UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
| ☒ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2020
Or
| ☐ | TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Transition Period From to .
is Commission File Number 0-7406
PrimeEnergy Resources Corporation
(Exact name of registrant as specified in its charter)
| Delaware | 84-0637348 | |
(state or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
| 9821 Katy Freeway, Houston, Texas | 77024 | |
| (Address of principal executive offices) | (Zip Code) | |
Registrant’s telephone number, including area code: (713) 735-0000
Securities registered pursuant to Section 12(g) of the Act
Title of each class | Trading Symbol | Name of each Exchange on which registered | ||
| Common Stock, par value $0.10 (per share) | PNRG | NASDAQ |
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒
Indicate whether Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
| Large Accelerated Filer | ☐ | Accelerated Filer | ☐ | |||
| Non-Accelerated Filer | ☐ | Smaller Reporting Company | ☒ | |||
| Emerging growth company | ☐ | |||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
The aggregate market value of the voting stock of the Registrant held by non-affiliates, computed by reference to the average bid and asked price of such common equity as of the last business day of the Registrant’s most recently completed second fiscal quarter, was $40,188,536.
The number of shares outstanding of each class of the Registrant’s Common Stock as of April 23, 2021 was 1,994,177 Common Stock, $0.10 par value.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant’s proxy statement to be furnished to stockholders in connection with its Annual Meeting of Stockholders to be held on June 9, 2021, are incorporated by reference in Part III hereof.
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FORWARD-LOOKING STATEMENTS AND RISK
This Annual Report on Form 10-K includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements other than statements of historical facts included or incorporated by reference in this report, including, without limitation, statements regarding our future financial position, business strategy, budgets, projected revenues, projected costs, the potential impact of epidemics and pandemics, including the COVID-19 coronavirus (“COVID-19”), and plans and objectives of management for future operations, are forward-looking statements. Such forward-looking statements are based on our examination of historical operating trends, the information that was used to prepare our estimate of proved reserves as of December 31, 2020, and other data in our possession or available from third parties. In addition, forward-looking statements generally can be identified by the use of forward-looking terminology such as “may,” “will,” “could,” “expect,” “intend,” “project,” “estimate,” “anticipate,” “plan,” “believe,” or “continue” or similar terminology. Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to have been correct. Important factors that could cause actual results to differ materially from our expectations include, but are not limited to, our assumptions about:
| • | The market prices of oil, natural gas, NGLs, and other products or services, |
| • | Our commodity hedging arrangements |
| • | The supply and demand for oil, natural gas, NGLs, and other products or services |
| • | Production and reserve levels; |
| • | Drilling risks; |
| • | Economic and competitive conditions; |
| • | The availability of capital resources; |
| • | Capital expenditure and other contractual obligations; |
| • | Weather conditions’ |
| • | Inflation rates; |
| • | The availability of goods and services; |
| • | Legislative, regulatory or policy changes; |
| • | Terrorism or cyber attacks |
| • | Occurrence of property acquisitions or divestitures; |
| • | The integration of acquisitions; |
| • | The securities or capital markets and related risks such as general credit, liquidity, market and interest-rate risks; and |
| • | Other factors disclosed under Items 1 and 2—Business and Properties—Estimated Proved Reserves and Future Net Cash Flows, Item 1A—Risk Factors, Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations, and elsewhere in this Form 10-K |
All subsequent written and oral forward-looking statements attributable to the Company, or persons acting on its behalf, are expressly qualified in their entirety by the cautionary statements. Except as required by law, we assume no duty to update or revise our forward-looking statements based on changes in internal estimates or expectations or otherwise.
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PrimeEnergy Resources Corporation
FORM 10-K ANNUAL REPORT
For the Fiscal Year Ended
December 31, 2020
PART I
| Item 1. | BUSINESS. |
General
PrimeEnergy Resources Corporation (the “Company”) was organized in March, 1973, under the laws of the State of Delaware.
We are an independent oil and natural gas company engaged in acquiring, developing and producing oil and natural gas. We presently own producing and non-producing properties located primarily in Texas, and Oklahoma. All of our oil and gas properties and interests are located in the United States. Through our subsidiaries Prime Operating Company, Eastern Oil Well Service Company and EOWS Midland Company, we act as operator and provide well-servicing support operations for many of the onshore oil and gas wells in which we have an interest, as well as for third parties. We are also active in the acquisition of producing oil and gas properties through joint ventures with industry partners. Our subsidiary, PrimeEnergy Management Corporation (“PEMC”), acts as the managing general partner of one oil and gas limited partnerships (the “Partnerships”), and acts as the managing trustee of one asset and income business trusts (“the Trusts”).
Exploration, Development and Recent Activities
The Company’s activities include development and exploratory drilling. Our strategy is to develop the Company’s extensive oil and gas reserves primarily through horizontal drilling. This strategy includes targeting reservoirs with high initial production rates and cash flow as well as targeting reservoirs with lower initial production rates but with higher expected return on investment. We believe that with today’s technology, horizontal development of our reserves provides superior economic results as compared to vertical development, by delivering higher production rates through greater contact and stimulation of a larger volume of reservoir rock while minimizing the surface footprint required to develop those same reserves.
Maintaining a strong balance sheet and ample liquidity are key components of our business strategy. For 2021, we will continue our focus on preserving financial flexibility and ample liquidity as we manage the risks facing our industry. Our 2021 capital budget is reflective of current commodity prices and has been established based on an expectation of available cash flows, with any cash flow deficiencies expected to be funded by borrowings under our revolving credit facility. As we have done historically to preserve or enhance liquidity, we may adjust our capital program throughout the year, divest non-strategic assets, or enter into strategic joint ventures.
In accordance with SEC rules governing the scheduling of development of proved undeveloped (PUD) reserves, our year-end reserve report includes only those three wells that were slated to be drilled in 2021 along with 10 PUD locations that at year-end 2020 had been drilled but not yet completed. The three new wells drilled in the first quarter of 2021 and the six wells drilled in 2020 on the same Upton County, Texas tract are slated to be completed and on production by the end of the second quarter of 2021. The Company has an average of 47.5% interest in these nine wells. The remaining four PUD horizontal wells, drilled but not completed at year-end, are located in Grady County, Oklahoma. Of these, the Company has 10% interest in one well and less than one percent interest in each of three wells.
Since the start of our West Texas horizontal drilling program in 2015 and through the first quarter of 2021 the Company has participated in 77 horizontal wells in the Permian Basin, one of which was drilled and brought into production in 2020. As of year-end, the Company has invested approximately $108 MM in this drilling program, including over $4 million in six wells drilled in 2020 that will be completed in 2021. In addition, the Company has invested another $3.2 million in three new horizontals drilled in the first quarter of 2021. All nine of these wells are designated as proved undeveloped in the year-end reserve report and are to be completed and on-line by the end of the second quarter of 2021. Of the total 77 horizontal wells in this program, the Company has an average of 30.75% interest in 62 wells, and less than one percent interest in 15 wells.
In Upton County, West Texas, we are developing a contiguous 3,260 acre block with our joint venture partner, Apache Corporation. In this block the Company has leasehold acres with interest between 14% and 56%, depending on the particular lease and depth being developed. In 2018, in this block, eight wells drilled horizontally in the Wolfcamp “B”, were participated in for 49% interest and brought on production in February, 2019. This is believed to be full development of the Wolfcamp “B” reservoir for this lease block. Future development is expected in the Upper Wolfcamp, Jo Mill, and Lower Spraberry reservoirs for this block, following
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the 2019 successful development of these reservoirs on our offset 1,280 acre lease block of the Kashmir Tract. Given the favorable results achieved by the initial three wells on the 1,280 block it is expected that as many as 54 additional horizontals will be developed on this 3,260 acre block in the near future. The cost of development would be approximately $370.6 million with the Company’s share being approximately $170.8 million. In addition to the 54 wells likely to be drilled for these three reservoirs, there is a fourth target reservoir, the Middle Spraberry, that is also prospective for future development. The potential of the Middle Spraberry on the 3,260 acre block is for 18 horizontal wells to be drilled and completed at a gross cost of approximately $126.3 million with the Company’s share being approximately $61.8 million. The actual number of wells that are eventually drilled as well as the cost and the timing of drilling will vary based upon many factors, including commodity market conditions.
In addition to the 3,260 acre block being developed, as described above, the Company is also developing an offsetting 1,280 acre block in Upton County, Texas, with Apache Corporation as operator. In the second quarter of 2019 three horizontal wells were completed and brought on production from reservoirs above the Middle Wolfcamp: one in the Wolfcamp “A”, one in the Jo Mill, and one in the Lower Spraberry, confirming the economic viability of these reservoirs on our acreage. Prime holds 47.5% working interest in these reservoirs. As a result of the success of the initial three wells, nine new horizontals were spud in the first quarter of 2020 with six being fully drilled by May, 2020. The three remaining wells were drilled in the first quarter of 2021. All nine of these wells are slated for completion and to be on production by the end of the second quarter of 2021. Our average 47.5% share of the cost of these nine horizontal wells will be approximately $26.7 million in total. In addition to the nine new development locations in the Wolfcamp “A”, Jo Mill and Lower Sprayberry, four locations in the Middle Spraberry will be considered for future development at an estimated gross cost of approximately $30.2 million with the Company’s share being approximately $14.2 million.
Also in the Permian Basin of West Texas, we are developing a 965 acre block with Connoco Phillips in Martin County, Texas. In 2016 and 2017, four horizontal wells were drilled and completed and put on production. The Company owns 35% to 38% interest in this joint venture acreage where Connoco Phillips is the operator. No near-term additional drilling plans have been received from Connoco Phillips, however, offset operators have been actively drilling and their results are encouraging for the future development of multiple landing zones within this acreage block.
In 2020, the Company also added reserves through a 1% Overriding Royalty Interest (ORRI) in one horizontal well and 0.56% ORRI in 10 additional horizontal wells in Midland County, Texas.
In Central Reagan County, of West Texas, during 2020, the Company sold deep rights covering approximately 1,950 acres for net proceeds of $10.8 million.
As of December 31, 2020, we had net capitalized costs related to proved oil and gas properties of $185,098 million. Total expenditures for the acquisition, exploration and development of our properties during 2020 were $8.57 million as we continue development under the programs discussed above. Proved reserves as of December 31, 2020, were 10.4 MMBOE which consisted of 69% proved developed reserves.
In 2020, the Company acquired approximately 232 net acres in Reagan County, Texas for $343,900 and between 15 and 16.66% working interest in 53 oil and gas wells and 16.66% working interest in one salt water disposal well. We also acquired net acreage in Upton County located where the Company currently has leasehold acreage and where future horizontal drilling will likely occur. In addition, the Company acquired 9.36 acres in Upton County, Texas for $5,100, where the Company has leasehold acreage with expected future horizontal development.
We believe that our diversified portfolio approach to our drilling activities produces more consistent and predictable economic results than would otherwise be experienced with a less diversified or higher risk drilling program profile. DoublePoint Energy now in the process of being acquired by Pioneer Natural Resources, entered into a joint development agreement for the horizontal development of lands located in Reagan County, Texas in February of 2021 with PrimeEnergy . The agreement covers approximately 3,680 gross acres of blocked up leasehold to allow for 1.5 and 2 mile horizontal laterals. We believe this agreement represents significant future value for PrimeEnergy.
We attempt to assume the position of operator in all acquisitions of producing properties. We will continue to evaluate prospects for leasehold acquisitions and for exploration and development operations in areas in which we own interests and are actively pursuing the acquisition of producing properties. In order to diversify and broaden our asset base, we will consider acquiring the assets or stock in other entities and companies in the oil and gas business. Our main objective in making any such acquisitions will be to acquire income producing assets to increase our net worth and increase our oil and gas reserve base.
We presently own producing and non-producing properties located primarily in Texas, and Oklahoma, and we own a substantial amount of well servicing equipment.
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We do not own any refinery or marketing facilities, and do not currently own or lease any bulk storage facilities or pipelines other than adjacent to and used in connection with producing wells and the interests in certain gas gathering systems. All of our oil and gas properties and interests are located in the United States.
In the past, the supply of gas has exceeded demand on a cyclical basis, and we are subject to a combination of shut-in and/or reduced takes of gas production during summer months. Prolonged shut-ins could result in reduced field operating income from properties in which we act as operator.
Exploration for oil and gas requires substantial expenditures particularly in exploratory drilling in undeveloped areas, or “wildcat drilling.” As is customary in the oil and gas industry, substantially all of our exploration and development activities are conducted through joint drilling and operating agreements with others engaged in the oil and gas business.
Summaries of our oil and gas drilling activities, oil and gas production, and undeveloped leasehold, mineral, and royalty interests are set forth under Item 2., “Properties”, below. Summaries of our oil and gas reserves, future net revenue and present value of future net revenue are also set forth under Item 2., “Properties—Reserves”, below.
Well Operations
Our operations are conducted through our principal offices in Houston, Texas, and district offices in Houston and Midland, Texas, and Oklahoma City, Oklahoma. We currently operate 760 active wells, including producing, saltwater disposal, injection, and supply wells: 167 through the Houston office, 331 through the Midland office, and 262 through the Oklahoma City office. Substantially all of the wells we operate are wells in which we have an interest.
We operate wells pursuant to operating agreements that govern the relationship between us, as operator, and the other owners of working interests in the properties, including the Partnerships, Trusts and joint venture participants. For each operated well, we receive monthly fees that are competitive in the areas of operations and we also are reimbursed for expenses incurred in connection with well operations.
The Partnerships, Trusts and Joint Ventures
Since 1975, PEMC has acted as managing general partner of various partnerships, trusts and joint ventures.
PEMC, as managing general partner of the Partnerships and managing trustee of the Trusts, is responsible for all Partnership and Trust activities, the drilling of development wells and the production and sale of oil and gas from productive wells. PEMC also provides administration, accounting and tax preparation for the Partnerships and Trusts from our offices in Houston, Texas. PEMC is liable for all debts and liabilities of the Partnerships and Trusts, to the extent that the assets of a given limited partnership or trust are not sufficient to satisfy its obligations. We stopped sponsoring partnerships and trusts in 1992. As we entered 2021, we only have one partnership and one trust remaining. All other partnerships and the other trusts have been liquidated. The aggregate number of limited partners in the Partnerships and beneficial owners of the Trusts now administered by PEMC is approximately 69.
Regulation
Regulation of the Oil and Natural Gas Industry
Our operations are substantially affected by federal, state and local laws and regulations. Failure to comply with applicable laws and regulations can result in substantial penalties. The regulatory burden on the industry increases the cost of doing business and affects profitability. Although we believe we are in substantial compliance with all applicable laws and regulations, such laws and regulations are frequently amended or reinterpreted. Therefore, we are unable to predict the future costs or impact of compliance. Additional proposals and proceedings that affect the oil and natural gas industry are regularly considered by the United States Congress (“Congress”), state governments, the Federal Energy Regulatory Commission (the “FERC”) and other federal and state regulatory agencies and federal, state and local courts. We cannot predict when or whether any such proposals may become effective. We do not believe that such action or proposal would have a material disproportionate effect on us as compared to similarly situated competitors.
Regulation Affecting Production
As described above, natural gas production and related operations are, or have been, subject to price controls, taxes and numerous other laws and regulations. In addition, all of the jurisdictions in which we own or operate producing oil and natural gas
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properties have statutory provisions regulating the exploration for and production of oil and natural gas, including provisions related to permits for the drilling of wells, bonding requirements to drill or operate wells, the location of wells, the method of drilling and casing wells, the surface use and restoration of properties upon which wells are drilled, sourcing and disposal of water used in the drilling and completion process and the abandonment of wells. Our operations are also subject to various conservation laws and regulations. These include the regulation of the size of drilling and spacing units or proration units, the number of wells that may be drilled in an area and the unitization or pooling of crude oil or natural gas wells, as well as regulations that generally prohibit the venting or flaring of natural gas and impose certain requirements regarding the ratability or fair apportionment of production from fields and individual wells. These laws and regulations may limit the number of oil and natural gas wells we can drill. Moreover, each state generally imposes a production or severance tax with respect to the production and sale of oil, natural gas and NGLs within its jurisdiction. States do not regulate wellhead prices or engage in other similar direct regulation, but there can be no assurance that they will not do so in the future. The effect of such future regulations may be to limit the amounts of oil and natural gas that may be produced from our wells, negatively affect the economics of production from these wells or limit the number of locations we can drill.
The failure to comply with the rules and regulations of oil and natural gas production and related operations can result in substantial penalties. Our competitors in the oil and natural gas industry are subject to the same regulatory requirements and restrictions that affect our operations.
Regulation Affecting Sales and Transportation of Commodities
Sales prices for oil, natural gas and NGLs are not currently regulated and therefore are dictated by the prevailing market prices. Although prices of these energy commodities are currently unregulated, Congress historically has been active in their regulation. We cannot predict whether new legislation to regulate oil and natural gas, or the prices charged for these commodities, might be proposed, what proposals, if any, might actually be enacted by Congress or the various state legislatures and what effect, if any, the proposals might have on our operations. Sales of oil and natural gas may be subject to certain state and federal reporting requirements.
The price and terms of service of transportation of commodities, including access to pipeline transportation capacity, are subject to extensive federal and state regulation. Such regulation may affect the marketing of oil and natural gas produced, as well as the revenues received for sales of such production. Gathering systems may be subject to state ratable take statutes and common purchaser statutes. Ratable take statutes generally require gatherers to take, without undue discrimination, oil and natural gas production that may be tendered to the gatherer for handling. Similarly, common purchaser statutes generally require gatherers to purchase, or accept for gathering, without undue discrimination as to source of supply or producer. These statutes are designed to prohibit discrimination in favor of one producer over another producer or one source of supply over another source of supply. These statutes may affect whether and to what extent gathering capacity is available for oil and natural gas production, if any, of the drilling program and the cost of such capacity. Further, state laws and regulations govern rates and terms of access to intrastate pipeline systems, which may similarly affect market access and cost.
The FERC regulates interstate natural gas pipeline transportation rates and service conditions. The FERC regularly proposes and implements new rules and regulations affecting interstate transportation. The stated purpose of many of these regulatory changes is to promote competition among the various sectors of the natural gas industry and to promote market transparency. We do not believe that such FERC action would have a material disproportionate effect on our drilling program as compared to other similarly situated natural gas producers.
Gathering services, which occur upstream of FERC jurisdictional transmission services, and which are performed onshore and in state-controlled waters are regulated by state governments. Although the FERC has set forth a general test for determining whether facilities perform a non-jurisdictional gathering function or a jurisdictional transmission function, the FERC’s determinations as to the classification of facilities is conducted on a case-by-case basis. State regulation of natural gas gathering facilities generally includes various safety, environmental and, in some circumstances, nondiscriminatory take requirements. Although such regulation has not generally been affirmatively applied by state agencies, natural gas gathering may receive greater regulatory scrutiny in the future.
In addition to the regulation of natural gas pipeline transportation, the FERC has jurisdiction over the purchase or sale of gas or the purchase or sale of transportation services subject to the FERC’s jurisdiction pursuant to the Energy Policy Act of 2005. Under this law, it is unlawful for “any entity,” including a producer such as us, that is otherwise not subject to the FERC’s jurisdiction under the Natural Gas Act of 1938 to use any deceptive or manipulative device or contrivance in connection with the purchase or sale of gas, or the purchase or sale of transportation services subject to regulation by the FERC, in contravention of rules prescribed by the FERC. The FERC’s rules implementing this provision make it unlawful, in connection with the purchase or sale of gas subject to the jurisdiction of the FERC, or the purchase or sale of transportation services subject to the jurisdiction of the FERC, for any entity, directly or indirectly, to use or employ any device, scheme or artifice to defraud, to make any untrue statement of material fact or omit to make any such statement necessary to make the statements made not misleading, or to engage in any act or practice that operates as a fraud or deceit upon any person. The Energy Policy Act of 2005 also gives the FERC authority to impose civil penalties for
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violations of the Natural Gas Act of 1938 and the Natural Gas Policy Act of 1978 up to $1,291,894 per day per violation (adjusted annually based on inflation) and disgorge profits associated with any violation. The anti-manipulation rule applies to activities of otherwise non-jurisdictional entities to the extent the activities are conducted “in connection with” gas sales, purchases or transportation subject to FERC jurisdiction, which includes the annual reporting requirements under Order 704 (defined below).
In December 2007, the FERC issued a final rule on the annual natural gas transaction reporting requirements, as amended by subsequent orders on rehearing (“Order 704”). Under Order 704, any market participant that engages in wholesale sales or purchases of gas that equal or exceed 2.2 million MMBtus of physical natural gas in the previous calendar year, must annually report such sales and purchases to the FERC on Form No. 552 on May 1 of each year. Form No. 552 contains aggregate volumes of natural gas purchased or sold at wholesale in the prior calendar year to the extent such transactions utilize or contribute to the formation of price indices. It is the responsibility of the reporting entity to determine which individual transactions should be reported based on the guidance of Order 704. Order 704 is intended to increase the transparency of the wholesale gas markets and to assist the FERC in monitoring those markets and in detecting market manipulation.
The FERC also regulates rates and service conditions for the interstate transportation of liquids, including oil and NGLs, under the Interstate Commerce Act (the “ICA”). Prices received from the sale of liquids may be affected by the cost of transporting those products to market. The ICA requires that pipelines maintain a tariff on file with the FERC. The tariff sets forth the established rates as well as the rules and regulations governing the service. The ICA requires, among other things, that rates and terms and conditions of service on interstate common carrier pipelines be “just and reasonable.” Such pipelines must also provide jurisdictional service in a manner that is not unduly discriminatory or unduly preferential. Shippers have the power to challenge new and existing rates and terms and conditions of service before the FERC.
Rates of interstate liquids pipelines are currently regulated by the FERC primarily through an annual indexing methodology, under which pipelines increase or decrease their rates in accordance with an index adjustment specified by the FERC. For the five-year period beginning on July 1, 2016, the FERC established an annual index adjustment equal to the change in the producer price index for finished goods plus 1.23%. This adjustment is subject to review every five years. Under the FERC’s regulations, a liquids pipeline can request the authority to charge market-based rates for transportation service if it satisfies certain criteria, and also can request a rate increase that exceeds the rate obtained through application of the indexing methodology by using a cost-of-service approach, but only after the pipeline establishes that a substantial divergence exists between the actual costs experienced by the pipeline and the rates resulting from application of the indexing methodology. Increases in liquids transportation rates may result in lower revenue and cash flows.
In addition, due to common carrier regulatory obligations of liquids pipelines, capacity must be prorated among shippers in an equitable manner in the event there are nominations in excess of capacity. Therefore, requests for service by new shippers or increased volume by existing shippers may reduce the capacity available to us. Any prolonged interruption in the operation or curtailment of available capacity of the pipelines that we rely upon for liquids transportation could have a material adverse effect on our business, financial condition, results of operations and cash flows. However, we believe that access to liquids pipeline transportation services generally will be available to us to the same extent as to our similarly situated competitors.
Intrastate liquids pipeline transportation rates are subject to regulation by state regulatory commissions. The basis for intrastate liquids pipeline regulation, and the degree of regulatory oversight and scrutiny given to intrastate liquids pipeline rates, varies from state to state. We believe that the regulation of liquids pipeline transportation rates will not affect our operations in any way that is materially different from the effects on our similarly situated competitors.
In addition to the FERC’s regulations, we are required to observe anti-market manipulation laws with regard to our physical sales of energy commodities. In November 2009, the Federal Trade Commission (the “FTC”) issued regulations pursuant to the Energy Independence and Security Act of 2007 intended to prohibit market manipulation in the petroleum industry. Violators of the regulations face civil penalties of up to $1,231,690 per violation per day (adjusted annually based on inflation). In July 2010, Congress passed the Dodd-Frank Act, which incorporated an expansion of the authority of the Commodity Futures Trading Commission (the “CFTC”) to prohibit market manipulation in the markets regulated by the CFTC. This authority, with respect to crude oil swaps and futures contracts, is similar to the anti-manipulation authority granted to the FTC with respect to crude oil purchases and sales. In July 2011, the CFTC issued final rules to implement its new anti-manipulation authority. The rules subject violators to a civil penalty of up to the greater of $1,212,866 (adjusted annually based on inflation) or triple the monetary gain to the person for each violation.
Regulation of Environmental and Occupational Safety and Health Matters
Our operations are subject to stringent and complex federal, state and local laws and regulations governing environmental protection as well as the discharge of materials into the environment and occupational health and safety. These laws and regulations may, among other things: (i) require the acquisition of permits to conduct exploration, drilling and production operations; (ii) restrict
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the types, quantities and concentration of various substances that can be released into the environment or injected into formations in connection with oil and natural gas drilling and production activities; (iii) limit or prohibit drilling activities on certain lands lying within wilderness, wetlands and other protected areas; (iv) require remedial measures to mitigate pollution from former and ongoing operations, such as requirements to close pits and plug abandoned wells; and (v) impose substantial liabilities for pollution resulting from drilling and production operations. Any failure to comply with these laws and regulations may result in the assessment of administrative, civil and criminal penalties, the imposition of corrective or remedial obligations and the issuance of orders enjoining performance of some or all of our operations.
These laws and regulations may also restrict the rate of oil and natural gas production below the rate that would otherwise be possible. The regulatory burden on the oil and natural gas industry increases the cost of doing business in the industry and consequently affects profitability. Additionally, Congress and federal and state agencies frequently revise environmental laws and regulations and any changes that result in more stringent and costly waste handling, disposal and cleanup requirements for the oil and natural gas industry could have a significant impact on our operating costs.
