CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the reference to our firm under the caption
"Experts" in this Registration Statement on Form S-3 and related
Prospectus of Hondo Oil & Gas Company and to the incorporation by
reference therein of our report dated November 21, 1997, except for
Note 5 thereof as to which the date is December 18, 1997, with
respect to the consolidated financial statements and schedules of
Hondo Oil & Gas Company included in its Annual Report (Form 10-K)
for the year ended September 30, 1997, filed with the Securities
and Exchange Commission.
Ernst & Young LLP
Denver, Colorado
February 20, 1998
[O'MELVENY & MYERS LLP LETTERHEAD]
February
23rd
1 9 9 8
(213) 669-6643
394,215-999
LA1-778646.V5
Securities and Exchange Commission
Judiciary Plaza
450 Fifth Street, N.W.
Washington, D.C. 20549-1004
Re: Hondo Oil & Gas Company Registration Statement
on Form S-3 (File No. 333-43819)
Ladies and Gentlemen:
On behalf of our client, Hondo Oil & Gas Company (the
"Company"), enclosed please find for filing via EDGAR, Amendment
No. 1 to the Company's Registration Statement on Form S-3 (the
"Amendment"). The Company has also received the letters from the
Staff of the Securities and Exchange Commission dated February
11, 1998 and February 12, 1998 containing the Staff's comments on
the above-referenced Registration Statement. The Company has
asked us to convey to you its responses to your comments.
The following numbered items correspond to the numbered
comments in the Staff's letter dated February 11, 1998:
1. The Company maintains a website available to the
public which may be found at www.hondooil.com.
2. The Company's definitive proxy statement has been
incorporated by reference in the Amendment under the heading
"Documents Incorporated by Reference."
3. The requested risk factor has been added to the
Amendment.
4. Colombia's highly inflationary economic
environment has little or no impact on the Company's
reported results of operations, nor has it caused the
Company to incur economic gains or losses, for the following
reasons:
(a) In accordance with the accounting guidance
for a highly inflationary economic environment, the
Company translates each peso-denominated transaction to
dollars before it is recorded. Thus, the only source
for currency gains and losses is remeasurement of peso-
denominated current assets and liabilities at period
end (primarily cash and certain current tax
receivables). As a result of the Company's funding
practices and non-operator status, peso-denominated
current assets and liabilities, and the resultant
currency gains and losses, have not been material since
the Company began its Colombian operations in 1991 and
are not expected to be material in the future.
(b) Over time, inflation will cause a loss of
buying power, or an economic loss, when a currency is
held. The Company has never held large amounts of
Colombian pesos, but rather has funded payment of peso-
denominated obligations on a current basis. Pesos used
to pay bills during periods of significant activity are
rarely more than four weeks old. While the exchange
rate for the Colombian peso has steadily increased over
time, loss of buying power has been insignificant
because of the Company's funding practices.
(c) In regard to revenues (which are being paid
25% in pesos and 75% in dollars for the Ecopetrol
contract and 100% in dollars for the Termosantander
contract), current law sets natural gas prices by
reference to world oil prices denominated in dollars.
Likewise, revenues for the associated liquids are
indexed to U.S. oil markets and expressed in terms of
dollars. The Company uses revenues received in pesos
to pay for capital and operating expenditures on a
concurrent basis. The loss of buying power due to
inflation should be largely mitigated by this practice.
The Company does not hedge foreign exposure.
Accordingly, the Company does not believe inclusion of the
requested risk factor in the Amendment is necessary.
5. The requested risk factor has been added to the
Amendment.
6. The risk factor has been modified to disclose the
requested information.
7. The risk factor has been modified as requested.
8. The requested additional disclosures have been
made under the caption "Risk Factors - Ecopetrol's Inherent
Conflict of Interest and Role" in the Amendment.
9. The risk factor has been modified as requested.
10. The requested disclosures have been made by the
modification or addition of the risk factors captioned
"Acreage Relinquishments," "Highly Leveraged," "Limited
Capital" and "Change of Control and Financial Support of
Shareholder" in the Amendment.
11. The requested disclosure has been made under the
risk factors captioned "Limited Capital" and "Ecopetrol's
Inherent Conflict of Interest and Role."
12. The requested disclosure has been added to the
risk factor captioned "Limited Capital."
13. The risk factor has been modified as requested.
14. The requested disclosure has been added to the
risk factor.
15. The risk factor has been modified as requested.
16. The requested change under the caption "Selling
Stockholder" has been made.
17. The Company believes it has listed in and filed
with the Registration Statement all exhibits required to be
filed pursuant to Item 601 of Regulation S-K for
registration statements on Form S-3.
