties Sales Volumes: Oil (Bbls) 439,540 496,567 Natural Gas (Mcf) 2,782,568 3,357,233 Combined (Boe) 903,301 1,056,106 Average Prices: Oil – NYMEX (applicable NPI period) ($/Bbl) $ 76.83 $ 91.84 Differential $ 2.01 $ (1.88 ) Oil prices realized ($/Bbl) $ 78.84 $ 89.96 Natural gas – NYMEX (applicable NPI period) ($/Mcf) $ 2.26 $ 5.85 Differential $ 1.53 $ (0.64 ) Natural gas prices realized ($/Mcf) $ 3.79 $ 5.21 Years Ended December 31, 2023 and 2022 Net profits attributable to the Underlying Properties for the year ended December 31, 2023 are calculated from the following: ● oil sales related to oil produced from the Underlying Properties primarily from September 2022 through July 2023; ● natural gas sales related to natural gas produced from the Underlying Properties primarily from August 2022 through June 2023; and ● direct operating and development expenses related to expenses and capital incurred primarily from October 2022 to August 2023. Net profits attributable to the Underlying Properties for the year ended December 31, 2023 were $12.0 million compared to $20.2 million for the year ended December 31, 2022. As discussed in “—Computation of Income from Net Profits Interest Received by the Trust” above, no distribution was made to Trust unitholders in December 2023 due to the Net Profits Interest shortfall. Accordingly, under the modified cash basis of accounting, the oil and natural gas sales, direct operating expenses and development expenses attributable to that period was not included and instead will be included in the Trust’s results once the shortfall is recouped. Therefore, several variances between the periods are due to the inclusion of only eleven months of results in the year ended December 31, 2023 compared to twelve months in the year ended December 31, 2022. The $8.2 million decrease in net profits attributable to the Underlying Properties from the 2022 period to the 2023 period was primarily due to the following items: 52 ● Oil sales decreased $10.0 million, primarily due to lower sales volumes, which decreased oil sales by $5.1 million. Oil sales volumes decreased 11% primarily due to the inclusion of only eleven months of oil sales volumes in the year ended December 31, 2023. The remaining $4.9 million decrease in oil sales was due to lower realized sales prices. The average oil price received decreased 12% as a result of the corresponding decrease in the average NYMEX oil price for the relevant production months. ● Natural gas sales decreased $6.9 million due to lower realized sales prices, which decreased natural gas sales by $3.9 million. The average natural gas price received decreased 27% as a result of the corresponding decreases in the average NYMEX gas price for the relevant production months. The remaining $3.0 million decrease in natural gas sales was due to lower sales volumes. Natural gas sales volumes decreased 17% primarily due to the inclusion of only eleven months of natural gas sales volumes in the year ended December 31, 2023. ● Lease operating expenses during the year ended December 31, 2023 were $22.1 million compared to $21.9 million for the year ended December 31, 2022. Approximately $1.4 million of the 2023 expenses were attributable to a settlement between COERT and one of the operators of the Underlying Properties relating to a dispute with respect to certain lease operating expenses from 2018 and 2019 that the operator had mistakenly coded for Enduro instead of the Sponsor. In May 2023, the Sponsor and the operator agreed to settle the dispute at a discounted amount, resulting in an incremental lease operating expense adjustment of approximately $0.4 million per month from June 2023 through December 2023, after which no additional amounts relating to the disputed expenses will be owed to the operator. ● Compression, gathering and transportation expenses decreased from $3.3 million in 2022 to $1.7 million in 2023 due to lower sales volumes and the inclusion of only eleven months of expenses in the year ended December 31, 2023. ● Production, ad valorem and other taxes decreased $1.8 million in 2023 compared to 2022, primarily due to the decrease in realized sales prices, and lower sales volumes. ● Development expenses decreased $5.4 million due to drilling and completion costs for drilling multiple new wells in the Permian and Haynesville areas during 2022. During the year ended December 31, 2022, the Sponsor withheld from the net profits otherwise payable to the Trust a net aggregate of $1.0 million for the establishment of a cash reserve for approved, future development expenses. This reserve was intended to fund an expected increase in development expenses; however, if those expenses are ultimately delayed or are less than expected, or if the outlook changes, amounts reserved but unspent would be released as an incremental cash distribution in a future period. This cash reserve for future development was fully released to the Trust during the year ended 2023. The Trust withheld $1.3 million and paid $0.9 million for general and administrative