| CROSS TIMBERS ROYALTY TRUST Item 1A Risk Factors The following factors, among others, could cause actual results to differ materially from those contained in forward-looking statements made in this report and presented elsewhere by the trustee from time to time |
| Such factors, among others, may have a material adverse effect upon the trust’s financial condition, distributable income and changes in trust corpus |
| The following discussion of risk factors should be read in conjunction with the financial statements and related notes included in the trust’s annual report to unitholders for the year ended December 31, 2005 |
| Because of these and other factors, past financial performance should not be considered an indication of future performance |
| The market price for the trust units may not reflect the value of the net profits interests held by the trust |
| The public trading price for the trust units tends to be tied to the recent and expected levels of cash distributions on the trust units |
| The amounts available for distribution by the trust vary in response to numerous factors outside the control of the trust or XTO Energy, including prevailing prices for oil and natural gas produced from the underlying properties |
| The market price of the trust units is not necessarily indicative of the value that the trust would realize if the net profits interests were sold to a third party buyer |
| In addition, such market price is not necessarily reflective of the fact that, since the assets of the trust are depleting assets, a portion of each cash distribution paid on the trust units should be considered by investors as a return of capital, with the remainder being considered as a return on investment |
| There is no guarantee that distributions made to a unitholder over the life of these depleting assets will equal or exceed the purchase price paid by the unitholder |
| Oil and natural gas prices fluctuate due to a number of uncontrollable factors, and any decline will adversely affect the net proceeds payable to the trust and trust distributions |
| The trust’s monthly cash distributions are highly dependent upon the prices realized from the sale of natural gas and, to a lesser extent, oil |
| Oil and natural gas prices can fluctuate widely on a month-to-month basis in response to a variety of factors that are beyond the control of the trust and XTO Energy |
| Factors that contribute to price fluctuations include instability in oil-producing regions, worldwide economic conditions, weather conditions, the supply and price of domestic and foreign oil and natural gas, consumer demand, the price and availability of alternative fuels, the proximity to, and capacity of, transportation facilities and the effect of worldwide energy conservation measures |
| Moreover, government regulations, such as regulation of natural gas transportation and price controls, can affect product prices in the long term |
| Lower oil and natural gas prices may reduce the amount of oil and natural gas that is economic to produce and will reduce net profits available to the trust |
| The volatility of energy prices reduces the predictability of future cash distributions to trust unitholders |
| Higher production expense and/or development costs, without concurrent increases in revenue, will directly decrease the net proceeds payable to the trust from the properties underlying the 75prca net profits interests |
| Production expense and development costs are deducted in the calculation of the trust’s share of net proceeds from properties underlying the 75prca net profits interests |
| Accordingly, higher or lower production expense and development costs, without concurrent increases in revenue, will directly decrease or increase the amount received by the trust for its 75prca net profits interests |
| If development costs and production expense for properties underlying the 75prca net profits in a particular state exceed the production proceeds from the properties, the trust will not receive net proceeds for those properties until future proceeds from production in that state exceed the total of the excess costs plus accrued interest during the deficit period |
| Development activities may not generate sufficient additional revenue to repay the costs |
| Proved reserve estimates depend on many assumptions that may turn out to be inaccurate |
| Any material inaccuracies in reserve estimates or underlying assumptions could cause the quantities and net present value of the reserves to be overstated |
| Estimating proved oil and gas reserves is inherently uncertain |
| Petroleum engineers consider many factors and make assumptions in estimating reserves and future net cash flows |
| Those factors and assumptions include 3 ______________________________________________________________________ historical production from the area compared with production rates from similar producing areas, the effects of governmental regulation, assumptions about future commodity prices, production expense and development costs, taxes and capital expenditures, the availability of enhanced recovery techniques and relationships with landowners, working interest partners, pipeline companies and others |
| Lower oil and gas prices generally cause lower estimates of proved reserves |
| Ultimately, actual production, revenues and expenditures for the underlying properties will vary from estimates and those variances could be material |
| Estimated proved reserves for the net profits interests are based on estimates of reserves for the underlying properties and an allocation method that considers estimated future net proceeds and oil and gas prices |
| Increases or decreases in oil and gas prices directly increase or decrease estimated reserves of the 75prca net profits interests |
