Item 2.
Trustee's Discussion and Analysis of Financial Condition and Results of Operations.
References to the “Trust” in
this document refer to ECA Marcellus Trust I. As discussed in “Overview” below, Greylock Energy, LLC and certain of
its wholly-owned subsidiaries (“Greylock Energy”) acquired substantially all of the assets of Energy Corporation
of America in November 2017. References to “Legacy ECA” in this document refer to Energy Corporation of America and
its wholly-owned subsidiaries and, when discussing the conveyance documents, the Private Investors, as such entities existed prior
to the asset acquisition by Greylock Energy. The following review of the Trust’s financial condition and results of operations
should be read in conjunction with the financial statements and notes thereto and the audited financial statements and notes thereto
included in the Trust’s Annual Report on Form 10-K for the year ended December 31, 2019 (the “2019 Form 10-K”).
The Trust’s annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to
those reports are available on the SEC’s website at www.sec.gov and also at www.businesswire.com/cnn/ect.htm. Certain terms
used herein are defined in Appendix A. All information regarding operations has been provided to the Trustee by Greylock Energy.
Note Regarding Forward-Looking Statements
This report contains “forward-looking
statements” about Greylock Energy and the Trust and other matters discussed herein that are subject to risks and uncertainties.
All statements other than statements of historical fact included in this document, including, without limitation, statements under
“Trustee’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors”
regarding the financial position, business strategy, production and reserve growth, development activities and costs and other
plans and objectives for the future operations of Greylock Energy and all matters relating to the Trust are forward-looking statements.
Actual outcomes and results may differ materially from those projected.
When used in this document, the words “believes,”
“expects,” “anticipates,” “intends” or similar expressions, are intended to identify such forward-looking
statements. Further, all statements regarding future circumstances or events are forward-looking statements. The following important
factors, in addition to those discussed elsewhere in this document, could affect the future results of the energy industry in general,
and Greylock Energy and the Trust in particular, and could cause those results to differ materially from those expressed in such
forward-looking statements:
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risks incident to the operation of natural gas wells;
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future production costs;
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the effects of existing and future laws and regulatory actions;
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the effects of changes in commodity prices;
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conditions in the capital markets;
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competition in the energy industry;
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the uncertainty of estimates of natural gas reserves and production; and
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other risks described under the caption “Risk Factors” in Part I, Item 1A of the 2019 Form 10-K and in Part
II, Item 1A of this report.
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This report describes other important factors
that could cause actual results to differ materially from expectations of Greylock Energy and the Trust. All subsequent written
and oral forward-looking statements attributable to Greylock Energy or the Trust or persons acting on behalf of Greylock Energy
or the Trust are expressly qualified in their entirety by such factors. The Trust assumes no obligation, and disclaims any duty,
to update these forward-looking statements.
Overview
The Trust is a statutory
trust created under the Delaware Statutory Trust Act. The Bank of New York Mellon Trust Company, N.A. serves as Trustee. The
Trust does not conduct any operations or activities. The Trust’s purpose is, in general, to hold the Royalty Interests (described
below), to distribute to the Trust unitholders cash that the Trust receives in respect of the Royalty Interests after payment of
Trust expenses and to perform certain administrative functions in respect of the Royalty Interests and the Trust units. The Trustee
has no authority or responsibility for, and no involvement with, any aspect of the oil and gas operations on the properties to
which the Royalty Interests relate. The Trust derives all or substantially all of its income and cash flows from the Royalty Interests.
The Trust is treated as a partnership for federal and state income tax purposes.
In November 2017,
Greylock Energy, LLC and certain of its wholly owned subsidiaries (“Greylock Energy”), including Greylock Production,
LLC (“Greylock Production”), which serves as operator of the subject wells, and Greylock Midstream, LLC (“Greylock
Midstream”), whose subsidiaries market and gather certain of the gas, acquired substantially all of the gas production and
midstream assets of Legacy ECA, including all of Legacy ECA’s interests in certain natural gas properties that are subject
to royalty interests held by the Trust.
