ITEM 1. BUSINESS.
The following is a glossary of certain defined terms used in this Annual Report on Form 10-K.
GLOSSARY
"Administrative Services Agreement" means the Administrative Services Agreement, dated effective December 1, 1992, between Williams and the Trust, a copy of which is filed as an exhibit to this Form 10-K.
"Aftertax Cash Flow per Unit" means the sum of the following amounts that a hypothetical purchaser of a Unit in the Public Offering would have received or been allocated if such Unit were held through the date of such determination: (a) total cash distributions per Unit plus (b) total tax credits available per Unit under Section 29 of the IRC less (c) the net taxes payable per Unit (assuming a Federal income tax rate of 31 percent, which at the time of the formation of the Trust was the highest Federal income tax rate applicable to individuals).
"Bcf" means billion cubic feet of natural gas. Natural gas volumes are stated herein at the legal pressure base of 14.73 pounds per square inch absolute at 60 degrees Fahrenheit.
"Blanco Hub Spot Price" means the posted index price of spot gas delivered to pipelines per MMBtu (dry basis) as published in the first issue of the month during which gas is delivered or such determination is made, as the case may be, in Inside FERC's Gas Market Report for "El Paso Natural Gas Company, San Juan," or in the event a Blanco Hub posted index price is at some time in the future reported by Inside FERC's Gas Market Report, then the Blanco Hub posted index price will be substituted in place of the "El Paso Natural Gas Company, San Juan" posted index price.
"Btu" means British Thermal Unit, the common unit of gross heating value measurement.
"Citibank's Base Rate" means a fluctuating interest rate per annum (compounded quarterly) as shall be in effect from time to time which rate per annum shall at all times be equal to the rate of interest announced publicly by Citibank, N.A. in New York, New York, from time to time, as its base rate.
"Confirmation Agreement" means the Confirmation Agreement dated effective as of May 1, 1995 by and among WPC, Williams and the Trust, a copy of which is filed as an exhibit to this Form 10-K.
"Conveyance" means the Net Profits Conveyance dated effective as of October 1, 1992, by and among Williams, WPC, the Trustee and the Delaware Trustee, a copy of which is filed as an exhibit to this Form 10-K.
"December 31, 2000 Reserve Report" means the Reserve Report, dated March 6, 2001, on the estimated reserves, estimated future net revenues and the discounted estimated future net revenues attributable to the Royalty Interests and the Underlying Properties as of December 31, 2000, prepared by Miller and Lents, Ltd., independent petroleum engineers, a copy of which is filed as an exhibit to this Form 10-K.
"Delaware Code" means the Delaware Business Trust Act, Title 12, Chapter 38 of the Delaware Code, Sections 3801 et seq.
"Delaware Trustee" means Chemical Bank Delaware, in its capacity as a trustee of the Trust.
"Enhanced recovery or similar operations" means operations conducted for the purpose of maintaining, sustaining or enhancing production from the Underlying Properties. These operations may include additional compression, the injection of carbon dioxide or other gases or hydraulic fracturing.
"Farmout Properties" means the 5,348 gross acres in La Plata County, Colorado on which Quatro Finale owns a 35 percent net profits interest, also referred to as the PLA-9 Properties.
"Gas Gathering Contract" means the Gas Gathering and Treating Agreement, dated October 1, 1992, as amended, between WPX Gas Resources (as successor in interest to WGM) and WFS, a copy of which is filed as an exhibit to this Form 10-K.
"Gas Purchase Contract" means the Gas Purchase Agreement, dated October 1, 1992, as amended, between WPX Gas Resources (as successor in interest to WGM) and Quatro Finale (as successor to WPC), a copy of which is filed as an exhibit to this Form 10-K.
"Grantor trust" means a trust as to which the grantor, or its successor, has retained an interest in the income from the trust.
"Gross acres" means the total number of surface acres of land without regard to ownership.
"Gross wells" means the total whole number of gas wells without regard to ownership interest.
"Index Price" means 97 percent of the Blanco Hub Spot Price as of the date the determination is made.
"Infill Net Proceeds" consists generally of the aggregate proceeds based on the price at the Wellhead of gas produced from WPC's net revenue interest in any possible Infill Wells less (a) Quatro Finale's working interest share of property and production taxes on such Infill Wells; (b) WPC's working interest share of operating costs on such Infill Wells; (c) WPC's working interest share of capital costs on such Infill Wells, including costs of drilling and completing such Infill Wells and the costs of associated surface facilities; and (d) interest on the unrecovered portion, if any, of the foregoing costs at Citibank's Base Rate.
"Infill NPI" refers to one of the net profits interests conveyed to the Trust, consisting of a 20 percent interest in WPC's Infill Net Proceeds.
"Infill Wells" means any possible additional well drilled on a producing drilling block when well spacing rules are effectively modified from the existing 320 acre spacing.
"IRC" means the Internal Revenue Code of 1986, as amended.
"IRR" means the annual discount rate (compounded quarterly) that equates the present value of the Aftertax Cash Flow per Unit to the initial price to the public of the Units in the Public Offering (which was $20.00 per Unit).
"Mcf" means thousand cubic feet of natural gas.
"Minimum Purchase Price" means 97 percent of $1.75 per MMBtu (dry basis).
"MMBtu" means million Btu.
"MMcf" means million cubic feet of natural gas.
"Net profits interest" generally refers to a real property interest entitling the owner to receive a specified percentage of the net proceeds from the sale of production attributable to the properties burdened thereby, the amount of which is based on a revenue formula specified in such net profits interest.
"NPI" refers to one of the net profits interests conveyed to the Trust, generally entitling the Trust to receive 81 percent (subject to reduction as described below) of the NPI Net Proceeds attributable to (i) Quatro Finale's net revenue interest (working interest less lease burdens) in the WI Properties and (ii) the revenue stream received by WPC attributable to its 35 percent net profits interest in the Farmout Properties. The percentage of the NPI Net Proceeds to which the Trust is entitled was subject to permanent reduction to 60 percent under certain conditions, and such a reduction occurred in the fourth quarter of 2000 as described under "Item 2
ITEM 2. PROPERTIES.
THE ROYALTY INTERESTS
The Royalty Interests conveyed to the Trust consist of net profits interests in the Underlying Properties. The Royalty Interests were conveyed to the Trust by means of a single instrument of conveyance. The Conveyance was recorded in the appropriate real property records in each county in New Mexico and Colorado where the Underlying Properties are located so as to give notice of the Royalty Interests to creditors and transferees, who would take an interest in the Underlying Properties subject to the Royalty Interests. The Conveyance was intended to convey the Royalty Interests as real property interests under applicable state law.
On May 7, 1997, effective as of May 1, 1997, WPC transferred the Underlying Properties to Quatro Finale LLC, a Delaware limited liability company, pursuant to the terms of a Purchase and Sale Agreement dated as of May 1, 1997 ("1997 Transaction"). Prior to the 1997 Transaction, WPC had owned the Underlying Properties, subject to and burdened by the Royalty Interests owned by the Trust, since the inception of the Trust. The sale of the Underlying Properties is expressly permitted under the Trust Agreement. Neither the Trustee nor the Delaware Trustee has any control over or responsibility relating to the operation of the Underlying Properties. Under the terms of the 1997 Transaction, ownership of the Underlying Properties reverted back to WPC effective February 1, 2001. Pursuant to a Purchase and Sale Agreement dated March 14, 2001 (the "2001 Transaction Agreement") and effective March 1, 2001, WPC transferred the Underlying Properties to Quatro Finale V LLC, a Delaware limited liability company (the "2001 Transaction").
As used in this Report, the term "Quatro Finale" generally refers to either of Quatro Finale LLC or Quatro Finale V LLC that at the time in question was or is the owner of the Underlying Properties. Consequently, unless otherwise dictated by context, "Quatro Finale" generally means (a) with respect to the period May 1, 1997 until February 28, 2001,Quatro Finale LLC (which entity
acquired and owned the Underlying Properties effective from May 1, 1997 until February 1, 2001), and (b) with respect to the period from and after March 1, 2001, Quatro Finale V LLC (which entity acquired and has owned the Underlying Properties effective and since March 1, 2001). Notwithstanding the foregoing, with respect to the ownership of the Underlying Properties for any period prior to May 1, 1997, and for the period from February 1 through February 28, 2001, references herein to Quatro Finale should be deemed to refer to WPC.
Concurrently with the 2001 Transaction, WPC and Quatro Finale entered into a Management Services Agreement dated March 1, 2001 (the "Management Services Agreement") whereby WPC agreed, among other things, to continue to manage and operate the Underlying Properties and to handle the receipt and payment of funds with respect thereto. Prior to the 2001 Transaction, WPC received all payments relating to the Underlying Properties and, pursuant to the Conveyance, paid to the Trust the portion thereof attributable to the Royalty Interests. Following the 2001 Transaction, under the Management Services Agreement, WPC continues to collect all revenues on behalf of Quatro Finale and remains obligated to pay to the Trust on behalf of Quatro Finale the amounts payable with respect to the Royalty Interests.
Under the Conveyance, the amounts payable with respect to the Royalty Interests are computed with respect to each calendar quarter ending prior to termination of the Trust, and such amounts are to be paid to the Trust not later than the last day of the calendar month next following the end of each calendar quarter. The amount paid to the Trust does not include interest on any amounts payable with respect to the Royalty Interests that are held by WPC prior to payment to the Trust. WPC is entitled to retain any amounts attributable to the Underlying Properties that are not required to be paid to the Trust with respect to the Royalty Interests.
Concurrently with the 2001 Transaction, WPC, Williams, the Trust and Quatro Finale entered into an Agreement dated March 1, 2001, (the "Performance Acknowledgement Agreement"), pursuant to which (i) the parties acknowledged that, although WPC was selling the Underlying Properties to Quatro Finale, WPC retained all of its duties and obligations under the Trust Agreement, Conveyance and related documents (the "Trust Documents"), subject to the terms and conditions set forth in the 2001 Transaction Agreement and the agreements entered into pursuant to the 2001 Transaction Agreement, (ii) Williams and WPC each confirmed and agreed that, notwithstanding the sale of the Underlying Properties to Quatro Finale, Williams and WPC would continue to perform their respective obligations to the Trust pursuant to the Trust Documents, including without limitation the performance assurances of Williams set forth in the Conveyance, and (iii) Quatro Finale acknowledged and agreed that it was purchasing the Underlying Properties burdened by the Royalty Interests owned by the Trust.
The following description contains a summary of the material terms of the Conveyance and is subject to and qualified by the more detailed provisions of the Conveyance, a copy of which is filed as an exhibit to this Form 10-K.
THE UNDERLYING PROPERTIES
The Royalty Interests were conveyed by WPC to the Trust from its net revenue interest (working interest less lease burdens) in the WI Properties and its net profits interest in the Farmout Properties. Substantially all of the production from the Underlying Properties is from the Fruitland coal formation in the San Juan Basin. The San Juan Basin (the "Basin"), one of the largest gas producing basins in the United States, encompasses approximately 12,000 square miles in northwest New Mexico and southwest Colorado, just east of the common corner of the states of Utah, Arizona, New Mexico and Colorado known as the Four Corners. It covers parts of La Plata and Archuleta counties in Colorado, as well as parts of San Juan, Rio Arriba, McKinley and Sandoval counties in New Mexico. The Basin has been an active area for coal seam gas development within the Fruitland coal formation.