expenses during the year ended December 31, 2023. Expenses paid during the period primarily consisted of fees for the preparation of 2022 tax information for Trust unitholders, preparation of the Trust’s 2022 reserve report and Annual Report on Form 10-K, 2022 financial statement audit fees, preparation of the Trust’s 2023 monthly press releases and Quarterly Reports on Form 10-Q, Trustee fees, and New York Stock Exchange listing fees. For the year ended December 31, 2022, the Trust withheld $1.7 million and paid $0.8 million for general and administrative expenses. Liquidity and Capital Resources The Trust’s principal sources of liquidity are cash flow generated from the Net Profits Interest and borrowing capacity under the letter of credit described below. Other than Trust administrative expenses, including any reserves established by the Trustee for future liabilities, the Trust’s only use of cash is for distributions to Trust unitholders. Available funds are the excess cash, if any, received by the Trust from the Net Profits Interest and other sources (such as interest earned on any amounts reserved by the Trustee) in any given month, over the Trust’s expenses paid for that month. Available funds are reduced by any cash the Trustee determines to hold as a reserve against future expenses. 53 The Trustee may create a cash reserve to pay for future liabilities of the Trust. In November 2021, the Trustee notified the Sponsor of the Trustee’s intent to build a cash reserve for the payment of future known, anticipated or contingent expenses or liabilities of the Trust. From February 2022 through March 2023, the Trustee withheld $37,833, and commencing with the distribution to Trust unitholders paid in April 2023 has been withholding and, in the future, intends to withhold $50,000, from the funds otherwise available for distribution each month to gradually build a cash reserve of approximately $2.3 million. The Trustee may increase or decrease the targeted cash reserve amount at any time and may increase or decrease the rate at which it is withholding funds to build the cash reserve at any time, without advance notice to the Trust unitholders. Cash held in reserve will be invested as required by the Trust Agreement. Any cash reserved in excess of the amount necessary to pay or provide for the payment of future known, anticipated or contingent expenses or liabilities eventually will be distributed to Trust unitholders, together with interest earned on the funds. As of December 31, 2023, this cash reserve totaled $941,386. If the Trustee determines that the cash on hand and the cash to be received are, or will be, insufficient to cover the Trust’s liabilities, the Trustee may authorize the Trust to borrow money to pay administrative or incidental expenses of the Trust that exceed cash held by the Trust. The Trustee may authorize the Trust to borrow from any person, including the Trustee or the Delaware Trustee or an affiliate thereof, although none of the Trustee, the Delaware Trustee or any affiliate thereof intends to lend funds to the Trust. The Trustee may also cause the Trust to mortgage its assets to secure payment of the indebtedness. The terms of such indebtedness and security interest, if funds were to be loaned by the entity serving as Trustee or Delaware Trustee or an affiliate thereof, would be similar to the terms which such entity would grant to a similarly situated commercial customer with whom it did not have a fiduciary relationship. In addition, the Sponsor has provided the Trust with a $1.2 million letter of credit to be used by the Trust if its cash on hand (including available cash reserves) is insufficient to pay ordinary course administrative expenses. Further, if the Trust requires more than the $1.2 million under the letter of credit to pay administrative expenses, the Sponsor has agreed to loan funds to the Trust necessary to pay such expenses. Any loan made by the Sponsor to the Trust would be evidenced by a written promissory note, be on an unsecured basis, and have terms that are no less favorable to the Sponsor than those that would be obtained in an arm’s length transaction between the Sponsor and an unaffiliated third party. If the Trust borrows funds or draws on the letter of credit, no further distributions will be made to Trust unitholders until such amounts borrowed or drawn are repaid. Except for the foregoing, the Trust has no source of liquidity or capital resources. The Trustee has no current plans to authorize the Trust to borrow money other than Sponsor advances to pay the Trust’s monthly operating expenses. At December 31, 2023 and 2022, the Trust held cash reserves of $1,394,697 and $922,913, respectively, for future Trust expenses. Since its formation, the Trust has not borrowed any funds other than Sponsor advances to pay the Trust’s monthly operating expenses and no amounts have been drawn on the letter of credit. From time to time, if the Trust’s cash on hand (including available cash reserves, if any) is not sufficient to pay the Trust’s ordinary course