The clear trend in environmental regulation has been to place more restrictions and limitations on activities that may affect the environment and thus any changes in environmental laws and regulations or re-interpretation of enforcement policies that result in more stringent and costly waste handling, storage, transportation, disposal, or remediation requirements could have a material adverse effect on our financial position and results of operations. We may be unable to pass on such increased compliance costs to our purchasers. Moreover, accidental releases or spills may occur in the course of our operations and we cannot assure you that we will not incur significant costs and liabilities as a result of such releases or spills, including any third-party claims for damage to property, natural resources or persons. While compliance with existing environmental laws and regulations has not had a material adverse effect on our operations to date, we can provide no assurance that this will continue in the future.
The following is a summary of the more significant existing and proposed environmental, occupational health and safety laws and regulations to which our business operations are or may be subject to and for which compliance may have a material adverse impact on our capital expenditures, results of operations or financial position.
The Resource Conservation and Recovery Act
The Resource Conservation and Recovery Act (“RCRA”), and comparable state statutes, regulate the generation, transportation, treatment, storage, disposal and cleanup of hazardous and non-hazardous wastes. Pursuant to rules issued by the U.S. Environmental Protection Agency (the “EPA”), individual state governments administer some or all of the provisions of RCRA, sometimes in conjunction with their own, more stringent requirements. Drilling fluids, produced waters and most of the other wastes associated with the exploration, development and production of crude oil or natural gas are currently regulated under RCRA’s non-hazardous waste provisions. However, it is possible that certain oil and natural gas drilling and production wastes now classified as non-hazardous could be classified as hazardous wastes in the future. A change in the classification of exploration and production wastes has the potential to significantly increase our waste disposal costs to manage, which in turn will result in increased operating costs and could adversely impact our results of operations and financial position. Also, in the course of our operations, we generate some amounts of ordinary industrial wastes, such as paint wastes, waste solvents and waste oils that may be regulated as hazardous wastes if such wastes have hazardous characteristics.
Comprehensive Environmental Response, Compensation and Liability Act
The Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”), also known as the Superfund law, imposes joint and several liability, without regard to fault or legality of conduct, on classes of persons who are considered to be responsible for the release of a hazardous substance into the environment. These persons include the current and former owners and operators of the site where the release occurred and anyone who disposed or arranged for the disposal of a hazardous substance released at the site. Under CERCLA, such persons may be subject to joint and several liability for the costs of cleaning up the hazardous substances that have been released into the environment, for damages to natural resources and for the costs of certain health studies. In addition, it is not uncommon for neighboring landowners and other third-parties to file claims for personal injury and property damage allegedly caused by the hazardous substances released into the environment.
We generate materials in the course of our operations that may be regulated as hazardous substances. Despite the “petroleum exclusion” of CERCLA, which currently encompasses natural gas, we may nonetheless handle hazardous substances within the meaning of CERCLA, or similar state statutes, in the course of our ordinary operations and, as a result, may be jointly and severally liable under CERCLA for all or part of the costs required to clean up sites at which these hazardous substances have been released into the environment. In addition, we currently own, lease, or operate numerous properties that have been used for oil and natural gas exploration, production and processing for many years. Although we believe that we have utilized operating and waste disposal practices that were standard in the industry at the time, hazardous substances, wastes, or hydrocarbons may have been released on,
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under or from the properties owned or leased by us, or on, under or from other locations, including off-site locations, where such substances have been taken for disposal. In addition, some of our properties have been operated by third parties or by previous owners or operators whose treatment and disposal of hazardous substances, wastes, or hydrocarbons was not under our control. These properties and the substances disposed or released on, under or from them may be subject to CERCLA, RCRA and analogous state and local laws. Under such laws, we could be required to undertake investigatory, response, or corrective measures, which could include soil and groundwater sampling, the removal of previously disposed substances and wastes, the cleanup of contaminated property, or remedial plugging or pit closure operations to prevent future contamination, the costs of which could be substantial.
Water Discharges
The Federal Water Pollution Control Act, or the Clean Water Act (the “CWA”), and analogous state laws impose restrictions and strict controls with respect to the discharge of pollutants, including spills and leaks of oil and other substances, into waters of the United States. The discharge of pollutants into regulated waters, including wetland areas, is prohibited, except in accordance with the terms of a permit issued by the EPA, the U.S. Army Corps of Engineers (the “USACE”) or an analogous state agency. In September 2015, the EPA and the USACE issued a final rule redefining the scope of the EPA’s and the USACE’s jurisdiction under the CWA with respect to certain types of waterbodies and classifying these waterbodies as regulated wetlands (the “WOTUS” rule). Several legal challenges to the rule followed, along with attempts to stay implementation of the WOTUS rule following the change in U.S. presidential administrations. Currently, the WOTUS rule is active in 22 states and enjoined in 28 states. However, in December 2018, the EPA and the USACE proposed changes to regulations under the CWA that would provide discrete categories of jurisdictional waters and tests for determining whether a particular waterbody meets any of those classifications. Several groups have already announced their intent to challenge the proposed WOTUS replacement rule. Therefore, the scope of jurisdiction under the CWA is uncertain at this time. To the extent the original WOTUS rule or any replacement rule expands the scope of the CWA’s jurisdiction, we could face increased costs and delays with respect to obtaining permits for dredge and fill activities in wetland areas. In addition, federal and state regulatory agencies can impose administrative, civil and criminal penalties for non-compliance with discharge permits or other requirements of the CWA and analogous state laws and regulations. We do not expect the costs to comply with the requirements of the CWA to have a material adverse effect on our operations.
The Oil Pollution Act of 1990 amends the CWA and establishes strict liability for owners and operators of facilities that cause a release of oil into waters of the United States. In addition, this law requires owners and operators of facilities that store oil above specified threshold amounts to develop and implement spill prevention, control and countermeasures plans.
Safe Drinking Water Act and Saltwater Disposal Wells
In the course of our operations, we produce water in addition to oil and natural gas. Water that is not recycled or otherwise disposed of on the lease may be sent to saltwater disposal wells for injection into subsurface formations. Underground injection operations are regulated under the federal Safe Drinking Water Act and permitting and enforcement authority may be delegated to state governments. In Texas, the Texas Railroad Commission (“RRC”) regulates the disposal of produced water by injection well. The RRC requires operators to obtain a permit from the agency for the operation of saltwater disposal wells and establishes minimum standards for injection well operations. In response to recent seismic events near underground injection wells used for the disposal of oil and natural gas-related waste waters, federal and some state agencies have begun investigating whether such wells have caused increased seismic activity, and some states have shut down or placed volumetric injection limits on existing wells or imposed moratoria on the use of such injection wells. In response to concerns related to induced seismicity, regulators in some states have already adopted or are considering additional requirements related to seismic safety. For example, the RRC has adopted rules for injection wells to address these seismic activity concerns in Texas. Among other things, the rules require companies seeking permits for disposal wells to provide seismic activity data in permit applications, provide for more frequent monitoring and reporting for certain wells and allow the RRC to modify, suspend, or terminate permits on grounds that a disposal well is likely to be, or determined to be, causing seismic activity. More stringent regulation of injection wells could lead to reduced construction or the capacity of such wells, which could in turn impact the availability of injection wells for disposal of wastewater from our operations. Increased costs associated with the transportation and disposal of produced water, including the cost of complying with regulations concerning produced water disposal, may reduce our profitability. The costs associated with the disposal of proposed water are commonly incurred by all oil and natural gas producers, however, and we do not believe that these costs will have a material adverse effect on our operations.
Air Emissions
The federal Clean Air Act and comparable state laws restrict the emission of air pollutants from many sources, such as tank batteries and compressor stations, through air emissions standards, construction and operating permitting programs and the imposition of other compliance requirements. These laws and regulations may require us to obtain pre-approval for the construction or modification of certain projects or facilities expected to produce or significantly increase air emissions, obtain and strictly comply
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with stringent air permit requirements or utilize specific equipment or technologies to control emissions of certain pollutants. Over the next several years, we may be required to incur certain capital expenditures for air pollution control equipment or other air emissions related issues. For example, in October 2015, the EPA lowered the National Ambient Air Quality Standard for ozone from 75 to 70 parts per billion. The EPA approved final attainment/nonattainment designations with the new ozone standards in July 2018 and currently all of the areas in which we operate are in attainment with such standards. However, state implementation of these revised air quality standards or a change in the attainment status of the areas in which we operate could result in stricter permitting requirements, delay or prohibit our ability to obtain such permits and result in increased expenditures for pollution control equipment, the costs of which could be significant. Separately, in June 2016, the EPA finalized a rule regarding criteria for aggregating multiple small surface sites into a single source for air-quality permitting purposes applicable to the oil and natural gas industry. This rule could cause small facilities, on an aggregate basis, to be deemed a major source, thereby triggering more stringent air permitting requirements, which in turn could result in operational delays or require us to install costly pollution control equipment. The EPA has also adopted new rules under the Clean Air Act that require the reduction of volatile organic compound emissions from certain fractured and refractured natural gas wells for which well completion operations are conducted and further require that most wells use reduced emission completions, also known as “green completions.” These regulations also establish specific new requirements regarding emissions from production-related wet seal and reciprocating compressors and from pneumatic controllers and storage vessels. The EPA expanded on its emission standards for volatile organic compounds in June 2016 with the issuance of first-time standards, known as Subpart OOOOa, to address emissions of methane from equipment and processes across the oil and natural gas source category, including hydraulically fractured oil and natural gas well completions. Following the change in presidential administration, there have been attempts to modify these regulations, and litigation concerning the regulations is ongoing. As a result of these developments, substantial uncertainty exists with respect to implementation of the EPA’s 2016 methane rule. However, given the long-term trend toward increasing regulation, future federal methane regulation of the oil and gas industry remains a possibility, and several states have separately imposed their own regulations on methane emissions from oil and gas production activities. These and other air pollution control and permitting requirements have the potential to delay the development of oil and natural gas projects and increase our costs of development and production, which costs could be significant. We do not believe that compliance with such requirements, however, will have a material adverse effect on our operations.
Regulation of Greenhouse Gas Emissions
In response to findings that emissions of carbon dioxide, methane and other greenhouse gases (“GHGs”) endanger public health and the environment, the EPA has adopted regulations under existing provisions of the Clean Air Act that, among other things, establish Prevention of Significant Deterioration (“PSD”), construction and Title V operating permit reviews for certain large stationary sources. Facilities required to obtain PSD permits for their GHG emissions also will be required to meet “best available control technology” standards for these emissions. EPA rulemakings related to GHG emissions could adversely affect our operations and restrict or delay our ability to obtain air permits for new or modified sources. In addition, the EPA has adopted rules requiring the annual reporting of GHG emissions from certain petroleum and natural gas system sources in the U.S., including, among others, onshore and offshore production facilities, which include certain of our operations. Also, as noted above, the EPA has promulgated a New Source Performance Standard related to methane emissions from the oil and natural gas source category.
While Congress has considered legislation related to the reduction of GHG emissions in the past, no significant legislation to reduce GHG emissions has been adopted at the federal level. In the absence of Congressional action, a number of state and regional GHG restrictions have emerged. At the international level, the United States joined the international community at the 21st Conference of the Parties of the United Nations Framework Convention on Climate Change in Paris, France. The Paris Agreement entered into force in November 2016. Although this agreement does not create any binding obligations for nations to limit their GHG emissions, it does include pledges from participating nations to voluntarily limit or reduce future emissions. In June 2017, President Trump stated that the United States would withdraw from the Paris Agreement, but may enter into a future international agreement related to GHGs. The Paris Agreement provides for a four-year exit process beginning when it took effect in November 2016, which would result in an effective exit date of November 2020. The United States’ adherence to the exit process is uncertain, and the terms on which the United States may reenter the Paris Agreement or a separately negotiated agreement are unclear at this time. Although it is not possible at this time to predict how legislation or new regulations that may be adopted to address GHG emissions would impact our business, any such future laws and regulations imposing reporting obligations on, or limiting emissions of GHGs from, our equipment and operations could require us to incur costs to reduce emissions of GHGs associated with our operations.
Substantial limitations on GHG emissions could adversely affect demand for the oil and natural gas we produce and lower the value of our reserves. Notwithstanding potential risks related to climate change, the International Energy Agency estimates that global energy demand will continue to represent a major share of global energy use through 2040, and other private sector studies project continued growth in demand for the next two decades. However, recent activism directed at shifting funding away from companies with energy-related assets could result in limitations or restrictions on certain sources of funding for the energy sector. Finally, it should also be noted that many scientists have concluded that increasing concentrations of GHGs in the Earth’s atmosphere may produce climate changes that have significant physical effects, such as increased frequency and severity of storms, floods, droughts and other climatic events; if any such effects were to occur, they could have an adverse effect on our financial condition and results of operations.
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Hydraulic Fracturing Activities
Hydraulic fracturing is an important and common practice that is used to stimulate production of natural gas and/or oil from dense subsurface rock formations. Hydraulic fracturing involves the injection of water, sand or alternative proppant and chemicals under pressure into target geological formations to fracture the surrounding rock and stimulate production. We regularly use hydraulic fracturing as part of our operations. Recently, there has been increased public concern regarding an alleged potential for hydraulic fracturing to adversely affect drinking water supplies, resulting in new legislative and regulatory initiatives that seek to increase the regulatory burden imposed on hydraulic fracturing.
At the federal level, the EPA has asserted federal regulatory authority pursuant to the Safe Drinking Water Act over certain hydraulic fracturing activities involving the use of diesel fuels and published permitting guidance in February 2014 addressing the performance of such activities. Further, the EPA finalized regulations under the CWA in June 2016 that prohibit wastewater discharges from hydraulic fracturing and certain other natural gas operations to publicly owned wastewater treatment plants. Also, in December 2016, the EPA released its final report on the potential impacts of hydraulic fracturing on drinking water resources. The final report concluded that “water cycle” activities associated with hydraulic fracturing may impact drinking water resources under certain limited circumstances.
At the state level, several states have adopted or are considering legal requirements that could impose more stringent permitting, disclosure and well construction requirements on hydraulic fracturing activities. For example, in May 2013, the RRC adopted new rules governing well casing, cementing and other standards for ensuring that hydraulic fracturing operations do not contaminate nearby water resources. Local governments also may seek to adopt ordinances within their jurisdictions regulating the time, place and manner of, or prohibiting, drilling or hydraulic fracturing activities. We believe that we follow applicable standard industry practices and legal requirements for groundwater protection in our hydraulic fracturing activities. Nonetheless, if new or more stringent federal, state, or local legal restrictions relating to the hydraulic fracturing process are adopted in areas where we operate, we may be required to incur significant added costs to comply with such requirements, experience delays or curtailment in the pursuit of exploration, development or production activities and perhaps even be precluded from drilling wells.
If new federal, state or local laws or regulations that significantly restrict hydraulic fracturing are adopted, such legal requirements could result in delays, eliminate certain drilling and injection activities and make it more difficult or costly to perform fracturing. Any such regulations limiting or prohibiting hydraulic fracturing could reduce oil and natural gas exploration and production activities and, therefore, adversely affect our business. Such laws or regulations could also materially increase our costs of compliance and doing business by more strictly regulating how hydraulic fracturing wastes are handled or disposed.
Endangered Species Act and Migratory Birds
The federal Endangered Species Act (“ESA”) and (in some cases) comparable state laws were established to protect endangered and threatened species. Pursuant to the ESA, if a species is listed as threatened or endangered, restrictions may be imposed on activities adversely affecting that species’ habitat. We may conduct operations on oil and natural gas leases in areas where certain species that are listed as threatened or endangered are known to exist and where other species, such as the sage grouse, that potentially could be listed as threatened or endangered under the ESA may exist. The U.S. Fish and Wildlife Service (the “FWS”) may designate critical habitat and suitable habitat areas that it believes are necessary for the survival of a threatened or endangered species. A critical habitat or suitable habitat designation could result in further material restrictions to federal land use and may materially delay or prohibit land access for oil and natural gas development. Moreover, as a result of a 2011 settlement agreement, the FWS was required to make a determination on listing of more than 250 species as endangered or threatened under the FSA by no later than completion of the agency’s 2017 fiscal year. The FWS missed the deadline but reportedly continues to review new species for protected status under the ESA pursuant to the settlement agreement. Similar protections are offered to migratory birds under the Migratory Bird Treaty Act. Recently, there have been renewed calls to review protections currently in place for the dunes sagebrush lizard, whose habitat includes portions of the Permian Basin, and to reconsider listing the species under the ESA. The designation as threatened or endangered of previously unprotected species in areas where we operate could cause us to incur increased costs arising from species protection measures or could result in limitations on our development and production activities that could have a material adverse impact on our ability to develop and produce our reserves. If we were to have a portion of our leases designated as critical or suitable habitat, it could adversely impact the value of our leases.
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OSHA
We are subject to the requirements of the Occupational Safety and Health Administration (“OSHA”) and comparable state statutes whose purpose is to protect the health and safety of workers. In addition, the OSHA hazard communication standard, the Emergency Planning and Community Right-to-Know Act and comparable state statutes and any implementing regulations require that we organize and/or disclose information about hazardous materials used or produced in our operations and that this information be provided to employees, state and local governmental authorities and citizens.
Related Permits and Authorizations
Many environmental laws require us to obtain permits or other authorizations from state and/or federal agencies before initiating certain drilling, construction, production, operation, or other oil and natural gas activities and to maintain these permits and compliance with their requirements for on-going operations. These permits are generally subject to protest, appeal, or litigation, which, in certain cases, can delay or halt projects and cease production or operation of wells, pipelines and other operations.
Related Insurance
We maintain insurance against some risks associated with above or underground contamination that may occur as a result of our exploration and production activities. However, this insurance is limited to activities at the well site, and there can be no assurance that this insurance will continue to be commercially available or that this insurance will be available at premium levels that justify its purchase by us. The occurrence of a significant event that is not fully insured or indemnified against could have a material adverse effect on our financial condition and operations.
Although we have not experienced any material adverse effect from compliance with environmental requirements, there is no assurance that this will continue. We did not have any material capital or other non-recurring expenditures in connection with complying with environmental laws or environmental remediation matters in 2019, nor do we anticipate that such expenditures will be material in 2020.
Competition and Markets
The business of acquiring producing properties and non-producing leases suitable for exploration and development is highly competitive. Our competition, in our efforts to acquire both producing and non-producing properties, include oil and gas companies, independent concerns, income programs and individual producers and operators, many of which have financial resources, staffs and facilities substantially greater than those available to us. Furthermore, domestic producers of oil and gas must not only compete with each other in marketing their output, but must also compete with producers of imported oil and gas and alternative energy sources such as coal, nuclear power and hydroelectric power. Competition among petroleum companies for favorable oil and gas properties and leases can be expected to increase.
The availability of a ready market for any oil and gas produced by us at acceptable prices per unit of production will depend upon numerous factors beyond our control, including the extent of domestic production and importation of oil and gas, the proximity of our producing properties to gas pipelines and the availability and capacity of such pipelines, the marketing of other competitive fuels, fluctuation in demand, governmental regulation of production, refining, transportation and sales, general national and worldwide economic conditions, and use and allocation of oil and gas and their substitute fuels. There is no assurance that we will be able to market all of the oil or gas produced by us or that favorable prices can be obtained for the oil and gas production.
We derive our revenue and cash flow principally from the sale of oil, natural gas and NGLs. As a result, our revenues are determined, to a large degree, by prevailing prices for crude oil, natural gas and NGLs. We sell our oil and natural gas on the open market at prevailing market prices or through forward delivery contracts. Because some of our operations are located outside major markets, we are directly impacted by regional prices regardless of Henry Hub, WTI or other major market pricing. The market price for oil, natural gas and NGLs is dictated by supply and demand; consequently, we cannot accurately predict or control the price we may receive for our oil, natural gas and NGLs. The price of oil and natural gas has fallen significantly since the beginning of 2020, due in part to failed Organization of Petroleum Exporting Countries (“OPEC”) negotiations as well as concerns about the COVID-19 pandemic and its impact on the worldwide economy and global demand for oil and gas. The resulting precipitous decline in oil and gas pricing experienced during March 2020, through the date of this report, if prolonged, or a further deterioration of the market price for oil and natural gas, will negatively impact our cash flows.
We have an active hedging program to mitigate risk regarding our cash flow and to protect returns from our development activity in the event of decreases in the prices received for our production; however, hedging arrangements may expose us to risk of financial loss in some circumstances and may limit the benefit we would receive from increases in the prices for oil, natural gas and NGLs.
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Major Customers
The Company sells its oil and gas production to a number of direct purchasers under direct contracts or through other operators under joint operating agreements. Listed below are the percent of the Company’s total oil and gas sales made which represented more than 10% of the Company’s oil and gas sales in the year 2020.
Oil Purchasers: | ||||
Apache Corporation | 47 | % | ||
Plains All American Inc. | 19 | % | ||
Gas Purchasers: | ||||
Apache Corporation | 42 | % | ||
Targa Pipeline Mid-Continent West Tex, LLC | 12 | % |
Although there are no long-term purchasing agreements with these purchasers, we believe that they will continue to purchase our oil and gas products and, if not, could be readily replaced by other purchasers.
Employees
At December 31, 2020, we had 96 full time employees, 26 of whom were employed at our principal offices in Houston, Texas, at the offices of Prime Operating Company, Eastern Oil Well Service Company and EOWS Midland Company, and 70 employees who were primarily involved in our district operations in Midland, Texas, Elmore City and Oklahoma City, Oklahoma.
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| Item 1A. | RISK FACTORS. |
The prices of oil, NGL and gas are highly volatile and have declined significantly in recent years. A sustained decline in these commodity prices could materially and adversely affect the Company’s business, financial condition and results of operations.
Our revenues, operating results, financial condition and ability to borrow funds or obtain additional capital depend substantially on prevailing prices for natural gas and oil. Lower commodity prices may reduce the amount of natural gas and oil that we can produce economically. Natural gas prices, based on the twelve-month average first-of-the-month Henry Hub index price, were $1.985 per MMBTU in 2020 as compared to $2.577 per MMBTU in 2019, and have ranged from $2.385 to $2.645 per MMBTU for the first three months of 2021. Average monthly spot crude oil prices for West Texas Intermediate (WTI), as reported by the U.S. Energy Information Administration, were $39.23 per barrel in 2020 as compared to $56.98 per barrel in 2019, and have averaged $57.79 per barrel for the first three months of 2021. The average WTI oil price has rebounded $45.78 a barrel from its low monthly average price of $16.55 per barrel in April, 2020, occurring as a result of the economic slow-down caused by the COVID-19 pandemic, to its most recent monthly average price of $62.33 per barrel in March, 2021.
Any substantial or extended decline in future natural gas or crude oil prices would have a material adverse effect on our future business, financial condition, results of operations, cash flows, liquidity or ability to finance planned capital expenditures and commitments. Furthermore, substantial, extended decreases in natural gas and crude oil prices may cause us to delay or postpone a significant portion of our exploration, development and exploitation projects or may render such projects uneconomic, which may result in significant downward adjustments to our estimated proved reserves and could negatively impact our ability to borrow and cost of capital and our ability to access capital markets, increase our costs under our revolving credit facility, and limit our ability to execute aspects of our business plans.
Prices for natural gas and oil are subject to wide fluctuations in response to relatively minor changes in the supply of and demand for natural gas and oil, market uncertainty and a variety of additional factors that are beyond our control. These factors include:
| • | the level of consumer product demand; |
| • | weather conditions; |
| • | political conditions in natural gas and oil producing regions, including the Middle East, Africa and South America; |
| • | the ability of the members of the Organization of Petroleum Exporting Countries to agree to and maintain oil price and production controls; |
| • | the price levels and quantities of foreign imports; |
| • | actions of governmental authorities; |
| • | the availability, proximity and capacity of gathering, transportation, processing and/or refining facilities in regional or localized areas that may affect the realized price for natural gas and oil; |
| • | inventory storage levels; |
| • | the nature and extent of domestic and foreign governmental regulations and taxation, including environmental and climate change regulation; |
| • | the price, availability and acceptance of alternative fuels; |
| • | technological advances affecting energy consumption; |
| • | speculation by investors in oil and natural gas; |
| • | variations between product prices at sales points and applicable index prices; |
| • | overall economic conditions and |
| • | global or national health concerns, including the outbreak of pandemic or contagious disease, such as the coronavirus. |
In response to recent volatility in commodity prices, many producers have reduced their capital expenditure budgets. If the prices of oil and natural gas decline further, our operations, financial condition and level of expenditures for the development of our oil and natural gas reserves may be materially and adversely affected.
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In addition, lower oil and natural gas prices may reduce the amount of oil and natural gas that we can produce economically. This may result in our having to make substantial downward adjustments to our estimated proved reserves. If this occurs or if our production estimates change or our exploration or development activities are curtailed, full cost accounting rules may require us to write down, as a noncash charge to earnings, the carrying value of our oil and natural gas properties. Reductions in our reserves could also negatively impact the borrowing base under our revolving credit facility, which could further limit our liquidity and ability to conduct additional exploration and development activities.
Concerns over general economic, business or industry conditions may have a material adverse effect on our results of operations, liquidity and financial condition.
Concerns over global economic conditions, energy costs, geopolitical issues, inflation, the availability and cost of credit, the European, Asian and the United States financial markets have in the past contributed, and may in the future contribute, to economic uncertainty and diminished expectations for the global economy. In addition, continued hostilities in the Middle East, the occurrence or threat of terrorist attacks in the United States or other countries and global or national health concerns could adversely affect the global economy. These factors, combined with volatility in commodity prices, business and consumer confidence and unemployment rates, may precipitate an economic slowdown. Concerns about global economic growth may have an adverse impact on global financial markets and commodity prices. If the economic climate in the United States or abroad deteriorates, worldwide demand for petroleum products could diminish, which could impact the price at which we can sell our production, affect the ability of our vendors, suppliers and customers to continue operations and ultimately adversely impact our results of operations, liquidity and financial condition. These factors and the volatile nature of the energy markets make it impossible to predict with any certainty the future prices of natural gas and oil. If natural gas and oil prices decline significantly for a sustained period of time, the lower prices may adversely affect our ability to make planned expenditures, raise additional capital or meet our financial obligations.