In connection with
the transaction, Greylock Production assumed all of Legacy ECA’s obligations under the Trust Agreement and other instruments
to which Legacy ECA and the Trustee were parties, including (1) the Administrative Services Agreement by and among Legacy ECA,
the Trust and the Trustee dated July 7, 2010, and (2) a letter agreement between Legacy ECA and the Trustee regarding certain loans
to be made by Legacy ECA to the Trust as necessary to enable the Trust to pay its liabilities as they become due (the “Letter
Agreement”). In addition, Legacy ECA, Greylock Production, and the Trustee entered into a Reaffirmation and Amendment of
Mortgage, Assignment of Leases, Security Agreement, Fixture Filing and Financing Statement (the “Reaffirmation Agreement”),
pursuant to which, among other things, Greylock Production (1) reaffirmed the liens and the security interest granted pursuant
to the existing mortgage securing the interests in the subject properties, as well as the mortgage and the obligations of Legacy
ECA under the mortgage, and (2) assumed the obligations of Legacy ECA under the Letter Agreement.
As part of the initial
acquisition of substantially all of Legacy ECA’s assets, neither Greylock Energy nor Greylock Production acquired title ownership
of Legacy ECA’s working interest in two wells in which the Trust also has an interest, the Penneco Morrow #1MH and Penneco
Morrow #2MH wells. In March 2019 Legacy ECA sold the title ownership and working interest in these two wells to Greylock Production.
The Royalty Interests were conveyed to the
Trust from the working interest now held by Greylock Production in the Producing Wells and the PUD Wells limited to the Underlying
Properties. The PDP Royalty Interest entitles the Trust to receive 90% of the proceeds (exclusive of any production or development
costs but after deducting post-production costs and any applicable taxes) from the sale of production of natural gas attributable
to the Sponsor’s initial interest in the Producing Wells for a period of 20 years commencing on April 1, 2010 and
45% thereafter. The PUD Royalty Interest entitles the Trust to receive 50% of the proceeds (exclusive of any production or development
costs but after deducting post-production costs and any applicable taxes) from the sale of production of natural gas attributable
to the Sponsor’s initial interest in the PUD Wells for a period of 20 years commencing on April 1, 2010 and 25%
thereafter.
Legacy ECA was obligated
to drill all of the PUD Wells by March 31, 2014. As of November 30, 2011, Legacy ECA had fulfilled its drilling obligation
to the Trust by drilling 40 PUD Wells (52.06 Equivalent PUD Wells), calculated as provided in the Development Agreement. Consequently,
no additional wells will be drilled for the Trust. The Trust was not responsible for any costs related to the drilling of development
wells or any other development or operating costs. As of March 31, 2020, the Trust owns royalty interests in 14 Producing Wells
and the 40 development wells (52.06 Equivalent PUD Wells) that are now completed and in production.
The
Trust’s cash receipts in respect of the Royalty Interests are determined after deducting post-production costs and any
applicable taxes associated with the Royalty Interests, and the Trust’s cash available for distribution is reduced by
Trust administrative expenses and any amounts reserved for administrative expenses. Post-production costs generally
consist of costs incurred to gather, compress, transport, process, treat, dehydrate and market the natural gas produced.
Charges (the “Post-Production Services Fee”) payable to Legacy ECA for such post-production costs on the
related GCGS were limited to $0.52 per MMBtu gathered until Legacy ECA fulfilled its drilling obligation in 2011; since then
the Spnosor has been permitted to increase the Post-Production Services Fee to the extent necessary to recover certain
capital expenditures in the GCGS.
Generally, the percentage
of production proceeds to be received by the Trust with respect to a well equals the product of (i) the percentage of proceeds
to which the Trust is entitled under the terms of the conveyances (90% for the Producing Wells and 50% for the PUD Wells) multiplied
by (ii) Greylock Production’s net revenue interest in the well. Greylock Production on average owns an 81.53% net revenue
interest in the Producing Wells. Therefore, the Trust is entitled to receive on average 73.37% of the proceeds of production from
the Producing Wells. With respect to the PUD Wells, the conveyance related to the PUD Royalty Interest provides that the proceeds
from the PUD Wells will be calculated on the basis that the underlying PUD Wells are burdened only by interests that in total would
not exceed 12.5% of the revenues from such properties, regardless of whether the royalty interest owners are actually entitled
to a greater percentage of revenues from such properties. As an example, assuming Greylock Production owns a 100% working interest
in a PUD Well, the applicable net revenue interest is calculated by multiplying Greylock Production’s percentage working
interest in the 100% working interest well by the unburdened interest percentage (87.5%), and such well would have a minimum 87.5%
net revenue interest. Accordingly, the Trust is entitled to a minimum of 43.75% of the production proceeds from the well provided
in this example. To the extent Greylock Production’s working interest in a PUD Well is less than 100%, the Trust’s
share of proceeds would be proportionately reduced.