18. Additional information regarding Lonrho's
intentions concerning the Company has been included in the
Amendment under the risk factor captioned "Change of Control
and Financial Support of Shareholder" and in the Company's
Quarterly Report on Form 10-Q for the quarter ended December
31, 1997 (the "Form 10-Q").
19. The requested disclosure was included under the
caption "Business - International Operations" in the
Company's Annual Report on Form 10-K for the fiscal year
ended September 30, 1997 (the "Form 10-K") and has been
included in the Form 10-Q under the captions "Management's
Discussion and Analysis of Financial Condition and Results
of Operations - General Discussion - Introduction" and
"Cautionary Statements - Substantial Reliance on Single
Investment."
20. In future Annual Reports on Form 10-K, the Company
agrees to provide subcaptions under the heading "Business -
International Operations."
21. The Company will, in future filings, identify that
15.4% relates to the commercial area of the Opon Contract
area and 30.9% relates to the non-commercial area.
22. Please see the response to comment No. 26.
23. Production from the wells in the Opon project did
not commence until December 1997, after the end of fiscal
1997. Disclosure regarding the commencement of production
appears under the captions "Business - International
Operations" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Opon
Exploration," in the Form 10-K.
24. Fletcher was notified by the EPA in November 1987
that it was a potentially responsible party. As noted in
the Form 10-K under the caption "Business - Other Factors
Affecting the Company's Business - Environmental matters -
Fletcher Refinery," the Company was not an owner of Fletcher
until after the alleged dumping occurred. Thus, the Company
believes the dates of the alleged dumping and the actual
dates of the Company's ownership are immaterial. Please
also see the response to comment No. 3.
25. There has been no material developments in the
buyer's January 1997 suit against the Company since the date
of the Form 10-K. As disclosed in the Form 10-K, the buyer
claims indemnity for amounts allegedly due to the State of
California. The Form 10-K sets forth the amounts alleged by
the State of California. Accordingly, the Company believes
that the required disclosures have been made.
26. The budget for the surface geological study is
$105,000 and the budget for the petrochemical analysis is
$129,727. The Company's share of these costs is $36,252.
Amoco Colombia has previously considered putting the Lilia
wells into production. Undoubtedly, there will be overhead
charges from other divisions of Amoco for writing and
submitting a report to Ecopetrol on this topic. However,
the amount is so minor it was not even budgeted
individually. On the basis of materiality, the Company does
believes its disclosure is adequate.
27. The discussion regarding the Opon No. 6 well in
the Form 10-Q under the caption "Management's Discussion and
Analysis of Financial Condition and Results of Operations -
General Information - Opon Exploration" has been updated to
state that a decision on the proposal will be made in the
Spring of 1998 following an economic and technical analysis.
28. The suppliers of services on the Opon No. 6 well
include the Colombian branches of Schlumberger, Baker Oil
Tools and Weatherford Enterra. As noted in the Form 10-K
and Form 10-Q, the associate parties are attempting to
negotiate a settlement with the suppliers. Disclosure of
the basis for the Company's claims and the identity of the
suppliers could adversely affect the Company's negotiations,
which in turn could adversely affect the Company and its
shareholders, and would be of little value to the Company's
shareholders. Accordingly, the Company does not believe any
additional disclosure is required.
29. Under applicable Colombian regulations, owners of
pipelines recover their investment, and earn a rate of
return, through a tariff. The tariff is set by CREG, the
regulatory agency. Pursuant to these regulations and the
methodology for determining rates in those regulations, the
Company, through the operator, submitted a tariff
application to CREG, a copy of which is filed under separate
cover for the Staff's information. The Company has
described the status of the tariff process in the Form 10-Q.
Because the CREG has initially set the tariff much lower
than the amount in the application, as described in the Form
10-Q, the Company has revised the risk factor captioned
"Laws and Regulations."
30. The discussion regarding amounts invoiced to
Ecopetrol has been expanded in the Form 10-Q. The
disclosure includes the basis for the invoice (i.e. the
"take-or-pay" clause and the completion of improvements) and
the amount of the invoices. As disclosed in the Form 10-Q,
the associate parties are reviewing their legal options to
pursue the collection of these invoices, which could include
negotiation of a settlement or arbitration in a Colombian
forum. Disclosure of any additional information regarding
the Company's options or the basis for its claim could
adversely affect the Company's position and, in turn,
adversely affect the Company and its shareholders.
Accordingly, the Company believes the revised disclosure
appearing in the Form 10-Q is adequate. The Company has
added disclosure regarding this dispute under the risk
factor captioned "Ecopetrol's Inherent Conflict of Interest
and Role" in the Amendment.