Financial difficulties encountered by our oil and natural gas purchasers, third-party operators or other third parties could decrease cash flow from operations and adversely affect our exploration and development activities.
We derive essentially all of our revenues from the sale of our oil, natural gas and NGLs to unaffiliated third-party purchasers, independent marketing companies and midstream companies. Any delays in payments from such purchasers caused by their financial difficulties, including those resulting from the impacts of COVID-19 and its impact on the global economy, will have an immediate negative effect on our results of operations and cash flows.
Additionally, liquidity and cash flow problems encountered by our working interest co-owners or the third-party operators of our non-operated properties may prevent or delay the drilling of a well or the development of a project. Our working interest co-owners may be unwilling or unable to pay their share of the costs of projects as they become due. In the case of a working interest owner, we could be required to pay the working interest owner’s share of the project costs.
The shut-in of our wells could negatively impact our production, liquidity, and, ultimately, our operations, results, and performance.
Our production depends, in part, upon our wells that are capable of commercial production not being shut-in (i.e., suspended from production). The lack of availability of capacity on third-party systems and facilities or the shut-in of an oil field’s production could result in the shut-in of our wells. In response to recent commodity prices our efforts to reduce costs include reducing operating costs. The Company elected to shut-in marginal wells and will continue to review field operations to minimize costs and identify wells for short term shut-ins through May and June.
The producing wells in which we have an interest occasionally experience reduced or terminated production. These curtailments can result from mechanical failures, contract terms, pipeline and processing plant interruptions, market conditions, operator priorities, and weather conditions. These curtailments can last from a few days to many months, any of which could have an adverse effect on our results of operations.
If we experience low oil production volumes due to the shut-in of our wells or other mechanical failures or interruptions, it would impact our ability to generate cash flows from operations and we could experience a reduction in our available liquidity. A decrease in our liquidity could adversely affect our ability to meet our anticipated working capital, debt service, and other liquidity needs.
Drilling natural gas and oil wells is a high-risk activity.
Our growth is materially dependent upon the success of our drilling program. Drilling for natural gas and oil involves numerous risks, including the risk that no commercially productive natural gas or oil reservoirs will be encountered. The cost of drilling, completing and operating wells is substantial and uncertain, and drilling operations may be curtailed, delayed or cancelled as a result of a variety of factors beyond our control, including:
| • | decreases in natural gas and oil prices; |
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| • | unexpected drilling conditions, pressure or irregularities in formations; |
| • | equipment failures or accidents; |
| • | adverse weather conditions; |
| • | loss of title or other title related issues; |
| • | surface access restrictions; |
| • | lack of available gathering or processing facilities or delays in the construction thereof; |
| • | compliance with, or changes in, governmental requirements and regulation, including with respect to wastewater disposal, discharge of greenhouse gases and fracturing; and |
| • | shortages or delays in the availability of required goods or services such as drilling rigs or crews, the delivery of equipment and the availability of sufficient water for drilling operations. |
Our future drilling activities may not be successful and, if unsuccessful, such failure will have an adverse effect on our future results of operations and financial condition. Our overall drilling success rate or our drilling success rate within a particular geographic area may decline. We may be unable to lease or drill identified or budgeted prospects within our expected time frame, or at all. We may be unable to lease or drill a particular prospect because, in some cases, we identify a prospect or drilling location before seeking an option or lease rights in the prospect or location. Similarly, our drilling schedule may vary from our capital budget. The final determination with respect to the drilling of any scheduled or budgeted wells will be dependent on a number of factors, including:
| • | the results of exploration efforts and the acquisition, review and analysis of the seismic data; |
| • | the availability of sufficient capital resources to us and the other participants for the drilling of the prospects; |
| • | the approval of the prospects by other participants after additional data has been compiled; |
| • | economic and industry conditions at the time of drilling, including prevailing and anticipated prices for natural gas and oil and the availability of drilling rigs and crews; |
| • | our financial resources and results; and |
| • | the availability of leases and permits on reasonable terms for the prospects. |
These projects may not be successfully developed and the wells, if drilled, may not encounter reservoirs of commercially productive natural gas or oil.
Reserve estimates depend on many assumptions that may prove to be inaccurate. Any material inaccuracies in our reserve estimates or underlying assumptions could cause the quantities and net present value of our reserves to be overstated.
Reserve engineering is a subjective process of estimating underground accumulations of natural gas and oil that cannot be measured in an exact manner. The process of estimating quantities of proved reserves is complex and inherently uncertain, and the reserve data included in this document are only estimates. The process relies on interpretations of available geologic, geophysical, engineering and production data. As a result, estimates of different engineers may vary. In addition, the extent, quality and reliability of this technical data can vary. The differences in the reserve estimation process are substantially due to the geological conditions in which the wells are drilled. The process also requires certain economic assumptions, some of which are mandated by the SEC, such as natural gas and oil prices. Additional assumptions include drilling and operating expenses, capital expenditures, taxes and availability of funds. The accuracy of a reserve estimate is a function of:
| • | the quality and quantity of available data; |
| • | the interpretation of that data; |
| • | the accuracy of various mandated economic assumptions; and |
| • | the judgment of the persons preparing the estimate. |
Results of drilling, testing and production subsequent to the date of an estimate may justify revising the original estimate. Accordingly, initial reserve estimates often vary from the quantities of natural gas and oil that are ultimately recovered, and such variances may be material. Any significant variance could reduce the estimated quantities and present value of our reserves.
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You should not assume that the present value of future net cash flows from our proved reserves is the current market value of our estimated natural gas and oil reserves. In accordance with SEC requirements, we base the estimated discounted future net cash flows from our proved reserves on the twelve-month average oil and gas index prices, calculated as the unweighted arithmetic average for the first day of the month price for each month, and costs in effect on the date of the estimate, holding the prices and costs constant throughout the life of the properties. Actual future prices and costs may differ materially from those used in the net present value estimate, and future net present value estimates using then current prices and costs may be significantly less than the current estimate. In addition, the 10% discount factor we use when calculating discounted future net cash flows for reporting requirements in compliance with the Financial Accounting Standards Board (“FASB”) in Accounting Standards Codification (“ASC”) Section 932 may not be the most appropriate discount factor based on interest rates in effect from time to time and risks associated with us or the natural gas and oil industry in general.
The Company’s expectations for future drilling activities will be realized over several years, making them susceptible to uncertainties that could materially alter the occurrence or timing of such activities.
The Company has identified drilling locations and prospects for future drilling opportunities, including development and infill drilling activities. These drilling locations and prospects represent a significant part of the Company’s future drilling plans. The Company’s ability to drill and develop these locations depends on a number of factors, including the availability of capital, seasonal conditions, regulatory approvals, negotiation of agreements with third parties, commodity prices, costs, access to and availability of equipment, services, resources and personnel and drilling results. Changes in the laws or regulations on which the Company relies in planning and executing its drilling programs could adversely impact the Company’s ability to successfully complete those programs. For example, under current Texas laws and regulations the Company may receive permits to drill, and may drill and complete, certain horizontal wells that traverse one or more units and/or leases; a change in those laws or regulations could adversely impact the Company’s ability to drill those wells. Because of these uncertainties, the Company cannot give any assurance as to the timing of these activities or that they will ultimately meet the Company’s expectations for success. As such, the Company’s actual drilling activities may materially differ from the Company’s current expectations, which could have a significant adverse effect on the Company’s proved reserves, financial condition and results of operations.
Our future performance depends on our ability to find or acquire additional natural gas and oil reserves that are economically recoverable.
In general, the production rate of natural gas and oil properties declines as reserves are depleted, with the rate of decline depending on reservoir characteristics. Unless we successfully replace the reserves that we produce, our reserves will decline, eventually resulting in a decrease in natural gas and oil production and lower revenues and cash flow from operations. Our future natural gas and oil production is, therefore, highly dependent on our level of success in finding or acquiring additional reserves. We may not be able to replace reserves through our exploration, development and exploitation activities or by acquiring properties at acceptable costs. Low natural gas and oil prices may further limit the kinds of reserves that we can develop economically. Lower prices also decrease our cash flow and may cause us to decrease capital expenditures.
Exploration, development and exploitation activities involve numerous risks that may result in dry holes, the failure to produce natural gas and oil in commercial quantities and the inability to fully produce discovered reserves.
We are continually identifying and evaluating opportunities to acquire natural gas and oil properties. We may not be able to successfully consummate any acquisition, to acquire producing natural gas and oil properties that contain economically recoverable reserves, or to integrate the properties into our operations profitably.
We have substantial capital requirements, and we may not be able to obtain needed financing on satisfactory terms, if at all.
We rely upon access to our revolving credit facility as a source of liquidity for any capital requirements not satisfied by cash flow from operations or other sources. Future challenges in the global financial system, including the capital markets, may adversely affect our business and our financial condition. Our ability to access the capital markets may be restricted at a time when we desire, or need, to raise capital, which could have an impact on our flexibility to react to changing economic and business conditions. Adverse economic and market conditions could adversely affect the collectability of our trade receivables and cause our commodity hedging counterparties to be unable to perform their obligations or to seek bankruptcy protection. Future challenges in the economy could also lead to reduced demand for natural gas which could have a negative impact on our revenues.
Our debt agreements also require compliance with covenants to maintain specified financial ratios. If the price that we receive for our natural gas and oil production further deteriorates from current levels or continues for an extended period, it could lead to further reduced revenues, cash flow and earnings, which in turn could lead to a default under those ratios. Because the calculations of the financial ratios are made as of certain dates, the financial ratios can fluctuate significantly from period to period. A prolonged period of decreased natural gas and oil prices or a further decline could further increase the risk of our inability to comply with covenants to maintain specified financial ratios. In order to provide a margin of comfort with regard to these financial covenants, we may seek to reduce our capital expenditure plan, sell non-strategic assets or opportunistically modify or increase our derivative instruments to the extent permitted under our debt agreements. In addition, we may seek to refinance or restructure all or a portion of our indebtedness. We cannot assure you that we will be able to successfully execute any of these strategies, and such strategies may be unavailable on favorable terms or not at all.
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The borrowing base under our revolving credit facility may be reduced in light of recent commodity price declines, which could limit us in the future.
The borrowing base under our revolving credit facility is currently $40 million, and lender commitments under our revolving credit facility are $300 million. The borrowing base is redetermined semi-annually under the terms of the revolving credit facility. In addition, either we or the lenders may request an interim redetermination twice a year or in conjunction with certain acquisitions or sales of oil and gas properties. Our borrowing base may decrease as a result of lower natural gas or oil prices, operating difficulties, declines in reserves, lending requirements or regulations, the issuance of new indebtedness or for other reasons set forth in our revolving credit agreement. In the event of a decrease in our borrowing base due to declines in commodity prices or otherwise, our ability to borrow under our revolving credit facility may be limited and we could be required to repay any indebtedness in excess of the redetermined borrowing base. In addition, we may be unable to access the equity or debt capital markets to meet our obligations, including any such debt repayment obligations.
Strategic determinations, including the allocation of capital and other resources to strategic opportunities, are challenging, and our failure to appropriately allocate capital and resources among our strategic opportunities may adversely affect our financial condition and reduce our growth rate.
Our future growth prospects are dependent upon our ability to identify optimal strategies for our business. In developing our business plan, we considered allocating capital and other resources to various aspects of our businesses including well-development (primarily drilling), reserve acquisitions, exploratory activity, corporate items and other alternatives. We also considered our likely sources of capital. Notwithstanding the determinations made in the development of our 2021 plan, business opportunities not previously identified periodically come to our attention, including possible acquisitions and dispositions. If we fail to identify optimal business strategies, or fail to optimize our capital investment and capital raising opportunities and the use of our other resources in furtherance of our business strategies, our financial condition and growth rate may be adversely affected. Moreover, economic or other circumstances may change from those contemplated by our 2021 plan, and our failure to recognize or respond to those changes may limit our ability to achieve our objectives.
Negative public perception regarding us and/or our industry could have an adverse effect on our operations.
Negative public perception regarding us and/or our industry resulting from, among other things, concerns raised by advocacy groups about hydraulic fracturing, oil spills, greenhouse gas or methane emissions and explosions of natural gas transmission lines, may lead to increased regulatory scrutiny, which may, in turn, lead to new state and federal safety and environmental laws, regulations, guidelines and enforcement interpretations. These actions may cause operational delays or restrictions, increased operating costs, additional regulatory burdens and increased risk of litigation. Moreover, governmental authorities exercise considerable discretion in the timing and scope of permit issuance and the public may engage in the permitting process, including through intervention in the courts. Negative public perception could cause the permits we need to conduct our operations to be withheld, delayed, or burdened by requirements that restrict our ability to profitably conduct our business.
We face a variety of hazards and risks that could cause substantial financial losses.
Our business involves a variety of operating risks, including:
| • | blowouts, cratering and explosions; |
| • | mechanical problems; |
| • | uncontrolled flows of natural gas, oil or well fluids; |
| • | formations with abnormal pressures; |
| • | pollution and other environmental risks; and |
| • | natural disasters. |
Our operation of natural gas gathering and pipeline systems also involves various risks, including the risk of explosions and environmental hazards caused by pipeline leaks and ruptures.
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We may not be insured against all of the operating risks to which we are exposed.
We maintain insurance coverage against certain, but not all, hazards that could arise from our operations. Such insurance is believed to be reasonable for the hazards and risks faced by us. We do not carry business interruption insurance. In addition, pollution and environmental risks are not fully insurable.
We maintain for our operations total excess liability insurance with limits of $20 million per occurrence and in the aggregate covering certain general liability and certain “sudden and accidental” environmental risks with a deductible of $10,000 per occurrence, subject to all terms, restrictions and sub-limits of the policies. We also maintain general liability insurance limits of $1 million per occurrence and $2 million in the aggregate.
We have several policies that cover environmental risks. We have environmental coverage under the per occurrence and aggregate limits of our general and umbrella liability policies (for a twelve-month term). These policies provide third-party surface cleanup, bodily injury and property damage coverage, and defense costs when a pollution event is sudden and accidental and is discovered within thirty days of commencement and reported to the insurance company within ninety days of discovery. This is standard coverage in oil and gas insurance policies.
We seek to protect ourselves from some but not all operating hazards through insurance coverage. However, some risks are either not insurable or insurance is available only at rates that we consider uneconomical. Depending on competitive conditions and other factors, we attempt to obtain contractual protection against uninsured operating risks from our customers and contractors. However, customers and contractors who provide contractual indemnification protection may not in all cases maintain adequate insurance to support their indemnification obligations. Our insurance or indemnification arrangements may not adequately protect us against liability or loss from all the hazards of our operations. The occurrence of a significant event that we have not fully insured or indemnified against or the failure of a customer to meet its indemnification obligations to us could materially and adversely affect our results of operations and financial condition. Furthermore, we may not be able to maintain adequate insurance in the future at rates we consider reasonable.
From time to time, a small number of our contractors have requested contractual provisions that require us to respond to third-party claims. In some of these instances we have accepted the risk with the understanding that it would be covered under our current coverage. We evaluate these risk-transferring negotiations cautiously, and we feel that we have adequately mitigated this risk through existing coverage or acquiring supplemental coverage when appropriate.
Laws and regulations regarding hydraulic fracturing, as well as governmental reviews of such activities, could result in increased costs and additional operating restrictions, delays or cancellations and have a material adverse effect on the Company’s production.
Hydraulic fracturing is a common practice that is used to stimulate production of hydrocarbons from tight formations. The Company conducts hydraulic fracturing in its drilling and completion programs. The process involves the injection of water, sand or other proppants and additives under pressure into targeted subsurface formations to stimulate oil and gas production. The process is typically regulated by state oil and gas commissions or similar agencies, but in recent years, several federal agencies have conducted investigations or asserted regulatory authority over certain aspects of the process. For example, in 2016, the EPA released its final report on the potential impacts of hydraulic fracturing on drinking water resources, concluding that “water cycle” activities associated with hydraulic fracturing may impact drinking water resources under certain circumstances. Additionally, the EPA has asserted regulatory authority pursuant to the SDWA’s UIC program over hydraulic fracturing activities involving the use of diesel and has issued guidance covering such activities. Moreover, the EPA has published an Advance Notice of Proposed Rulemaking to collect data on chemicals used in hydraulic fracturing under the Toxic Substances Control Act and has implemented a final rule under the CWA prohibiting the discharge of wastewater from onshore unconventional oil and gas extraction facilities to publicly-owned wastewater treatment plants. Also, the federal Bureau of Land Management (“BLM”) published a final rule in 2015 that established new or more stringent standards for performing hydraulic fracturing on federal and Indian lands. The BLM rescinded the 2015 rule in late 2017; however, litigation challenging the BLM’s decision to rescind the 2015 rule remains pending in federal district court.
From time to time, the U.S. Congress has considered adopting legislation intended to provide for federal regulation of hydraulic fracturing and to require disclosure of the additives used in the hydraulic-fracturing process. In addition, certain states, including Texas where the Company operates, have adopted, and other states are considering adopting, regulations that could impose new or more stringent permitting, disclosure, disposal and well-construction requirements on hydraulic-fracturing operations. For example, in April 2019, Colorado passed legislation reforming exploration and production activities by the oil and gas industry in the state including, among other things, revising the mission of the state oil and gas agency from fostering energy development in the state to instead focusing on regulating the industry in a manner that is protective of public health and safety and the environment, as well as authorizing cities and counties to regulate oil and gas operations within their jurisdictions as they do other development. While the Company does not conduct operations in Colorado, passage or enactment of similar legislation in other states in which it does operate could significantly increase the Company’s operating costs and have a significant adverse effect on the Company’s ability to conduct operations. States could elect to
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prohibit hydraulic fracturing or high volume hydraulic fracturing altogether, following the approach taken by the states of Vermont, Maryland and New York. Also, local land use restrictions, such as city ordinances, may be adopted to restrict or prohibit drilling in general or hydraulic fracturing in particular. In Texas, legislation was adopted providing that the regulation of oil and gas operations in Texas is under the exclusive jurisdiction of the state and thus preempts local regulation of those operations. Nonetheless, municipalities and political subdivisions in Texas continue to have the right to enact “commercially reasonable” regulations for surface activities.
In the event federal, state or local restrictions or bans pertaining to hydraulic fracturing are adopted in areas where the Company is currently conducting operations, or in the future plans to conduct operations, the Company may incur additional costs to comply with such requirements, experience restrictions, delays or cancellations in the pursuit of exploration, development or production activities, and perhaps be limited or precluded in the drilling of wells or in the volume that the Company is ultimately able to produce from its reserves; one or more of which developments could have a material adverse effect on the Company.
The Company’s operations are subject to stringent environmental, oil and gas-related and occupational safety and health laws and regulations that could cause it to delay, curtail or cease its operations or expose it to material costs and liabilities.
The Company’s operations are subject to stringent federal, state and local laws and regulations governing, among other things, the drilling of wells, rates of production, the size and shape of drilling and spacing units or proration units, the transportation and sale of oil, NGL and gas, and the discharging of materials into the environment and environmental protection. For example, state laws regulate the size and shape of drilling and spacing units or proration units governing the pooling of oil and gas properties. Some states allow forced pooling or integration of tracts to facilitate development, while other states rely on voluntary pooling of lands and leases. In some instances, forced pooling or unitization may be implemented by third parties and may reduce the Company’s interest in the unitized properties. In addition, state conservation laws (i) establish maximum rates of production from oil and gas wells, (ii) generally prohibit the venting or flaring of gas and (iii) impose requirements regarding production rates. These laws and regulations may limit the amount of oil and gas the Company can produce from the Company’s wells or limit the number of wells or the locations that the Company can drill.
In connection with its operations, the Company must obtain and maintain numerous environmental and oil and gas-related permits, approvals and certificates from various federal, state and local governmental authorities, and may incur substantial costs in doing so. The need to obtain permits has the potential to delay, curtail or cease the development of oil and gas projects. The Company may in the future be charged royalties on gas emissions or required to incur certain capital expenditures for air pollution control equipment or other air emissions related issues. For example, in 2015, the EPA issued a final rule under the CAA lowering the National Ambient Air Quality Standard (“NAAQS”) for ground-level ozone from 75 parts per billion to 70 parts per billion under standards to provide protection of public health and welfare. In subsequent years, the EPA has issued area designations with respect to ground-level ozone and final requirements that apply to state, local and tribal air agencies for implementing the 2015 NAAQS for ground-level ozone. State implementation of the revised NAAQS could, among other things, require installation of new emission controls on some of the Company’s equipment, resulting in longer permitting timelines, and significantly increase the Company’s capital expenditures and operating costs. In another example, the EPA and U.S. Army Corps of Engineers (the “Corps”) released a final rule in 2015 outlining federal jurisdictional reach under the CWA over waters of the U.S., including wetlands. In 2017, the EPA and the Corps agreed to reconsider the 2015 rule and, thereafter, on October 22, 2019, the agencies published a final rule, which became effective on December 31, 2019, rescinding the 2015 rule. On January 23, 2020, the two agencies issued a final rule re-defining the Clean Water Act’s jurisdiction over waters of the United States, which redefinition is narrower than found in the 2015 rule. Upon being published in the Federal Register and the passage of 60 days thereafter, the January 23, 2020 final rule will become effective, at which point the United States will be covered under a single regulatory scheme as it relates to federal jurisdictional reach over waters of the United States. However, there remains the expectation that the January 23, 2020 final rule also will be legally challenged in federal district court. To the extent that any challenge to the January 23, 2020 final rule is successful and the 2015 rule or a revised rule expands the scope of the Clean Water Act’s jurisdiction in areas where the Company conducts operations, the Company could incur (i) delays, restrictions or prohibitions in the issuance of necessary permits, (ii) restrictions or cessations in the development or expansion of projects, or (iii) increases in the Company’s capital expenditures and operating expenses by, for example, requiring installation of new emission controls on some of the Company’s equipment, any one or more of which developments could have a material adverse effect on the Company’s business, financial condition and results of operations.
Additionally, the Company’s operations are subject to a number of federal and state laws and regulations, including the federal OSHA and comparable state statutes, whose purpose is to protect the health and safety of employees. Among other things, the OSHA hazard communication standard, the EPA community right-to-know regulations under Title III of the federal Superfund Amendment and Reauthorization Act and comparable state statutes require that information be maintained concerning hazardous materials used or produced in the Company’s operations and that this information be provided to employees, state and local government authorities and citizens.
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There can be no assurance that existing or future regulations will not result in a delay, curtailment or cessation of production or processing activities, result in a material increase in the costs of production, development, exploration or processing operations or materially and adversely affect the Company’s future operations and financial condition. Noncompliance with these laws and regulations may subject the Company to sanctions, including administrative, civil or criminal penalties, remedial cleanups or corrective actions, delays in permitting or performance of projects, natural resource damages and other liabilities. Such laws and regulations may also affect the costs of acquisitions. In addition, these laws and regulations are subject to amendment or replacement in the future with more stringent legal requirements. Further, any delay, reduction or curtailment of the Company’s development and producing operations due to these laws and regulations could result in the loss of acreage through lease expiration.
The nature of the Company’s assets and production operations may impact the environment or cause environmental contamination, which could result in material liabilities to the Company.
The Company’s assets and production operations may give rise to significant environmental costs and liabilities as a result of the Company’s handling of petroleum hydrocarbons and wastes, because of air emissions and water discharges related to its operations, and due to past industry operations and waste disposal practices. The Company’s oil and gas business involves the generation, handling, treatment, storage, transport and disposal of wastes, hazardous substances and petroleum hydrocarbons and is subject to environmental hazards, such as oil and produced water spills, NGL and gas leaks, pipeline and vessel ruptures and unauthorized discharges of such wastes, substances and hydrocarbons, that could expose the Company to substantial liability due to pollution and other environmental damage. For example, drilling fluids, produced waters and certain other wastes associated with the Company’s exploration, development and production of oil or gas are currently excluded under RCRA from the definition of hazardous waste. These wastes are instead regulated under RCRA’s less stringent non-hazardous waste provisions. There have been efforts from time to time to remove this exclusion. For example, in response to a federal consent decree issued in 2016, the EPA was required during 2019 to determine whether certain Subtitle D criteria regulations required revision in a manner that could result in oil and gas wastes being regulated as RCRA hazardous waste. In April 2019, the EPA made a determination that such revision of the regulations was unnecessary. Any future loss of the RCRA exclusion could have a material adverse effect on the Company’s results of operations and financial position.
The Company currently owns, leases or operates, and in the past has owned, leased or operated, properties that for many years have been used for oil and gas exploration and production activities, and petroleum hydrocarbons, hazardous substances and wastes may have been released on or under such properties, or on or under other locations, including off-site locations, where such substances have been taken for treatment or disposal. These wastes, substances and hydrocarbons may also be released during future operations. In addition, some of the Company’s properties have been operated by predecessors or previous owners or operators whose treatment and disposal of hazardous substances, wastes or petroleum hydrocarbons were not under the Company’s control. Joint and several strict liabilities may be incurred in connection with such releases of petroleum hydrocarbons, hazardous substances and wastes on, under or from the Company’s properties. Private parties, including lessors of properties on which the Company operates and the owners or operators of properties adjacent to the Company’s operations and facilities where the Company’s petroleum hydrocarbons, hazardous substances or wastes are taken for reclamation or disposal, may also have the right to pursue legal actions to enforce compliance as well as seek damages for noncompliance with environmental laws and regulations or for personal injury or damage to property or natural resources. Such properties and the substances disposed or released on or under them may be subject to CERCLA, RCRA and analogous state laws, which could require the Company to remove previously disposed substances, wastes and petroleum hydrocarbons, remediate contaminated property or perform remedial plugging or pit closure operations to prevent future contamination, the costs of which could have a material adverse effect on the Company’s business, financial condition and results of operations.