administrative expenses that are due prior to the monthly payment to the Trust of proceeds from the Net Profits Interest, the Sponsor may advance funds to the Trust to pay such expenses. Such advances are recorded as a liability on the Statements of Assets, Liabilities and Trust Corpus until repaid. Cash held by the Trustee as a reserve against future liabilities or for distribution at the next distribution date may be held in a noninterest-bearing account or may be invested in: ● interest-bearing obligations of the United States government; ● money market funds that invest only in United States government securities; ● repurchase agreements secured by interest-bearing obligations of the United States government; or ● bank certificates of deposit. The Sponsor has not entered into any hedge contracts relating to oil and natural gas volumes produced from the Underlying Properties, attributable to the Net Profits Interest for the years ended December 31, 2023 or 2022, and the terms of the Conveyance prohibit the Sponsor from entering into new hedging arrangements burdening the Trust. 54 The Trust pays the Trustee an administrative fee of $200,000 per year. The Trust pays the Delaware Trustee an annual fee of $2,000. The Trust also incurs, either directly or as a reimbursement to the Trustee, legal, accounting, tax and engineering fees, printing costs and other expenses that are deducted by the Trust before distributions are made to Trust unitholders. The Trust also is responsible for paying other expenses incurred as a result of being a publicly traded entity, including costs associated with annual and quarterly reports to Trust unitholders, tax return and Form 1099 preparation and distribution, NYSE listing fees, independent auditor fees and registrar and transfer agent fees. The Trust does not have any transactions, arrangements or other relationships with unconsolidated entities or persons that could materially affect the Trust’s liquidity or the availability of capital resources. New Accounting Pronouncements As the Trust’s financial statements are prepared on the modified cash basis, most accounting pronouncements are not applicable to the Trust’s financial statements. No new accounting pronouncements have been adopted or issued that would impact the financial statements of the Trust. Critical Accounting Policies and Estimates The Trust uses the modified cash basis of accounting to report Trust receipts of income from the Net Profits Interest and payments of expenses incurred. The Net Profits Interest represents the right to receive revenues (oil and natural gas sales), less direct operating expenses (lease operating expenses and production and property taxes) and development expenses of the Underlying Properties plus any payments made or net payments received in connection with the settlement of certain hedge contracts, multiplied by 80%. Cash distributions of the Trust are made based on the amount of cash received by the Trust pursuant to terms of the Conveyance. Under the terms of the Conveyance, the monthly Net Profits Interest calculation includes oil and natural gas revenues received. Monthly operating expenses and capital expenditures represent incurred expenses, and as a result, represent accrued expenses as well as expenses paid during the period. The financial statements of the Trust are prepared on the following basis: (a) Income from Net Profits Interest is recorded when distributions are received by the Trust; (b) Distributions to Trust unitholders are recorded when paid by the Trust; (c) Trust general and administrative expenses (which includes the Trustee’s fees as well as accounting, engineering, legal, and other professional fees) are recorded when paid; (d) Cash reserves for Trust expenses may be established by the Trustee for certain future expenditures that would not be recorded as contingent liabilities under accounting principles generally accepted in the United States of America (“GAAP”); (e) Amortization of the Net Profits Interest in oil and natural gas properties is calculated on a unit-of-production basis and is charged directly to the Trust corpus. Such amortization does not affect distributable income of the Trust; and (f) The Net Profits Interest in oil and natural gas properties is periodically assessed whenever events or circumstances indicate that the aggregate value may have been impaired below its total capitalized cost based on the Underlying Properties. If an impairment loss is indicated by the carrying amount of the assets exceeding the sum of the undiscounted expected future net cash flows of the Net Profits Interest, then an impairment loss is recognized for the amount by which the carrying amount of the asset exceeds its estimated fair value determined using discounted cash flows. 