Williams acquired its interests in the Underlying Properties in 1983 through the acquisition of Northwest Pipeline Corporation ("Northwest"), and such Underlying Properties were transferred to WPC on December 31, 1990. Northwest originally owned working interests which were burdened by overriding royalty interests in the Underlying Properties. The overriding royalty interests resulted in excessive burdens and Northwest negotiated settlements with the owners of the overriding royalty interests. Pursuant to one of these settlements, Northwest and Amoco Production Company ("Amoco") entered into a joint venture under which Northwest agreed to assign to Amoco certain oil and
gas properties in two exploratory areas, one of which (the PLA-9 properties) comprises the Farmout Properties. In consideration for such assignment, Northwest received an overriding royalty interest in the Farmout Properties. Northwest's rights under the joint venture agreement were subsequently assigned to WPC, which elected, effective as of October 1, 1992, to convert the overriding royalty interest in the Farmout Properties to a 35 percent net profits interest. Effective May 1, 1997, WPC conveyed its rights in the Underlying Properties to Quatro Finale.
Development of the Fruitland coal formation acreage has resulted in the drilling of 600 gross coal seam gas wells in the Underlying Properties, 22 of which are in the Farmout Properties. Quatro Finale owns mineral rights in the Fruitland coal formation under 214 oil and gas leases. Under the terms of these leases, Quatro Finale has the right to extract oil and gas from the lease properties. Quatro Finale holds either a record title interest, operating right interest or net profits interest in the leases. Record title and operating right interests are commonly referred to as working interests. The Underlying Properties constitute substantially all of Quatro Finale's proved reserves in the Fruitland coal formation. Neither Quatro Finale nor WPC operate any of the coal seam gas wells on the Underlying Properties.
Unitized Areas. Approximately 90 percent of the Fruitland coal formation proved developed coal seam gas wells on the WI Properties are located within the boundaries of New Mexico Federal Units. Pursuant to the Federal Mineral Leasing Act of 1920, as amended, and applicable state regulations, owners of oil and gas leases in New Mexico created large unitized areas consisting of several contiguous sections for the orderly development and conservation of oil and gas reserves. The WI Properties participate in production from the 12 unitized areas in New Mexico referred to in the following table (the "Federal Units"). Operation and development of the Federal Units is governed by unit agreements and unit operating agreements (collectively, the "Unit Agreement"). Under the Unit Agreement and applicable government regulations, the Federal Unit operators request regulatory approval from the New Mexico Commission of Public Lands, the New Mexico Oil Conservation Commission and the Bureau of Land Management to establish or expand participating areas which produce oil and gas in paying quantities from designated formations. The interests of participants in a participating area are based on the surface acreage included in the participating area. Under the terms of the Unit Agreements, the operators, selected by a vote of the respective working interest owners, perform all operating functions.
In all of the Federal Units, participating areas have been formed for the Fruitland coal formation. After the wells capable of producing gas in paying quantities from the Fruitland coal formation are drilled on the undeveloped drill blocks included within a Federal Unit, such wells are added to the participating area if approved in accordance with the appropriate Unit Agreement. A delay of at least 18-36 months is usually incurred after a well is completed and producing before it is added to a participating area. As participating areas are created and expanded, such modification (which will be effective retroactively to the date production commenced from the wells causing such expansion) results in a participant owning undivided interests in all of the producing wells within the participating area. Therefore, Quatro Finale's working interest and net revenue interest in the wells in a Federal Unit or participating area may be modified retroactively, which could affect significantly the amount of NPI Net Proceeds with respect to production from October 1, 1992. If any well(s) that produced or may have produced marketable quantities of coal seam gas prior to 1980 is included in or added to a participating area in which the WI Properties participate, the Conveyance provides that such well(s) will be treated as, and the Trust will own, a separate net profits interest in such well(s) (the "Pre-80 Production NPI"). The net proceeds for such Pre-80 Production NPI would be calculated in a manner similar to the calculation of Infill Net Proceeds, and the Trust's share of such net proceeds will be 81 percent, subject to decrease upon the same terms as the NPI. If a participating area expansion includes production from wells that do not qualify for Section 29 tax credits, the tax credit available to Unitholders in respect of production attributable to the NPI from such Federal Unit could be reduced. See "Item 1 - -Federal Income Taxation."
The following table reflects certain information from the Reserve Report as of December 31, 2000 prepared by Miller and Lents, Ltd. dated March 6, 2001 (the "December 31, 2000 Reserve Report") regarding the Federal Units in which the WI Properties participate. At December 31, 2000, the WI Properties covered 600 gross (68 net) coal seam gas wells with working interests ranging from .0589 percent to 100 percent, with an average working interest of approximately 11. percent. The Royalty Interests participate in each Federal Unit and participating area in which the WI Properties participate based on the acreage containing wells with proved reserves on December 31, 2000.
Meridian Oil Inc. is a subsidiary of Burlington Resources Inc. and Blackwood & Nichols Co., Ltd. is a subsidiary of Devon Energy Corporation.
Well Count and Acreage Summary. The following table shows as of December 31, 1998, 1999 and 2000, the gross and net wells and acreage by proved producing and nonproducing categories for the WI Properties.
Of the total gross wells described above at December 31, 2000, 492 gross wells are located in unitized areas. In addition to the above, the Farmout Properties have 22 gross wells.
Properties Outside Unitized Areas. The WI Properties also include interests held by Quatro Finale in 28 proved developed Fruitland formation coal seam gas wells held in areas outside of Federal Units that are not reflected in the foregoing table. As of December 31, 2000, Quatro Finale's working interest and net revenue interests in these wells averaged 8.5 percent and 6.9 percent, respectively.
The Farmout Properties consist of a 35 percent net profits interest on a property farmed out to Amoco in La Plata County, Colorado. Such properties are not within any Federal Unit boundary. The Farmout Properties are owned, and most of the wells thereon are operated, by Amoco. Neither Quatro Finale, Williams, WPC, the Delaware Trustee, the Trustee nor the Unitholders are able to influence or control the operation or future development of the Farmout Properties. WPC has advised the Trustee that it believes that a majority of the production from the Farmout Properties is sold by Amoco under short-term marketing arrangements at spot market prices and qualifies for the Section 29 tax credit. No assurance can be given, however, that Amoco will not in the future subject production from the Farmout Properties to long-term sales contracts at non-market responsive prices. A portion of the production from the Farmout Properties is gathered by WFS pursuant to a gathering contract at rates and subject to other terms that were negotiated on an arms-length basis. As of December 31, 2000, 22 gross wells had been drilled on the Farmout Properties. For a further description of the Farmout Properties, see "--The NPI."
THE NPI
The NPI generally entitles the Trust to receive 81 percent of the NPI Net Proceeds, subject to permanent reduction under certain conditions as described under "--NPI Percentage Changes." The percentage of NPI Net Proceeds which the Trust is entitled to receive was permanently reduced to 60 percent in the fourth quarter of 2000. NPI Net Proceeds consists generally of the aggregate proceeds attributable to (i) Quatro Finale's net revenue interest based on the sale at the Wellhead of gas produced from the WI Properties and (ii) the revenue stream received by Quatro Finale from its 35 percent net profits interest in the Farmout Properties, less (a) Quatro Finale's working interest share of property and production taxes on the WI Properties; (b) Quatro Finale's working interest share of actual operating costs on the WI Properties to the extent in excess of those agreed to be paid by Quattro Finale (as successor to WPC) as described herein; (c) Quatro Finale's working interest share of capital costs on the WI Properties to the extent in excess of those agreed to be paid by Quatro Finale (as successor to WPC) as described herein; and (d) interest on the unrecovered portion, if any, of the foregoing costs at Citibank's Base Rate.
Most of the wells reflected in the December 31, 2000 Reserve Report were drilled prior to 1994. Significant additional capital expenditures were not incurred during the early years of the production lives of such wells, and it is not anticipated that further significant capital expenditures will be incurred. Consequently, the December 31, 2000 Reserve Report was prepared on the basis that there will be no capital expenditures borne by the Royalty Interests. Nevertheless, the operators and working interest owners of the wells could elect at any time to implement measures to increase the producible reserves. These measures, if implemented, could involve additional compression or enhanced or secondary recovery operations requiring substantial capital expenditures that would be proportionately borne by the Royalty Interests.
Exhibit B to the Conveyance reflects estimated annual operating expenses for wells on the WI Properties. No operating expenses in respect of the WI Properties will be deducted in calculating NPI Net Proceeds except when the actual cumulative operating expenses attributable to Quatro Finale's working interests in the WI Properties exceed the estimated cumulative operating expenses reflected in Exhibit B to the Conveyance as of the close of a calendar quarter (less the estimated operating costs in such Exhibit that are allocable to two wells that were repurchased effective as of January 1, 1994 by WPC as a purchase price adjustment or to any wells that are reconveyed to WPC as uneconomic). The amount by which such actual cumulative operating expenses exceed estimated cumulative operating expenses reflected in such Exhibit will be deducted in calculating NPI Net Proceeds and, therefore, will reduce the amounts payable to the Trust.
If, during any period, costs and expenses deductible in calculating the NPI Net Proceeds exceed gross proceeds, neither the Trust nor Unitholders will be liable for such excess, but the Trust will receive no payments for distribution to Unitholders with respect to the NPI until future gross proceeds exceed future costs and expenses plus the cumulative excess of such costs and expenses plus interest thereon at Citibank's Base Rate. However, if the excess costs are the result of capital costs incurred for enhanced recovery or similar operations on the WI Properties, the Trust will receive no less than 20 percent of the NPI Net Proceeds (calculated before such capital costs are deducted) until such excess costs plus interest thereon at Citibank's Base Rate are recovered by Quatro Finale unless such capital costs are $3,000,000 or more, in which event the Trust will only receive payments equal to the administrative costs of the Trust until such unrecovered costs plus interest thereon at Citibank's Base Rate are less than $3,000,000.
The calculation of NPI Net Proceeds includes amounts received by Quatro Finale in respect of its 35 percent net profits interest in the Farmout Properties. Quatro Finale's net profits interest in the Farmout Properties is calculated on a total operations basis and is defined as lease revenues less burdens, operating expenses (including overhead as defined in the applicable operating agreement) and all taxes related to the value of reserves, production, property and equipment (e.g., severance and ad valorem taxes).
WPC has advised the Trustee that the majority of the coal seam gas from the Farmout Properties is sold by Amoco under short-term marketing arrangements at spot market prices and the remainder is marketed by the other operators of the wells in the Farmout Properties. Neither the Gas Purchase Contract nor the Gas Gathering Contract covers the volumes produced from the Farmout Properties.
RESERVE REPORT
The following table summarizes net proved reserves estimated as of December 31, 2000, and certain related information for the Royalty Interests and Underlying Properties from the December 31, 2000 Reserve Report prepared by Miller and Lents, Ltd., independent petroleum engineers. A summary of the December 31, 2000 Reserve Report is filed as an exhibit to this Form 10-K and incorporated herein by reference. See Note 9 of the Notes to Financial Statements in Item 8 hereof for additional information regarding the net proved reserves of the Trust.
A net profits interest does not entitle the Trust to a specific quantity of gas but to a portion of the net proceeds derived therefrom. Ordinarily and in the case of the Farmout Properties, proved reserves attributable to a net profits interest are calculated by deducting an amount of gas sufficient, if sold at the prices used in preparing the reserve estimates for such net profits interest, to pay the future estimated costs and expenses deducted in the calculation of the net proceeds of such interest. Because Quatro Finale (as successor to WPC) has agreed to pay certain operating and capital costs with respect to the WI Properties, no amount of gas in respect of such costs has been deducted from the amount of reserves attributable to the WI Properties in determining the amount of reserves attributable to the Royalty Interests. Accordingly, the reserves presented for the Royalty Interests reflect quantities of gas that are free of future costs and expenses (other than production, severance and ad valorem taxes in respect of the WI Properties) if the price and cost assumptions set forth in the December 31, 2000 Reserve Report occur. The December 31, 2000 Reserve Report was prepared in accordance with criteria established by the Commission and, accordingly, is based upon a contractual price for gas for December 2000, of $5.2025 per MMBtu before transportation charges. The December 31, 2000 Reserve Report is also based on the percentage share of NPI Net Proceeds payable to the Trust continuing at 60 percent (permanently reduced from 81 percent since the fourth quarter of 2000) for the remaining life of the reserves.