The Company may not be able to recover some or any of these costs from sources of contractual indemnity or insurance, as pollution and similar environmental risks generally are not insurable or fully insurable, either because such insurance is not available or because of the high premium costs and deductibles associated with obtaining such insurance.
The Company’s operations are subject to a number of risks arising out of concerns regarding the threat of climate change, including regulatory, political, litigation and financial risks, that could result in increased operating costs and costs of compliance, limit the areas in which oil and gas production may occur, reduce demand for the oil and gas the Company produces, and expose the Company to the risk of increased activism and decreased funding for the industry, while the potential physical effects of climate change could disrupt the Company’s production and cause it to incur significant costs in preparing for or responding to those effects.
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The threat of climate change continues to attract considerable attention in the United States and in foreign countries. Numerous initiatives have been proposed and are expected to continue to be proposed at the international, national, regional and state levels of government to monitor and limit existing sources of GHG emissions as well as to restrict or eliminate emissions from new sources. As a result, the Company’s operations are subject to a series of regulatory, political, litigation and financial risks associated with the production and processing of fossil fuels and emission of GHGs.
In the United States, no comprehensive climate change legislation has been implemented at the federal level. However, following the U.S. Supreme Court finding that GHG emissions constitute a pollutant under the CAA, the EPA has adopted regulations that, among other things, (i) establish construction and operating permit reviews for GHG emissions from certain large stationary sources, (ii) require the monitoring and annual reporting of GHG emissions from certain petroleum and gas system sources in the United States, (iii) implement CAA emission standards directing the reduction of methane from certain new, modified, or reconstructed facilities in the oil and gas sector, and (iv) together with the DOT, implement GHG emissions limits on vehicles manufactured for operation in the United States. Additionally, various states, groups of states, and other countries have adopted or are considering adopting legislation, regulations or other regulatory initiatives that are focused on such areas as GHG cap and trade programs, carbon taxes, reporting and tracking programs, and restriction of emissions. At the international level, there is a non-binding agreement, the United Nations sponsored “Paris Agreement,” for nations to limit their GHG emissions through individually-determined reduction goals every five years after 2020, although the United States has announced its withdrawal from such agreement, effective November 4, 2020.
Governmental, scientific, and public concern over the threat of climate change arising from GHG emissions has resulted in increasing political risks in the United States, including climate change related pledges made by certain candidates seeking the office of the President of the United States in 2020. Critical declarations made by one or more candidates running for President include proposals to ban hydraulic fracturing of oil and gas wells and ban new leases for production of minerals on federal properties, including onshore lands and offshore waters. Other actions that could be pursued by presidential candidates may include more restrictive requirements for the establishment of pipeline infrastructure or the permitting of LNG export facilities, the reversal of the United States’ withdrawal from the Paris Agreement in November 2020 and reinstatement of the ban on oil exports. Litigation risks are also increasing, as a number of cities, local governments or other persons have sought to bring suit against oil and gas exploration and production companies in state or federal court, alleging, among other things, that such companies created public nuisances by producing fuels that contributed to global warming effects, such as rising sea levels, and therefore are responsible for roadway and infrastructure damages, or alleging that the companies have been aware of the adverse effects of climate change for some time but defrauded their investors by failing to adequately disclose those impacts.
There are also financial risks for fossil fuel producers as stockholders or bondholders currently invested in fossil-fuel energy companies concerned about the threat of climate change may elect in the future to shift some or all of their investments into non-fossil fuel energy related sectors. Institutional lenders who provide financing to fossil-fuel energy companies also have become more attentive to sustainable lending practices and some of them may elect not to provide funding for fossil fuel energy companies. Additionally, investing and lending practices of various investment firms and institutional lenders have been the subject of intensive lobbying efforts in recent years, oftentimes public in nature, by environmental activists, proponents of the Paris Agreement, and foreign citizenry concerned about the threat of climate change not to provide funding for fossil fuel producers. For example, there have been efforts in recent years to influence the investment community, including investment advisors and certain sovereign wealth, pension and endowment funds, to divest of fossil fuel equities and lenders to limit funding to companies engaged in the extraction of fossil fuel reserves. Limitation of investments in and financings for fossil fuel energy companies could result in the restriction, delay or cancellation of drilling programs or development or production activities.
The adoption and implementation of new or more stringent international, federal or state regulations or other regulatory initiatives that impose more stringent standards for GHG emissions from the oil and gas sector or otherwise restrict the areas in which this sector may produce oil and gas or generate GHG emissions could result in increased compliance and consumption costs, and thereby reduce demand for the oil and gas the Company produces. Additionally, political, litigation and financial risks could result in the restriction or cancellation of production activities, incurring liability for infrastructure damages as a result of climate changes, or impairing the Company’s ability to continue to operate in an economic manner. Finally, if increasing concentrations of GHGs in the Earth’s atmosphere were to result in significant physical effects, such as increased frequency and severity of storms, floods, droughts and other extreme climatic events, then such effects could have a material adverse effect on the Company’s exploration and production operations.
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In addition, companies in the oil and gas industry have been the target of activist efforts from both individuals and non-governmental organizations, including instituting litigation and supporting political or regulatory efforts to, among other things, limit or ban hydraulic fracturing, restrict or ban certain operating practices, including the disposal of waste materials, such as hydraulic fracturing fluids and produced water, deny or delay drilling permits, prohibit the venting or flaring of gas, reduce access of the oil and gas industry to federal and state government lands, and delay or cancel oil and gas developmental or expansion projects. The Company may need to incur significant costs associated with responding to these initiatives, and complying with any resulting additional legal or regulatory requirements could have a material adverse effect on the Company’s business, financial condition, cash flows and results of operations.
Laws and regulations pertaining to protection of threatened and endangered species or to critical habitat, wetlands and natural resources could delay, restrict or prohibit the Company’s operations and cause it to incur substantial costs that may have a material adverse effect on the Company’s development and production of reserves.
The federal ESA and comparable state laws were established to protect endangered and threatened species. Under the ESA, if a species is listed as threatened or endangered, restrictions may be imposed on activities adversely affecting that species’ habitat. Similar protections are offered to migratory birds under the Federal Migratory Bird Treaty Act. Oil and gas operations in the Company’s operating areas may be adversely affected by seasonal or permanent restrictions imposed on drilling activities by the U.S. Fish and Wildlife Services (the “FWS”) that are designed to protect various wildlife, which may materially restrict the Company’s access to federal or private land use. Permanent restrictions imposed to protect endangered and threatened species could prohibit drilling in certain areas, impact suppliers of critical materials or services, or require the implementation of expensive mitigation measures. Additionally, federal statutes, including the CWA, the OPA and CERCLA, as well as comparable state laws, prohibit certain actions that adversely affect critical habitat, wetlands and natural resources. If harm to species or damages to wetlands, habitat or natural resources occur or may occur, government entities or, at times, private parties may act to prevent oil and gas exploration or development activities or seek damages for harm to species, habitat or natural resources resulting from drilling, construction or releases of petroleum hydrocarbons, wastes, hazardous substances or other regulated materials, and, in some cases, may seek criminal penalties.
Moreover, as a result of one or more settlements entered into by the FWS, the agency is required to make determinations on the potential listing of numerous species as endangered or threatened under the ESA. The designation of previously unprotected species as threatened or endangered in areas where the Company conducts operations could cause the Company to incur increased costs arising from species protection measures or could result in delays, restrictions or prohibitions on its development and production activities that could have a material adverse effect on the Company’s ability to develop and produce reserves.
We have limited control over the activities on properties we do not operate.
Other companies operate some of the properties in which we have an interest. We have limited ability to influence or control the operation or future development of these non-operated properties or the amount of capital expenditures that we are required to fund with respect to them. The failure of an operator of our wells to adequately perform operations, an operator’s breach of the applicable agreements or an operator’s failure to act in ways that are in our best interest could reduce our production and revenues. Our dependence on the operator and other working interest owners for these projects and our limited ability to influence or control the operation and future development of these properties could materially adversely affect the realization of our targeted returns on capital in drilling or acquisition activities and lead to unexpected future costs.
Terrorist activities and the potential for military and other actions could adversely affect our business.
The threat of terrorism and the impact of military and other action have caused instability in world financial markets and could lead to increased volatility in prices for natural gas and oil, all of which could adversely affect the markets for our operations. Future acts of terrorism could be directed against companies operating in the United States. The U.S. government has issued public warnings that indicate that energy assets might be specific targets of terrorist organizations. These developments have subjected our operations to increased risk and, depending on their ultimate magnitude, could have a material adverse effect on our business.
Our ability to sell our natural gas and oil production could be materially harmed if we fail to obtain adequate services such as transportation and processing.
The sale of our natural gas and oil production depends on a number of factors beyond our control, including the availability and capacity of transportation and processing facilities. Our failure to obtain these services on acceptable terms could materially harm our business.
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Competition in our industry is intense, and many of our competitors have substantially greater financial and technological resources than we do, which could adversely affect our competitive position.
Competition in the natural gas and oil industry is intense. Major and independent natural gas and oil companies actively bid for desirable natural gas and oil properties, as well as for the equipment and labor required to operate and develop these properties. Our competitive position is affected by price, contract terms and quality of service, including pipeline connection times, distribution efficiencies and reliable delivery record. Many of our competitors have financial and technological resources and exploration and development budgets that are substantially greater than ours. These companies may be able to pay more for exploratory projects and productive natural gas and oil properties and may be able to define, evaluate, bid for and purchase a greater number of properties and prospects than our financial or human resources permit. In addition, these companies may be able to expend greater resources on the existing and changing technologies that we believe are and will be increasingly important to attaining success in the industry.
We may have hedging arrangements that expose us to risk of financial loss and limit the benefit to us of increases in prices for natural gas and oil.
From time to time, when we believe that market conditions are favorable, we use certain derivative financial instruments to manage price risks associated with our production in all of our regions. These hedging arrangements limit the benefit to us of increases in prices. While there are many different types of derivatives available, we generally utilize put options and swap agreements to attempt to manage price risk more effectively.
The put options used to establish floor prices for a fixed volume of production during a certain time period. They provide for payments from the counterparties if the index price falls below the floor. The swap agreements call for payments to, or receipts from, counterparties based on whether the index price for the period is greater or less than the fixed price established for that period when the swap is put in place. These arrangements limit the benefit to us of increases in prices. In addition, these arrangements expose us to risks of financial loss in a variety of circumstances, including when:
| • | a counterparty is unable to satisfy its obligations |
| • | production is less than expected; or |
| • | there is an adverse change in the expected differential between the underlying price in the derivative instrument and actual prices received for our production. |
The CFTC has promulgated regulations to implement statutory requirements for swap transactions. These regulations are intended to implement a regulated market in which most swaps are executed on registered exchanges or swap execution facilities and cleared through central counterparties. While we believe that our use of swap transactions exempt us from certain regulatory requirements, the changes to the swap market due to increased regulation could significantly increase the cost of entering into new swaps or maintaining existing swaps, materially alter the terms of new or existing swap transactions and/or reduce the availability of new or existing swaps. If we reduce our use of swaps as a result of the Dodd-Frank Act and regulations, our results of operations may become more volatile and our cash flows may be less predictable.
The loss of key personnel could adversely affect our ability to operate.
Our operations are dependent upon a relatively small group of key management and technical personnel, and one or more of these individuals could leave our employment. The unexpected loss of the services of one or more of these individuals could have a detrimental effect on us. In addition, our drilling success and the success of other activities integral to our operations will depend, in part, on our ability to attract and retain experienced geologists, engineers and other professionals. Competition for experienced geologists, engineers and some other professionals is intense. If we cannot retain our technical personnel or attract additional experienced technical personnel, our ability to compete could be harmed.
We are subject to complex laws and regulations, including environmental regulations, which can adversely affect the cost, manner or feasibility of doing business.
Our operations are subject to extensive federal, state and local laws and regulations, including tax laws and regulations and those relating to the generation, storage, handling, emission, transportation and discharge of materials into the environment. These laws and regulations can adversely affect the cost, manner or feasibility of doing business. Many laws and regulations require permits for the operation of various facilities, and these permits are subject to revocation, modification and renewal. Governmental authorities have the power to enforce compliance with their regulations, and violations could subject us to fines, injunctions or both. These laws and regulations have increased the costs of planning, designing, drilling, installing and operating natural gas and oil facilities. In addition, we may be liable for environmental damages caused by previous owners of property we purchase or lease. Risks of substantial costs and liabilities related to environmental compliance issues are inherent in natural gas and oil operations. It is possible that other developments, such as stricter environmental laws and regulations, and claims for damages to property or persons resulting from natural gas and oil production, would result in substantial costs and liabilities.
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A failure of technology systems, data breach or cyberattack could materially affect our operations.
Our information technology systems may be vulnerable to security breaches, including those involving cyberattacks using viruses, worms or other destructive software, process breakdowns, phishing or other malicious activities, or any combination of the foregoing. Such breaches could result in unauthorized access to information, including customer, employee, or other confidential data. We do not carry insurance against these risks, although we do invest in security technology, perform penetration tests, and design our business processes to attempt to mitigate the risk of such breaches. However, there can be no assurance that security breaches will not occur. Moreover, the development and maintenance of these measures requires continuous monitoring as technologies change and security measures evolve. We have experienced, and expect to continue to experience, cyber security threats and incidents, none of which has been material to us to date. However, a successful breach or attack could have a material negative impact on our operations or business reputation and subject us to consequences such as litigation and direct costs associated with incident response.
Information technology solution failures, network disruptions, breaches of data security and cyberattacks could disrupt our operations by causing delays, impeding processing of transactions and reporting financial results, resulting in the unintentional disclosure of customer, employee or our information, or damage to our reputation. A system failure, data security breach or cyberattack could have a material adverse effect on our financial condition, results of operations or cash flows. In the past, we have experienced data security breaches resulting from unauthorized access to our e-mail systems, which to date have not had a material impact on our business; however, there is no assurance that such impacts will not be material in the future.
| Item 1B. | UNRESOLVED STAFF COMMENTS. |
We are a smaller reporting company and therefore no response is required pursuant to this Item.
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| Item 2. | PROPERTIES. |
Our executive offices, as well as offices of Prime Operating Company, Eastern Oil Well Service Company and EOWS Midland Company are located in leased premises in Houston, Texas.
We maintain district offices in Midland, Texas and Oklahoma City, Oklahoma and have field offices in Carrizo Springs and Midland, Texas, and Elmore City, Oklahoma.
Substantially all of our oil and gas properties are subject to a mortgage given to collateralize indebtedness or are subject to being mortgaged upon request by our lenders for additional collateral.
The information set forth below concerning our properties, activities, and oil and gas reserves include our interests in affiliated entities.
The following table sets forth the exploratory and development drilling experience with respect to wells in which we participated during the three years ended December 31, 2020. In 2020, we participated in seven new horizontal wells, however, only one well was completed in 2020, and the remaining six wells are to be completed in 2021.
| 2020 | 2019 | 2018 | ||||||||||||||||||||||
| Gross | Net | Gross | Net | Gross | Net | |||||||||||||||||||
Exploratory: | ||||||||||||||||||||||||
Oil | — | — | — | — | — | — | ||||||||||||||||||
Gas | — | — | — | — | — | — | ||||||||||||||||||
Dry | — | — | — | — | — | — | ||||||||||||||||||
Development: | ||||||||||||||||||||||||
Oil | 1 | 0.1 | 18 | 1.6 | 28 | 6.1 | ||||||||||||||||||
Gas | — | — | — | — | — | — | ||||||||||||||||||
Dry | — | — | — | — | — | — | ||||||||||||||||||
Total: | ||||||||||||||||||||||||
Oil | 1 | 0.1 | 18 | 1.6 | 28 | 6.1 | ||||||||||||||||||
Gas | — | — | — | — | — | — | ||||||||||||||||||
Dry | — | — | — | — | — | — | ||||||||||||||||||
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| 1 | 0.1 | 18 | 1.6 | 28 | 6.1 | |||||||||||||||||||
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Oil and Gas Production
As of December 31, 2020, we had ownership interests in the following numbers of gross and net producing oil and gas wells (1).
| Gross | Net | |||||||
Producing wells(1): | ||||||||
Oil Wells | 1,008 | 788 | ||||||
Gas Wells | 273 | 99 | ||||||
| (1) | A gross well is a well in which a working interest is owned. A net well is the sum of the fractional revenue interests owned in gross wells. Wells are classified by their primary product. Some wells produce both oil and gas. |
The following table shows our net production of oil, NGL and natural gas for each of the three years ended December 31, 2020. “Net” production is net after royalty interests of others are deducted and is determined by multiplying the gross production volume of properties in which we have an interest by percentage of the leasehold, mineral or royalty interest owned by us.
| 2020 | 2019 | 2018 | ||||||||||
Oil (barrels) | 733,000 | 1,242,000 | 1,187,000 | |||||||||
NGL (barrels) | 437,000 | 574,000 | 463,000 | |||||||||
Gas (Mcf) | 3,381,000 | 4,397,000 | 3,735,000 | |||||||||
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The following table sets forth our average sales prices together with our average production costs per unit of production for the three years ended December 31, 2020.
| 2020 | 2019 | 2018 | ||||||||||
Average sales price per barrel of oil | $ | 38.02 | $ | 55.04 | $ | 60.46 | ||||||
Average sales price per barrel of NGL | $ | 11.22 | $ | 15.87 | $ | 27.79 | ||||||
Average sales price per Mcf of natural gas | $ | 1.24 | $ | 1.49 | $ | 2.30 | ||||||
Average production costs per net equivalent barrel of oil(1) | $ | 12.25 | $ | 11.52 | $ | 13.12 | ||||||
| (1) | Net equivalent barrels are computed at a rate of 6 Mcf per barrel and costs exclude production taxes. |
Average oil, NGL and gas prices received including the impact of derivatives were:
| 2020 | 2019 | 2018 | ||||||||||
Average sales price per barrel of oil | $ | 45.79 | $ | 53.58 | $ | 57.39 | ||||||
Average sales price per barrel of NGL | $ | 11.22 | $ | 16.49 | $ | 27.40 | ||||||
Average sales price per Mcf of natural gas | $ | 1.38 | $ | 1.51 | $ | 2.23 | ||||||
Acreage
The following table sets forth the approximate gross and net undeveloped acreage in which we have leasehold and mineral interests as of December 31, 2020. “Undeveloped acreage” is that acreage on which wells have not been drilled or completed to a point that would permit the production of commercial quantities of oil and gas, regardless of whether or not such acreage contains proved reserves.
| Developed | Undeveloped | Total | ||||||||||||||||||||||
| Gross | Net | Gross | Net | Gross | Net | |||||||||||||||||||
Leasehold acreage | 101,830 | 28,101 | — | — | 101,830 | 28,101 | ||||||||||||||||||
Mineral fee acreage | 1,640 | 117 | 19,257 | 417 | 20,897 | 534 | ||||||||||||||||||
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Total | 103,470 | 28,218 | 19,257 | 417 | 122,727 | 28,635 | ||||||||||||||||||
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Total Net Undeveloped Acreage Expiration
As of December 31, 2020, we have no acreage subject to expiration during the years ending 2021 through 2023.
Reserves
Our interests in proved developed and undeveloped oil and gas properties, including the interests held by the Partnerships, have been evaluated by Ryder Scott Company, L.P. for each of the three years ended December 31, 2020. The professional qualifications of the technical persons primarily responsible for overseeing the preparation of the reserve estimates can be found in Exhibit 99.1, the Ryder Scott Company, L.P. Report on Registrant’s Reserves Estimates. In matters related to the preparation of our reserve estimates, our district managers report to the Engineering Data manager, who maintains oversight and compliance responsibility for the internal reserve estimate process and provides oversight for the annual preparation of reserve estimates of 100% of our year-end reserves by our independent third-party engineers, Ryder Scott Company, L.P. The members of our district and central groups consist of degreed engineers and geologists with between approximately twenty and thirty-five years of industry experience, and between eight and twenty-five years of experience managing our reserves. Our Engineering Data manager, the technical person primarily responsible for overseeing the preparation of reserves estimates, has over thirty years of experience, holds a Bachelor degree in Geology and an MBA in finance and is a member of the Society of Petroleum Engineers and American Association of Petroleum Geologist. See Part II, Item 8 “Financial Statements and Supplementary Data”, for additional discussions regarding proved reserves and their related cash flows.
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All of our reserves are located within the continental United States. The following table summarizes our oil and gas reserves at each of the respective dates:
| Reserve Category | ||||||||||||||||||||||||||||||||||||||||||||||||
| Proved Developed | Proved Undeveloped | Total | ||||||||||||||||||||||||||||||||||||||||||||||
As of December 31, | Oil (MBbls) | NGLs (MBbls) | Gas (MMcf) | Total (MBoe) | Oil (MBbls) | NGLs (MBbls) | Gas (MMcf) | Total (MBoe) | Oil (MBbls) | NGLs (MBbls) | Gas (MMcf) | Total (MBoe) | ||||||||||||||||||||||||||||||||||||
| 2018 | 6,404 | 2,707 | 21,065 | 12,622 | 10 | 12 | 124 | 43 | 6,414 | 2,719 | 21,189 | 12,665 | ||||||||||||||||||||||||||||||||||||
| 2019 | 4,381 | 2,914 | 19,995 | 10,268 | 1,833 | 1,017 | 4,547 | 3,608 | 6,214 | 3,931 | 24,542 | 14,235 | ||||||||||||||||||||||||||||||||||||
| 2020 | 2,684 | 2,258 | 13,633 | 7,214 | 1,784 | 787 | 3,897 | 3,221 | 4,468 | 3,045 | 17,530 | 10,435 | ||||||||||||||||||||||||||||||||||||
| (a) | In computing total reserves on a barrels of oil equivalent (Boe) basis, gas is converted to oil based on its relative energy content at the rate of six Mcf of gas to one barrel of oil and NGLs are converted based upon volume; one barrel of natural gas liquids equals one barrel of oil. |
In 2018, the Company drilled and completed 17 horizontal wells in West Texas and 11 horizontal wells in Oklahoma. In addition, the Company added reserves through overriding royalty interest in 16 wells, primarily in Oklahoma and Texas. At year-end 2018, thirteen of the seventeen wells completed in 2018 were designated as Shut-In: eight located in our West Texas horizontal development program that were brought on production in February, 2019, and five in our Oklahoma Scoop-Stack development program, which were brought on production in March, 2019.
At December 31, 2018, our reserve report included 43 MBoe of proved undeveloped reserves attributable to eight horizontal wells that had been drilled but not yet been completed: three of these were completed in 2019, converting 24 Mboe of undeveloped reserves to proved developed, and four remained uncompleted as of December 31, 2020, which account for 18 Mboe of the 43 Mboe. The Company has 9% ownership in one of these four wells and less than 1% in three wells.
In 2019, in West Texas, in addition to the eight wells classified as Shut-in at year-end 2018 that were brought on production in February, we participated in the drilling and completion of three wells on our Kashmir tract: two wells with an average 49% interest, and a third well for 5.3% interest. One of each of these wells was completed in the Wolfcamp “A”, Jo Mill, and Lower Spraberry. All three wells were brought on production in May of 2019.
In 2020, in West Texas we participated in the drilling of seven wells: one for 8.6% which was brought into production in July of 2020, and six wells with an average 47.5% interest that were shut-in and are planned for completion in mid-2021 with production to start early in the third quarter of 2021. The Company invested approximately $4.5 million in these seven wells in 2020. Also in 2020, reserves were added in West Texas through the addition of 11 horizontal wells completed in Midland County, Texas, in which we receive 0.56% to 1% over-riding royalty interest.
In our Oklahoma, Scoop-Stack play, in 2019, we participated in the drilling and completion of six wells on our WM Wallace tract for 7.67% interest, and nine wells, included on Slash, Osborn, and Leon tracts, with an average 1.34% interest. In addition, three wells drilled in Oklahoma in 2018, designated as proved undeveloped at year-end 2018, were completed in 2019 converting 24 Mboe of reserves to proved developed. Also in Oklahoma, six wells designated as Shut-in on December 31, 2018, were brought into production in 2019: five located on our Ruthie tract, and one on our Braum tract.
In 2019, in our Gulf Coast region, we added production through the recompletion of three vertical wells in Polk County, Texas: one operated by the Company in which we have 72.5% interest, and two operated by Unit Petroleum in which the Company owns 2.81% working interest and 3.77 net revenue interest. In 2020, the Company successfully recompleted one additional operated well in the Segno field with a 72.5% interest.
At December 31, 2020, the Company had 3,221 Mboe of proved undeveloped reserves attributable to 13 wells operated by others, three of which are new wells, spud in 2020 but not drilled until the first quarter of 2021 and 10 of which were drilled as of year-end. The three new horizontals along with six uncompleted wells are located in Upton County, Texas and are in the process of being completed and we expect them to be placed on production by the end of the second quarter of 2021. Apache Corporation is the operator of these wells. These nine PUD wells account for 3,127 Mboe of the total undeveloped reserves. The nine wells mentioned above are located on our 1,300 acre Kashmir tract in Upton County, operated by Apache Corporation. Our average 47.5% share of the total cost of these nine horizontal wells will be approximately $26 million. The four remaining PUD wells, drilled but not completed, are located in Grady County, Oklahoma and account for 95 Mboe of the total undeveloped reserves.
Additional drilling and future development plans will be established based on an expectation of available cash flows from operations and availability of funds under our revolving credit facility.