55 The financial statements of the Trust differ from financial statements prepared in accordance with GAAP because revenues are not accrued in the month of production; certain cash reserves may be established for contingencies which would not be accrued in financial statements prepared in accordance with GAAP; general and administrative expenses are recorded when paid instead of when incurred; Any impairment; and amortization of the net profits interest calculated on a unit-of-production basis is charged directly to trust corpus instead of as an expense. While these statements differ from financial statements prepared in accordance with GAAP, the modified cash basis of reporting revenues, expenses, and distributions is considered to be the most meaningful because monthly distributions to the Trust unitholders are based on net cash receipts. This comprehensive basis of accounting other than GAAP corresponds to the accounting permitted for royalty trusts by the SEC as specified by Staff Accounting Bulletin Topic 12:E, Financial Statements of Royalty Trusts . The preparation of financial statements requires the Trust to make estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Oil and Natural Gas Reserves. The proved oil and natural gas reserves for the Underlying Properties are estimated by independent petroleum engineers. Reserve engineering is a subjective process that is dependent upon the quality of available data and the interpretation thereof. Estimates by different engineers often vary, sometimes significantly. In addition, physical factors such as the results of drilling, testing and production subsequent to the date of an estimate, as well as economic factors such as changes in product prices, may justify revision of such estimates. Because proved reserves are required to be estimated using prices at the date of the evaluation, estimated reserve quantities can be significantly impacted by changes in product prices. Accordingly, oil and natural gas quantities ultimately recovered and the timing of production may be substantially different from original estimates. The Financial Accounting Standards Board requires supplemental disclosures for oil and gas producers based on a standardized measure of discounted future net cash flows relating to proved oil and natural gas reserve quantities. Under this disclosure, future cash inflows are computed by applying the average prices during the 12-month period prior to fiscal year-end, determined as an unweighted arithmetic average of the first-day-of-the-month benchmark price for each month within such period, unless prices are defined by contractual arrangements, excluding escalations based upon future conditions. Future price changes are only considered to the extent provided by contractual arrangements in existence at year-end. The standardized measure of discounted future net cash flows is achieved by using a discount rate of 10% a year to reflect the timing of future cash flows relating to proved oil and natural gas reserves. Changes in any of these assumptions, including consideration of other factors, could have a significant impact on the standardized measure. The standardized measure does not necessarily result in an estimate of the current fair market value of proved reserves. Amortization of Net Profits Interest. The Trust calculates amortization of the Net Profits Interest in oil and natural gas properties on a unit-of-production basis based on the Underlying Properties’ production and reserves. The reserves upon which the amortization rate is based are quantity estimates which are subject to numerous uncertainties inherent in the estimation of proved reserves. The volumes considered to be commercially recoverable fluctuate with changes in prices and operating costs. These estimates are expected to change as additional information becomes available in the future. Downward revisions in proved reserves may result in an increased rate of amortization. Amortization is recorded on sales volumes paid by the Trust during the relevant period and is charged directly to the Trust corpus balance. As a result, amortization does not affect the cash earnings of the Trust. Impairment of Net Profits Interest. The Net Profits Interest in oil and natural gas properties is periodically assessed for impairment whenever events or circumstances indicate that the current fair value based on expected future cash flows of the Underlying Properties may be less than the carrying value of the Net Profits Interest. The Trust did not realize any impairment during the years ended December 31, 2023 or 2022. Future downward revisions in actual production volumes relative to current forecasts, higher than expected operating costs, or lower than anticipated market pricing could result in recognition of impairment in future periods. Any impairment of the Net Profits Interest will result in a non-cash charge to Trust corpus and will not affect distributable income. For further information, see “Note 3. Net Profits Interest in Oil and Gas Properties” of the Notes to Financial Statements in Part II, Item 8 of this Form 10-K. 56 Item 7A. Quantitative and Qualitative Disclosures About Market Risk. As a “smaller reporting company” as defined in Item 10(f)(1) of Regulation S-K, the Trust is not required to provide information required by this Item. 57