The Trust will make quarterly cash distributions of substantially all its cash receipts, after deducting the Trust’s expenses, through and including the quarter ending June 30, 2031. Chesapeake Energy Corporation has established quarterly target levels of cash distributions for the life of the Trust. Such target distribution levels are set forth in the table of Annex B on page B-1 of the final prospectus filed by the Trust with the Securities and Exchange Commission on November 14, 2011.
The target distributions were prepared by Chesapeake Energy Corporation on a cash basis, based on assumptions regarding production volumes, pricing and other assumptions that are described beginning on page 58 of the final prospectus filed by the Trust with the Securities and Exchange Commission on November 14, 2011. The production forecasts are estimates prepared by Ryder Scott and have been used to calculate target distributions. Actual cash distributions to the Trust unit holders will fluctuate quarterly, based on the quantity of oil, natural gas liquids and natural gas produced from the underlying properties, the prices received for such production, payments under the hedge arrangements, the Trust’s administrative expenses and other factors.
Chesapeake Energy Corporation will pay to the Trust each quarter an amount equal to the proceeds of production attributable to the Trust’s royalty interest in the underlying properties received during the calendar quarter most recently ended (after deducting post-production expenses and any applicable taxes). The Trust, in turn, will make quarterly cash distributions of substantially all its quarterly cash receipts, after deducting the Trust’s expenses, to holders of trust units approximately 60 days following the end of each quarter.
In order to provide support for cash distributions on the common units, Chesapeake Energy Corporation has agreed to subordinate 11,687,500 of the trust units it retained following the initial public offering, which constitutes 25% of the outstanding trust units. The subordinated units are entitled to receive pro rata distributions from the Trust if and to the extent there is sufficient cash to provide a cash distribution on the common units that is no less than the applicable quarterly subordination threshold. If there is insufficient cash to fund such a distribution on all trust units, the distribution to be made with respect to the subordinated units will be reduced or eliminated in order to make a distribution, to the extent possible, of up to the subordination threshold amount on the common units. Each applicable quarterly subordination threshold is 20% below the target distribution level for the corresponding quarter, as reflected on the table. In exchange for agreeing to subordinate these trust units, and in order to provide additional financial incentive to Chesapeake Energy Corporation to perform its drilling obligation and operations on the underlying properties in an efficient and cost-effective manner, Chesapeake Energy Corporation is entitled to receive incentive distributions equal to 50% of the amount by which the cash available for distribution on all of the trust units in any quarter during the subordination period exceeds the target distribution for such quarter by more than 20%. Chesapeake Energy Corporation’s right to receive incentive distributions will terminate upon the expiration of the subordination period.
The subordinated units will automatically convert into common units on a one-for-one basis and Chesapeake Energy Corporation’s right to receive incentive distributions will terminate at the end of the fourth full calendar quarter following Chesapeake Energy Corporation’s satisfaction of its drilling obligation to the Trust. Chesapeake Energy Corporation currently intends to complete its drilling obligation on or before June 30, 2015, and accordingly, Chesapeake Energy Corporation expects the subordinated units will convert into common units on or before June 30, 2016. Chesapeake Energy Corporation is required to complete its drilling obligation by June 30, 2016, in which event the subordinated units would convert into common units on or before June 30, 2017.