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We employ technologies to establish proved reserves that have been demonstrated to provide consistent results capable of repetition. The technologies and economic data being used in the estimation of our proved reserves include, but are not limited to, electrical logs, radioactivity logs, geologic maps, production data, and well test data. The estimated reserves of wells with sufficient production history are estimated using appropriate decline curves. Estimated reserves of producing wells with limited production history and for undeveloped locations are estimated using performance data from analogous wells in the area. These wells are considered analogous based on production performance from the same formation and with similar completion techniques.
The estimated future net revenue (using current prices and costs as of those dates) and the present value of future net revenue (at a 10% discount for estimated timing of cash flow) for our proved developed and proved undeveloped oil and gas reserves at the end of each of the three years ended December 31, 2020, are summarized as follows (in thousands of dollars):
| Proved Developed | Proved Undeveloped | Total | ||||||||||||||||||||||||||||||
As of December 31, | Future Net Revenue | Present Value 10 Of Future Net Revenue | Future Net Revenue | Present Value 10 Of Future Net Revenue | Future Net Revenue | Present Value 10 Of Future Net Revenue | Present Value 10 Of Future Income Taxes | Standardized Measure of Discounted Cash flow | ||||||||||||||||||||||||
| 2018 | $ | 239,337 | $ | 161,376 | $ | 767 | $ | 525 | $ | 240,104 | $ | 161,901 | $ | 23,992 | $ | 137,909 | ||||||||||||||||
| 2019 | $ | 116,592 | $ | 82,155 | $ | 42,700 | $ | 17,876 | $ | 159,292 | $ | 100,031 | $ | 18,419 | $ | 81,612 | ||||||||||||||||
| 2020 | $ | 43,886 | $ | 34,717 | $ | 37,346 | $ | 21,823 | $ | 81,232 | $ | 56,539 | $ | 14,920 | $ | 41,619 | ||||||||||||||||
The PV 10 Value represents the discounted future net cash flows attributable to our proved oil and gas reserves before income tax, discounted at 10%. Although this measure is not in accordance with U.S. generally accepted accounting principles (“GAAP”), we believe that the presentation of the PV10 Value is relevant and useful to investors because it presents the discounted future net cash flow attributable to proved reserves prior to taking into account corporate future income taxes and the current tax structure. We use this measure when assessing the potential return on investment related to oil and gas properties. The PV10 of future income taxes represents the sole reconciling item between this non-GAAP PV10 Value versus the GAAP measure presented in the standardized measure of discounted cash flow. A reconciliation of these values is presented in the last three columns of the table above. The standardized measure of discounted future net cash flows represents the present value of future cash flows attributable to proved oil and natural gas reserves after income tax, discounted at 10%.
“Proved developed” oil and gas reserves are reserves that can be expected to be recovered from existing wells with existing equipment and operating methods. “Proved undeveloped” oil and gas reserves are reserves that are expected to be recovered from new wells on undrilled acreage, or from existing wells where a relatively major expenditure is required for recompletion. Our reserves include amounts attributable to non-controlling interests in the Partnerships. These interests represent less than 10% of our reserves.
In accordance with U.S. generally accepted accounting principles, product prices are determined using the twelve-month average oil and gas index prices, calculated as the unweighted arithmetic average for the first day of the month price for each month, adjusted for oilfield or gas gathering hub and wellhead price differentials (e.g. grade, transportation, gravity, sulfur, and basic sediment and water) as appropriate. Also, in accordance with SEC specifications and U.S. generally accepted accounting principles, changes in market prices subsequent to December 31 are not considered.
While it may be reasonably anticipated that the prices received for the sale of our production may be higher or lower than the prices used in this evaluation, as described above, and the operating costs relating to such production may also increase or decrease from existing levels, such possible changes in prices and costs were, in accordance with rules adopted by the SEC, omitted from consideration in making this evaluation for the SEC case. Actual volumes produced, prices received and costs incurred may vary significantly from the SEC case.
Natural gas prices, based on the twelve-month average of the first of the month Henry Hub index price, were $1.985 per MMBtu in 2020 as compared to $2.58 per MMBtu in 2019, and $3.10 per MMBtu in 2018. Oil prices, based on the NYMEX first of the month average price, were $39.57 per barrel in 2020 as compared to $55.69 per barrel in 2019, and $65.56 per barrel in 2018. Since January 1, 2020, we have not filed any estimates of our oil and gas reserves with, nor were any such estimates included in any reports to, any federal authority or agency, other than the Securities and Exchange Commission.
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District Information
The following table represents certain reserve and well information as of December 31, 2020.
| Gulf Coast | Mid- Continent | West Texas | Other | Total | ||||||||||||||||
Proved Reserves as of December 31, 2020 (MBoe) | ||||||||||||||||||||
Developed | 517 | 1,575 | 5,116 | 6 | 7,214 | |||||||||||||||
Undeveloped | — | 95 | 3,126 | — | 3,221 | |||||||||||||||
Total | 517 | 1,670 | 8,242 | 6 | 10,435 | |||||||||||||||
Average Daily Production (Boe per day) | 297 | 788 | 3,178 | 2 | 4,265 | |||||||||||||||
Gross Productive Wells (Working Interest and ORRI Wells) | 239 | 549 | 556 | 170 | 1,514 | |||||||||||||||
Gross Productive Wells (Working Interest Only) | 209 | 485 | 518 | 69 | 1,281 | |||||||||||||||
Net Productive Wells (Working Interest Only) | 124 | 217 | 263 | 2 | 606 | |||||||||||||||
Gross Operated Productive Wells | 158 | 209 | 325 | — | 692 | |||||||||||||||
Gross Operated Water Disposal, Injection and Supply wells | 9 | 53 | 6 | — | 68 | |||||||||||||||
In several of our producing regions we have field service groups to service our operated wells and locations as well as third-party operators in the area. These services consist of well service support, site preparation and construction services for drilling and workover operations. Our operations are performed utilizing workover or swab rigs, water transport trucks, saltwater disposal facilities, various land excavating equipment and trucks we own and that are operated by our field employees.
Gulf Coast Region
Our development, exploitation, exploration and production activities in the Gulf Coast region are primarily concentrated in southeast Texas. This region is managed from our office in Houston, Texas. Principal producing intervals are in the Wilcox, San Miguel, Olmos, and Yegua formations at depths ranging from 3,000 to 12,500 feet. We had 239 producing wells (124 net) in the Gulf Coast region as of December 31, 2020, of which 158 wells are operated by us. Average net daily production in our Gulf Coast Region in 2020 was 297 Boe. At December 31, 2020, we had 517 MBoe of proved reserves in the Gulf Coast region, which represented 5% of our total proved reserves. We maintain an acreage position of over 12,700 gross (5,120 net) acres in this region, primarily in Dimmit and Polk counties. We operate a field service group in this region from a field office in Carrizo Springs, Texas utilizing four workover rigs, nineteen water transport trucks, two saltwater disposal wells and several trucks and excavating equipment. Services including well service support, site preparation and construction services for drilling and workover operations are provided to third-party operators as well as utilized in our own operated wells and locations. As of March 31, 2021, the Gulf Coast region has no operated wells in the process of being drilled, no waterfloods in the process of being installed and no other related activities of material importance.
Mid-Continent Region
Our Mid-Continent activities are concentrated in central Oklahoma. This region is managed from our office in Oklahoma City, Oklahoma. As of December 31, 2020, we had 549 wells (217 net) in the Mid-Continent area, of which 209 wells are operated by us. Principal producing intervals are in the Roberson, Avant, Skinner, Sycamore, Bromide, McLish, Hunton, Mississippian, Oswego, Red Fork, and Chester formations at depths ranging from 1,100 to 10,500 feet. Average net daily production in our Mid-Continent Region in 2020 was 788 Boe. At December 31, 2020, we had 1670 MBoe of proved reserves in the Mid-Continent area, or 16% of our total proved reserves. We maintain an acreage position of approximately 56,000 gross (10,355 net) acres in this region, primarily in Canadian, Kingfisher, Grant, Major, and Garvin counties. We operate a field service group in this region from a field office in Elmore City, utilizing one workover rig and one saltwater hauling truck. Our Mid-Continent region is actively participating with third-party operators in the horizontal development of lands that include Company owned interest in several counties in the Stack and Scoop plays of Oklahoma where drilling is primarily targeting reservoirs of the Mississippian, and Woodford formations. As of March 31, 2021, in the Mid-Continent region, the Company was participating in the completion of four wells included as Proved Undeveloped in the 2020 year-end reserve report.
West Texas Region
Our West Texas activities are concentrated in the Permian Basin in Texas and New Mexico. The Spraberry field was discovered in 1949, encompasses eight counties in West Texas and the Company believes it is the largest oil field in the United States. The field is approximately 150 miles long and 75 miles wide at its widest point. The oil produced is West Texas Intermediate Sweet, and the gas produced is casing-head gas with an average energy content of 1,400 Btu. The oil and gas are produced primarily from five intervals; the Upper and Lower Spraberry, the Wolfcamp, the Strawn, and the Atoka, at depths ranging from 6,700 feet to 11,300 feet. This
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region is managed from our office in Midland, Texas. As of December 31, 2020, we had 556 wells (263 net) in the West Texas area, of which 325 wells are operated by us. Principal producing intervals are in the Spraberry, Wolfcamp, and San Andres formations at depths ranging from 4,200 to 12,500 feet. Average net daily production in Our West Texas Region in 2020 was 3,178 Boe. At December 31, 2020, we had 8,242 MBoe of proved reserves in the West Texas area, or 79% of our total proved reserves. We maintain an acreage position of approximately 19,679 gross (12,461 net) acres in the Permian Basin in West Texas, primarily in Reagan, Upton, Martin and Midland counties and believe this acreage has significant resource potential for horizontal drilling in the Spraberry, Jo Mill, and Wolfcamp intervals. We operate a field service group in this region utilizing nine workover rigs, four hot oiler trucks, one kill truck and two roustabout trucks. Services including well service support, site preparation and construction services for drilling and workover operations are provided to third-party operators as well as utilized in our own operated wells and locations.
At December 31, 2020, the Company was committed to participate with Apache Corporation in the drilling of three Proved Undeveloped horizontal locations in Upton County, Texas and the completion of these along with six other wells drilled in 2020 on the same tract. The three new horizontals have been drilled and cased as of April 1, 2021. Completion operations for all nine are scheduled for June 2021.
| Item 3. | LEGAL PROCEEDINGS. |
None.
| Item 4. | MINE SAFETY DISCLOSURES. |
Not applicable.
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| Item 5. | MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES. |
Our common stock is listed and principally traded on the NASDAQ Stock Market under the ticker symbol “PNRG”. The following table presents the high and low prices per share of our common stock during certain periods, as reported in the consolidated transaction reporting system.
| High | Low | |||||||
2020 | ||||||||
First Quarter | $ | 154.38 | $ | 47.68 | ||||
Second Quarter | 110.79 | 49.70 | ||||||
Third Quarter | 79.13 | 62.60 | ||||||
Fourth Quarter | 71.80 | 42.39 | ||||||
2019 | ||||||||
First Quarter | $ | 184.20 | $ | 70.53 | ||||
Second Quarter | 154.00 | 118.56 | ||||||
Third Quarter | 132.30 | 106.36 | ||||||
Fourth Quarter | 170.99 | 113.43 | ||||||
The above quotations reflect inter-dealer prices, without retail mark-up, mark-down or commissions, and may not represent actual transactions.
As of March 25, 2021, there were 251 registered holders of the common stock.
Provisions of our line of credit agreement restrict our ability to pay dividends. Such dividends may be declared out of funds legally available therefore, when and as declared by our Board of Directors.
Issuer Purchases of Equity Securities
In December 1993, we announced that the Board of Directors authorized a stock repurchase program whereby we may purchase outstanding shares of the common stock from time-to-time, in open market transactions or negotiated sales. On October 31, 2012 and June 13, 2018, the Board of Directors of the Company approved an additional 500,000 and 200,000 respectively, shares of the Company’s stock to be included in the stock repurchase program. A total of 3,700,000 shares have been authorized, to date, under this program. Through December 31, 2020, a total of 3,552,279 shares have been repurchased under this program for $74,934,725 at an average price of $21.09 per share. Additional purchases of shares may occur as market conditions warrant. We expect future purchases will be funded with internally generated cash flow or from working capital.
2020 Month | Number of Shares | Average Price Paid per share | Maximum Number of Shares that May Yet Be Purchased Under The Program at Month-End | |||||||||
January | 3,701 | $ | 149.30 | 148,821 | ||||||||
February | 900 | 143.31 | 147,921 | |||||||||
March | 200 | 139.68 | 147,921 | |||||||||
April | — | — | 147,921 | |||||||||
May | — | — | 147,921 | |||||||||
June | — | — | 147,921 | |||||||||
July | — | — | 147,921 | |||||||||
August | — | — | 147,921 | |||||||||
September | — | — | 147,921 | |||||||||
October | — | — | 147,921 | |||||||||
November | — | — | 147,921 | |||||||||
December | — | — | 147,921 | |||||||||
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Total / Average | 4.801 | $ | 147.78 | |||||||||
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| Item 6. | SELECTED FINANCIAL DATA |
We are a smaller reporting company and therefore no response is required pursuant to this Item.
| Item 7. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
The following discussion is intended to assist you in understanding our results of operations and our present financial condition. Our Consolidated Financial Statements and the accompanying Notes to the Consolidated Financial Statements included elsewhere in this Report contains additional information that should be referred to when reviewing this material. Our subsidiaries are listed in Note 1 to the Consolidated Financial Statements.
Overview:
We are an independent oil and natural gas company engaged in acquiring, developing and producing oil and natural gas. We presently own producing and non-producing properties located primarily in Texas, and Oklahoma. In addition, we own a substantial amount of well servicing equipment. All our oil and gas properties and interests are located in the United States. Assets in our principal focus areas include mature properties with long-lived reserves and significant development opportunities as well as newer properties with development and exploration potential. We believe our balanced portfolio of assets and our ongoing hedging program position us well for both the current commodity price environment and future potential upside as we develop our attractive resource opportunities. Our primary sources of liquidity are cash generated from our operations and our credit facility.
We attempt to assume the position of operator in all acquisitions of producing properties and will continue to evaluate prospects for leasehold acquisitions and for exploration and development operations in areas in which we own interests. We continue to actively pursue the acquisition of producing properties. To diversify and broaden our asset base, we will consider acquiring the assets or stock in other entities and companies in the oil and gas business. Our main objective in making any such acquisitions will be to acquire income producing assets to build stockholder value through consistent growth in our oil and gas reserve base on a cost-efficient basis.
Our cash flows depend on many factors, including the price of oil and gas, the success of our acquisition and drilling activities and the operational performance of our producing properties. We use derivative instruments to manage our commodity price risk. This practice may prevent us from receiving the full advantage of any increases in oil and gas prices above the maximum fixed amount specified in the derivative agreements and subjects us to the credit risk of the counterparties to such agreements. Since all our derivative contracts are accounted for under mark-to-market accounting, we expect continued volatility in gains and losses on mark-to-market derivative contracts in our consolidated statement of operations as changes occur in the NYMEX price indices.
Market Conditions and Commodity Prices:
Our financial results depend on many factors, particularly the price of natural gas and crude oil and our ability to market our production on economically attractive terms. Commodity prices are affected by many factors outside of our control, including changes in market supply and demand, which are impacted by weather conditions, pipeline capacity constraints, inventory storage levels, basis differentials and other factors. In addition, our realized prices are further impacted by our derivative and hedging activities. We derive our revenue and cash flow principally from the sale of oil, natural gas and NGLs. As a result, our revenues are determined, to a large degree, by prevailing prices for crude oil, natural gas and NGLs. We sell our oil and natural gas on the open market at prevailing market prices or through forward delivery contracts. Because some of our operations are located outside major markets, we are directly impacted by regional prices regardless of Henry Hub, WTI or other major market pricing. The market price for oil, natural gas and NGLs is dictated by supply and demand; consequently, we cannot accurately predict or control the price we may receive for our oil, natural gas and NGLs. Index prices for oil,natural gas, and NGLs have improved since the lows of 2020 however we expect prices to remain volatile and consequently cannot determine with any degree of certainty what effect increases or decreases in these prices will have on our capital program, production volumes or revenues.
Critical Accounting Estimates:
Proved Oil and Gas Reserves
Proved oil and gas reserves directly impact financial accounting estimates, including depreciation, depletion and amortization. Proved reserves represent estimated quantities of natural gas, crude oil, condensate, and natural gas liquids that geological and engineering data demonstrate, with reasonable certainty, to be recoverable in future years from known reservoirs under economic and operating conditions existing at the time the estimates were made. The process of estimating quantities of proved oil and gas reserves is very complex, requiring significant subjective decisions in the evaluation of all available geological, engineering and economic data for each reservoir. The data for a given reservoir may also change substantially over time as a result of numerous factors including, but
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not limited to, additional development activity, evolving production history and continual reassessment of the viability of production under varying economic conditions. Consequently, material revisions (upward or downward) to existing reserve estimates may occur from time to time.
Depreciation, Depletion and Amortization for Oil and Gas Properties
The quantities of estimated proved oil and gas reserves are a significant component of our calculation of depletion expense and revisions in such estimates may alter the rate of future expense. Holding all other factors constant, if reserves were revised upward or downward, earnings would increase or decrease respectively. Depreciation, depletion and amortization of the cost of proved oil and gas properties are calculated using the unit-of-production method. The reserve base used to calculate depletion, depreciation or amortization is the sum of proved developed reserves and proved undeveloped reserves for leasehold acquisition costs and the cost to acquire proved properties. The reserve base includes only proved developed reserves for lease and well equipment costs, which include development costs and successful exploration drilling costs. Estimated future dismantlement, restoration and abandonment costs, net of salvage values, are taken into account.
Liquidity and Capital Resources:
Our primary sources of liquidity are cash generated from our operations, through our producing oil and gas properties, field services business and sales of acreage.
Net cash provided by operating activities for the year ended December 31, 2020 was $16.4 million, compared to $27.2 million in the prior year. Excluding the effects of significant unforeseen expenses or other income, our cash flow from operations fluctuates primarily because of variations in oil and gas production and prices or changes in working capital accounts. Our oil and gas production will vary based on actual well performance but may be curtailed due to factors beyond our control.
Our realized oil and gas prices vary due to world political events, supply and demand of products, product storage levels, and weather patterns. We sell the majority of our production at spot market prices. Accordingly, product price volatility will affect our cash flow from operations. To mitigate price volatility, we sometimes lock in prices for some portion of our production through the use of derivatives.
If our exploratory drilling results in significant new discoveries, we will have to expend additional capital to finance the completion, development, and potential additional opportunities generated by our success. We believe that, because of the additional reserves resulting from the successful wells and our record of reserve growth in recent years, we will be able to access sufficient additional capital through bank financing.
Maintaining a strong balance sheet and ample liquidity are key components of our business strategy. For 2021, we will continue our focus on preserving financial flexibility and ample liquidity as we manage the risks facing our industry. Our 2021 capital budget is reflective of commodity prices and has been established based on an expectation of available cash flows, with any cash flow deficiencies expected to be funded by borrowings under our revolving credit facility. As we have done historically to preserve or enhance liquidity we may adjust our capital program throughout the year, divest assets, or enter into strategic joint ventures. We are actively in discussions with financial partners for funding to develop our asset base and, if required, pay down our revolving credit facility should our borrowing base become limited due to the deterioration of commodity prices.
The Company maintains a Credit Agreement with a maturity date of February 15, 2023, providing for a credit facility totaling $300 million, with a borrowing base of $40 million. As of April 15, 2021, the Company has $35.95 million in outstanding borrowings and $4.05 million in availability under this facility. The bank reviews the borrowing base semi-annually and, at their discretion, may decrease or propose an increase to the borrowing base relative to a re-determined estimate of proved oil and gas reserves. The next borrowing base review is scheduled for July 2021. Our oil and gas properties are pledged as collateral for the line of credit and we are subject to certain financial and operational covenants defined in the agreement. We are currently in compliance with these covenants and expect to be in compliance over the next twelve months. If we do not comply with these covenants on a continuing basis, the lenders have the right to refuse to advance additional funds under the facility and/or declare all principal and interest immediately due and payable. Our borrowing base may decrease as a result of lower natural gas or oil prices, operating difficulties, declines in reserves, lending requirements or regulations, the issuance of new indebtedness or for other reasons set forth in our revolving credit agreement. In the event of a decrease in our borrowing base due to declines in commodity prices or otherwise, our ability to borrow under our revolving credit facility may be limited and we could be required to repay any indebtedness in excess of the re-determined borrowing base.
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Our credit agreement requires us to hedge a portion of our production as forecasted for the PDP reserves included in our borrowing base review engineering reports. Accordingly, the Company has in place the following swap and put agreements for oil and natural gas.
| 2021 | 2022 | 2023 | 2021 | 2022 | 2023 | |||||||||||||||||||
Swap Agreements | ||||||||||||||||||||||||
Natural Gas (MMBTU) | 1,219,000 | 928,000 | 131,000 | $ | 2.48 | $ | 2.67 | $ | 2.81 | |||||||||||||||
Oil (barrels) | 157,500 | 196,200 | 27,200 | $ | 53.60 | $ | 51.99 | $ | 50.31 | |||||||||||||||
Put Agreements | ||||||||||||||||||||||||
Oil (barrels) | 30,000 | $ | 35.00 | |||||||||||||||||||||
On March 27, 2020, President Trump signed into law the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”). The CARES Act, among other things, includes provisions relating to refundable payroll tax credits, deferment of employer side social security payments, net operating loss carryback periods, alternative minimum tax credit refunds, modifications to the net interest deduction limitations, increased limitations on qualified charitable contributions, and technical corrections to tax depreciation methods for qualified improvement property.
The Company’s activities include development and exploratory drilling. Our strategy is to develop a balanced portfolio of drilling prospects that includes lower risk wells with a high probability of success and higher risk wells with greater economic potential. In 2016, based upon the results of horizontal wells and historical vertical well performance, we decided to reduce the number of vertical wells in our drilling program and focus primarily on horizontal well drilling. We believe horizontal development of our resource base provides superior returns relative to vertical development, due to the ability of horizontals to come in contact with and drain from a greater volume of reservoir rock over more acreage, with less infrastructure, and thus at a lower cost of development per acre.
In 2019, we participated in the drilling of three horizontal wells in Upton County, Texas, adding significantly to our proved reserves, as these probable undeveloped locations were the initial test wells in the Wolfcamp “A” the Jo Mill and the Lower Spraberry of this acreage. These tests proved-up these reservoirs for the 1,280 acre block in which they were drilled and led to the drilling of nine additional wells in 2020 and the first quarter of 2021.
In early 2020, six of the nine horizontals mentioned above were drilled, and in the first quarter of 2021 the remaining three were drilled. All nine wells are slated for completion and to be on production by the end of the second quarter of 2021. We have an average 47.5% interest in these wells and our anticipated total investment is expected to be approximately $27 million.
The successful development of these reservoirs has also proved-up locations to be drilled on our nearby 3,260-acre block in which the Company holds between 14% and 56% interest. It is anticipated that development of as many as 54 additional horizontal wells on this 3,260-acre block will occur over the coming years. The cost of such development will be approximately $370 million with the Company’s share being approximately $170 million. The actual number of wells that will be drilled, the cost, and the timing of drilling will vary based upon many factors, including commodity market conditions.
Also in 2020, in Upton County, Texas, we participated for 8.3% interest in the horizontal drilling of a well operated by Pioneer Natural Resources that was completed and on production in July of 2020. Our total net expenditure for this well was approximately $580,000.
Additional drilling and future development plans will be established based on an expectation of available cash flows from operations and availability of funds under our revolving credit facility.
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The Exploration, Development and Recent Activities section in Part I above describes in more detail the recent activities of the Company. The focus of our future activity will be on the continued development of our resource’s potential in the West Texas horizontal drilling program as well as our Scoop-Stack horizontal drilling program acreage in Oklahoma in order to maximize cash flow and return on investment.
The Company maintains an acreage position of 19,679 gross (12,461 net) acres in the Permian Basin in West Texas, primarily in Reagan, Upton, Martin and Midland counties and we believe this acreage has significant resource potential in as many as 10 reservoirs, including benches of the Spraberry, Jo Mill, and Wolfcamp that support the potential drilling of as many as 180 additional horizontal wells.
In Oklahoma, the Company’s horizontal activity is primarily focused in Canadian, Grady, Kingfisher, Garfield, Major, and Garvin counties where we have approximately 3,460 net leasehold acres. We believe this acreage has significant additional resource potential that could support the drilling of as many as 52 new horizontal wells based on an estimate of six wells per section: three in the Mississippian and three in the Woodford Shale. Should we choose to participate in future development, our share of the capital expenditures would be approximately $40 million at an average 10% ownership level; the Company will otherwise sell its rights for cash, or cash plus a royalty or working interest.
To supplement cash flow and finance our drilling program during 2020, the Company sold or farmed-out leasehold rights through one transaction in Texas, receiving gross proceeds of approximately $10.8 million in exchange for 1950 net leasehold acres specific to certain depths, reserving rights to shallower and deeper formations for future development.
The majority of our capital spending is discretionary, and the ultimate level of expenditures will be dependent on our assessment of the oil and gas business environment, the number and quality of oil and gas prospects available, the market for oilfield services, and oil and gas business opportunities in general.
The Company has in place both a stock repurchase program and a limited partnership interest repurchase program. Spending under these programs in 2020 and 2019 was $1,452 thousand and $5.9 million, respectively. The Company expects continued spending under these programs in 2021.