| Operational risks and hazards associated with the development of the underlying properties may decrease trust distributions |
| There are operational risks and hazards associated with the production and transportation of oil and natural gas, including without limitation natural disasters, blowouts, explosions, fires, leakage of oil or natural gas, releases of other hazardous materials, mechanical failures, cratering, and pollution |
| Any of these or similar occurrences could result in the interruption or cessation of operations, personal injury or loss of life, property damage, damage to productive formations or equipment, damage to the environment or natural resources, or cleanup obligations |
| The operation of oil and gas properties is also subject to various laws and regulations |
| Non-compliance with such laws and regulations could subject the operator to additional costs, sanctions or liabilities |
| The uninsured costs resulting from any of the above or similar occurrences could be deducted as a production expense or development cost in calculating the net proceeds payable to the trust from properties underlying the 75prca net profits interests, and would therefore reduce trust distributions by the amount of such uninsured costs |
| Trust unitholders and the trustee have no influence over the operations on, or future development of, the underlying properties |
| Because XTO Energy does not operate most of the underlying properties, it is unable to significantly influence the operations or future development of the underlying properties |
| Neither the trustee nor the trust unitholders can influence or control the operation or future development of the underlying properties |
| The failure of an operator to conduct its operations or discharge its obligations in a proper manner could have an adverse effect on the net proceeds payable to the trust |
| The current operators of the underlying properties are under no obligation to continue operating the properties |
| Neither the trustee nor trust unitholders have the right to replace an operator |
| The assets of the trust represent interests in depleting assets and, if XTO Energy and any other operators developing the underlying properties do not perform additional development projects, the assets may deplete faster than expected |
| Eventually, the assets of the trust will cease to produce in commercial quantities and the trust will cease to receive proceeds from such assets |
| The net proceeds payable to the trust are derived from the sale of depleting assets |
| Eventually, the properties underlying the trust’s net profits interests will cease to produce in commercial quantities and the trust will, therefore, cease to receive any net proceeds therefrom |
| The reduction in proved reserve quantities is a common measure of the depletion |
| Future maintenance and development projects on the underlying properties will affect the quantity of proved reserves |
| The timing and size of these projects will depend on the market prices of oil and natural gas |
| If XTO Energy or other operators of the properties do not implement additional maintenance and development projects, the future rate of production decline of proved reserves may be higher than the rate currently estimated |
| Terrorism and continued geopolitical hostilities could adversely affect trust distributions or the market price of the trust units |
| Terrorist attacks and the threat of terrorist attacks, whether domestic or foreign, as well as the military or other actions taken in response, cause instability in the global financial and energy markets |
| Terrorism and other 4 ______________________________________________________________________ geopolitical hostilities could adversely affect trust distributions or the market price of the trust units in unpredictable ways, including through the disruption of fuel supplies and markets, increased volatility in oil and natural gas prices, or the possibility that the infrastructure on which the operators of the underlying properties rely could be a direct target or an indirect casualty of an act of terror |
| XTO Energy may transfer its interest in the underlying properties without the consent of the trust or the trust unitholders |
| XTO Energy may at any time transfer all or part of its interest in the underlying properties to another party |
| Neither the trust nor the trust unitholders are entitled to vote on any transfer of the properties underlying the trust’s net profits interests, and the trust will not receive any proceeds of any such transfer |
| Following any transfer, the transferred property will continue to be subject to the net profits interests of the trust, but the calculation, reporting and remitting of net proceeds to the trust will be the responsibility of the transferee |
| In January 2006, XTO Energy announced that it will consider selling the underlying properties |
| Any sale is dependent upon XTO Energy’s ability to structure a tax-efficient transaction and receive sufficient consideration from a buyer it deems to be qualified |
| The operators of any underlying property may abandon the property, thereby terminating the related net profits interest payable to the trust |
| The operators of the underlying properties, or any transferee thereof, may abandon any well or property without the consent of the trust or the trust unitholders if they reasonably believe that the well or property can no longer produce in commercially economic quantities |
| This could result in the termination of the net profits interest relating to the abandoned well or property |
| The net profits interests can be sold and the trust would be terminated |