(a) Although the prices utilized in preparing the estimates in this table are in accordance with criteria established by the Commission, such prices were influenced by seasonal demand for natural gas and other factors and may not be the most representative prices for estimating future net revenues or related reserve data.
(b) The gas reserves were estimated by Miller and Lents, Ltd. by applying decline curve analyses utilizing type curves for the various areas in the Basin. The bases for the consideration of type curves are the production histories, the water and gas production rates and the initial reservoir pressures of the wells in the separate areas.
(c) Estimated future net revenues are defined as the total revenues attributable to the Underlying Properties and Royalty Interests less royalties, severance and ad valorem taxes, operating costs and future capital expenditures in excess of estimated amounts to be paid by Quatro Finale. Overhead costs (beyond the standard overhead charges for the nonoperated properties) have not been included, nor have the effects of depreciation, depletion and Federal income tax. Estimated future net revenues and discounted estimated future net revenues are not intended and should not be interpreted as representing the fair market value for the estimated reserves.
Based upon the production estimates used in the December 31, 2000 Reserve Report for the January 1, 2001 through December 31, 2003 period, and assuming constant future Section 29 tax credits at the estimated 2000 rate of $1.059 per MMBtu, the estimated total future tax credits available from the production and sale of the net proved reserves from the Royalty Interests would be approximately $13.5 million, having a discounted present value (assuming a 10 percent discount rate) of approximately $12.3 million.
There are many uncertainties inherent in estimating quantities and values of proved reserves and in projecting future rates of production and the timing of development expenditures. The reserve data set forth herein, although prepared by independent petroleum engineers in a manner customary in the industry, are estimates only, and actual quantities and values of natural gas are likely to differ from the estimated amounts set forth herein. In addition, the reserve estimates for the Royalty Interests will be affected by future changes in sales prices for natural gas produced and costs that are deducted in calculating NPI Net Proceeds and Infill Net Proceeds. Further, the discounted present values shown herein were prepared using guidelines established by the Commission for disclosure of reserves and should not be considered representative of the market value of such reserves or the Units. A market value determination would include many additional factors.
Information concerning historical changes in net proved reserves attributable to the Underlying Properties, and the calculation of the standardized measure of discounted future net revenues related thereto, are contained in Note 9 (Supplemental Oil and Gas Reserve Information (Unaudited)) to the Financial Statements of the Trust included in this Form 10-K. Williams has not filed reserve estimates covering the Underlying Properties with any Federal authority or agency other than the Commission.
HISTORICAL GAS SALES PRICES AND PRODUCTION
The following table sets forth the actual net production volumes from the WI Properties, weighted average lifting costs and information regarding historical gas sales prices for each of the years ended December 31, 1998, 1999 and 2000:
The published Blanco Hub Spot Price for December 2000 was $6.00 per MMBtu. Information regarding average wellhead sales prices for production from the Farmout Properties is not available to WPC (as manager of Quatro Finale's interests in the Underlying Properties on behalf of Quatro Finale), although WPC has advised the Trustee that it believes production from such properties is currently sold by Amoco under short-term marketing arrangements at spot market prices.
NPI PERCENTAGE REDUCTION
As described above under "--The NPI," since the Trust's inception, the NPI has generally entitled the Trust to receive 81 percent of NPI Net Proceeds. However, under the terms of the Conveyance, at the point that (i) cumulative gas production since October 1, 1992 from the Underlying Properties has exceeded 178.5 Bcf and (ii) the internal rate of return of the "Aftertax Cash flow per Unit" (as defined below) has equaled or exceeded 12 percent, the percentage of NPI Net Proceeds payable to the Trust in respect of the NPI is automatically and permanently reduced to 60 percent. In such event, Quattro Finale's retained percentage of NPI Net Proceeds is correspondingly increased from 19 percent to 40 percent. For purposes hereof, "Aftertax Cash Flow per Unit" is equal to the sum of the following amounts that a hypothetical purchaser of a Unit in the Public Offering would have received or been allocated if such Unit were held through the date of such determination: (a) total cash distributions per Unit plus (b) total tax credits available per Unit under Section 29 of the IRC less (c) the net taxes payable per Unit (assuming a Federal income tax rate of 31 percent, which at the time of the formation of the Trust was the highest Federal income tax rate applicable to individuals). Internal rate of return ("IRR") is the annual discount rate (compounded quarterly) that equates the present value of the Aftertax Cash Flow per Unit to the initial price to the public of the Units in the Public Offering (which was $20.00 per Unit).
Cumulative production since October 1, 1992 from the Underlying Properties has been in excess of 178.5 since 1999. Although the 12 percent internal rate of return of Aftertax Cash Flow per Unit was previously not projected to be reached until the first quarter of 2001, this internal rate of return was in fact reached and exceeded during the fourth quarter of 2000. Consequently, beginning in the fourth quarter of 2000, the percentage of NPI Net Proceeds the Trust is entitled to receive under the NPI has been permanently reduced from 81 percent to 60 percent.
It is expected that the reduction in the NPI percentage will substantially reduce the distributions paid to the Trust, and in turn the Quarterly Distribution Amount payable to Unitholders, beginning with the Quarterly Distribution Amount for the first quarter of 2001, which generally relates to proceeds from production occurring during fourth quarter 2000.
GAS PURCHASE CONTRACT
Under the terms of the Gas Purchase Contract, WPX Gas Resources (as successor in interest to WGM) purchases the natural gas produced from the WI Properties (except for certain small volumes) at the Wellhead. The Gas Purchase Contract commenced October 1, 1992 and expires on the termination of the Trust. The Gas Purchase Contract provides for a pricing mechanism during an initial five-year period ("Primary Term") which expired on December 31, 1997. Following the expiration of the Primary Term, the pricing mechanism continues for one or more consecutive additional one-year terms (each such term a "Contract Year") unless and until WPX Gas Resources exercises its annual option, exercisable fifteen (15) days prior to the end of each Contract year, to discontinue purchasing gas from Quatro Finale (as successor to WPC) under the pricing provision of the Gas Purchase Contract and instead purchase gas at a monthly price equal to the "Index Price" as described hereafter. For each of the Contract Years 1998, 1999, 2000 and 2001, WPX Gas Resources did not exercise this option and therefore the pricing mechanism of the Primary Term remained in effect for each of those past years and will continue to remain in effect through at least December 31, 2001. Under this mechanism, the monthly price to be paid by WPX Gas Resources for natural gas purchased pursuant to the Gas Purchase Contract shall be (a) the $1.70 Minimum Purchase Price, less (b) any costs paid by WPX Gas Resources to gather, treat and process the gas and deliver it to specified delivery points and plus (c) under certain circumstances, additional amounts determined as described below:
(i) If the Index Price in any month during any Contract Year, including 2001, is greater than $1.94 per MMBtu, then WPX Gas Resources will pay Quatro Finale (as successor to WPC) an amount for gas purchased equal to $1.94 per MMBtu, less the costs paid by WPX Gas Resources to gather and process such gas and deliver it to specified delivery points, plus 50 percent of the excess of the Index Price over $1.94 per MMBtu (the "Price Differential"), provided WPX Gas Resources has no accrued Price Credits (see below) in the Price Credit Account (defined below). If WPX Gas Resources has accrued Price Credits in the Price Credit Account, then WPX Gas Resources will be entitled to reduce the amount in excess of the Minimum Purchase Price (before deducting gathering and processing costs and costs to deliver the gas to specified delivery points) that otherwise would be payable by any accrued and unrecouped Price Credits in the Price Credit Account, and WPX Gas Resources will not be obligated to pay Quatro Finale any amounts in excess of the Minimum Purchase Price until such time as all accrued Price Credits have been recouped and a zero balance exists in the Price Credit Account.
(ii) If the Index Price in any month during any Contract Year, including 2001, is greater than the Minimum Purchase Price but less than or equal to $1.94 per MMBtu, then WPX Gas Resources will pay Quatro Finale an amount for each MMBtu purchased equal to the Index Price less the costs paid by WPX Gas Resources to gather and process such gas and deliver it to specified delivery points, provided WPX Gas Resources has no accrued Price Credits in the Price Credit Account. If WPX Gas Resources has accrued Price Credits in the Price Credit Account, then WPX Gas Resources will be entitled to reduce the amount in excess of the Minimum Purchase Price (before deducting, gathering and processing costs and costs to deliver to specified delivery points) that otherwise would be payable by any accrued and unrecouped Price Credits in the Price Credit Account, and WPX Gas Resources will not be obligated to pay WPC any amounts in excess of the Minimum Purchase Price until such time as all accrued Price Credits have been recouped and a zero balance exists in the Price Credit Account.
(iii) If the Index Price in any month during any Contract Year, including 2001, is less than the Minimum Purchase Price, then WPX Gas Resources will pay for each MMBtu of gas purchased the Minimum Purchase Price less the costs paid by WPX Gas Resources to gather and process such gas and deliver it at specified delivery points, and WPX Gas Resources will receive a credit (the "Price Credit") from Quatro Finale for each MMBtu of gas purchased by WPX Gas Resources equal to the difference between the Minimum Purchase Price and the Index Price. Quatro Finale is required to establish and maintain an account (the "Price Credit Account") containing the accrued and unrecouped amount of such Price Credits. No Price Credits were accrued in respect of production purchased by WPX Gas Resources prior to January 1, 1994.
Beginning in 1994, the Index Price has often been below the Minimum Purchase Price, resulting in the periodic accrual of Price Credits in the Price Credit Account. For the year ended December 31, 2000, the Index Price exceeded
the Minimum Purchase Price for each month during the year. During 2000, WPX Gas Resources recouped approximately $5.5 million of Price Credits in the Price Credit Account, which, based on the Trust's 81 percent interest in the WI Properties, represented an offset of approximately $4.5 million against royalty income the Trust would have otherwise received during the year. As of December 31, 2000, there were no remaining unrecouped Price Credits in the Price Credit Account.
To the extent there may in the future be a balance in the Price Credit Account, the entitlement to recoup Price Credits means that if and when the Index Price is above the Minimum Purchase Price, future royalty income paid to the Trust would be reduced until such time as such Price Credits have been fully recouped. Corresponding cash distributions to Unitholders would also be reduced.
Subsequent to the expiration of the Primary Term of the pricing provision of the Gas Purchase Contract, which occurred on December 31, 1997, WPX Gas Resources has an annual option (which can be exercised only once during the term of the Gas Purchase Contract) to discontinue purchasing gas under the pricing provision of the Gas Purchase Contract by giving written notice of its election to pay solely the Index Price (less the costs paid by WPX Gas Resources to gather, treat and process such gas and deliver it to specified points). If WPX Gas Resources so elects to discontinue paying under the pricing provision, WPX Gas Resources will no longer be entitled to retain the Price Differential when the Index Price exceeds $1.94 per MMBtu and any accrued and unrecouped Price Credits will be extinguished. Since there is no published price in the San Juan Basin for wellhead deliveries, the wellhead price in the Gas Purchase Contract is determined by utilizing a published price which is inclusive of gathering, treating and processing costs. As used herein, "Index Price" means 97 percent of the first of month El Paso Natural Gas Co. -- San Juan Spot Price. The El Paso Natural Gas Co. -- San Juan Spot Price is a posted index price per MMBtu (dry basis) published in Inside F.E.R.C.'s Gas Market Report which is a bi-monthly publication by The McGraw-Hill Companies, Inc. The Gas Purchase Contract provides WPX Gas Resources a one-time option to convert the Index Price from the first of month posting of El Paso Natural Gas Co. -- San Juan Spot Price to the average of the bi-monthly postings for that same index. The Gas Purchase Contract further provides for an alternative indexing mechanism in the event the Inside F.E.R.C.'s Gas Market Report indices are modified or discontinued. All prices used as index prices are delivered prices at the specified point of delivery and are, therefore, before deducting gathering and/or transportation charges, taxes, treating costs or other costs payable prior to the delivery points. During periods when there is a Price Differential, WPX Gas Resources will absorb a portion of the gathering charges based on a formula specified within the Gas Purchase Contract.