Results of Operations:
2020 and 2019 Compared
We reported a net loss of $2.3 million for 2020, or $1.16 per share, compared to net income of $3.5 million, or $1.72 per share for 2019. The current year net loss reflects decreases in production combined with commodity price decreases, increases in gains related to the sale of acreage and changes related to the valuation of derivative instruments. The significant components of income and expense are discussed below.
Oil, NGL and gas sales decreased $47.0 million, or 56% to $37.0 million for the year ended December 31, 2020 from $84.0 million for the year ended December 31, 2019. Crude oil, NGL and natural gas sales vary due to changes in volumes of production sold and realized commodity prices. Our realized prices at the well head decreased an average of $17.02 per barrel, or 30.9% on crude oil, decreased an average of $4.65 per barrel, or 29.3% on NGL and decreased $0.25 per Mcf, or 16.60% on natural gas during 2020 as compared to 2019.
Our crude oil production decreased by 509,000 barrels, or 41.0% to 733,000 barrels for the year ended December 31, 2020 from 1,242,000 barrels for the year ended December 31, 2019. Our NGL production decreased by 137,000 or 23.9% to 437,000 for the year ended December 31, 2020 from 574,000 barrels for the year ended December 31, 2019. Our natural gas production decreased by 1,016 MMcf, or 23.1% to 3,381 MMcf for the year ended December 31, 2020 from 4,397 MMcf for the year ended December 31, 2019. The decreases in crude oil, NGL and natural gas production volumes are a result of the natural decline of existing properties combined with the shut in of marginal properties due to low commodity prices, slightly offset by new wells placed in production.
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The following table summarizes the primary components of production volumes and average sales prices realized for the years ended December 31, 2020 and 2019 (excluding realized gains and losses from derivatives).
| Twelve months ended December 31, | Increase / (Decrease) | Increase / (Decrease) | ||||||||||||||
| 2020 | 2019 | |||||||||||||||
Barrels of Oil Produced | 733,000 | 1,242,000 | (509,000 | ) | (41.00 | )% | ||||||||||
Average Price Received | $ | 38.02 | $ | 55.04 | $ | (17.02 | ) | (30.90 | )% | |||||||
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Oil Revenue (In 000’s) | $ | 27,865 | $ | 68,366 | $ | (40,501 | ) | (59.20 | )% | |||||||
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Mcf of Gas Sold | 3,381,000 | 4,397,000 | (1,016,000 | ) | (23.10 | )% | ||||||||||
Average Price Received | $ | 1.24 | $ | 1.49 | $ | (0.25 | ) | (16.60 | )% | |||||||
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Gas Revenue (In 000’s) | $ | 4,202 | $ | 6,539 | $ | (2,337 | ) | (35.70 | )% | |||||||
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Barrels of Natural Gas Liquids Sold | 437,000 | 574,000 | (137,000 | ) | (23.90 | )% | ||||||||||
Average Price Received | $ | 11.22 | $ | 15.87 | $ | (4.65 | ) | (29.30 | )% | |||||||
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Natural Gas Liquids Revenue (In 000’s) | $ | 4,906 | $ | 9,110 | $ | (4,204 | ) | (46.10 | )% | |||||||
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Total Oil & Gas Revenue (In 000’s) | $ | 36,973 | $ | 84,015 | $ | (47,042 | ) | (56.00 | )% | |||||||
Oil, Natural Gas and NGL Derivatives We do not apply hedge accounting to any of our commodity based derivatives, thus changes in the fair market value of commodity contracts held at the end of a reported period, referred to as mark-to-market adjustments, are recognized as unrealized gains and losses in the accompanying condensed consolidated statements of operations. As oil and natural gas prices remain volatile, mark-to-market accounting treatment creates volatility in our revenues.
The following table summarizes the results of our derivative instruments for the twelve months ended December 2020 and 2019:
| Twelve months ended December 31, | ||||||||
| 2020 | 2019 | |||||||
Oil derivatives – realized gains (losses) | $ | 5,697 | $ | (1,814 | ) | |||
Oil derivatives – unrealized gains (losses) | 161 | (2,776 | ) | |||||
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Total gains (losses) on oil derivatives | $ | 5,858 | $ | (4,590 | ) | |||
Natural gas derivatives – realized gains | 476 | 90 | ||||||
Natural gas derivatives – unrealized (losses) gains | (351 | ) | 123 | |||||
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Total gains on natural gas derivatives | $ | 125 | $ | 213 | ||||
NGL derivatives – realized gains | — | 353 | ||||||
NGL derivatives – unrealized losses | — | (124 | ) | |||||
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Total gains on NGL derivatives | $ | — | $ | 229 | ||||
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Total gains (losses) on oil, natural gas and NGL derivatives | $ | 5,983 | $ | (4,148 | ) | |||
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Prices received for the twelve months ended December 31, 2020 and 2019, respectively, including the impact of derivatives were:
| 2020 | 2019 | Increase / (Decrease) | Increase / (Decrease) | |||||||||||||
Oil Price | $ | 45.79 | $ | 53.58 | $ | (7.79 | ) | (14.50 | )% | |||||||
Gas Price | $ | 1.38 | $ | 1.51 | $ | (0.13 | ) | (8.40 | )% | |||||||
NGL Price | $ | 11.22 | $ | 16.49 | $ | (5.27 | ) | (31.90 | )% | |||||||
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Field service income decreased $8.1 million, or 42.1% to $11.1 million for the year ended December 31, 2020 from $19.2 million for the year ended December 31, 2019. This decrease is a combined result of decreased utilization and rates charged to customers as oil and gas prices declined during 2020. Workover rig services, hot oil treatments, saltwater hauling and disposal represent the bulk of our field service operations.
Lease operating expenses decreased $10.4 million, or 31.2% to $23.0 million for the year ended December 31, 2020 from $33.5 million for the year ended December 31, 2019. This decrease is primarily due to the shut-in of high lifting cost properties during 2020 combined with lower production taxes related to lower commodity prices.
Field service expense decreased $6.4 million, or 41.7% to $9.0 million for the year ended December 31, 2020 from $15.4 million for the year ended December 31, 2019. Field service expenses primarily consist of salaries and vehicle operating expenses which have decreased during 2020 related to decreased utilization of our equipment services.
Depreciation, depletion, amortization and accretion on discounted liabilities decreased $8.0 million, or 22.1% to $28.2 million for the year ended December 31, 2020 from $36.2 million for the year ended December 31, 2019. The DD&A expense is primarily attributable to our properties in West Texas and Oklahoma, reflecting the declining cost basis of those properties.
General and administrative expense decreased $0.6 million, or 3.91% to $15.0 million for the year ended December 31, 2020 from $15.6 million for the year ended December 31, 2019. This decrease in 2020 reflects cost reductions put in place responding to sharply lower commodity prices.
Gain on sale and exchange of assets of $15.8 million for the year ended December 31, 2020 and $4.6 million for the year ended December 31, 2019 consists principally of sales of deep rights in undeveloped acreage in West Texas and marginal wells in West Virginia.
Interest expense decreased $1.7 million, or 47.7% to $1.9 million for the year ended December 31, 2020 from $3.6 million for the year ended December 31, 2019. This decrease reflects reduced overall debt for 2020 as compared to 2019. The average interest rate paid on outstanding bank borrowings under its revolving credit facility during 2020 and 2019 were 3.95% and 5.34%, respectively. As of December 31, 2020 and 2019, the total outstanding borrowings under its revolving credit facility were $37.0 million and $53.5 million, respectively.
Tax expense of $1.4 and tax benefit of $0.5 million were recorded for the years ended December 31, 2019 and 2020, respectively. The change in our income tax provision was primarily due to the decrease in pre-tax income for the year ended December 31, 2020 and the change in the deferred income tax assets and liabilities related to Alternative Minimum Tax Credit refunds during 2020.
| Item 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. |
We are a smaller reporting company and therefore no response is required pursuant to this Item.
| Item 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. |
The consolidated financial statements and supplementary information included in this Report are described in the Index to Consolidated Financial Statements at Page F-1 of this Report.
| Item 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. |
None.
| Item 9A. | CONTROLS AND PROCEDURES. |
As of the end of the period covered by this Annual Report on Form 10-K, our principal executive officer and principal financial officer have evaluated the effectiveness of our “disclosure controls and procedures” (“Disclosure Controls”). Disclosure Controls, as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are procedures that are designed with the objective of ensuring that information required to be disclosed in our reports filed under the Exchange Act, such as this Annual Report, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure Controls are also designed with the objective of ensuring that such information is accumulated and communicated to our management, including the chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.
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Our management, including the chief executive officer and chief financial officer, does not expect that our Disclosure Controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
Members of our management, including our chief executive officer and chief financial officer, have evaluated the effectiveness of our disclosure controls and procedures, as defined by paragraph (e) of Exchange Act Rules 13a-15 or 15d-15, as of December 31, 2020 the end of the period covered by this Report. Based upon that evaluation, these officers concluded that our disclosure controls and procedures were effective as of December 31, 2020.
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our internal control over financial reporting is a process designed to provide reasonable assurance that assets are safeguarded against loss from unauthorized use or disposition, transactions are executed in accordance with appropriate management authorization and accounting records are reliable for the preparation of financial statements in accordance with U.S. generally accepted accounting principles.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2020. Management based this assessment on criteria for effective internal control over financial reporting described in “Internal Control – Integrated Framework (2013)” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Management’s assessment included an evaluation of the design of our internal control over financial reporting and testing of the operational effectiveness of its internal control over financial reporting. Management reviewed the results of its assessment with the Audit Committee of our Board of Directors.
Based on this assessment, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2020.
This Annual Report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this Annual Report.
There have been no changes in our internal controls over financial reporting during the fourth fiscal quarter ended December 31, 2020 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
| Item 9B. | OTHER INFORMATION. |
None.
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PART III
| Item 10. | DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE. |
Information relating to the Company’s Directors, nominees for Directors and executive officers will be included in the Company’s definitive proxy statement relating the Company’s Annual Meeting of Stockholders to be held in June, 2021, and which is incorporated herein by reference.
| Item 11. | EXECUTIVE COMPENSATION. |
Information relating to executive compensation will be included in the Company’s definitive proxy statement relating to the Company’s Annual Meeting of Stockholders to be held in June, 2021, and which is incorporated herein by reference.
| Item 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS. |
Information relating to security ownership of certain beneficial owners and management will be included in the Company’s definitive proxy statement relating to the Company’s Annual Meeting of Stockholders to be held in June, 2021, and which is incorporated herein by reference.
| Item 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE. |
Information relating to certain transactions by Directors and executive officers of the Company will be included in the Company’s definitive proxy statement relating to the Company’s Annual Meeting of Stockholders to be held in June, 2021, and which is incorporated herein by reference.
| Item 14. | PRINCIPAL ACCOUNTANT FEES AND SERVICES. |
Information relating to principal accountant fees and services will be included in the Company’s definitive proxy statement relating to the Company’s Annual Meeting of Stockholders to be held in June, 2021, and which is incorporated herein by reference.
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PART IV
| Item 15. | EXHIBITS AND FINANCIAL STATEMENT SCHEDULES. |
The following documents are filed as part of this Report:
| 1. | Financial statements (Index to Consolidated Financial Statements at page F-1 of this Report) |
| 2. | Financial Statement Schedules (Index to Consolidated Financial Statements – Supplementary Information at page F-1 of this Report) |
| 3. | Exhibits: |
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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, on the 23rd , day of April 2021.
| PrimeEnergy Resources Corporation | ||
| By: | /s/ Charles E. Drimal, Jr. | |
| Charles E. Drimal, Jr. | ||
| Chairman, Chief Executive Officer and President | ||
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated and on the 23rd day of April 2021.
/s/ Charles E. Drimal, Jr. Charles E. Drimal, Jr. |
| Chairman, Chief Executive Officer and President; The Principal Executive Officer | ||
/s/ Beverly A. Cummings Beverly A. Cummings | Director, Executive Vice President and Treasurer; The Principal Financial Officer | |||
/s/ Clint Hurt Clint Hurt | Director | /s/ Thomas S. T. Gimbel Thomas S. T. Gimbel | Director | |||
/s/ H. Gifford Fong H. Gifford Fong | Director | |||||
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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
F-1
INDEPENDENT AUDITORS’ REPORT
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
PrimeEnergy Resources Corporation and Subsidiaries:
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of PrimeEnergy Resources Corporation and Subsidiaries (the “Company”) as of December 31, 2020 and 2019, the related consolidated statements of operations, equity, and cash flows for each of the years then ended, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the years then ended, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
Depreciation, Depletion and Amortization and Impairment of Property and Equipment
Description of the Matter | At December 31, 2020, the carrying value of the Company’s property and equipment was $191.1 million and depreciation, depletion and amortization (DD&A) expense was $27.3 million for the year then ended. As described in Note 1, the Company follows the “successful efforts” method of accounting for its oil and gas properties. Under the “successful efforts” method, costs of acquiring undeveloped oil and gas leasehold acreage, including lease bonuses, brokers’ fees and other related costs are capitalized. Provisions for impairment of undeveloped oil and gas leases are based on periodic evaluations. Annual lease rentals and exploration expenses, including geological and geophysical expenses and exploratory dry hole costs, are charged against income as incurred. Costs of drilling and equipping productive wells, including development dry holes and related production facilities, are capitalized. All other property and equipment are carried at cost. Depreciation and depletion of oil and gas production equipment and properties are determined under the unit-of-production method based on estimated proved developed recoverable oil and gas reserves. Depreciation of all other equipment is determined under the straight-line method using various rates based on useful lives generally ranging from 5 to 10 years. The cost of assets and related accumulated depreciation is removed from the accounts when such assets are disposed of, and any related gains or losses are reflected in current earnings. |
F-2
Interest costs related to financing major oil and gas projects in progress are capitalized until the projects are evaluated or until the projects are substantially complete and ready for their intended use if the projects are evaluated and successful
The Company reviews long-lived assets, including oil and gas properties, for impairment whenever events or changes in circumstances indicate that the carrying amounts may not be recovered. If the carrying amounts are not expected to be recovered by undiscounted cash flows, the assets are impaired, and an impairment loss is recorded. The amount of impairment is based on the estimated fair value of the assets determined by discounting anticipated future net cash flows.
Proved oil and gas reserves directly impact financial accounting estimates, including depreciation, depletion and amortization. Proved reserves represent estimated quantities of natural gas, crude oil, condensate, and natural gas liquids that geological and engineering data demonstrate, with reasonable certainty, to be recoverable in future years from known reservoirs under economic and operating conditions existing at the time the estimates were made. The process of estimating quantities of proved oil and gas reserves is very complex, requiring significant subjective decisions in the evaluation of all available geological, engineering and economic data for each reservoir. The data for a given reservoir may also change substantially over time as a result of numerous factors including, but not limited to, additional development activity, evolving production history and continual reassessment of the viability of production under varying economic conditions. Consequently, material revisions (upward or downward) to existing reserve estimates may occur from time to time.
Estimates of oil and gas reserves, as determined by independent petroleum engineers, are continually subject to revision based on price, production history and other factors. Depletion expense, which is computed based on the units of production method, could be significantly impacted by changes in such estimates. Additionally, U.S. generally accepted accounting principles require that if the expected future undiscounted cash flows from an asset are less than its carrying cost, that asset must be written down to its fair market value. As the fair market value of an oil and gas property will usually be significantly less than the total undiscounted future net revenues expected from that asset, slight changes in the estimates used to determine future net revenues from an asset could lead to the necessity of recording a significant impairment of that asset.
Auditing the Company’s DD&A and impairment calculations is complex because of the use of independent petroleum engineers and the evaluation of management’s determination of the inputs described above used by the engineers in estimating oil and gas reserves. | ||
| How We Addressed the Matter in Our Audit | We obtained an understanding and evaluated the design of the Company’s controls over its process to calculate DD&A and impairment, including management’s controls over the completeness and accuracy of the financial data utilized by the engineers in estimating oil and gas reserves.
Our audit procedures included, among others, evaluating the professional qualifications and objectivity of the Company’s independent petroleum engineers responsible for the preparation of the proved oil and gas reserve estimates for select properties. In addition, we compared the Company’s recent production with its reserve estimates for properties that have significant production or significant reserve quantities and inquired of disproportionate ratios that did not align with our expectations. We also tested the mathematical accuracy of the DD&A and impairment calculations, including comparing the oil and gas reserve amounts used in the calculations to the Company’s reserve reports. | |
F-3
Accounting for Asset Retirement Obligations
Description of the Matter | At December 31, 2020, the asset retirement obligation (ARO) balance totaled $13.7 million. As further described in Note 5, the Company’s ARO primarily represents the estimated present value of the amount the Company will incur to plug, abandon, and remediate producing properties at the end of their productive lives, in accordance with applicable state laws. The Company determined its asset retirement obligation by calculating the present value of estimated cash flows related to the liability. The asset retirement obligation is recorded as a liability at its estimated present value at its inception, with an offsetting increase to producing properties. Periodic accretion of discount of the estimated liability is recorded as an expense in the statement of operations.
The Company’s liability is determined using significant assumptions, including current estimates of plugging and abandonment costs, annual inflation of these costs, the productive life of wells and a risk-adjusted interest rate. Changes in any of these assumptions can result in significant revisions to the estimated asset retirement obligation. Revisions to the asset retirement obligation are recorded with an offsetting change to producing properties, resulting in prospective changes to depreciation, depletion and amortization expense and accretion of discount. Because of the subjectivity of assumptions and the relatively long life of most of the Company’s wells, the costs to ultimately retire the wells may vary significantly from previous estimates.
Auditing the Company’s ARO is complex and highly judgmental because of the significant estimation by management in determining the obligation. In particular, the estimate was sensitive to significant subjective assumptions such as retirement cost estimates and the estimated timing of settlements, which are both affected by expectations about future market and economic conditions. | |
| How We Addressed the Matter in Our Audit | We obtained an understanding and evaluated the design of the Company’s internal controls over its ARO estimation process, including management’s review of the significant assumptions that have a material effect on the determination of the obligations. To test the ARO for the Company, our audit procedures included, among others, assessing the significant assumptions and inputs used in the valuation, such as retirement cost estimates and timing of settlement assumptions. Additionally, we compared the ARO against historical results, reviewed the reasonableness of the discount rate utilized in the estimate, considered the reasonableness of the current and long-term portion of the obligation by comparing the accretion expense trends, and considered the completeness of the properties included in the estimate by comparing to the Company’s reserve reports. | |
GRASSI & CO., CPAs, P.C.
We have served as the Company’s auditor since 1989.
New York, New York
April 23, 2021
F-4
PRIMEENERGY RESOURCES CORPORATION AND SUBSIDIARIES
(Thousands of dollars)
| As of December 31, | ||||||||
| 2020 | 2019 | |||||||
ASSETS | ||||||||
Current Assets | ||||||||
Cash and cash equivalents | $ | 996 | $ | 1,015 | ||||
Accounts receivable, net | 7,221 | 14,360 | ||||||
Prepaid obligations | 590 | 625 | ||||||
Derivative asset short-term | — | 272 | ||||||
Other current assets | 104 | 127 | ||||||
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|
|
| |||||
Total Current Assets | 8,911 | 16,399 | ||||||
Property and Equipment | ||||||||
Oil and gas properties at cost | 520,488 | 527,729 | ||||||
Less: Accumulated depletion and depreciation | (335,390 | ) | (322,409 | ) | ||||
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|
| |||||
| 185,098 | 205,320 | |||||||
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|
|
| |||||
Field and office equipment at cost | 26,797 | 27,542 | ||||||
Less: Accumulated depreciation | (20,842 | ) | (20,762 | ) | ||||
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|
|
| |||||
| 5,955 | 6,780 | |||||||
|
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|
| |||||
Total Property and Equipment, Net | 191,053 | 212,100 | ||||||
Derivative asset long-term and other assets | 520 | 866 | ||||||
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| |||||
Total Assets | $ | 200,484 | $ | 229,365 | ||||
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LIABILITIES AND EQUITY | ||||||||
Current Liabilities | ||||||||
Accounts payable | $ | 5,217 | $ | 6,634 | ||||
Accrued liabilities | 6,787 | 6,836 | ||||||
Due to related parties | 38 | — | ||||||
Current portion of long-term debt | 487 | — | ||||||
Current portion of asset retirement and other long-term obligations | 868 | 1,369 | ||||||
Derivative liability short-term | 723 | 753 | ||||||
|
|
|
| |||||
Total Current Liabilities | 14,120 | 15,592 | ||||||
Long-Term Bank Debt | 38,267 | 53,500 | ||||||
Asset Retirement Obligations | 12,891 | 20,330 | ||||||
Deferred Income Taxes | 36,367 | 35,924 | ||||||
Other Long-Term Obligations | 841 | 656 | ||||||
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|
| |||||
Total Liabilities | 102,486 | 126,002 | ||||||
Commitments and Contingencies | ||||||||
Equity | ||||||||
Common stock, $.10 par value; 2020 and 2019: Authorized: 2,810,000 shares, outstanding 2020: 1,994,177 shares; outstanding 2019: 1,998,978 shares. | 281 | 281 | ||||||
Paid-in capital | 7,541 | 7,505 | ||||||
Retained earnings | 126,804 | 129,120 | ||||||
Treasury stock, at cost; 2020: 815,823 shares; 2019: 811,022 shares | (37,502 | ) | (36,792 | ) | ||||
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| |||||
Total Stockholders’ Equity – PrimeEnergy | 97,124 | 100,114 | ||||||
Non-controlling interest | 874 | 3,249 | ||||||
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| |||||
Total Equity | 97,998 | 103,363 | ||||||
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Total Liabilities and Equity | $ | 200,484 | $ | 229,365 | ||||
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The accompanying Notes are an integral part of these Consolidated Financial Statements
F-5
PRIMEENERGY RESOURCES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(Thousands of dollars, except per share amounts)
| For the Year Ended December 31, | ||||||||
| 2020 | 2019 | |||||||
Revenues | ||||||||
Oil sales | $ | 27,865 | $ | 68,366 | ||||
Natural gas sales | 4,202 | 6,539 | ||||||
Natural gas liquids sales | 4,906 | 9,110 | ||||||
Realized gain (loss) on derivative instruments, net | 6,173 | (1,371 | ) | |||||
Field service income | 11,120 | 19,214 | ||||||
Administrative overhead fees | 4,163 | 5,659 | ||||||
Unrealized (loss) on derivative instruments | (190 | ) | (2,777 | ) | ||||
Other income | 182 | 84 | ||||||
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Total Revenues | 58,421 | 104,824 | ||||||
Costs and Expenses | ||||||||
Lease operating expense | 23,028 | 33,461 | ||||||
Field service expense | 9,006 | 15,446 | ||||||
Depreciation, depletion, amortization and accretion on discounted liabilities | 28,176 | 36,156 | ||||||
General and administrative expense | 15,027 | 15,639 | ||||||
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Total Costs and Expenses | 75,237 | 100,702 | ||||||
Gain on Sale and Exchange of Assets | 15,836 | 4,574 | ||||||
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(Loss) Income from Operations | (980 | ) | 8,696 | |||||
Other Income and Expenses | ||||||||
Less: Interest expense | 1,902 | 3,635 | ||||||
Add: Interest income | 2 | 19 | ||||||
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| |||||
(Loss) Income Before (Benefit from) Provision for Income Taxes | (2,880 | ) | 5,080 | |||||
(Benefit from) Provision for Income Taxes | (517 | ) | 1,421 | |||||
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| |||||
Net (Loss) Income | (2,363 | ) | 3,659 | |||||
Less: Net (Loss) Income Attributable to Non-Controlling Interest | (47 | ) | 183 | |||||
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Net (Loss) Income Attributable to PrimeEnergy | $ | (2,316 | ) | $ | 3,476 | |||
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Basic (Loss) Income Per Common Share | $ | (1.16 | ) | $ | 1.72 | |||
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Diluted (Loss) Income Per Common Share | $ | (1.16 | ) | $ | 1.25 | |||
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The accompanying Notes are an integral part of these Consolidated Financial Statements
F-6
PRIMEENERGY RESOURCES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF EQUITY
(Thousands of dollars, except share amounts)
| Shares Outstanding | Common Stock | Additional Paid-In Capital | Retained Earnings | Treasury Stock | Total Stockholders’ Equity – PrimeEnergy | Non- Controlling Interest | Total Equity | |||||||||||||||||||||||||
Balance at December 31, 2018 | 2,039,919 | $ | 281 | $ | 7,388 | $ | 125,644 | $ | (31,304 | ) | $ | 102,009 | $ | 3,994 | $ | 106,003 | ||||||||||||||||
Purchase 40,941 shares of common stock | (40,941 | ) | — | — | — | (5,488 | ) | (5,488 | ) | — | (5,488 | ) | ||||||||||||||||||||
Net income | — | — | — | 3,476 | — | 3,476 | 183 | 3,659 | ||||||||||||||||||||||||
Purchase of non-controlling interest | — | — | 117 | — | — | 117 | (616 | ) | (499 | ) | ||||||||||||||||||||||
Distributions to non-controlling interest | — | — | — | — | — | — | (312 | ) | (312 | ) | ||||||||||||||||||||||
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Balance at December 31, 2019 | 1,998,978 | $ | 281 | $ | 7,505 | $ | 129,120 | $ | (36,792 | ) | $ | 100,114 | $ | 3,249 | $ | 103,363 | ||||||||||||||||
Purchase 4,801 shares of common stock | (4,801 | ) | — | — | — | (710 | ) | (710 | ) | — | (710 | ) | ||||||||||||||||||||
Net loss | — | — | — | (2,316 | ) | — | (2,316 | ) | (47 | ) | (2,363 | ) | ||||||||||||||||||||
Purchase of non-controlling interest | — | — | 36 | — | — | 36 | (58 | ) | (22 | ) | ||||||||||||||||||||||
Distributions to non-controlling interest | — | — | — | — | — | — | (2,270 | ) | (2,270 | ) | ||||||||||||||||||||||
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| |||||||||||||||||
Balance at December 31, 2020 | 1,994,177 | $ | 281 | $ | 7,541 | $ | 126,804 | $ | (37,502 | ) | $ | 97,124 | $ | 874 | $ | 97,998 | ||||||||||||||||
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The accompanying Notes are an integral part of these Consolidated Financial Statements
F-7
PRIMEENERGY RESOURCES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(Thousands of dollars)
| For the Year Ended December 31, | ||||||||
| 2020 | 2019 | |||||||
Cash Flows from Operating Activities: | ||||||||
Net (Loss) Income | $ | (2,363 | ) | $ | 3,659 | |||
Adjustments to reconcile net (loss) income to net cash provided by operating activities: | ||||||||
Depreciation, depletion, amortization and accretion on discounted liabilities | 28,176 | 36,156 | ||||||
Gain on sale of properties | (15,836 | ) | (4,574 | ) | ||||
Unrealized loss (gain) on derivative instruments | �� | 190 | 2,777 | |||||
Provision for deferred income taxes | 443 | 3,096 | ||||||
Changes in assets and liabilities: | ||||||||
Accounts receivable | 7,139 | 601 | ||||||
Due to related parties | 38 | (5 | ) | |||||
Prepaid expenses and other assets | 58 | 15 | ||||||
Accounts payable | (1,417 | ) | (2,919 | ) | ||||
Accrued liabilities | (49 | ) | (11,595 | ) | ||||
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| |||||
Net Cash Provided by Operating Activities | 16,379 | 27,211 | ||||||
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| |||||
Cash Flows from Investing Activities: | ||||||||
Capital expenditures, including exploration expense | (10,523 | ) | (18,046 | ) | ||||
Proceeds from sale of properties and equipment | 10,862 | 4,579 | ||||||
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| |||||
Net Cash (Used in) provided by Investing Activities | 339 | (13,467 | ) | |||||
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| |||||
Cash Flows from Financing Activities: | ||||||||
Purchase of stock for treasury | (710 | ) | (5,488 | ) | ||||
Purchase of non-controlling interests | (742 | ) | (499 | ) | ||||
Increase in long-term bank debt and other long-term obligations | 6,755 | 25,000 | ||||||
Repayment of long-term bank debt and other long-term obligations | (21,983 | ) | (37,745 | ) | ||||
Distribution to non-controlling interest | (57 | ) | (312 | ) | ||||
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|
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| |||||
Net Cash (used in) provided by Financing Activities | (16,737 | ) | (19,044 | ) | ||||
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| |||||
Cash and Cash Equivalents Period Decrease | (19 | ) | (5,300 | ) | ||||
Cash and Cash Equivalents at the Beginning of the Year | 1,015 | 6,315 | ||||||
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| |||||
Cash and Cash Equivalents at the End of the Year | $ | 996 | $ | 1,015 | ||||
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| |||||
Supplemental Disclosures: | ||||||||
Income taxes paid during the year | $ | 1 | $ | 65 | ||||
Interest paid during the year | $ | 2,052 | $ | 3,659 | ||||
Non-Cash Disclosures: | ||||||||
Purchase of non-controlling interest | $ | 36 | $ | 111 | ||||
Distribution of non-controlling interest in liquidated partnerships | $ | 1,550 | $ | — | ||||
The accompanying Notes are an integral part of these Consolidated Financial Statements
F-8
PRIMEENERGY RESOURCES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Description of Operations and Significant Accounting Policies
Nature of Operations:
PrimeEnergy Resources Corporation (“PERC”), a Delaware corporation, was organized in March 1973 and is engaged in the development, acquisition and production of oil and natural gas properties. PrimeEnergy Resources Corporation and its subsidiaries are herein referred to as the “Company.” The Company owns leasehold, mineral and royalty interests in producing and non-producing oil and gas properties across the United States, primarily in Oklahoma, and Texas. The Company operates approximately 760 active wells and owns non-operating interests and royalties in approximately 800 additional wells. Additionally, the Company provides well-servicing support operations, site-preparation and construction services for oil and gas drilling and reworking operations, both in connection with the Company’s activities and providing contract services for third parties. The Company is publicly traded on the NASDAQ under the symbol “PNRG.” PERC owns Eastern Oil Well Service Company (“EOWSC”) and EOWS Midland Company (“EMID”) which perform oil and gas field servicing. PERC also owns Prime Operating Company (“POC”), which serves as operator for most of the producing oil and gas properties owned by the Company and affiliated entities. PrimeEnergy Management Corporation (“PEMC”), a wholly-owned subsidiary, acts as the managing general partner, providing administration, accounting and tax preparation services for 1 limited partnership and 1 trust (collectively, the “Partnerships”). The markets for the Company’s products are highly competitive, as oil and gas are commodity products and prices depend upon numerous factors beyond the control of the Company, such as economic, political and regulatory developments and competition from alternative energy sources.