| The trust may sell the net profits interests if the holders of 80prca or more of the trust units approve the sale or vote to terminate the trust |
| The trust will terminate if it fails to generate gross proceeds from the underlying properties of at least dlra1cmam000cmam000 per year over any consecutive two-year period |
| Sale of all of the net profits interests will terminate the trust |
| The net proceeds of any sale must be for cash with the proceeds promptly distributed to the trust unitholders |
| Trust unitholders have limited voting rights and have limited ability to enforce the trust’s rights against the current or any future operators of the underlying properties |
| The voting rights of a trust unitholder are more limited than those of stockholders of most public corporations |
| For example, there is no requirement for annual meetings of trust unitholders or for an annual or other periodic re-election of the trustee |
| Additionally, trust unitholders have no voting rights in XTO Energy |
| The trust indenture and related trust law permit the trustee and the trust to sue XTO Energy or operators of the underlying properties to compel them to fulfill the terms of the conveyance of the net profits interests |
| If the trustee does not take appropriate action to enforce provisions of the conveyance, the recourse of the trust unitholders would likely be limited to bringing a lawsuit against the trustee to compel the trustee to take specified actions |
| Trust unitholders probably would not be able to sue XTO Energy or operators of the underlying properties |
| Financial information of the trust is not prepared in accordance with GAAP The financial statements of the trust are prepared on a modified cash basis of accounting, which is a comprehensive basis of accounting other than accounting principles generally accepted in the US, or GAAP Although this basis of accounting is permitted for royalty trusts by the Securities and Exchange Commission, the financial statements of the trust differ from GAAP financial statements because net profits income is not accrued in the month of production, expenses are not recognized when incurred and cash reserves may be established for certain contingencies that would not be recorded in GAAP financial statements |
| 5 ______________________________________________________________________ The limited liability of trust unitholders is uncertain |
| The trust unitholders are not protected from the liabilities of the trust to the same extent that a shareholder would be protected from a corporation’s liabilities |
| The structure of the trust does not include the interposition of a limited liability entity such as a corporation or limited partnership which would provide further limited liability protection to trust unitholders |
| While the trustee is liable for any excess liabilities incurred if the trustee fails to insure that such liabilities are to be satisfied only out of trust assets, under the laws of Texas, which are unsettled on this point, a unitholder may be jointly and severally liable for any liability of the trust if the satisfaction of such liability was not contractually limited to the assets of the trust and the assets of the trust and the trustee are not adequate to satisfy such liability |
| As a result, trust unitholders may be exposed to personal liability |
| The trust, however, is not liable for production costs or other liabilities of the underlying properties |
| Drilling oil and natural gas wells is a high-risk activity and subjects the trust to a variety of factors that it cannot control |
| Drilling oil and natural gas wells, including development wells, involves numerous risks, including the risk that commercially productive oil and natural gas reservoirs are not encountered |
| The presence of unanticipated pressures or irregularities in formations, miscalculations or accidents may cause drilling activities to be unsuccessful |
| In addition, there is often uncertainty as to the future cost or timing of drilling, completing and operating wells |
| Further, the development activities may be curtailed, delayed or canceled as a result of a variety of factors, including: • unexpected drilling conditions; • title problems; • restricted access to land for drilling or laying pipeline; • pressure or irregularities in formations; • equipment failures or accidents; • adverse weather conditions; and • costs of, or shortages or delays in the availability of, drilling rigs, tubular materials and equipment |
| While these risks do not expose the trust to liabilities of the driller or operator of the well, they can reduce net proceeds payable to the trust and trust distributions by decreasing oil and gas revenues or increasing production expense or development costs from the underlying properties |
| Furthermore, these risks may cause the costs of development activities on properties underlying the 75prca net profits interests to exceed the revenues therefrom, thereby reducing net proceeds payable to the trust and trust distributions |
| The underlying properties are subject to complex federal, state and local laws and regulations that could adversely affect net proceeds payable to the trust and trust distributions |
| Extensive federal, state and local regulation of the oil and natural gas industry significantly affects operations on the underlying properties |
| In particular, oil and natural gas development and production are subject to stringent environmental regulations |
| These regulations have increased the costs of planning, designing, drilling, installing, operating and abandoning oil and natural gas wells and other related facilities, which costs could reduce net proceeds payable to the trust and trust distributions |
| These regulations may become more demanding in the future |