A small volume of gas produced from the WI Properties (less than 5 percent) is sold by the operators of certain wells under gas purchase contracts with other buyers.
The prices paid to Quatro Finale pursuant to the Gas Purchase Contract are prices payable for the value of gas purchased for production at the Wellhead. Title to the gas purchased pursuant to the Gas Purchase Contract passes to WPX Gas Resources at the Wellhead. WPX Gas Resources is responsible for gathering, treating, processing and marketing all gas purchased pursuant to the Gas Purchase Contract. Approximately 90 percent of the production from the WI Properties is gathered by WPX on behalf of WPX Gas Resources. The balance of the production is gathered on behalf of WPX Gas Resources by third parties. See "--Gas Gathering Contract." The price paid to Quatro Finale pursuant to the Gas Purchase Contract is after deducting the costs incurred by WPX Gas Resources to gather, treat and process such gas (including costs incurred by WPX Gas Resources under the Gas Gathering Contract). Payments to Quatro Finale for gas purchased pursuant to the Gas Purchase Contract are made by WPX Gas Resources on or before the last day of the first calendar month next following the end of each calendar quarter.
NPI Net Proceeds and Infill Net Proceeds are calculated on an entitlements or entitled volume basis, whereby the aggregate proceeds from the sale of gas under applicable gas sales contracts (excluding production from the Farmout Properties) are determined by WPC as agent for Quatro Finale as if Quatro Finale had produced and sold its working interest share of production from the WI Properties, even if the actual volumes delivered to and sold by Quatro Finale are different than the entitlement volumes. The effect of such an "entitlements basis" calculation is that NPI Net Proceeds or Infill Net Proceeds and, therefore, the amount thereof paid to the Trust, may include amounts in respect
of production not taken by Quatro Finale because of a so-called imbalance (that is, where a working interest owner is delivered more or less than the actual share of production to which it is entitled).
The Gas Purchase Contract may not be amended in a manner that would materially adversely affect the revenues to the Trust without the approval of the holders of a majority of the Units present or represented at a meeting of Unitholders at which a quorum (consisting of a majority of the outstanding Units) is present or represented. As noted elsewhere herein, the Units held by Williams (or an affiliate) immediately after the Public Offering may not be voted on any such amendment nor will such Units be counted for quorum purposes so long as such Units are held by Williams (or an affiliate). Effective August 11, 2000, Williams sold all of its remaining holdings of Units to QFIV. A copy of the Gas Purchase Contract is filed as an exhibit to this Form 10-K. The foregoing summary of the material provisions of the Gas Purchase Contract is qualified in its entirety by reference to the terms of such agreement as set forth in such exhibit.
GAS GATHERING CONTRACT
In accordance with the Confirmation Agreement, effective May 1, 1995, WGM assigned to WPX Gas Resources all of its right, title, interest, duties and obligations under the Gas Gathering Contract, and WPX Gas Resources assumed all of WGM's right, title, interest, duties and obligations thereunder.
The Gas Gathering Contract, which will be in effect until December 31, 2022, subject to annual extensions thereafter, covers approximately 90 percent of the production from the WI Properties and commits WFS on behalf of WPX Gas Resources to gather such production (except production from 19 wells in the San Juan 29-7 unit as described below), at rates starting at $.35 per Mcf (plus a fuel reimbursement estimated to be 6.2 percent to 7.3 percent of gathered volumes on a Btu equivalent basis, and subject to increase if the CO2 content of the gas exceeds 10 percent) and adjusted annually based on average annual price comparisons determined on the basis of the Blanco Hub Spot Price, provided that the gathering rate will be no less than $.35 per Mcf increased or decreased on the basis of an increase or decrease in a published index measuring the gross domestic product. A significant portion of the gas to be gathered pursuant to the Gas Gathering Contract must first be gathered from the wellhead to a Federal Unit central delivery point by Burlington Resources Gathering Inc. ("Burlington"). WPX Gas Resources has been assigned a one-year gathering contract (with a monthly evergreen provision) whereby Burlington provides interruptible gathering service at the price of $.06 per Mcf which escalates annually at 3 percent, plus actual fuel used (historically averaging approximately .5 percent). It is anticipated that WPX Gas Resources will be able to extend the term of this agreement.
The remainder of the production on the WI Properties is not physically connected to the WFS system and is not covered by the Gas Gathering Contract. This gas is gathered either by Burlington or El Paso Field Services ("EFS") for delivery at the Blanco Hub or by WFS for delivery at the outlet of the Ignacio Plant in La Plata County, Colorado. WPC has existing long-term gathering agreements with EFS and short-term gathering agreements with Burlington with rates and terms generally comparable to the Gas Gathering Contract.
The Gas Gathering Contract may not be amended in a manner that would materially adversely affect the revenues to the Trust without the approval of the holders of a majority of the Units present or represented at a meeting of Unitholders at which a quorum (consisting of a majority of the outstanding Units) is present or represented. As noted elsewhere herein, the Units held by Williams (or an affiliate) immediately after the Public Offering may not be voted on any such amendment nor will such Units be counted for quorum purposes so long as such Units are held by Williams (or an affiliate).
The Gas Gathering Contract was twice amended, each effective as of October 1, 1993, with respect to 19 wells located in the San Juan 29-7 unit. WFS is obligated to gather production from such wells at a rate of $.36 per Mcf (plus a fuel reimbursement of 5.5 percent of the gas received at the Wellhead Receipt Points (as defined)), fixed for a 10 year term. In connection with these amendments to the Gas Gathering Contract, the Trustee received an opinion of counsel to Williams that such amendments need not be submitted for approval by vote of the Unitholders.
The Gas Gathering Contract was further amended effective as of April 1, 1997, for the purpose of increasing the field rights held by the Trust on the Manzanares gathering system. The increase accommodates incremental gas flow that will occur due to WFS's expansion and enhancement of gathering facilities.
A copy of the Gas Gathering Contract is filed as an exhibit to this Form 10-K. The foregoing summary of the material provisions of the Gas Gathering Contract is qualified in its entirety by reference to the terms of such agreement as set forth in such exhibit.
FEDERAL AND INDIAN LANDS
Approximately 80 percent of the Underlying Properties are burdened by royalty interests held by the Federal government or the Southern Ute Indian Tribe. Royalty payments due to the U.S. Government for gas produced from Federal and Indian lands included in the Underlying Properties must be calculated in conformance with its interpretation of regulations issued by the Minerals Management Service ("MMS"), a subagency of the U.S. Department of the Interior which administers and receives revenues from Federal and Indian royalties on behalf of the U.S. Government and as agent for the Indian tribes. The MMS regulations cover both valuation standards which establish the basis for placing a value on production and cost allowances which define those post-production costs that are deductible by the lessee.
Where gas is sold by a lessee to a marketing affiliate such as WPX Gas Resources, the MMS regulations essentially ignore the lessee-affiliate transaction and consider the arm's-length sale by the affiliate as the point of valuation for royalty purposes. Accordingly, Quatro Finale is required to calculate royalty payments based on the price WPX Gas Resources receives when it markets the gas production ("Resale Price"), notwithstanding the price payable by WPX Gas Resources to Quatro Finale pursuant to the Gas Purchase Contract. With respect to the Farmout Properties, Amoco pays royalties based on the price it receives for production from such properties as long as the gas is purchased by nonaffiliates. The NPI Net Proceeds, a portion of which is payable to the Trust, reflects the deduction of all royalty and overriding royalty burdens. The ratio of royalties paid on Federal and Indian lands to the NPI Net Proceeds increases as the Resale Price exceeds the price under the Gas Purchase Contract.
The MMS regulations permit a lessee to deduct from its gross proceeds its reasonable actual costs of transportation and processing to transport the gas from the lease to the point of sale in calculating the market value of its production. Although WPX Gas Resources deducts the gathering charges paid by it to WFS, Burlington, EFS and Northwest in calculating the wellhead price it pays to Quatro Finale, the MMS could disallow the deduction of some portion of the gathering charges after review of such charges on audit of Quatro Finale's royalty as discussed below. If some portion of the gathering charges is disallowed, the MMS will likely demand additional royalties plus interest on the amount of the underpayment.
The Trustee has been advised by WPC that the MMS has from time to time considered the inclusion of the value of the Section 29 tax credits attributable to coal seam gas production in the calculation of gross proceeds for purposes of calculating the royalty that is payable to the MMS. On August 30, 1993, the U.S. Office of the Inspector General (the "OIG") issued an audit report stating that Section 29 tax credits should be included in the calculation of gross proceeds and recommending that the MMS pursue collection of additional royalties with respect to past and future production. On December 8, 1993, however, the Office of the Solicitor of the U.S. Department of the Interior gave its opinion to the MMS that the report of the OIG was incorrect and that Section 29 tax credits are not part of gross proceeds for the purpose of federal royalty calculations. WPC believes that any such inclusion of the value of Section 29 tax credits for purposes of calculating royalty payments required to be made on Federal and Indian lands would be inappropriate since all mineral interest owners, including royalty owners, are entitled to Section 29 tax credits for their proportionate share of qualifying coal seam gas production. WPC has advised the Trustee that it would vigorously oppose any attempt by the MMS to require the inclusion of the value of Section 29 tax credits in the calculation of gross proceeds. However, if regulations providing for the inclusion of such value were adopted and upheld, royalty payments would be increased which would decrease NPI Net Proceeds and, therefore, the amounts payable to the Trust. The
reduction in amounts payable to the Trust would cause a corresponding reduction in associated Section 29 tax credits available to Unitholders.
The MMS generally audits royalty payments within a six-year period. Although WPC, on behalf of Quatro Finale, calculates royalty payments in accordance with its interpretation of the then applicable MMS regulations, WPC does not know whether the royalty payments made to the U.S. Government are totally in conformance with MMS standards until the payments are audited. If an MMS audit, or any other audit by a Federal or state body, results in additional royalty charges, together with interest, relating to production from and after October 1, 1992 in respect of the Underlying Properties, such charges and interest will be deducted in calculating NPI Net Proceeds for the quarter in which the charges are billed and in each quarter thereafter until the full amount of the additional royalty charges and interest have been recovered.
On January 5, 2001, the State of New Mexico, acting under authority of the MMS, presented WPC with an Audit Issue Letter for the alleged underpayment of royalties in the amount of $948,501, on gas produced from the Underlying Properties due to federal royalty owners during the time period from January 1992 through December 1996. MMS regulations permit a lessee to deduct from its gross proceeds its reasonable actual costs of transportation and processing to transport the gas from the lease to the point of sale in calculating the market value of its production. The State of New Mexico claims that certain costs of removing and transporting carbon dioxide gas are not deductible. On March 22, 2001, WPC responded to the Audit Issue Letter and contested the State of New Mexico's claim for additional royalties as being contrary to law. While WPC believes that its past computations have been appropriately stated, applying the MMS methodology asserted by the State of New Mexico could potentially result in negative adjustments to amounts previously paid to the Trust of approximately $3,000,000.
SALE AND ABANDONMENT OF UNDERLYING PROPERTIES
Quatro Finale (and any transferees) has the right to abandon any well or working interest included in the Underlying Properties if, in its opinion, such well or property ceases to produce or is not capable of producing in commercially paying quantities. Since Quatro Finale does not operate any of the wells on the Underlying Properties, Quatro Finale does not normally control the timing of plugging and abandoning wells. The Conveyance provides that Quatro Finale's working interest share of the costs of plugging and abandoning uneconomic wells will be deducted in calculating NPI Net Proceeds.