Effects of Coronavirus on Business:
On March 11, 2020, the World Health Organization declared the outbreak of the Coronavirus (“COVID-19”), which continues to spread throughout the U.S. and the world, a pandemic. The outbreak is having an impact on the global economy, resulting in rapidly changing market and economic conditions. Similar to many businesses in the energy sector, our business has been impacted by the recent COVID-19 outbreak and associated restrictions that have been implemented. The Company temporarily implemented social distancing requirements and work from home accommodations where appropriate.
The oversupply in the oil markets and related price volatility, depending on its duration may have an adverse impact on cash flows from operations and the valuation of capitalized costs related to oil and gas producing activities. The full extent to which COVID-19 will impact the Company’s results will depend on future developments, which are highly uncertain and cannot be predicted, including new information which may emerge concerning the severity of the virus and the actions to contain or treat its impact.
Consolidation and Presentation:
The consolidated financial statements include the accounts of PrimeEnergy Resources Corporation, its subsidiaries and the Partnerships, using the full consolidation method for those partnerships which are controlled by the Company. The Company’s reserve estimates are based on the full consolidation method. DD&A expense and evaluation of impairment may differ from the Partnership as the Company’s cost basis for the Partnership interests acquired may be different than the cost basis at the Partnership level for properties acquired by the Partnership. All significant intercompany balances and transactions are eliminated in preparing the consolidated financial statements.
Reclassifications:
Certain reclassifications have been made to prior year statements to conform with the current year presentation. These reclassifications have no impact on net income and no material impact on any other financial statement captions.
Subsequent Events:
Subsequent events have been evaluated through the date that the consolidated financial statements were issued. During this period, there were no material subsequent items requiring disclosure other than as stated in footnote 4 to these financial statements.
Use of Estimates:
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
F-9
Estimates of oil and gas reserves, as determined by independent petroleum engineers, are continually subject to revision based on price, production history and other factors. Depletion expense, which is computed based on the units of production method, could be significantly impacted by changes in such estimates. Additionally, U.S. generally accepted accounting principles require that if the expected future undiscounted cash flows from an asset are less than its carrying cost, that asset must be written down to its fair market value. As the fair market value of an oil and gas property will usually be significantly less than the total undiscounted future net revenues expected from that asset, slight changes in the estimates used to determine future net revenues from an asset could lead to the necessity of recording a significant impairment of that asset.
Property and Equipment:
The Company follows the “successful efforts” method of accounting for its oil and gas properties. Under the successful efforts method, costs of acquiring undeveloped oil and gas leasehold acreage, including lease bonuses, brokers’ fees and other related costs are capitalized. Provisions for impairment of undeveloped oil and gas leases are based on periodic evaluations. Annual lease rentals and exploration expenses, including geological and geophysical expenses and exploratory dry hole costs, are charged against income as incurred. Costs of drilling and equipping productive wells, including development dry holes and related production facilities, are capitalized. All other property and equipment are carried at cost. Depreciation and depletion of oil and gas production equipment and properties are determined under the unit-of-production method based on estimated proved developed recoverable oil and gas reserves. Depreciation of all other equipment is determined under the straight-line method using various rates based on useful lives generally ranging from 5 to 10 years. The cost of assets and related accumulated depreciation is removed from the accounts when such assets are disposed of, and any related gains or losses are reflected in current earnings.
Capitalization of Interest:
Interest costs related to financing major oil and gas projects in progress are capitalized until the projects are evaluated or until the projects are substantially complete and ready for their intended use if the projects are evaluated and successful.
Impairment of Long-Lived Assets:
The Company reviews long-lived assets, including oil and gas properties, for impairment whenever events or changes in circumstances indicate that the carrying amounts may not be recovered. If the carrying amounts are not expected to be recovered by undiscounted cash flows, the assets are impaired, and an impairment loss is recorded. The amount of impairment is based on the estimated fair value of the assets determined by discounting anticipated future net cash flows.
Fair Value:
The Company follows the authoritative guidance that establishes a formal framework for measuring fair values of assets and liabilities in financial statements that are already required by U.S. generally accepted accounting principles to be measured at fair value. The guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). The transaction is based on a hypothetical transaction in the principal or most advantageous market considered from the perspective of the market participant that holds the asset or owes the liability.
The Company utilizes market data or assumptions that market participants who are independent, knowledgeable and willing and able to transact would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated or generally unobservable. The Company attempts to utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. The Company is able to classify fair value balances based on the observability of those inputs. The guidance establishes a formal fair value hierarchy based on the inputs used to measure fair value. The hierarchy gives the highest priority to Level 1 inputs, which consist of unadjusted quoted prices for identical instruments in active markets. Level 2 inputs consist of quoted prices for similar instruments. Level 3 valuations are derived from inputs that are significant and unobservable; hence, these valuations have the lowest priority.
Asset Retirement Obligation:
The asset retirement obligation primarily represents the estimated present value of the amount the Company will incur to plug, abandon and remediate producing properties at the end of their productive lives, in accordance with applicable state laws. The Company determined its asset retirement obligation by calculating the present value of estimated cash flows related to the liability. The asset retirement obligation is recorded as a liability at its estimated present value at its inception, with an offsetting increase to producing properties. Periodic accretion of discount of the estimated liability is recorded as an expense in the statement of operations.
F-10
Income Taxes:
The Company follows the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recorded for the estimated future tax consequences attributable to the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using the tax rate in effect for the year in which those temporary differences are expected to turn around. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in the year of the enacted rate change. A valuation allowance is established to reduce deferred tax assets if it is more likely than not that the related tax benefits will not be realized. As of December 31, 2020, and 2019, we had no valuation allowance.
The Company is required to make judgments, including estimating reserves for potential adverse outcomes regarding tax positions that the Company has taken. The Company accounts for uncertainty in income taxes using a recognition and measurement threshold for tax positions taken or expected to be taken in a tax return. The effective tax rate and the tax basis of assets and liabilities reflect management’s estimates of the ultimate outcome of various tax uncertainties.
General and Administrative Expenses:
General and administrative expenses represent cost and expenses associated with the operation of the Company.
Earnings Per Common Share:
Basic earnings per share are computed by dividing earnings available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflect per share amounts that would have resulted if dilutive potential common stock had been converted to common stock in gain periods.
Statements of Cash Flows:
For purposes of the consolidated statements of cash flows, the Company considers short-term, highly liquid investments with original maturities of less than ninety days to be cash equivalents.
Concentration of Credit Risk:
The Company maintains significant banking relationships with financial institutions in the State of Texas. The Company limits its risk by periodically evaluating the relative credit standing of these financial institutions. The Company’s oil and gas production purchasers consist primarily of independent marketers and major gas pipeline companies.
Hedging:
The Company periodically enters into oil and gas financial instruments to manage its exposure to oil and gas price volatility. The oil and gas reference prices upon which the price hedging instruments are based reflect various market indices that have a high degree of historical correlation with actual prices received by the Company.
The financial instruments are accounted for in accordance with applicable accounting standards for derivative instruments and hedging activities. Such standards require that applicable derivative instruments be measured at fair market value and recognized as assets or liabilities in the balance sheet. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation is generally established at the inception of a derivative. For derivatives designated as cash flow hedges and meeting applicable effectiveness guidelines, changes in fair value, to the extent effective, are recognized in other comprehensive income until the hedged item is recognized in earnings. Hedge effectiveness is measured at least quarterly based on the relative changes in fair value between the derivative contract and the hedged item over time. Any change in fair value of a derivative resulting from ineffectiveness or an excluded component of the gain/loss is recognized immediately in the statement of operations.
New Pronouncements Issued But Not Yet Adopted:
In October 2020, the FASB issued ASU 2020-10, “Codification Improvements,” which clarifies or improves disclosure requirements for various topics to align with Securities and Exchange Commission (SEC) regulations. This update is effective for the Company beginning in the first quarter of 2021 and will be applied retrospectively. The adoption and implementation of this ASU will not have a material impact on the Company’s financial statements.
F-11
In March 2020, the FASB issued ASU 2020-04, “Reference Rate Reform (Topic 848),” which provides optional expedients and exceptions for applying U.S. GAAP to contracts, hedging relationships, and other transactions affected by the discontinuation of the London Interbank Offered Rate (LIBOR) or by another reference rate expected to be discontinued. In January 2021, the FASB issued ASU 2021-01, which clarified the scope and application of the original guidance. The guidance was effective beginning March 12, 2020 and can be applied prospectively through December 31, 2022. The Company is evaluating whether to apply any of these expedients and, if elected, will adopt these standards when LIBOR is discontinued.
2. Acquisitions and Dispositions
Historically, the Company has repurchased the non-controlling interests of the partners and trust unit holders in certain of the Partnerships, which consist primarily of oil and gas interests. The Company purchased such non-controlling interests in an amount totaling $22,000 in 2020 and $499,000 in 2019. Such purchases resulted in the non-cash acquisition of non-controlling equity interests of $36,000 and $111,000 respectively. In 2020 the Company liquidated three partnerships for total cash payments of $720,000 resulting in the non-cash distribution of non-controlling interest of $1,550 million.
During 2020 the Company acquired 232 net acres, along with 15% to 16.6% working interest ownership in 53 oil and gas wells and one commercial salt water disposal well operated by the Company, all located in Reagan County, Texas, for $343,000. In addition, we acquired 9.36 net acre in Upton County, Texas at a cost of $5,100.
During 2020 and 2019 the Company sold or farmed out interests in certain non-core undeveloped and developed oil and natural gas properties through a number of individually negotiated transactions in exchange for cash and a royalty or working interest in Oklahoma, Texas, New Mexico, Wyoming and West Virginia. Proceeds under these agreements were approximately $10.9 million and $4.3 million, respectively.
F-12
3. Additional Balance Sheet Information
Accounts receivable at December 31, 2020 and 2019 consisted of the following:
| December 31, | ||||||||
(Thousands of dollars) | 2020 | 2019 | ||||||
Joint interest billings | $ | 2,475 | $ | 3,339 | ||||
Trade receivables | 1,073 | 2,246 | ||||||
Oil and gas sales | 3,469 | 7,284 | ||||||
Tax refund receivable | — | 1,720 | ||||||
Other | 802 | 189 | ||||||
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| 7,819 | 14,778 | |||||||
Less: Allowance for doubtful accounts | (598 | ) | (418 | ) | ||||
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Total | $ | 7,221 | $ | 14,360 | ||||
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Accounts payable at December 31, 2020 and 2019 consisted of the following:
| December 31, | ||||||||
(Thousands of dollars) | 2020 | 2019 | ||||||
Trade | $ | 876 | $ | 261 | ||||
Royalty and other owners | 3,569 | 5,251 | ||||||
Partner advances | 193 | 205 | ||||||
Other | 579 | 917 | ||||||
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Total | $ | 5,217 | $ | 6,634 | ||||
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Accrued liabilities at December 31, 2020 and 2019 consisted of the following:
| December 31, | ||||||||
(Thousands of dollars) | 2020 | 2019 | ||||||
Compensation and related expenses | $ | 3,331 | $ | 3,620 | ||||
Property costs | 2,056 | 2,829 | ||||||
Taxes | 1,016 | — | ||||||
Other | 384 | 387 | ||||||
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Total | $ | 6,787 | $ | 6,836 | ||||
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4. Long-Term Debt
Bank Debt:
On February 15, 2017, the Company and its lenders entered into a Third Amended and Restated Credit Agreement (the “2017 Credit Agreement”) with a maturity date of February 15, 2021. The Second Amended and Restated Credit Agreement and subsequent amendments were amended and restated by the 2017 Credit Agreement. Pursuant to the terms and conditions of the 2017 Credit Agreement, the Company has a revolving line of credit and letter of credit facility of up to $300 million subject to a borrowing base that is determined semi-annually by the lenders based upon the Company’s financial statements and the estimated value of the Company’s oil and gas properties, in accordance with the Lenders’ customary practices for oil and gas loans. The credit facility is secured by substantially all of the Company’s oil and gas properties. The 2017 Credit Agreement includes terms and covenants that require the Company to maintain a minimum current ratio, total indebtedness to EBITDAX (earnings before depreciation, depletion, amortization, taxes, interest expense and exploration costs) ratio and interest coverage ratio, as defined, and restrictions are placed on the payment of dividends, the amount of treasury stock the Company may purchase, commodity hedge agreements, and loans and investments in its consolidated subsidiaries and limited partnerships.
On December 22, 2017, the Company and its lenders entered into a First Amendment to the 2017 Credit Agreement. The credit agreement includes the addition of a new lender and retains all other aspects of the original credit agreement. As of the effective date of this amendment the Company’s borrowing base was increased to $85 million.
F-13
On July 17, 2018, the Company and its lenders entered into a Second Amendment to the 2017 Credit Agreement. The credit agreement includes modifications for the borrowing base utilization margins and rates by type of borrowing, revises minimum quantifications for individual borrowings, reduces the overall percentage required for commodity hedge agreements, modifies the requirements placed on the Company’s ability to purchase equity interests and retains all other aspects of the original credit agreement. As of the effective date of this amendment the Company’s borrowing base was increased to $90 million.
On January 8, 2019, the Company and its lenders entered into a Third Amendment to the 2017 Credit Agreement. The credit agreement includes additions for a Beneficial Ownership Certification on the effective date of the amendment. The agreement includes further clarifications for potential LIBOR loan market rate issues, swap agreement modifications and retains all other aspects of the original credit agreement. As of the effective date of this amendment the Company’s borrowing base was increased to $100 million. Pursuant to borrowing base redeterminations on June 26, 2019 and December 18, 2019, the borrowing base was set at $90 million and $72 million, respectively.
On May 8, 2020, the Company and its lenders entered into a Fourth Amendment to the 2017 Credit Agreement which added loans under the Paycheck Protection Program to the Permitted loans, as defined in the agreement.
On September 4, 2020, the Company and its lenders entered into a Fifth Amendment to the 2017 Credit Agreement. As of the effective date of this amendment the Company’s borrowing base was decreased to $50 million. The amendment included an automatic reduction of $666,666.67 to the borrowing base on October 1, 2020, November 1, 2020, and December 1, 2020. The amendment also revised the applicable borrowing base utilization percentages for Eurodollar and ABR loans with a range of 2.5% to 3.5% and 1.5% to 2.5%, respectively. The agreement also adjusted percentages of title and mortgage guarantees supported by the oil and gas properties presented to the administrative agent at each borrowing redetermination as supported by the required reserve report.
On December 31, 2020, the Company had a total of $37 million of borrowings outstanding under its revolving credit facility at a weighted-average interest rate of 4.00% and $11 million was available for future borrowings. The combined weighted average interest rate paid on outstanding bank borrowings subject to base rate and LIBO interest was 3.95% for the year ended December 31, 2020 as compared to 5.34% for year ended December 31, 2019.
On February 11, 2021, the Company and its lenders entered into a Sixth Amendment to the 2017 Credit Agreement. Under this amendment the Company’s borrowing base is $40 million. Borrowings under the 2017 Credit Agreement will bear interest at a base rate plus an applicable margin ranging from 2.00% to 3.00% or at the Company’s option, at LIBOR plus an applicable margin ranging from 3.00% to 4.00%. The 2017 Credit Agreement will mature on February 11, 2023. The Company’s borrowings under this credit facility approximates fair value because the interest rates are variable and reflective of market rates.
Paycheck Protection Program Loans
During May 2020, Prime Operating Company and Eastern Oil Well Services Corporation, subsidiaries of the Company received loan proceeds in the amount of $1.28 million and $0.47 million, respectively, under the Paycheck Protection Program (the “PPP”) of the CARES Act, which was enacted March 27, 2020. The PPP Loans are evidenced by a promissory note in favor of the Lender, which bears interest at the rate of 1.00% per annum. No payments of principal or interest are due under the note until the date on which the amount of loan forgiveness (if any) under the CARES Act, which can be up to 10 months after the end of the related notes covered period (which is defined as 24 weeks after the date of the loan) (the “Deferral Period”). The note may be prepaid at any time prior to maturity with no prepayment penalties. Funds from the PPP Loans may be used only for payroll and related costs, costs used to continue group health care benefits, mortgage payments, rent, utilities, and interest on other debt obligations that were incurred prior to February 15, 2020 (the “Qualifying Expenses”). Under the terms of the PPP Loans, certain amounts thereunder may be forgiven if they are used for Qualifying Expenses as described in and in compliance with the CARES Act. The Company utilized the PPP Loan proceeds exclusively for Qualifying Expenses during the 24-week coverage period and will submit its application for forgiveness in accordance with the terms of the CARES Act and related guidance. In the event the PPP Loan or any portion thereof is forgiven, the amount forgiven is applied to the outstanding principal.
To the extent, if any, that any or all of the PPP loans are not forgiven, beginning one month following expiration of the Deferral Period, and continuing monthly until 24 months from the date of each applicable Note (the “Maturity Date”), the Company is obligated to make monthly payments of principal and interest to the Lender with respect to any unforgiven portion of the Note, in such equal amounts required to fully amortize the principal amount outstanding on such Note as of the last day of the applicable Deferral Period by the applicable Maturity Date. The Company accounts for these loans on the balance sheet as financial liabilities reported within the following lines: Current portion of long-term debt in the amount of $487 thousand and included as part of the long-term bank debt in the amount of $1.267 million.
F-14
Equipment Loans:
On July 29, 2014, the Company entered into additional equipment financing facilities (“Additional Equipment Loans”) totaling $6.0 million with JP Morgan Chase Bank. In August 2014, the Company drew down $4.8 million of this facility that is secured by field service equipment, carries an interest rate of 3.40% per annum, requires monthly payments (principal and interest) of $87,800, and has a final maturity date of July 31, 2019. The remaining $1.2 million under the Additional Equipment Loans was available for interim draws to finance the acquisition of any future field service equipment. In December 2014, the Company made an interim draw of an additional $0.5 million on this facility that is secured by recently purchased field service equipment. Interim draws on this facility carried a floating interest rate; payable monthly at the LIBO published rate plus 2.50% and on June 26, 2015 converted into a fixed term loan, with a rate of 3.50% and requiring monthly payments (principal and interest) of $8,700 with a final maturity date of June 26, 2020.
On January 12, 2018, the Company made a principal payment towards the third interim loan in the amount of $20,858. Effective with the payment due of January 26, 2018 the required monthly payments (principal and interest) on this loan changed to $7,986 with a continuing effective rate of 3.50% and a final maturity of June 26, 2020.
On May 23, 2019, the Company made its final payment towards both the second and third loans. At this time, all equipment loans were paid in full and the field service equipment liens secured by these loans were cancelled and all titles returned to the Company.
5. Commitments
Operating Leases:
The Company leases office facilities under operating leases and recognizes lease expense on a straight-line basis over the lease term. Leases assets and liabilities are initially recorded at commencement date based on the present value of lease payments over the lease term. A finance lease for office equipment is included in property and equipment, other current liabilities and other long-term liabilities. As most of the Company’s lease contracts do not provide an implicit discount rate, the Company uses its incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. The weighted average discount rate used was 5.5%. Certain leases may contain variable costs above the minimum required payments and are not included in the right-of-use assets or liabilities. Leases may include renewal, purchase or termination options that can extend or shorten the term of the lease. The exercise of those options is at the Company’s sole discretion and is evaluated at inception and throughout the contract to determine if a modification of the lease term is required. Leases with an initial term of 12 months or less are not recorded on the balance sheet.
Operating lease costs for the twelve months ended December 31, 2020 were $574 thousand. Cash payments included in the operating lease cost for twelve months ended December 31, 2020 were $616 thousand. The weighted-average remaining operating lease terms is 2.5 months. The amortization and interest expense for financing lease amounted to $7,165 and the cash payment for the lease was $7,655 and the lease term remaining was for 4 months.
The payment schedule for the Company’s operating and financing lease obligations as of December 31, 2020 is as follows:
(Thousands of dollars) | Operating Leases | Financing Leases | ||||||
2021 | $ | 106 | $ | 2 | ||||
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Total undiscounted lease payments | $ | 106 | $ | 2 | ||||
Less: Amount associated with discounting | (10 | ) | (0 | ) | ||||
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Net operating lease liabilities | $ | 96 | $ | 2 | ||||
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The Company amended certain leases for office space in Texas and Oklahoma providing for payments of $461 thousand and $89 thousand in 2020 and 2021, respectively.
Rent expense for office space for the years ended December 31, 2020 and 2019 was $663,000 and $594,000, respectively.
