Exhibit 1
November 3, 2022
The Bank of New York Mellon Trust Company, N.A.
Trustee for Pacific Coast Oil Trust
601 Travis, Floor 16
Houston, Texas 77002
Attn: Ms. Sarah Newell
Vice President
Dear Ms. Newell,
We reviewed your letter filed October 17, 2022 on Form 8-K, and we are disappointed that you continue to choose not to act in defense of Unitholders, to whom you owe a duty of loyalty, care, and good faith. While you note that you have relied on counsel in choosing not to file suit against PCEC, we believe you are relying on unsound legal advice. In addition to the issues and concerns noted in our October 11, 2022 letter, we believe that you are missing another fundamental issue: that PCEC is improperly trying to assess to the Trust asset retirement obligations (ARO) that rightly belong to PCEC.
The Conveyance Agreement Does Not Support PCEC’s Assessment
In court filings, PCEC’s counsel references the Conveyance Agreement as the basis for allowing the ARO assessment to the Trust. The portion they quote is:
[A]ll costs accrued for future plugging and abandonment of any well or facility on the Developed [or Remaining] Properties Subject Interests; provided that such amounts shall not be included as part of the Developed Properties Gross Deductions in subsequent Payment Periods. (Conveyance Agreement at 7, 22).
What PCEC ignores (and what Trustee’s counsel presumably overlooked) are the provisions regulating what costs and expenses can be deducted from distributions to Unitholders. Those provisions bar deductions relating to costs and expenses incurred before the Effective Time, which is April 1, 2012.
“Developed [or Remaining] Properties Gross Deductions” shall mean the following costs and expenses (and, where applicable, losses, liabilities and damages), to the extent that the same (x) are properly allocable to the Developed [or Remaining] Properties Subject Interests (and any related equipment or property used in connection therewith) and the production and marketing of Developed [or Remaining] Properties Subject Hydrocarbons therefrom and (y) have been incurred or accrued by Grantor, from and after the Effective Time, but that are not attributable to a production month that occurs prior to the Effective Time (excluding, in all instances, the Developed [or Remaining] Properties Excluded Deductions): (Conveyance Agreement at 5, 20)
The provision above states that deductions must be incurred or accrued by the Grantor after the Effective Time, but an ARO was incurred and accrued by the Grantor prior to the Effective Time. Further, the Conveyance Agreement states that the costs and expenses must not be attributable to a production month that occurred prior to April 1, 2012. Yet nearly all of the ARO does relate to months before the Effective Time, since it covers the lifetime production of the properties since ARO recognition.
The Offering Documents Do Not Support PCEC’s Assessment
The Offering documentsi clearly detail that PCEC had already accrued for the ARO in 2009 or earlier (see Note 7 PCEC-14, 15), and more importantly, that PCEC had excluded the ARO liability from the property being conveyed to the Trust:
Note 5. Pro Forma Adjustments
The Conveyed Interests are recorded at the historical cost of PCEC and are calculated as follows as of December 31, 2011 (in thousands):
Historical cost of Underlying Properties | $ | 421,207 | ||
Less: Asset Retirement Obligations | (22,300 | ) | ||
Less: Accumulated depletion, depreciation and amortization of Underlying Properties | (93,846 | ) | ||
Net property value to be conveyed | 305,061 | |||
Times 80% Net Profits Interest to Trust | $ | 244,049 |
Since the ARO was incurred and accrued prior to the Effective Time, the $22.3 million initial present value is not a liability of the Trust, nor would any accretion of that liability be attributable to the Trust since April 1, 2012 as it is due to the passage of time. That accretion, assuming the 7% discount rate compounded that PCEC used, would result in PCEC being responsible for a roughly $45 million ARO currently, which would not be assessable to the Trust.
PCEC has argued that it was an oversight by the prior owners not to assess the ARO or its accretion. PCEC provided no evidence for this supposition, which is not surprising since the offering documents refute their position. The offering documents, which the prior owners of PCEC wrote, did not attribute any balance sheet liability for, nor any cost of, the existing ARO in historical proformas (p. 11) or in projections (p. 46) to the trust. In fact, the offering documents show the liability for the ARO remaining with PCEC (PCEC-30, p. 169 the proforma copied below reflects the ARO balance still with PCEC). For PCEC to try and allocate the liability to the trust nearly eight years later may well be a securities violation.