Just as WPC sold the Underlying Properties to Quatro Finale, Quatro Finale may sell the Underlying Properties, subject to and burdened by the Royalty Interests, without the consent of the Unitholders. Under the Trust Agreement, WPC has certain rights (but not the obligation) to purchase the Royalty Interests upon termination of the Trust. See "Item 1 - -Description of the Trust--Termination and Liquidation of the Trust."
WPC has retained the right to repurchase from the Trust, commencing January 1, 2003, any portion of the NPI conveyed to the Trust if WPC's interest in the Underlying Properties burdened by such portion of the NPI ceases to produce or is not capable of producing in commercially paying quantities (ignoring for purposes of such determination the NPI and the Infill NPI). The purchase price payable by WPC will be the fair market value at the date of repurchase of the portion of the NPI or Infill NPI so purchased, as established on the basis of an appraisal provided by an independent expert.
THE INFILL NPI
The Royalty Interests include the Infill NPI, a net profits interest on any Infill Wells completed on the WI Properties. No Infill Wells have been drilled and none will be drilled unless the well spacing limitations for coal seam gas wells in the Basin are reduced. If such changes occur and Infill Wells are drilled, the Infill NPI will entitle the
Trust to receive 20 percent of the Infill Net Proceeds. No reserves have been attributed to any Infill Wells in the December 31, 2000 Reserve Report.
WILLIAMS' PERFORMANCE ASSURANCES
Pursuant to the Conveyance and the Performance Acknowledgement Agreement, Williams has agreed to pay each of the following to the extent not paid by Quatro Finale (as successor to WPC) when due and payable: all liabilities and operating and capital expenses that Quatro Finale is required under the Conveyance to pay as owner of the Underlying Properties, including without limitation, Quatro Finale's obligation to pay operating expenses with respect of the WI Properties up to the cumulative amounts specified in Exhibit B to the Conveyance and the capital costs incurred in respect of the WI Properties to the extent specified in the Conveyance, including amounts which Quatro Finale is obligated to pay with respect to environmental liabilities; (iv) all NPI Net Proceeds, Infill Net Proceeds and other amounts which Quatro Finale is obligated to pay to the Trust under the Conveyance, including amounts which Quatro Finale is obligated to pay with respect to environmental liability; and (v) any proceeds from a sale of any remaining Royalty Interests that Quatro Finale may elect to purchase upon termination of the Trust ((i) through (v) collectively, the "WPC Payment Obligations"). Williams has also agreed, to the extent not paid by WPX Gas Resources when due and payable, to pay all amounts which WPX Gas Resources is required to pay to Quatro Finale (as successor to WPC) in respect of production attributable to the Royalty Interests pursuant to the terms of the Gas Purchase Contract between WPC and WPX Gas Resources (the "WPX Gas Resources Payment Obligations"). In the Confirmation Agreement, Williams expressly confirmed that its agreement to cause the WPX Gas Resources Payment Obligations to be paid in full when due shall continue in full force and effect notwithstanding the assignments by WGM of the Gas Purchase Contract and the Gas Gathering Contract.
In the event and to the extent that WPC or Quatro Finale, as applicable, does not pay any of the WPC Payment Obligations in full when due and, in the event and to the extent that WPX Gas Resources does not pay any of the WFS Gas Resources Payment Obligations in full when due, the Trustee (but not Unitholders) is entitled, following notice to Williams and demand for payment by the Trustee and after a 10-day cure period, to enforce payment by Williams. Williams' assurance obligations terminate upon the earlier of (i) dissolution of the Trust, (ii) with respect to the WPC Payment Obligations, upon sale or other transfer by Quatro Finale of all or substantially all of the Underlying Properties, (iii) with respect to the WPC Payment Obligations, upon one or more sales or other transfers of a majority or more of Williams' ownership interests in WPC and (iv) with respect to the WPX Gas Resources Payment Obligations, upon one or more sales or other transfers of a majority or more of Williams' ownership interests in WPX Gas Resources; provided that, with respect to (ii), (iii) and (iv) above, only if the transferee has, at the time of transfer, a rating assigned to outstanding unsecured long-term debt from Moody's Investor Services of at least Baa3 or from Standard & Poor's Corporation of at least BBB- (or an equivalent rating from at least one nationally-recognized statistical rating organization), or such transferee is approved by holders of a majority of outstanding Units, and in any case, the transferee unconditionally agrees in writing, to assume and be bound by Williams' remaining assurance obligations.
TITLE TO PROPERTIES
Williams has advised the Trustee that it believes that Quatro Finale's title to the Underlying Properties (as successor to WPC), and the Trust's title to the Royalty Interests, are good and defensible in accordance with standards generally accepted in the gas industry, subject to such exceptions which, in the opinion of Williams, are not so material as to detract substantially from the use or value of such Underlying Properties or Royalty Interests. As is customary in the gas industry, only a perfunctory title examination is performed as a lease is acquired, except leases covering proved reserves. Generally, prior to drilling a well, a more thorough title examination of the drill site tract is conducted and curative work is performed with respect to significant title defects, if any, before proceeding with operations. However, prior to the sale of the Underlying Properties to Quatro Finale WPC (or its predecessor) had owned the leases covering the Underlying Properties since 1974, and conventional gas has been produced from formations other than
the Fruitland formation covered by all of the leases since the 1950s. Under these circumstances, WPC conducted an internal review of its title records prior to the drilling of the coal seam gas wells within the 12 Federal Units, but did not conduct title examinations. In addition to its internal review, WPC, when requested by the operator, participated in title examinations prior to the drilling of a few coal seam gas wells located outside the Federal Units.
The Underlying Properties are typically subject, in one degree or another, to one or more of the following: (i) royalties and other burdens and obligations, expressed and implied, under gas leases; (ii) overriding royalties and other burdens created by WPC or its predecessors in title; (iii) a variety of contractual obligations (including, in some cases, development obligations) arising under operating agreements, farmout agreements, production sales contracts and other agreements that may affect the properties or their titles; (iv) liens that arise in the normal course of operations, such as those for unpaid taxes, statutory liens securing unpaid suppliers and contractors and contractual liens under operating agreements; (v) pooling, unitization and communitization agreements, declarations and orders; and (vi) easements, restrictions, rights-of-way and other matters that commonly affect property. To the extent that such burdens and obligations affect Quatro Finale's rights to production and the value of production from the Underlying Properties, they have been taken into account in calculating the Trust's interests and in estimating the size and value of the reserves attributable to the Royalty Interests. Except as noted below, Williams believes that the burdens and obligations affecting the Underlying Properties and Royalty Interests are conventional in the industry for similar properties, do not, in the aggregate, materially interfere with the use of the Underlying Properties and will not materially and adversely affect the value of the Royalty Interests.
Although the matter is not entirely free from doubt, Williams has advised the Trustee that it believes (based upon the opinions of local counsel to WPC with respect to matters of Colorado law and New Mexico law) that the Royalty Interests should constitute real property interests under applicable state law. Consistent therewith, the Conveyance states that the Royalty Interests constitute real property interests and it was recorded in the appropriate real property records of Colorado and New Mexico, the states in which the Underlying Properties are located in accordance with local recordation provisions. If, during the term of the Trust, Quatro Finale (as successor to WPC) becomes involved as a debtor in bankruptcy proceedings, it is not entirely clear that all of the Royalty Interests would be treated as real property interests under the laws of Colorado and New Mexico. If in such a proceeding a determination were made that the Royalty Interests constitute real property interests, the Royalty Interests should be unaffected in any material respect by such bankruptcy proceeding. If in such a proceeding a determination were made that a Royalty Interest constitutes an executory contract (a term used, but not defined, in the United States Bankruptcy Code to refer to a contract under which the obligations of both the debtor and the other party to such contract are so unsatisfied that the failure of either to complete performance would constitute a material breach excusing performance by the other) and not a real property interest under applicable state law, and if such contract were not to be assumed in a bankruptcy proceeding involving Quatro Finale (as successor to WPC), the Trust would be treated as an unsecured creditor of Quatro Finale with respect to such Royalty Interest in the pending bankruptcy. Although no assurance is given, Williams has advised the Trustee that it does not believe that the Royalty Interests should be subject to rejection in a bankruptcy proceeding as executory contracts.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
There are no material pending proceedings to which the Trust is a party or of which any of its property is the subject.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The units of beneficial interest ("Units") in the Trust are listed and traded on the New York Stock Exchange under the symbol "WTU." The following table sets forth, for the periods indicated, the high and low sales prices per Unit and the amount of quarterly cash distributions per Unit made by the Trust.
At March 1, 2001, there were 9,700,000 Units outstanding and approximately 1,473 Unitholders of record.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
ITEM 7.
ITEM 7. TRUSTEE'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The Trust makes quarterly cash distributions to Unitholders. The only assets of the Trust, other than cash and cash equivalents being held for the payment of expenses and liabilities and for distribution to Unitholders, are the Royalty Interests. The Royalty Interests owned by the Trust burden the Underlying Properties, which are owned by Quatro Finale and not the Trust.
Distributable income of the Trust consists of the excess of royalty income plus interest income over the general and administrative expenses of the Trust. Upon receipt by the Trust, royalty income is invested in short-term investments in accordance with the Trust Agreement until its subsequent distribution to Unitholders.
The amount of distributable income of the Trust for any calendar year may differ from the amount of cash available for distribution to the Unitholders in such year due to differences in the treatment of the expenses of the Trust in the determination of those amounts. The financial statements of the Trust are prepared on a modified cash basis
pursuant to which the expenses of the Trust are recognized when incurred. Consequently, the reported distributable income of the Trust for any year is determined by deducting from the income received by the Trust the amount of expenses incurred by the Trust during such year. The amount of cash available for distribution to Unitholders, however, is determined in accordance with the provisions of the Trust Agreement and reflects the deduction from the income actually received by the Trust of the amount of expenses actually paid by the Trust and adjustment for changes in reserves for unpaid liabilities. See Note 5 to the financial statements of the Trust appearing elsewhere herein for additional information regarding the determination of the amount of cash available for distribution to Unitholders.
For 2000, royalty income received by the Trust amounted to $16,817,935 as compared to $12,242,379 and $16,452,220 for 1999 and 1998, respectively. The increase in royalty income in 2000 was primarily due to much higher prices for gas somewhat offset by lower net production from the Underlying Properties as compared to 1999 and 1998. Net production related to the royalty income received by the Trust in 2000 was approximately 12,636,517 MMBtu as compared to 13,968,990 MMBtu and 17,097,192 MMBtu in 1999 and 1998, respectively. Interest income for 2000 was $73,352 as compared to $37,344 and $55,364 for 1999 and 1998. The increase in interest income for 2000 reflects higher average invested balances in 2000.
General and administrative expenses for 2000 were $571,556 as compared to $525,076 and $539,310 for 1999 and 1998, respectively. The increase in these expenses in 2000 was primarily due to higher accounting services expense in 2000 than 1999 and 1998.
Distributable income for 2000 was $16,319,731, or $1.68 per Unit, compared to $11,754,647, or $1.21 per Unit, for 1999 and $15,968,274, or $1.65 per Unit, for 1998. This increase resulted from higher royalty income than in 1999 and 1998.
Reserve values at December 31, 2000 and December 31, 1999 were impacted by significant increases in natural gas prices used to value the reserves and the permanent reduction in the percentage of NPI Net Proceeds to which the Trust is entitled from 81 percent to 60 percent that occurred during the fourth quarter of 2000. See "Item 2 -- The Royalty Interests -- NPI Percentage Changes." The year end prices required to be utilized in such valuations were $6.35 per Mcf, $1.06 per Mcf and $1.09 per Mcf as at December 31, 2000, 1999 and 1998 respectively.