F-15
Asset Retirement Obligation:
A reconciliation of the liability for plugging and abandonment costs for the years ended December 31, 2020 and 2019 is as follows:
| Year Ended December 31, | ||||||||
(Thousands of dollars) | 2020 | 2019 | ||||||
Asset retirement obligation at beginning of period | $ | 21,118 | $ | 21,334 | ||||
Liabilities incurred | 4 | 4 | ||||||
Liabilities settled | (1,286 | ) | (1,442 | ) | ||||
Liabilities divested | (5,731 | ) | — | |||||
Accretion expense | 856 | 1,120 | ||||||
Revisions in estimated liabilities | (1,301 | ) | 102 | |||||
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Asset retirement obligation at end of period | $ | 13,660 | $ | 21,118 | ||||
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The Company’s liability is determined using significant assumptions, including current estimates of plugging and abandonment costs, annual inflation of these costs, the productive life of wells and a risk-adjusted interest rate. Changes in any of these assumptions can result in significant revisions to the estimated asset retirement obligation. Revisions to the asset retirement obligation are recorded with an offsetting change to producing properties, resulting in prospective changes to depreciation, depletion and amortization expense and accretion of discount. Because of the subjectivity of assumptions and the relatively long life of most of the Company’s wells, the costs to ultimately retire the wells may vary significantly from previous estimates.
6. Contingent Liabilities
The Company, as managing general partner of the affiliated Partnerships, is responsible for all Partnership activities, including the drilling of development wells and the production and sale of oil and gas from productive wells. The Company also provides the administration, accounting and tax preparation work for the Partnerships, and is liable for all debts and liabilities of the affiliated Partnerships, to the extent that the assets of a given limited Partnership are not sufficient to satisfy its obligations.
The Company is subject to environmental laws and regulations. Management believes that future expenses, before recoveries from third parties, if any, will not have a material effect on the Company’s financial condition. This opinion is based on expenses incurred to date for remediation and compliance with laws and regulations, which have not been material to the Company’s results of operations.
From time to time, the Company is party to certain legal actions arising in the ordinary course of business. While the outcome of these events cannot be predicted with certainty, management does not expect these matters to have a materially adverse effect on the financial position or results of operations of the Company.
7. Stock Options and Other Compensation
In May 1989, non-statutory stock options were granted by the Company to four key executive officers for the purchase of shares of common stock. At December 31, 2020 and 2019, options on 767,500 shares were outstanding and exercisable at prices ranging from $1.00 to $1.25. According to their terms, the options have no expiration date.
8. Income Taxes
The components of the provision (benefit) for income taxes for the years ended December 31, 2020 and 2019 are as follows:
| Year Ended December 31, | ||||||||
(Thousands of dollars) | 2020 | 2019 | ||||||
Current: | ||||||||
Federal | $ | 950 | $ | (1,798 | ) | |||
State | 80 | 123 | ||||||
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Total current | 1,030 | (1,675 | ) | |||||
Deferred: | ||||||||
Federal | (1,491 | ) | 3,536 | |||||
F-16
| Year Ended December 31, | ||||||||
(Thousands of dollars) | 2020 | 2019 | ||||||
State | (56 | ) | (440 | ) | ||||
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Total deferred | (1,547 | ) | 3,096 | |||||
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Total income tax provision | $ | (517 | ) | $ | 1,421 | |||
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| At December 31, | ||||||||
(Thousands of dollars) | 2020 | 2019 | ||||||
Deferred Tax Assets: | ||||||||
Accrued liabilities | $ | (584 | ) | $ | 614 | |||
Allowance for doubtful accounts | 136 | 95 | ||||||
Derivative Contracts | 153 | 110 | ||||||
Alternative minimum tax credits | — | 1,720 | ||||||
State Net operating loss carry-forwards | 760 | 821 | ||||||
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Total deferred tax assets | 465 | 3,360 | ||||||
Deferred Tax Liabilities: | ||||||||
Basis differences relating to managed partnerships | 544 | 2,109 | ||||||
Depletion and depreciation | 36,288 | 37,173 | ||||||
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Total deferred tax liabilities | 39,832 | 39,282 | ||||||
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Net deferred tax liabilities | $ | 36,367 | $ | 35,922 | ||||
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F-17
The total provision for income taxes for the years ended December 31, 2020 and 2019 varies from the federal statutory tax rate as a result of the following:
| Year Ended December 31, | ||||||||
(Thousands of dollars) | 2020 | 2019 | ||||||
Expected tax expense | $ | (595 | ) | $ | 1,028 | |||
Executive Compensation | 703 | 597 | ||||||
State income tax, net of federal benefit | 63 | (303 | ) | |||||
Percentage depletion | (182 | ) | (341 | ) | ||||
AMT and Marginal Well Credits | (502 | ) | 436 | |||||
Other, net | (4 | ) | 4 | |||||
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Total income tax provision (benefit) | $ | (517 | ) | $ | 1,421 | |||
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Deferred income taxes reflect the impact of temporary differences between the amount of assets and liabilities recognized for financial reporting purposes and such amounts recognized for tax purposes.
On December 22, 2017, the U.S. enacted into legislation the Tax Cuts and Jobs Act (2017 Tax Act). Under the 2017 Tax Act, the company may use alternative minimum tax (AMT) credits to fully offset any regular tax liability. In addition, a portion of the AMT credit which exceeds the regular tax liability is refundable in future years. The refundable portion was 50% of any excess credit in the years 2019 through 2020 and 100% in 2021. The Company expected to receive a refund of $1.720 million in 2020 based on refundable credits claimed on the 2019 return, and additional $1.720 million refunds of previously paid taxes on its tax returns for the years 2020 and 2021. On March 27, 2020, President Trump signed into law the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”). The CARES Act, among other things, includes provisions relating to refundable payroll tax credits, deferment of employer social security payments, net operating loss carryback periods, AMT credit refunds, modifications to the net interest deduction limitations and technical corrections to tax depreciation methods for qualified improvement property. Under the CARES Act the refundable portion of AMT credits was increased to 100% therefore the Company received a full refund of such credits in 2020.
The Company is entitled to percentage depletion on certain of its wells, which is calculated without reference to the basis of the property. To the extent that such depletion exceeds a property’s basis, it creates a permanent difference, which lowers the Company’s effective rate. The availability of the percentage depletion deduction is phased out as an entity’s production exceeds certain levels, and based on the Company’s increasing production the percentage depletion deduction is becoming less significant.
The Company is allowed a credit against the Texas Franchise Tax based on net operating losses incurred in prior periods. The credits allowed are $89 thousand in the years 2020 through 2026. Any credits not utilized in a given year due to the allowable credit exceeding the tax liability may be carried forward. No credit may be carried forward past 2026. The value of the credit is calculated net of the federal income tax effect.
The Company has not recorded any provision for uncertain tax positions. The Company files income tax returns in the U.S. federal jurisdiction and various state and local jurisdictions. The 2004, 2005, 2006, 2009 and 2017 federal income tax returns have been audited by the Internal Revenue Service. Returns for unexamined earlier years may be examined and adjustments made to the amount of percentage depletion and AMT credit carryforwards flowing from those years into an open tax year, although in general no assessment of income tax may be made for those years on which the statute has closed. State returns for the years 2018 through 2020 remain open for examination by the relevant taxing authorities
9. Segment Information and Major Customers
The Company operates in one industry – oil and gas exploration, development, operation and servicing. The Company’s oil and gas activities are entirely in the United States.
F-18
The Company sells its oil and natural gas and liquids production to a number of direct purchasers under direct contracts or through other operators under joint operating agreements. Listed below are the purchasers of the Company’s production which represented more than 10% of the Company’s sales in the year 2020.
Oil: | ||||
Apache Corporation | 47 | % | ||
Plains All American Inc. | 19 | % | ||
Natural gas and liquids: | ||||
Apache Corporation | 42 | % | ||
Targa Pipeline Mid-Continent West Tex, LLC | 12 | % |
Although there are no long-term oil and gas purchasing agreements with these purchasers, the Company believes that they will continue to purchase its oil and gas products and, if not, could be replaced by other purchasers.
10. Financial Instruments
Fair Value Measurements:
Authoritative guidance on fair value measurements defines fair value, establishes a framework for measuring fair value and stipulates the related disclosure requirements. The Company follows a three-level hierarchy, prioritizing and defining the types of inputs used to measure fair value. The fair values of the Company’s interest rate swaps, natural gas and crude oil price collars and swaps are designated as Level 3. The following fair value hierarchy table presents information about the Company’s assets and liabilities measured at fair value on a recurring basis at December 31, 2020 and December 31, 2019:
December 31, 2020 | Quoted Prices in Active Markets For Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Balance at December 31, 2020 | ||||||||||||
| (Thousands of dollars) | ||||||||||||||||
Assets | ||||||||||||||||
Commodity derivative contracts | $ | — | $ | — | $ | 97 | $ | 97 | ||||||||
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Total assets | $ | — | $ | — | $ | 97 | $ | 97 | ||||||||
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Liabilities | ||||||||||||||||
Commodity derivative contracts | $ | — | $ | — | $ | (768 | ) | $ | (768 | ) | ||||||
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Total liabilities | $ | — | $ | — | $ | (768 | ) | $ | (768 | ) | ||||||
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December 31, 2019 | Quoted Prices in Active Markets For Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Balance at December 31, 2019 | ||||||||||||
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(Thousands of dollars) | ||||||||||||||||
Assets | ||||||||||||||||
Commodity derivative contracts | $ | — | $ | — | $ | 272 | $ | 272 | ||||||||
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Total assets | $ | — | $ | — | $ | 272 | $ | 272 | ||||||||
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Liabilities | ||||||||||||||||
Commodity derivative contract | $ | — | $ | — | $ | (753 | ) | $ | (753 | ) | ||||||
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Total liabilities | $ | — | $ | — | $ | (753 | ) | $ | (753 | ) | ||||||
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The derivative contracts were measured based on quotes from the Company’s counterparties. Such quotes have been derived using valuation models that consider various inputs including current market and contractual prices for the underlying instruments, quoted forward prices for natural gas and crude oil, volatility factors and interest rates, such as a LIBOR curve for a similar length of time as the derivative contract term as applicable. These estimates are verified using comparable NYMEX futures contracts or are compared to multiple quotes obtained from counterparties for reasonableness.
F-19
The significant unobservable inputs for Level 3 derivative contracts include basis differentials and volatility factors. An increasee (decrease) in these unobservable inputs would result in an increase (decrease) in fair value, respectively. The Company does not have access to the specific assumptions used in its counterparties’ valuation models. Consequently, additional disclosures regarding significant Level 3 unobservable inputs were not provided.
The following table sets forth a reconciliation of changes in the fair value of financial assets and liabilities classified as Level 3 in the fair value hierarchy for the year ended December 2020.
(Thousands of dollars) | ||||
Net Liabilities – December 31, 2019 | $ | (481 | ) | |
Total realized and unrealized (gains) losses: | ||||
Included in earnings (a) | 5,983 | |||
Purchases, sales, issuances and settlements | (6,173 | ) | ||
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Net Liabilities — December 31, 2020 | $ | (671 | ) | |
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| (a) | Derivative instruments are reported in revenues as realized gain/loss and on a separately reported line item captioned unrealized gain/loss on derivative instruments. |
Derivative Instruments:
The Company is exposed to commodity price and interest rate risk, and management considers periodically the Company’s exposure to cash flow variability resulting from the commodity price changes and interest rate fluctuations. Futures, swaps and options are used to manage the Company’s exposure to commodity price risk inherent in the Company’s oil and gas production operations. The Company does not apply hedge accounting to any of its commodity-based derivatives. Both realized and unrealized gains and losses associated with commodity derivative instruments are recognized in earnings.
The following table sets forth the effect of derivative instruments on the consolidated balance sheets at December 31, 2020 and 2019:
| Fair Value | ||||||||||||
(Thousands of dollars) | Balance Sheet Location | December 31, 2020 | December 31, 2019 | |||||||||
Asset Derivatives: | ||||||||||||
Derivatives not designated as cash-flow hedging instruments: | ||||||||||||
Natural gas commodity contracts | Derivative asset short-term | $ | — | $ | 146 | |||||||
Natural gas liquid contracts | Derivative asset short-term | — | — | |||||||||
Crude oil commodity contracts | Derivative asset short-term | — | 126 | |||||||||
Natural gas commodity contracts | | Derivative asset long-term and other assets |
| 97 | — | |||||||
Crude oil commodity contracts | | Derivative asset short-term and other assets |
| — | — | |||||||
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Total | $ | 97 | $ | 272 | ||||||||
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Liability Derivatives: | ||||||||||||
Derivatives not designated as cash-flow hedging instruments: | ||||||||||||
Crude oil commodity contracts | Derivative liability short-term | $ | (428 | ) | $ | (715 | ) | |||||
Natural gas commodity contracts | Derivative liability short-term | (296 | ) | (38 | ) | |||||||
Natural gas liquid contracts | Derivative liability short-term | — | — | |||||||||
Natural gas commodity contracts | Derivative liability long-term | (44 | ) | — | ||||||||
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Total | $ | (768 | ) | $ | (753 | ) | ||||||
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Total derivative instruments | $ | (671 | ) | $ | (481 | ) | ||||||
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F-20
The following table sets forth the effect of derivative instruments on the consolidated statements of operations for the years ended December 31, 2020 and 2019:
| Location of gain/loss recognized in income | Amount of gain/loss recognized in income | |||||||||||
(Thousands of dollars) | 2020 | 2019 | ||||||||||
Derivatives not designated as cash-flow hedge instruments: | ||||||||||||
Natural gas commodity contracts | | Unrealized gain on derivative instruments, net | | (351 | ) | 123 | ||||||
Crude oil commodity contracts | | Unrealized gain (loss) on derivative instruments, net | | 161 | (2,776 | ) | ||||||
Natural gas liquids contracts | | Unrealized (loss) on derivative instruments, net | | — | (124 | ) | ||||||
Natural gas commodity contracts | | Realized (loss) gain on derivative instruments, net | | 476 | 90 | |||||||
Crude oil commodity contracts | | Realized gain (loss) on derivative instruments, net | | 5,697 | (1,814 | ) | ||||||
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| $ | 5,983 | $ | (4,148 | ) | ||||||||
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11. Related Party Transactions
The Company, as managing general partner or managing trustee, makes an annual offer to repurchase the interests of the partners and trust unit holders in certain of the Partnerships or Trusts. The Company purchased such interests in an amount totaling $742,000 during 2020 and $499,000 during 2019.
Payables owed to related parties primarily represent receipts collected by the Company as agent for the joint venture partners, which may include members of the Company’s Board of Directors, during a specific reporting year, for oil and gas sales net of expenses.
12. Salary Deferral Plan
The Company maintains a salary deferral plan (the “Plan”) in accordance with Internal Revenue Code Section 401(k), as amended. The Plan provides for matching contributions, of which $341,000 and $412,000 were made in 2020 and 2019, respectively.
13. Earnings per Share
Basic earnings per share are computed by dividing earnings available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflect per share amounts that would have resulted if dilutive potential common stock had been converted to common stock in gain periods. The following reconciles amounts reported in the financial statements:
| Year Ended December 31, | ||||||||||||||||||||||||
| 2020 | 2019 | |||||||||||||||||||||||
| Net Income (In 000’s) | Weighted Average Number of Shares Outstanding | Per Share Amount | Net Income (In 000’s) | Weighted Average Number of Shares Outstanding | Per Share Amount | |||||||||||||||||||
Basic | $ | (2,316 | ) | 1,994,425 | $ | (1.16 | ) | $ | 3,476 | 2,019,502 | $ | 1.72 | ||||||||||||
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Effect of dilutive securities: | ||||||||||||||||||||||||
Options | — | 761,233 | ||||||||||||||||||||||
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Diluted | $ | (2,316 | ) | 1,994,425 | $ | (1.16 | ) | $ | 3,476 | 2,780,735 | $ | 1.25 | ||||||||||||
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| (a) | The effect of the 767,000 outstanding stock options is antidilutive for the year ended December 31, 2020, due to net loss for this period. |
F-21
PRIMEENERGY RESOURCES CORPORATION AND SUBSIDIARIES
SUPPLEMENTARY INFORMATION
OIL AND GAS PRODUCING ACTIVITIES
(Unaudited)
| As of December 31, | ||||||||
(Thousands of dollars) | 2020 | 2019 | ||||||
Proved Developed oil and gas properties | $ | 520,488 | $ | 527,729 | ||||
Proved Undeveloped oil and gas properties | — | — | ||||||
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Total Capitalized Costs | 520,488 | 527,729 | ||||||
Accumulated depreciation, depletion and valuation allowance | 335,390 | 322,409 | ||||||
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Net Capitalized Costs | $ | 185,098 | $ | 205,320 | ||||
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COSTS INCURRED IN OIL AND GAS PROPERTY ACQUISITION,
EXPLORATION AND DEVELOPMENT ACTIVITIES
(Unaudited)
| Year Ended December 31, | ||||||||
(Thousands of dollars) | 2020 | 2019 | ||||||
Development Costs | $ | 9,339 | $ | 15,348 | ||||
STANDARDIZED MEASURE OF DISCOUNTED FUTURE
NET CASH FLOWS RELATING TO PROVED OIL AND GAS RESERVES
(Unaudited)
| As of December 31, | ||||||||
(Thousands of dollars) | 2020 | 2019 | ||||||
Future cash inflows | $ | 221,090 | $ | 423,839 | ||||
Future production costs | (100,691 | ) | (202,169 | ) | ||||
Future development costs | (39,167 | ) | (62,379 | ) | ||||
Future income tax expenses | (15,135 | ) | (29,678 | ) | ||||
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Future Net Cash Flows | 66,097 | 129,613 | ||||||
10% annual discount for estimated timing of cash flows | (24,479 | ) | (48,001 | ) | ||||
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Standardized Measure of Discounted Future Net Cash Flows | $ | 41,619 | $ | 81,612 | ||||
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See accompanying Notes to Supplementary Information
F-22
STANDARDIZED MEASURE OF DISCOUNTED FUTURE
NET CASH FLOWS AND CHANGES THEREIN
RELATING TO PROVED OIL AND GAS RESERVES
(Unaudited)
The following are the principal sources of change in the standardized measure of discounted future net cash flows during 2020 and 2019:
| Year Ended December 31, | ||||||||
(Thousands of dollars) | 2020 | 2019 | ||||||
Sales of oil and gas produced, net of production costs | $ (13,945) | $ (15,938) | ||||||
Net changes in prices and production costs | (16,578 | ) | (42,409 | ) | ||||
Extensions, discoveries and improved recovery | 314 | 31,276 | ||||||
Revisions of previous quantity estimates | (36,919 | ) | (3,319 | ) | ||||
Net change in development costs | 20,724 | (53,143 | ) | |||||
Reserves sold | (874 | ) | (113 | ) | ||||
Reserves purchased | 218 | 174 | ||||||
Accretion of discount | 8,161 | 13,791 | ||||||
Net change in income taxes | 5,386 | 5,572 | ||||||
Changes in production rates (timing) and other | (6,480 | ) | 7,812 | |||||
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Net change | (39,993 | ) | (56,297 | ) | ||||
Standardized measure of discounted future net cash flow: | ||||||||
Beginning of year | 81,612 | 137,909 | ||||||
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End of year | $ | 41,619 | $ | 81,612 | ||||
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See accompanying Notes to Supplementary Information
F-23
PRIMEENERGY RESOURCES CORPORATION AND SUBSIDIARIES
SUPPLEMENTARY INFORMATION
Years Ended December 31, 2020 and 2019
(Unaudited)
| As of December 31, | ||||||||||||||||||||||||
| 2020 | 2019 | |||||||||||||||||||||||
| Oil (MBbls) | NGL’s (MBbls) | Gas (MMcf) | Oil (MBbls) | NGLs (MBbls) | Gas (MMcf) | |||||||||||||||||||
Proved Developed Reserves: | ||||||||||||||||||||||||
Beginning of year | 4,381 | 2,914 | 19,995 | 6,404 | 2,707 | 21,065 | ||||||||||||||||||
Extensions, discoveries and improved recovery | 11 | 7 | 36 | 471 | 264 | 1,330 | ||||||||||||||||||
Revisions of previous estimates | (995 | ) | (239 | ) | (1,721 | ) | (1,260 | ) | 506 | 2,033 | ||||||||||||||
Converted from undeveloped reserves | 25 | 5 | 66 | 7 | 7 | 65 | ||||||||||||||||||
Reserves sold | (29 | ) | 0 | (1,400 | ) | (5 | ) | — | (120 | ) | ||||||||||||||
Reserve purchased | 24 | 8 | 38 | 6 | 4 | 19 | ||||||||||||||||||
Production | (733 | ) | (437 | ) | (3,381 | ) | (1,242 | ) | (574 | ) | (4,397 | ) | ||||||||||||
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End of year | 2,684 | 2,258 | 13,633 | 4,381 | 2,914 | 19,995 | ||||||||||||||||||
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Proved Undeveloped Reserves: | ||||||||||||||||||||||||
Beginning of year | 1,833 | 1,017 | 4,547 | 10 | 12 | 124 | ||||||||||||||||||
Extensions, discoveries and improved recovery | 1,834 | 1,013 | 4,530 | |||||||||||||||||||||
Revisions of previous estimates | (24 | ) | (224 | (584 | ) | (4 | ) | (1 | ) | (42 | ) | |||||||||||||
Converted to developed reserves | (25 | ) | (5 | ) | (66 | ) | (7 | ) | (7 | ) | (65 | ) | ||||||||||||
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End of year | 1,784 | 787 | 3,897 | 1,833 | 1,017 | 4,457 | ||||||||||||||||||
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Total Proved Reserves at the End of the Year | 4,468 | 3,045 | 17,530 | 6,214 | 3,931 | 24,542 | ||||||||||||||||||
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RESULTS OF OPERATIONS FROM OIL AND GAS PRODUCING ACTIVITIES
Years Ended December 31, 2020 and 2019
(Unaudited)
| Year Ended December 31, | ||||||||
(Thousands of dollars) | 2020 | 2019 | ||||||
Revenue: | ||||||||
Oil and gas sales | $ | 36,973 | $ | 84,015 | ||||
Costs and Expenses: | ||||||||
Lease operating expenses | 23,028 | 33,461 | ||||||
Depreciation, depletion and accretion | 25,921 | 34,616 | ||||||
Income tax expense | (2,515 | ) | 1,421 | |||||
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Total Costs and Expenses | 46,434 | 69,498 | ||||||
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Results of Operations from Producing Activities (excluding corporate overhead and interest costs) | $ | (9,461 | ) | $ | 14,517 | |||
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36,973, See accompanying Notes to Supplementary Information
F-24
PRIMEENERGY RESOURCES CORPORATION AND SUBSIDIARIES
NOTES TO SUPPLEMENTARY INFORMATION
(Unaudited)
1. Presentation of Reserve Disclosure Information
Reserve disclosure information is presented in accordance with U.S. generally accepted accounting principles. The Company’s reserves include amounts attributable to non-controlling interests in the Partnerships. These interests represent less than 10% of the Company’s reserves.
2. Determination of Proved Reserves
The estimates of the Company’s proved reserves were determined by an independent petroleum engineer in accordance with U.S. generally accepted accounting principles. The estimates of proved reserves are inherently imprecise and are continually subject to revision based on production history, results of additional exploration and development and other factors. Estimated future net revenues were computed by reserves, less estimated future development and production costs based on current costs.
Proved reserve quantity estimates are subject to numerous uncertainties inherent in the estimation of quantities of proved reserves and in the projection of future rates of production and the timing of development expenditures. The accuracy of such estimates is a function of the quality of available data and of engineering and geological interpretation and judgment. Results of subsequent drilling, testing and production may cause either upward or downward revision of previous estimates. Further, the volumes considered to be commercially recoverable fluctuate with changes in prices and operating costs. The Company emphasizes that proved reserve estimates are inherently imprecise and that estimates of new discoveries are more imprecise than those of currently producing oil and gas properties. Accordingly, these estimates are expected to change as additional information becomes available in the future.
3. Results of Operations from Oil and Gas Producing Activities
The results of operations from oil and gas producing activities were prepared in accordance with U.S. generally accepted accounting principles. General and administrative expenses, interest costs and other unrelated costs are not deducted in computing results of operations from oil and gas activities.
4. Standardized Measure of Discounted Future Net Cash Flows and Changes Therein Relating to Proved Oil and Gas Reserves
The standardized measure of discounted future net cash flows relating to proved oil and gas reserves and the changes of standardized measure of discounted future net cash flows relating to proved oil and gas reserves were prepared in accordance with U.S. generally accepted accounting principles.
Future cash inflows are computed as described in Note 2 by applying current prices to year-end quantities of proved reserves.
Future production and development costs are computed estimating the expenditures to be incurred in developing and producing the oil and gas reserves at year-end, based on year-end costs and assuming continuation of existing economic conditions.
Future income tax expenses are calculated by applying the 2020 U.S. tax rate to future pre-tax cash inflows relating to proved oil and gas reserves, less the tax basis of properties involved. Future income tax expenses give effect to permanent differences and tax credits and allowances relating to the proved oil and gas reserves.
Future net cash flows are discounted at a rate of 10% annually (pursuant to applicable guidance) to derive the standardized measure of discounted future net cash flows. This calculation does not necessarily represent an estimate of fair market value or the present value of such cash flows since future prices and costs can vary substantially from year-end and the use of a 10% discount figure is arbitrary.
F-25
5. Changes in Reserves
The 2020 and 2019 extensions and discoveries reflect the drilling activity in the Company’s West Texas and Mid-Continent areas. The Company is employing technologies to establish proved reserves that have been demonstrated to provide consistent results capable of repetition. The technologies and economic data being used in the estimation of its proved reserves include, but are not limited to, electrical logs, radioactivity logs, geologic maps, production data and well test data. The estimated reserves of wells with sufficient production history are estimated using appropriate decline curves. Estimated reserves of producing wells with limited production history and for undeveloped locations are estimated using performance data from analogous wells in the area. These wells are considered analogous based on production performance from the same formation and with similar completion techniques. Future development plans are reflective of the current commodity prices and have been established based on an expectation of available cash flows from operations and availability under our revolving credit facility.
F-26