The Trust makes
quarterly cash distributions of substantially all of its cash receipts, after deducting Trust administrative expenses and costs
and reserves therefor, on or about the 60th day following the completion of each quarter. Unless sooner terminated,
the Trust will begin to liquidate in March 2030 and will soon thereafter wind up its affairs and terminate.
The amount of Trust revenues and cash distributions
to Trust unitholders depends on, among other things:
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natural gas prices received;
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the volume and Btu rating of natural gas produced and sold;
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post-production costs and any applicable taxes; and
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administrative expenses of the Trust including expenses incurred as a result of being a publicly traded entity and any changes
in amounts reserved for such expenses.
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The markets for natural gas are volatile,
as demonstrated by significant price swings experienced during 2019 and further declines in 2020 attributable primarily to the
economic effects of the global outbreak of the novel form of coronavirus known as COVID-19. COVID-19 and the responses by federal,
state and local governmental authorities to the pandemic have also resulted in significant business and operational disruptions,
including business closures, supply chain disruptions, travel restrictions, stay-at-home orders and limitations on the availability
of workforces. The full impact of COVID-19 is unknown and is rapidly evolving. The extent to which COVID-19 negatively impacts
Greylock Energy will depend on the severity, location and duration of the effects and spread of COVID-19, the actions undertaken
by federal, state and local governments and health officials to contain the virus or treat its effects, and how quickly and to
what extent economic conditions improve and normal business and operating conditions resume. A prolonged period of low natural
gas prices will adversely affect Greylock Energy. As a result, there can be no assurance that prices for natural gas, and therefore
the Trust’s quarterly cash distributions, will be maintained for any significant period of time. There was no distribution
to unitholders for the quarter ended March 31, 2020, as Trust expenses exceeded net revenues to the Trust. Continued low natural
gas prices will reduce revenues to the Trust, which will reduce the amount of cash available for distribution to unitholders and
in certain periods could result in no distributions to unitholders
The effective date of the Trust was April 1,
2010, meaning the Trust has received the proceeds of production attributable to the PDP Royalty Interest from that date even though
the PDP Royalty Interest was not conveyed to the Trust until July 7, 2010. The amount of the quarterly distributions fluctuates
from quarter to quarter, depending on the proceeds received by the Trust, among other factors. There is no minimum required distribution.
Pursuant to IRC Section 1446, withholding
tax on income effectively connected to a United States trade or business allocated to non-U.S. persons (“ECI”) should
be made at the highest marginal rate. Under IRC Section 1441, withholding tax on fixed, determinable, annual, periodic income
from United States sources allocated to non-U.S. persons should be made at 30% of gross income unless the rate is reduced by treaty.
Nominees and brokers should withhold at the highest marginal rate on the distribution made to non-U.S. persons. As a result of
the Tax Cuts and Jobs Act enacted in December 2017, a non-U.S. holder’s gain on the sale of Trust units is now treated as
ECI to the extent such holder would have had ECI if the Trust had sold all of its assets at fair market value on the date of the
exchange. The new legislation also requires the transferee of units to withhold 10% of the amount realized on the sale of exchange
of units (generally, the purchase price) unless the transferor certifies that it is not a nonresident alien individual or foreign
corporation.
NYSE Listing Status. As previously disclosed, on
November 21, 2019, the Trust received written notification from The New York Stock Exchange (“NYSE”) that the Trust
no longer satisfied the continued listing compliance standards set forth under Rule 802.01C of the NYSE Listed Company Manual because
the average closing price of the Trust units fell below $1.00 over a 30 consecutive trading-day period that ended November 21,
2019. If the Trust is unable to regain compliance with the applicable standards within a six-month cure period, the NYSE will commence
suspension and delisting procedures. If delisted by the NYSE, the Trust units may be transferred
to the over-the-counter market. During the cure period, the Trust units will continue to trade on the NYSE, subject to compliance
with other continued listing requirements. On April 23, 2020, the NYSE notified the Trust that the NYSE had temporarily
suspended such continued listing compliance standards through June 30, 2020 in response to the effects of the COVID-19 pandemic,
and that as a result the Trust’s cure period has been extended until July 30, 2020.
Results of Trust Operations
For the Three Months Ended March 31, 2020 compared to the
Three Months Ended March 31, 2019
Distributable income for the three months
ended March 31, 2020 decreased to $0 from $1.1 million for the three months ended March 31, 2019. Compared to the quarter ended
March 31, 2019, royalty income decreased by $1.2 million and general and administrative expenses increased by $0.1 million.
Royalty income decreased to $0.5 million
for the three months ended March 31, 2020 from $1.7 million for the three months ended March 31, 2019, a decrease of $1.2 million.