Because the Trust incurs administrative expenses throughout a quarter but receives its royalty income only once in a quarter, the Trustee established in the first quarter of 1993 a cash reserve for the payment of expenses and liabilities of the Trust. The Trustee thereafter has adjusted the amount of such reserve in certain quarters as required for the payment of the Trust's expenses and liabilities, in accordance with the provisions of the Trust Agreement. The Trustee anticipates that it will maintain for the foreseeable future a cash reserve that will fluctuate as expenses are paid and royalty income is received.
Royalty income to the Trust is attributable to the sale of depleting assets. All of the Underlying Properties burdened by the Royalty Interests consist of producing properties. Accordingly, the proved reserves attributable to Quatro Finale's interest in the Underlying Properties are expected to decline substantially during the term of the Trust and a portion of each cash distribution made by the Trust will, therefore, be analogous to a return of capital. Accordingly, cash yields attributable to the Units are expected to decline over the term of the Trust.
Royalty income received by the Trust in a given calendar year will generally reflect the sum of (i) proceeds from the sale of gas produced from the WI Properties (as defined in Note 1 to the financial statements of the Trust appearing elsewhere herein ("Note 1")) during the first three quarters of that year and the fourth quarter of the preceding calendar year, plus (ii) cash received by WPC (on behalf of Quatro Finale) with respect to the Farmout Properties (as defined in Note 1) during the first three quarters of that year (or in the month immediately following the third quarter, if received by WPC in sufficient time to be paid to the Trust) and the fourth quarter of the preceding calendar year.
Accordingly, the royalty income included in distributable income for the years ended December 31, 2000, 1999 and 1998, was based on production volumes and natural gas prices for the twelve months ended in September 30, 2000,
1999 and 1998, respectively, as shown in the table below. The production volumes included in the table are for production attributable to the Underlying Properties, and not production attributable to the Royalty Interests owned by the Trust, and are net of the amount of production attributable to Quatro Finale's royalty obligations to third parties, which are determined by contractual arrangement with such parties.
- ----------
(1) Million British Thermal Units.
(2) Includes previously reported estimated amounts for certain months.
Production from the WI Properties is generally sold pursuant to the Gas Purchase Contract. For more information regarding the Gas Purchase Contract and the right of WFS Gas Resources to recoup certain Price Credits, see "Item 2. Properties - Gas Purchase Contract" in this Form 10-K of the Trust.
The information herein concerning production and prices relating to the Underlying Properties is based on information prepared and furnished by WPC (on behalf of Quatro Finale) to the Trustee. The Trustee has no control over and no responsibility relating to the operation of the Underlying Properties.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The only assets of and sources of income to the Trust are the Royalty Interests, which generally entitle the Trust to receive a share of the net profits from natural gas production from the Underlying Properties. Consequently, the Trust's financial results can be significantly affected by fluctuations in natural gas prices and the Trust has commodity price risk exposure associated with the natural gas markets in the United States. The Royalty Interests do not entitle the Trust to control or influence the operation of the Underlying Properties or the sale of gas produced therefrom. Natural gas produced from the WI Properties, which comprises the majority of production attributable to the Royalty Interests, is currently sold by Quatro Finale pursuant to the terms of the Gas Purchase Contract. Although the Trust is not a party to the Gas Purchase Contract, the Gas Purchase Contract may significantly impact revenues to the Trust. Although the Gas Purchase Contract mitigates the risk to the Trust of low gas prices, it also limits the ability of the Trust to benefit from the effects of higher gas prices, particularly to the extent a balance exists in the Price Credit Account. See "Item 2 -- The Royalty Interests - -- Gas Purchase Contract" for detailed information about the Gas Purchase Contract and its impact on the Trust and Unitholders.
The Trust is a passive entity and other than the Trust's ability to periodically borrow money as necessary to pay expenses, liabilities and obligations of the Trust that cannot be paid out of cash held by the Trust, the Trust is prohibited from engaging in borrowing transactions. The amount of any such borrowings is unlikely to be material to the Trust. The Trust periodically holds short term investments acquired with funds held by the Trust pending distribution to Unitholders and funds held in reserve for the payment of Trust expenses and liabilities. Because of the short-term nature of these borrowings and investments and certain limitations upon the types of such investments which may be held by the Trust, the Trustee believes that the Trust is not subject to any material interest rate risk. The Trust does not engage in transactions in foreign currencies which could expose the Trust or Unitholders to any foreign currency related market risk.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Audited Statements of Assets, Liabilities and Trust Corpus of the Trust as of December 31, 2000 and 1999, and the related Statements of Distributable Income and Changes in Trust Corpus for each of the three years in the period ended December 31, 2000, are included in this Form 10-K.
REPORT OF INDEPENDENT AUDITORS
THE TRUSTEE WILLIAMS COAL SEAM GAS ROYALTY TRUST
We have audited the accompanying statements of assets, liabilities and trust corpus of Williams Coal Seam Gas Royalty Trust as of December 31, 2000 and 1999, and the related statements of distributable income and changes in trust corpus for each of the three years in the period ended December 31, 2000. These financial statements are the responsibility of the Trust's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As described in Note 2 to the financial statements, these financial statements have been prepared on a modified cash basis of accounting, which is a comprehensive basis of accounting other than accounting principles generally accepted in the United States.
In our opinion, the financial statements referred to above present fairly, in all material respects, the assets, liabilities and trust corpus of Williams Coal Seam Gas Royalty Trust at December 31, 2000 and 1999, and its distributable income and its changes in trust corpus for each of the three years in the period ended December 31, 2000, on the basis of accounting described in Note 2.
/s/ ERNST & YOUNG LLP
Tulsa, Oklahoma March 26, 2001
FINANCIAL STATEMENTS WILLIAMS COAL SEAM GAS ROYALTY TRUST
STATEMENTS OF ASSETS, LIABILITIES AND TRUST CORPUS
STATEMENTS OF DISTRIBUTABLE INCOME
STATEMENTS OF CHANGES IN TRUST CORPUS
- ----------
See accompanying notes
NOTES TO FINANCIAL STATEMENTS
1. TRUST ORGANIZATION AND PROVISIONS
Williams Coal Seam Gas Royalty Trust (the "Trust") was formed as a Delaware business trust pursuant to the terms of the Trust Agreement of Williams Coal Seam Gas Royalty Trust (as amended, the "Trust Agreement") entered into effective as of December 1, 1992 by and among Williams Production Company, a Delaware corporation ("WPC"), as trustor, The Williams Companies, Inc., a Delaware corporation ("Williams"), and Bank of America, N.A. (as successor to NationsBank of Texas, N.A.), a national banking association (the "Trustee"), and Chemical Bank Delaware, a Delaware banking corporation (the "Delaware Trustee"), as trustees. The trustees are independent financial institutions.
The Trust was formed to acquire and hold certain net profits interests (the "Royalty Interests") in proved natural gas properties located in the San Juan Basin of New Mexico and Colorado (the "Underlying Properties") owned by WPC. The Trust was initially created effective as of December 1, 1992 with a $100 contribution by WPC. On January 21, 1993, the Royalty Interests were conveyed to the Trust by WPC pursuant to the Net Profits Conveyance (the "Conveyance") dated effective as of October 1, 1992 by and among WPC, Williams, the Trustee and the Delaware Trustee, in consideration for all the 9,700,000 authorized units of beneficial interest in the Trust ("Units"). WPC transferred its Units by dividend to its parent, Williams, which sold an aggregate of 6,131,209 Units to the public through various underwriters in January and February 1993 (the "Public Offering"). During the second quarter of 1995 Williams transferred its remaining Units to Williams Holdings of Delaware, Inc. ("WHD"), a separate holding company for Williams' non-regulated businesses. Effective July 31, 1999, WHD was merged into Williams and by operation of the merger Williams assumed all assets, liabilities and obligations of WHD, including without limitation ownership of WHD's Units. Effective August 11, 2000, Williams sold its Units to Quatro Finale IV LLC, a Delaware limited liability company ("QFIV"), in a privately negotiated transaction. Williams retained the voting rights and a "call" option on the transferred Units and QFIV was granted a "put" option on the Units. Substantially all of the production attributable to the Underlying Properties is from the Fruitland coal formation and constitutes "coal seam" gas that entitles the owners of such production, provided certain requirements are met, to tax credits for Federal income tax purposes pursuant to Section 29 of the Internal Revenue Code of 1986, as amended. Effective May 1, 1997, WPC transferred the Underlying Properties to Quatro Finale, LLC, a non-affiliated Delaware limited liability company ("Quatro Finale").
The Trustee has the power to collect and distribute the proceeds received by the Trust and to pay Trust liabilities and expenses. The Delaware Trustee has only such powers as are set forth in the Trust Agreement and is not empowered to otherwise manage or take part in the business of the Trust. The Royalty Interests are passive in nature and neither the Delaware Trustee nor the Trustee has any control over or any responsibility relating to the operation of the Underlying Properties.
The Trust will terminate no later than December 31, 2012, subject to earlier termination under certain circumstances described in the Trust Agreement (the "Termination Date"). Cancellation of the Trust will occur on or following the Termination Date when all Trust assets have been sold and the net proceeds thereof distributed to Unitholders.
The only assets of the Trust, other than cash and cash equivalents being held for the payment of expenses and liabilities and for distribution to Unitholders, are the Royalty Interests. The Royalty Interests consist primarily of a net profits interest (the"NPI") in the Underlying Properties. The NPI has generally entitled the Trust to receive 81 percent of the NPI Net Proceeds, as defined below, attributable to (i) gas produced and sold from Quatro Finale's net revenue interests (working interests less lease burdens) in the properties in which Quatro Finale has a working interest (the "WI Properties") and (ii) the revenue stream received by Quatro Finale attributable to its 35 percent net profits interest in 5,348 gross acres in La Plata County, Colorado (the "Farmout Properties"). However, the percentage of NPI Proceeds which the Trust is entitled to receive was subject to permanent reduction to 60 percent under certain conditions, and such a reduction occurred in the fourth quarter of 2000. The Royalty Interests also include a 20 percent interest in Quatro Finale's Infill Net Proceeds, as defined below, from the sale of production if well spacing rules are effectively modified and additional wells are drilled on producing drilling blocks on the WI Properties (the "Infill Wells") during the term of the Trust. No Infill Wells have been drilled on the WI Properties to date. "NPI Net Proceeds" consists generally of the revenue stream received by Quatro Finale from its 35 percent net profits interest in the Farmout Properties, plus the aggregate proceeds attributable to Quatro Finale's net revenue interest, based on the price paid at or in the vicinity of the wellhead (the "Wellhead"), of gas produced from the WI Properties, less Quatro Finale's share of certain taxes and costs. "Infill Net Proceeds" consists generally of the aggregate proceeds, based on the price at the Wellhead, of gas produced from Quatro Finale's net revenue interest in any Infill Wells less certain taxes and costs. The complete definitions of NPI Net Proceeds and Infill Net Proceeds are set forth in the Conveyance.
2. BASIS OF ACCOUNTING
The financial statements of the Trust are prepared on a modified cash basis and are not intended to present financial position and results of operations in conformity with accounting principles generally accepted in the United States ("GAAP"). Preparation of the Trust's financial statements on such basis includes the following:
o Revenues are recognized in the period in which amounts are received by the Trust. General and administrative expenses are recognized on an accrual basis.
o Amortization of the Royalty Interests is calculated on a unit-of-production basis and charged directly to trust corpus.
o Distributions to Unitholders are recorded when declared by the Trustee (see Note 5).
The financial statements of the Trust differ from financial statements prepared in accordance with GAAP because royalty income is not accrued in the period of production and amortization of the Royalty Interests is not charged against operating results.