Pacific Coast Energy Company LP and
Subsidiaries Unaudited Pro Forma
Balance Sheet
December 31, 2011 | ||||||||||||
In thousands | Historical | Adjustments | Pro Forma | |||||||||
ASSETS | ||||||||||||
Current assets: | ||||||||||||
Cash | $ | 1,380 | $ | 1,620 | (a) | $ | 3,000 | |||||
Accounts receivable, net | 13,428 | — | 13,428 | |||||||||
Derivative instruments | 1,482 | — | 1,482 | |||||||||
Prepaid expenses | 115 | — | 115 | |||||||||
Total current assets | 16,405 | 1,620 | 18,025 | |||||||||
Equity investment | 35,067 | — | 35,067 | |||||||||
Property, plant and equipment | ||||||||||||
Oil and gas properties | 421,207 | (153,016 | )(b) | 268,191 | ||||||||
Non-oil and gas assets | 9,149 | — | 9,149 | |||||||||
430,356 | (153,016 | ) | 277,340 | |||||||||
Accumulated depletion and depreciation | (94,241 | ) | 35,998 | (b) | (58,243 | ) | ||||||
Net property, plant and equipment | 336,115 | (117,018 | ) | 219,097 | ||||||||
Other long-term assets | ||||||||||||
Derivative instruments | 409 | — | 409 | |||||||||
Other long-term assets | 4,682 | — | 4,682 | |||||||||
Total assets | $ | 392,678 | $ | (115,398 | ) | $ | 277,280 | |||||
LIABILITIES AND EQUITY | ||||||||||||
Current liabilities: | ||||||||||||
Accounts payable | $ | 7,628 | $ | — | $ | 7,628 | ||||||
Derivative instruments | 866 | — | 866 | |||||||||
Short-term debt | 74,000 | (74,000 | )(a) | — | ||||||||
Related party payables | 3,159 | — | 3,159 | |||||||||
Revenue and royalties payable | 3,970 | — | 3,970 | |||||||||
Other current liabilities | 744 | — | 744 | |||||||||
Total current liabilities | 90,367 | (74,000 | ) | 16,367 | ||||||||
Long-term debt | 30,000 | (30,000 | )(a) | – | ||||||||
Asset retirement obligation | 22,300 | — | 22,300 | |||||||||
Derivative instruments | 3,059 | — | 3,059 | |||||||||
Other long-term liabilities | 899 | — | 899 | |||||||||
Total liabilities | 146,625 | (104,000 | ) | 42,625 | ||||||||
Equity: | ||||||||||||
Partners’ equity | 246,053 | 223,107 | (c) | 234,655 | ||||||||
(234,505 | )(a) | |||||||||||
Total equity | 246,053 | (11,398 | ) | 234,655 | ||||||||
Total liabilities and equity | $ | 392,678 | $ | (115,398 | ) | $ | 277,280 |
The accompanying notes are an integral part of these unaudited pro forma financial statements.
PCEC F-30
i https://royt.q4web.com/trust-overview/default.aspx ROYT - Final Prospectus. We believe GAAP required recognition of ARO in 2003.
The prior owners of PCEC, who created the trust, were the same group that owned BreitBurn, a clearly sophisticated oil and gas operator. We believe the offering documents and Conveyance Agreement that they themselves wrote accurately reflected their intent regarding the ARO. We contend that it is the new owners of PCEC who are trying to reinterpret both documents in a way contrary to what the original parties understood.
As trustee, you are responsible to represent Unitholders. Despite the obvious facts of the case, you have chosen to side with PCEC against Unitholders, we therefore intend to proceed with calling a Special Meeting to have you removed as Trustee.
Sincerely,
Tim Eriksen
Managing Member
Cedar Creek Partners LLC
tim@eriksencapital.com
Carson Mitchell
Managing Member
Shipyard Capital Management LLC
carson@shipyardcapital.com