This decrease was due to a decrease in the average sales price between periods as well as lower production between periods.
The average price realized for the three
months ended March 31, 2020 decreased $1.41 per Mcf to $0.67 per Mcf as compared to $2.08 per Mcf for the three months ended March
31, 2019. The decrease in the average sales price realized for natural gas production was due primarily to higher post-production
costs associated with firm transportation and a lower average sales price offset slightly by a decrease in other post-production
costs during the period. The average sales price, before post-production costs, decreased from $2.97 per Mcf for the three months
ended March 31, 2019 to $1.69 per Mcf for the three months ended March 31, 2020. The decrease in price was the result of a decrease
in the weighted average monthly closing NYMEX price for the current period to $1.96 per MMBtu compared to the weighted average
monthly closing NYMEX price of $3.16 per MMBtu for the three months ended March 31, 2019. This decrease was also attributable to
a decrease in the average Basis per MMBtu in the current period at minus $0.32 per MMBtu compared to the prior period Basis of
minus $0.28 per MMBtu.
Post-production costs consist of a post-production
services fee together with a charge for electricity used in lieu of gas for compression on the gathering system and firm transportation
charges on interstate gas pipelines. Overall, average post-production costs increased to $1.01 per Mcf in the current period
compared to $0.89 per Mcf for the three-month period ended March 31, 2019. During the three months ended March 31, 2020,
there was an increase in firm transportation fees related to the Mountaineer Xpress Project that were charged to the Trust beginning
with February 2019 production. These increased costs were partially offset by slightly lower post-production electricity fees.
Production decreased 12.9% from 808 MMcf
for the three months ended March 31, 2019 to 703 MMcf for the three months ended March 31, 2020. The decreased production was the
result of natural production declines that occur during the life of a well.
General and administrative
expenses paid by the Trust for the three months ended March 31, 2020 increased by $0.1 million to approximately $0.5 million compared
to $0.4 million for the three months ended March 31, 2019. This increase was the result of higher professional service fees. The
current quarter addition to the cash reserve of $2,006 of interest also decreased distributable income for the three months ended
March 31, 2020.
Liquidity and Capital Resources
The Trust has no source of liquidity or capital
resources other than net cash flows from the Royalty Interests. Other than Trust administrative expenses, including, if applicable,
expense reimbursements to Greylock Production and any reserves established by the Trustee for future liabilities, the Trust’s
only use of cash is for distributions to Trust unitholders. Administrative expenses include payments to the Trustee and the Delaware
Trustee as well as a quarterly fee of $15,000 to Greylock Production pursuant to the Administrative Services Agreement. Each quarter,
the Trustee determines the amount of funds available for distribution. Available funds are the excess cash, if any, received by
the Trust from the Royalty Interests and other sources (such as interest earned on any amounts reserved by the Trustee) that quarter,
over the Trust’s expenses for that quarter. Available funds are reduced by any cash the Trustee determines to hold as a reserve
against future expenses or liabilities. The Trustee, on behalf of the Trust, may borrow funds required to pay expenses or liabilities
if the Trustee determines that the cash on hand and the cash to be received are insufficient to cover the Trust’s expenses
or liabilities. If the Trustee borrows funds, the Trust unitholders will not receive distributions until the borrowed funds are
repaid.
Commencing
with the distribution paid to unitholders in the first quarter of 2019, the Trustee has been gradually building a cash reserve
for the payment of future expenses and liabilities of approximately $1.8 million by withholding cash reserve amounts from
each quarterly distribution equal to the greater of $90,000 or 10% of the amount distributable to unitholders. In February 2020,
the Trustee withheld $90,000 from funds otherwise available for distribution. These withholdings are in addition to the
existing cash reserve of $0.5 million, which is determined prior to the payments of quarterly expenses. The Trustee may increase
or decrease the targeted amount at any time, and may increase or decrease the rate at which it is withholding funds to build the
cash reserve at any time, without advance notice to the unitholders. After
the approximately $1.8 million has been withheld, the Trustee will have cash reserves of approximately $2.3 million. Cash held
in reserve will be invested as required by the Trust Agreement. Any cash reserved in excess of the amount necessary to pay or provide
for the payment of future known, anticipated or contingent expenses or liabilities eventually will be distributed to unitholders,
together with interest earned on the funds. As there was no distribution available for the quarter ended March 31, 2020, the Trustee
used approximately $38,000 of the cash reserve to pay for current period expenses and withheld $2,006 of interest earned on the
cash reserve balance. The Trustee has withheld from the funds otherwise available for distribution a total amount of $578,504 plus
$4,491 of interest related to the $1.8 million cash reserve.