3. FEDERAL INCOME TAXES
The Trust is a grantor trust for Federal income tax purposes. As a grantor trust, the Trust will not be required to pay Federal or state income taxes. Accordingly, no provision for income taxes has been made in these financial statements.
Because the Trust will be treated as a grantor trust, and because a Unitholder will be treated as directly owning an interest in the Royalty Interests, each Unitholder will be taxed directly on his per Unit pro rata share of income attributable to the Royalty Interests consistent with the Unitholder's method of accounting and without regard to the taxable year or accounting method employed by the Trust.
Production from the coal seam gas wells drilled after December 31, 1979 and prior to January 1, 1993, qualifies for the Federal income tax credit for producing nonconventional fuels under Section 29 of the Internal Revenue Code. This tax credit is calculated annually based on each year's qualified production through the year 2002. Such credit, based on the Unitholder's pro rata share of qualifying production, may not reduce his regular tax liability (after the foreign tax credit and certain other non-refundable credits) below his alternative minimum tax. Any part of the Section 29 credit not allowed for the tax year solely because of this limitation is subject to certain carryover provisions. Each Unitholder should consult his tax advisor regarding Trust tax compliance matters.
4. RELATED PARTY TRANSACTIONS
Williams provides accounting, bookkeeping and informational services to the Trust in accordance with an Administrative Services Agreement effective December 1, 1992. The fee is $50,000 per quarter, escalating 3 percent each October 1 commencing October 1, 1993. Amounts payable by the Trust to Williams at December 31, 2000 and 1999 represent the fourth quarter fees. Aggregate fees incurred by the Trust to Williams in 2000, 1999 and 1998 were $249,514, $242,247 and $222,373, respectively.
Aggregate fees paid by the Trust to the trustees in 2000, 1999 and 1998 were $47,473, $45,863 and $45,921, respectively.
5. DISTRIBUTIONS TO UNITHOLDERS
The Trustee determines for each quarter the amount of cash available for distribution to Unitholders. Such amount (the "Quarterly Distribution Amount") is an amount equal to the excess, if any, of the cash received by the Trust, on or prior to the last day of the month following the end of each calendar quarter from the Royalty Interests, plus, with certain exceptions, any other cash receipts of the Trust during such quarter, over the liabilities of the Trust paid during such quarter, subject to adjustments for changes made by the Trustee during such quarter in any cash reserves established for the payment of contingent or future obligations of the Trust.
The Quarterly Distribution Amount for each quarter is payable to Unitholders of record on the 45th day following the end of such calendar quarter unless such day is not a business day in which case the record date is the next business day thereafter. The Trustee distributes the Quarterly Distribution Amount within 60 days after the end of each calendar quarter to each person who was a Unitholder of record on the associated record date, together with interest estimated to be earned on such amount from the date of receipt thereof by the Trustee to the payment date.
In addition to the regular quarterly distributions, under certain circumstances specified in the Trust Agreement (such as upon a purchase price adjustment, if any, or pursuant to the sale of a Royalty Interest) the Trust would make a special distribution (a "Special Distribution Amount"). A Special Distribution Amount would be made when amounts received by the Trust under such circumstances aggregated in excess of $9,000,000. The record date for a Special Distribution Amount will be the 15th day following receipt of amounts aggregating a Special Distribution Amount by the Trust (unless such day is not a business day in which case the record date will be the next business day thereafter) unless such day is within 10 days of the record date for a Quarterly Distribution Amount in which case the record date will be the date as is established for the next Quarterly Distribution Amount. Distribution to Unitholders of a Special Distribution Amount will be made no later than 15 days after the Special Distribution Amount record date.
6. CONTINGENCIES
WPX Gas Resources Company ("WPX Gas Resources", as successor in interest to Willams Gas Marketing Company) purchases natural gas produced from the WI Properties (except for certain small volumes) at the wellhead under the terms of a gas purchase contract dated October 1, 1992, as amended (the "Gas Purchase Contract"). The Gas
Purchase Contract provides for a pricing mechanism during an initial five-year period, which expired on December 31, 1997, and continuing for one or more consecutive additional one-year terms unless and until WPX Gas Resources exercises its annual option, exercisable fifteen days prior to the end of each contract year, to discontinue purchasing gas under the pricing mechanism of the Gas Purchase Contract and instead purchase gas at a monthly market-based price. WPX Gas Resources has not exercised this option and therefore the pricing mechanism will continue to remain in effect through at least December 31, 2001.
Under the pricing mechanism of the Gas Purchase Contract, when the market price is less than $1.70 per MMBtu (the "Minimum Purchase Price"), the Trust will be paid the Minimum Purchase Price for the gas and an account (the "Price Credit Account") will be maintained to identify the accrued and unrecouped amount of payments made to the Trust in excess of the market price. Any amounts in the Price Credit Account are subject to future recoupment when the market price exceeds the Minimum Purchase Price. During 2000, WPX Gas Resources recouped approximately $5.5 million of price credits in the Price Credit Account. As of December 31, 2000, there were no remaining unrecouped price credits in the Price Credit Account. To the extent there may in the future be a balance in the Price Credit Account, the entitlement to recoup price credits means that if and when the index price is above the Minimum Purchase Price, future royalty income paid to the Trust would be reduced until such time as such Price Credit Account is once again reduced to zero. Corresponding cash distributions to Unitholders would also be reduced.
While the terms of the Gas Purchase Agreement pricing mechanism remain in place and no balance exists in the Price Credit Account, when the market price for natural gas exceeds $1.94 per MMBtu (as was the case during 2000), the Trust receives only 50 percent of the excess of the market price over the $1.94 price per MMBtu.
The majority of the production attributable to the Trust is within Federal units. Unit participating areas are formed by pooling production from the participating area. Entitlement to the pooled production is based on each party's acreage in the participating area divided by the total participating acreage. Wells drilled outside the participating area may create an enlargement to the participating area and a revision of the Unit ownership entitlement. The Bureau of Land Management ("BLM") must approve Unit participating area expansions. The effective date for Unit expansions is retroactive to the date the well creating the expansion was tested. The revenues presented in the accompanying statements of distributable income are on an entitlement basis and reflect the most recent BLM participating area approvals at December 31, 2000, 1999 and 1998, respectively. There are pending or anticipated applications or approvals for additional participating area enlargements. WPC has advised the Trustee that it does not believe that final approval of these Unit participating area enlargements and the resulting retroactive adjustments, if any, will have a material impact on the revenues as presented in these statements.
The Trustee has been advised by WPC that the Minerals Management Service ("MMS"), a subagency of the U.S. Department of the Interior, has from time to time considered the inclusion of the value of the Section 29 tax credits attributable to coal seam gas production in the calculation of gross proceeds for purposes of calculating the royalty that is payable to the MMS. On August 30, 1993, the U.S. Office of the Inspector General (the "OIG") issued an audit report stating that Section 29 tax credits should be included in the calculation of gross proceeds and recommending that the MMS pursue collection of additional royalties with respect to past and future production. On December 8, 1993, however, the Office of the Solicitor of the U.S. Department of the Interior gave its opinion to the MMS that the report of the OIG was incorrect and that Section 29 tax credits are not part of gross proceeds for the purpose of Federal royalty calculations. WPC believes that any such inclusion of the value of Section 29 tax credits for the purposes of calculating royalty payments required to be made on Federal and Indian lands would be inappropriate since all mineral interest owners, including royalty owners, are entitled to Section 29 tax credits for their proportionate share of qualifying coal seam gas production. WPC has advised the Trustee that it would vigorously oppose any attempt by the MMS to require the inclusion of the value of Section 29 tax credits in the calculation of gross proceeds. However, if such regulations were adopted and upheld, royalty payments would be increased which would decrease NPI Net Proceeds and, therefore, the amounts payable to the Trust. The reduction in amounts payable to the Trust would cause a corresponding reduction in associated Section 29 tax credits available to Unitholders.
On January 5, 2001, the State of New Mexico, acting under authority of the MMS, presented WPC with an Audit Issue Letter for the alleged underpayment of royalties in the amount of $948,501, on gas produced from the Underlying Properties due to federal royalty owners during the time period from January 1992 through December 1996. MMS regulations permit a lessee to deduct from its gross proceeds its reasonable actual costs of transportation and processing to transport the gas from the lease to the point of sale in calculating the market value of its production. The State of New Mexico claims that certain costs of removing and transporting carbon dioxide gas are not deductible. On March 22, 2001, WPC responded to the Audit Issue Letter and contested the State of New Mexico's claim for additional royalties as being contrary to law. While WPC believes that its past computations have been appropriately stated, applying the MMS methodology asserted by the State of New Mexico could potentially result in negative adjustments to amounts previously paid to the Trust of approximately $3,000,000.
7. SUBSEQUENT EVENT
Subsequent to December 31, 2000, the Trust declared the following distribution:
The Trustee has estimated the Section 29 tax credit associated with the February 14, 2001 quarterly distribution to be $.24 per Unit.
8. QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table sets forth the royalty income, distributable income and distributable income per Unit of the Trust for each quarter in the years ended December 31, 2000 and 1999 (in thousands, except per Unit amounts):
Selected 2000 fourth quarter data are as follows (in thousands except per Unit amounts):
9. SUPPLEMENTAL OIL AND GAS INFORMATION (UNAUDITED)
The net proved reserves attributable to the Royalty Interests have been estimated as of December 31, 2000, 1999 and 1998, by independent petroleum engineers. In accordance with Statement of Financial Accounting Standards No. 69, estimates of future net revenues from proved reserves have been prepared using contractual gas prices and related costs. The standardized measure of future net revenues from the gas reserves is calculated based on discounting such future net revenues at an annual rate of 10 percent. The Blanco Hub Spot Price for December 2000 of $8.41 per MMBtu, after adjustments for certain costs and provisions of the Gas Purchase Contract, resulted in a weighted average wellhead price of $6.35 per Mcf. The standardized measure of discounted future net revenues below has been reduced by operating and development costs which are paid by Williams and are included in computing the royalty income of the Trust. The standardized measure has not been reduced for income taxes as no income taxes are paid by the Trust (Note 3).
Numerous uncertainties are inherent in estimating volumes and value of proved reserves and in projecting future production rates and timing of development expenditures. Such reserve estimates are subject to change as additional information becomes available. The reserves actually recovered and the timing of production may be substantially different from the reserve estimates.
Based on inception to date experience in estimating reserves, production history and other information with regard to the status of the interest in the NPI, the reserve estimates as of January 1, 1998, December 31, 1998 and December 31, 1999 for Royalty Interests were based on a percentage share of NPI Net Proceeds payable to the Trust of 81 percent, adjusted to reflect possible reduction of the NPI upon meeting certain production targets and certain rates of return expected to be met in the future. The reserve estimates as of December 31, 2000 are based on a percentage share of NPI Net Proceeds payable to the Trust reduced to 60 percent.
All proved reserve estimates presented above at December 31, 2000, 1999 and 1998 and January 1, 1998 are proved developed.
Proved reserves are estimated quantities of natural gas which geological and engineering data indicate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions. Proved developed reserves are proved reserves which can be expected to be recovered through existing wells with existing equipment and operating methods.
The following table sets forth the standardized measure of discounted future net revenues at December 31, 2000, 1999 and 1998 relating to proved developed reserves (in thousands):
The following table sets forth the changes in the aggregate standardized measure of discounted future net revenues from proved reserves during the years ended December 31, 2000, 1999 and 1998 (in thousands):
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The Trust has no directors or executive officers. Each of the Trustee and the Delaware Trustee is a corporate trustee that may be removed as trustee under the Trust Agreement, with or without cause, at a meeting duly called and held by the affirmative vote of Unitholders of not less than a majority of all the Units then outstanding. Any such removal of the Delaware Trustee shall be effective only at such time as a successor Delaware Trustee fulfilling the requirements of Section 3807(a) of the Delaware Code has been appointed and has accepted such appointment, and any such removal of the Trustee shall be effective only at such time as a successor Trustee has been appointed and has accepted such appointment.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
The following is a description of certain fees and expenses anticipated to be paid or borne by the Trust, including fees expected to be paid to Williams, the Trustee, the Delaware Trustee, the Transfer Agent, or their affiliates.
Ongoing Administrative Expenses. The Trust is responsible for paying all legal, accounting, engineering and stock exchange fees, printing costs and other administrative and out-of-pocket expenses incurred by or at the direction of the Trustee or Delaware Trustee and the out-of-pocket expenses of the Transfer Agent.
Compensation of the Trustee, Delaware Trustee and Transfer Agent. The Trust Agreement provides for compensation to the Trustee and the Delaware Trustee for administrative services, out of the Trust assets. The Trustee was paid a 2000 base amount of $40,000, plus an hourly charge for services in excess of a combined total of 300 hours annually at the Trustee's then standard rate. The Delaware Trustee is paid a fixed annual amount which was initially set at $5,000. The Trustee and the Delaware Trustee received total compensation for 2000 of $41,324 and $6,149, respectively. The base amount of the Trustee's fee and the amount of the Delaware Trustee's fee for administrative services escalate at the rate of 3 percent per year. The Trustee and the Delaware Trustee are each entitled to reimbursement for out-of-pocket expenses. Upon termination of the Trust, the Trustee will receive, in addition to its out-of-pocket expenses, a termination fee in the amount of $8,000.
The Transfer Agent receives a transfer agency fee of $5.50 annually per account (minimum of $15,000 annually), subject to change each December, based upon the change in the Producers' Price Index as published by the Department of Labor, Bureau of Labor Statistics, plus $1.00 for each certificate issued in excess of 10,000 annually. The total fees paid by the Trust to the Transfer Agent in 2000 were $14,715.
Fees to Williams. Williams will receive, throughout the term of the Trust, an administrative services fee for accounting, bookkeeping and informational services relating to the Royalty Interests as described below in "Item 13 - -Administrative Services Agreement."
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
(a) Security Ownership of Certain Beneficial Owners. The following table sets forth as of March 1, 2001 information with respect to the only Unitholder who was known to the Trustee to be a beneficial owner of more than 5 percent of the outstanding Units.
WILLIAMS'S VOTING AUTHORITY OVER UNITS
Although Williams sold all of its remaining Units to QFIV effective August 11, 2000, Williams contractually retained the voting rights for those Units irrespective of the sale. Except as noted below, Williams (or its affiliate) has the same voting rights under the Trust Agreement as other Unitholders. Accordingly, so long as Williams (or its affiliate) continues to possess voting control of 36.8 percent of the Units, on any matters brought to a vote of Unitholders requiring the approval of the holders of a majority of Units present or represented at a meeting where a majority of outstanding Units are represented, Williams will likely be able to control the vote with respect to such matters if not less than the 14 percent of additional Units necessary for quorum purposes are represented at such meeting. With respect to the vote on any amendment to the Gas Purchase Contract or the Gas Gathering Contract,
the Units held by Williams (or its affiliate) immediately after the Public Offering (and now held by QFIV) may not be voted nor will such Units be counted for purposes of determining if a quorum is present so long as such Units continue to be held by Williams (or its affiliate). This voting limitation will not be applicable to Units Williams (or its affiliate) may acquire, if any, after the date of the Public Offering.
In addition, as noted below, certain potential conflicts of interest exist between Williams and its subsidiaries and the interests of the Trust and the Unitholders (see "Item 13
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
ADMINISTRATIVE SERVICES AGREEMENT
Pursuant to the Trust Agreement, Williams and the Trust entered into an Administrative Services Agreement effective December 1, 1992. A copy of the Administrative Services Agreement is filed as an exhibit to this Form 10-K.
The Administrative Services Agreement obligates the Trust to pay to Williams each quarter an administrative services fee for accounting, bookkeeping and informational services relating to the Royalty Interests. The administrative services fee was $51,500 per calendar quarter commencing October 1, 1993, through and including the quarter ended September 30, 1994, and increases 3 percent each October 1. Accordingly, the total of the administrative services fees paid by the Trust to Williams in 2000 was $249,514.
POTENTIAL CONFLICTS OF INTEREST
The interests of Quatro Finale and of Williams and its subsidiaries and the interests of the Trust and the Unitholders with respect to the Underlying Properties could at times be different. As a working interest owner in the WI Properties, Quatro Finale could have interests that conflict with the interests of the Trust and Unitholders. For example, such conflicts could be due to a number of factors including, but not limited to, future budgetary considerations and the absence of any contractual obligation on the part of Quatro Finale to spend for development of the WI Properties, except as noted herein. Such decisions may have the effect of changing the amount or timing of future distributions to Unitholders. Quatro Finale's interests may also conflict with those of the Trust and Unitholders in situations involving the sale or abandonment of Underlying Properties. Quatro Finale has the right at any time to sell any of the Underlying Properties subject to the Royalty Interests and under certain circumstances may abandon any of the WI Properties. Such sales or abandonment may not be in the best interest of the Trust. In addition, WPX Gas Resources has the right, exercisable in its sole discretion, to terminate its Minimum Purchase Price commitment under the Gas Purchase Contract. Williams' interests could conflict with those of the Trust and Unitholders to the extent the interests of WPX Gas Resources, under the Gas Purchase Contract, or WFS and WPX Gas Resources, under the Gas Gathering Contract, differ from the interests of the Trust and the Unitholders. Except for amendments to the Gas
Gathering Contract or Gas Purchase Contract that must be approved by the vote of a majority of the Unitholders present at a meeting at which a quorum is present if such amendment would materially adversely affect Trust revenues, no mechanism or procedure has been included to resolve potential conflicts of interest between the Trust and Quatro Finale, Williams, WPC or their affiliates.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) The following documents are filed as a part of this report:
1. Financial Statements (included in Item 8 of this report)
2. Financial Statement Schedules
Financial statement schedules are omitted because of the absence of conditions under which they are required or because the required information is included in the financial statements and notes thereto.
3. Exhibits
EXHIBIT NUMBER EXHIBIT
3.1 -- Certificate of Trust of Williams Coal Seam Gas Royalty Trust (filed as Exhibit 3.1 to the Registrant's Form 10-K for the year ended December 31, 1992 and incorporated herein by reference).
4.1 -- Trust Agreement of Williams Coal Seam Gas Royalty Trust effective as of December 1, 1992, by and among Williams Production Company, The Williams Companies, Inc. and Chemical Bank Delaware and Bank of America, N.A. (as successor to NationsBank of Texas, N.A.), as trustees (filed as Exhibit 4.1 to the Registrant's Form 10-K for the year ended December 31, 1992 and incorporated herein by reference).
4.2 -- First Amendment to the Trust Agreement of Williams Coal Seam Gas Royalty Trust effective as of December 15, 1992, by and among Williams Production Company, The Williams Companies, Inc., Chemical Bank Delaware and Bank of America, N.A. (as successor to NationsBank of Texas, N.A.) (filed as Exhibit 4.2 to the Registrant's Form 10-K for the year ended December 31, 1992 and incorporated herein by reference).
EXHIBIT NUMBER EXHIBIT
4.3 -- Second Amendment to the Trust Agreement of Williams Coal Seam Gas Royalty Trust effective as of January 12, 1993, by and among Williams Production Company, The Williams Companies, Inc., Chemical Bank Delaware and Bank of America, N.A. (as successor to NationsBank of Texas, N.A.) (filed as Exhibit 4.3 to the Registrant's Form 10-K for the year ended December 31, 1992 and incorporated herein by reference).
4.4 -- Net Profits Conveyance effective as of October 1, 1992, by and among Williams Production Company, The Williams Companies, Inc., and Bank of America, N.A. (as successor to NationsBank of Texas, N.A.), and Chemical Bank Delaware (filed as Exhibit 4.4 to the Registrant's Form 10-K for the year ended December 31, 1992 and incorporated herein by reference).
10.1 -- Administrative Services Agreement effective December 1, 1992, by and between The Williams Companies, Inc. and Williams Coal Seam Gas Royalty Trust (filed as Exhibit 10.1 to the Registrant's Form 10-K for the year ended December 31, 1992 and incorporated herein by reference).
10.2 -- Gas Purchase Agreement dated October 1, 1992, by and between Williams Gas Marketing Company and Williams Production Company (filed as Exhibit 10.2 to the Registrant's Form 10-K for the year ended December 31, 1992 and incorporated herein by reference).
10.3 -- First Amendment to the Gas Purchase Agreement effective January 12, 1993, by and between Williams Gas Marketing Company and Williams Production Company (filed as Exhibit 10.3 to the Registrant's Form 10-K for the year ended December 31, 1992 and incorporated herein by reference).
10.4 -- Gas Gathering and Treating Agreement effective October 1, 1992, by and between Williams Field Services Company and Williams Gas Marketing Company (filed as Exhibit 10.4 to the Registrant's Form 10-K for the year ended December 31, 1992 and incorporated herein by reference).
10.5 -- First Amendment to the Gas Gathering and Treating Agreement effective as of January 12, 1993, by and between Williams Field Services Company and Williams Gas Marketing Company (filed as Exhibit 10.5 to the Registrant's Form 10-K for the year ended December 31, 1992 and incorporated herein by reference).
10.6 -- Amendment #2 to the Gas Gathering and Treating Agreement dated as of October 1, 1993, by and between Williams Field Services Company and Williams Gas Marketing Company (filed as Exhibit 10.6 to the Registrant's Form 10-K for the year ended December 31, 1993 and incorporated herein by reference).
10.7 -- Amendment #3 to the Gas Gathering and Treating Agreement dated as of October 1, 1993, by and between Williams Field Services Company and Williams Gas Marketing Company (filed as Exhibit 10.7 to the Registrant's Form 10-K for the year ended December 31, 1993 and incorporated herein by reference).
23.1 -- Consent of Miller and Lents, Ltd.
99.1 -- The information under the section captioned "Tax Considerations" on pages 20-21, and the information under the sections captioned "Federal Income Tax Consequences" and "ERISA Considerations" on pages 45-52 of the Prospectus dated January 13, 1993, which constitutes a part of the Registration Statement on Form S-3 of The Williams Companies, Inc. (Registration No. 33-53662) (filed as Exhibit 28.1 to the Registrant's Form 10-K for the year ended December 31, 1992 and incorporated herein by reference).
EXHIBIT NUMBER EXHIBIT
99.2 -- Reserve Report, dated November 21, 1992, on the estimated reserves, estimated future net revenues and the discounted estimated future net revenues attributable to the Royalty Interests and the Underlying Properties as of October 1, 1992, prepared by Miller and Lents, Ltd., independent petroleum engineers, included as Exhibit A of the Prospectus dated January 13, 1993, which constitutes a part of the Registration Statement on Form S-3 of The Williams Companies, Inc. (Registration No. 33-53662) (filed as Exhibit 28.1 to the Registrant's Form 10-K for the year ended December 31, 1992 and incorporated herein by reference).
99.3 -- Reserve Report, dated March 6, 2001, on the estimated reserves, estimated future net revenues and the discounted estimated future net revenues attributable to the Royalty Interests and the Underlying Properties as of December 31, 2000, prepared by Miller and Lents, Ltd., independent petroleum engineers.
- ----------
(b) Reports on Form 8-K. No report on Form 8-K was filed by the Registrant during the last quarter of the period covered by this report.
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
WILLIAMS COAL SEAM GAS ROYALTY TRUST
By: BANK OF AMERICA, N.A., TRUSTEE
By: /s/ RON E. HOOPER --------------------------------------- RON E. HOOPER Senior Vice President and Administrator
Date: March 30, 2001
(The Registrant has no directors or executive officers.)
INDEX TO EXHIBITS