Payments to the Trust in respect of the Royalty
Interests are based on the complex provisions of the various conveyances held by the Trust, copies of which are filed as exhibits
to the 2019 Form 10-K, and reference is hereby made to the text of the conveyances for the actual calculations of amounts due to
the Trust.
The Trust does not have any transactions,
arrangements or other relationships with unconsolidated entities or persons that could materially affect the Trust’s liquidity
or the availability of capital resources.
Significant Accounting Policies
The financial statements of the Trust differ
from financial statements prepared in accordance with generally accepted accounting principles in the United States of America
(“GAAP”) because, among other differences, certain cash reserves may be established for contingencies, which would
not be accrued in financial statements prepared in accordance with GAAP. Amortization of the investment in overriding royalty interests
calculated on a unit-of-production basis is charged directly to Trust Corpus. This comprehensive basis of accounting other than
GAAP corresponds to the accounting permitted for royalty trusts by the SEC as specified by ASC Topic 932 Extractive Activities—Oil
and Gas: Financial Statements of Royalty Trusts.
Income determined on the basis of GAAP would
include all expenses incurred for the period presented. However, the Trust serves as a pass-through entity, with expenses for depreciation,
depletion, and amortization, interest and income taxes being based on the status and elections of the Trust unitholders. General
and administrative expenses, production taxes or any other allowable costs are charged to the Trust only when cash has been paid
for those expenses. In addition, the Royalty Interests are not burdened by field and lease operating expenses. Thus, the statement
shows distributable income, defined as income of the Trust available for distribution to the Trust unitholders before application
of those unitholders’ additional expenses, if any, for depreciation, depletion, and amortization, interest and income taxes.
The revenues are reflected net of existing royalties and overriding royalties and have been reduced by gathering/post-production
expenses.
Revenue and Expenses:
The Trust serves as a pass-through entity,
with items of depletion, interest income and expense, and income tax attributes being based upon the status and election of the
unitholders. Thus, the Statements of Distributable Income show income available for distribution before application of those unitholders’
additional expenses, if any, for depletion, interest income and expense, and income taxes.
The Trust uses the accrual basis to recognize
revenue, with royalty income recorded as reserves are extracted from the Underlying Properties and sold. Expenses are recognized
when paid.
Royalty Interest in Gas Properties:
The Royalty interest in gas properties is
assessed to determine whether the net capitalized cost is impaired, whenever events or changes in circumstances indicate that its
carrying amount may not be recoverable, pursuant to ASC Topic 360, Property, Plant and Equipment. The Trust determines whether
an impairment charge is necessary to its investment in the Royalty interest in gas properties if total capitalized costs, less
accumulated amortization, exceed undiscounted future net revenues attributable to proved gas reserves of the Underlying Properties.
Determination as to whether and how much an asset is impaired involves estimates of fair value, which is determined based on discounted
cash flow techniques using assumptions including projected revenues, future commodity prices, production costs, and market-specific
average cost of capital. Estimates of undiscounted future net revenues attributable to proved gas reserves utilize NYMEX forward
pricing curves. If required, the Trust will recognize an impairment charge to the extent that the net capitalized costs exceed
the discounted fair value of the investment in net profits interests attributable to proved gas reserves of the Underlying Properties.
Any such impairment charge would not reduce Distributable Income, although it would reduce Trust Corpus. At December 31, 2019,
the Underlying Properties were impaired by approximately $25 million primarily as a result of the decrease in the futures prices
of natural gas. No impairment in the Underlying Properties has been recognized during the quarter ended March 31, 2020. Significant
dispositions or abandonment of the Underlying Properties are charged to Royalty Interests and the Trust Corpus.
Amortization of the Royalty interest in gas
properties is calculated on a units-of-production basis, whereby the Trust’s cost basis in the properties is divided by Trust
total proved reserves to derive an amortization rate per reserve unit. Such amortization does not reduce Distributable Income,
rather it is charged directly to Trust Corpus. Revisions to estimated future units-of-production are treated on a prospective basis
beginning on the date significant revisions are known.
The conveyance of the Royalty Interests to
the Trust was accounted for as a purchase transaction. The $352,100,000 reflected in the Statements of Assets, Liabilities and
Trust Corpus as Royalty interest in gas properties represents 17,605,000 Trust units valued at $20.00 per unit. The carrying value
of the Trust’s investment in the Royalty Interests is not necessarily indicative of the fair value of such Royalty Interests.