31. The referenced disclosure states that the overhead
included in the expenditure budgets for 1996 and 1997 have
not been approved and are disputed. The Company's share of
Amoco's overhead is separately identified in the Company's
Statement of Operations. The disputes are still at a
conceptual level and have not advanced to the point that a
specific amount can be identified. Further, ODC and Hondo
Magdalena have different opinions about what concepts should
be used to determine a fair overhead charge. Therefore,
even disclosure of a range of disputed amounts would not
likely be meaningful. Therefore, the Company believes the
disclosures contained in the Form 10-K and Form 10-Q are
appropriate under the circumstances.
32. The requested discussion has been included in the
Form 10-Q under the caption "Management's Discussion and
Analysis of Financial Condition and Results of Operations -
Liquidity and Capital Resources."
33. For the past three years, Lonrho Plc has provided
a letter to the Company's auditors which commits Lonrho Plc
to fund the contingent fuel tax audit liability described in
the discontinued operations footnote if it should prove to
be payable. In light of the ongoing litigation of this
issue, the Company was unwilling to make specific reference
to this commitment in its public filings.
In January 1998, the opposing party became aware of
these letters during the discovery process. A sentence
describing the second commitment (in addition to the
previously described $7.0 million loan commitment) has been
included in the Form 10-Q.
34. The requested disclosure is included in the Form
10-Q under the Cautionary Statement captioned "Highly
Leveraged" and in the Amendment under the risk factor
captioned "Highly Leveraged." The Company believes, based
on consultation with its outside reserve engineers, that the
results of drilling the Opon No. 14 well will provide the
required 25% increase in reserves. Since the Company has
sufficient funding in place to drill the Opon No. 14 well,
and it is geologically reasonable to expect that the Opon
No. 14 well will discover the required reserves, there in no
reason to assume an event of default will occur. If there
is no event of default, it is appropriate to classify that
debt as long-term.
35. Under the agreement, the net profits interest is
5% of net income from Hondo Magdalena's operations, limited
to cash remitted to the U.S. from Colombia. The
determination is made on an annual basis, not a cumulative
basis. Because the net profits interest is essentially
determined after income taxes and future capital
expenditures, but without the possible benefit of
significant increases in reserves from further exploratory
drilling, it is difficult to estimate the precise future
value of the interest. The Company estimated the
undiscounted value of the net profits interest to be $0.7
million, using undiscounted future cash flows of $41.7
million from the 1996 reserve report.
The Company believes that a net profits interest
that is conservatively estimated to be 1.7% of the value of
the future cash flows is immaterial. Accordingly, the
Company does not believe it is necessary to discuss the net
profits interest in its Managements' Discussion and Analysis
of Financial Condition and Results of Operations.
36. As indicated on the statement of operations, there
were no significant operating revenues in 1997, 1996 or 1995
to be discussed and compared. The discussion of
management's expectations for 1998 results of operations
describes that production did commence in December 1997 and
that revenue will increase in 1998. Accordingly the Company
believes its disclosures regarding revenue are adequate.
37. The Company's beliefs about 1998 results of
operations, described in results of operations, are based on
its budget for 1998, prepared in October 1997. That budget
assumed that production would begin in December 1997 and
assumed production of 95 million cubic feet per day from
January to June and 130 million cubic feet per day for July
to September, at a price of $1.15 (which has turned out to
be the precise contractual price that will be received in
the first semester of 1998). Appropriate assumptions about
capital expenditures, associated liquids revenue, tariff
revenue, processing fees, operating costs, depreciation and
overheads were also included.
38. As disclosed in Management's Discussion and
Analysis of Financial Condition and Results of
Operations-Liquidity and Capital Resources, the conversion
price of Lonrho's debt is fixed. Disclosure of the number
of shares that could be converted at a recent price would
not be relevant information. Management believes its
disclosures with regard to Lonrho's debt conversion is
adequate.
39. FAS 95, paragraph 23 identifies interest expense
as an operating activity. The Company uses the indirect
method of determining cash flows from operations, as
permitted by FAS 95, paragraph 28. Paragraph 28 requires
net income to be adjusted for "the effects of all items
whose cash effects are investing or financing cash flows,
such as depreciation. . ." Depreciation is a non-cash
decrease in fixed assets and net income, which must be
eliminated to arrive at accurate cash flows from operating
activities and investing activities. Likewise, interest
expense which is paid with equity is a non-cash decrease to
net income and increase to equity, which must be eliminated
to arrive at accurate cash flows from operating activities
and financing activities. Alternatively, interest expense
in net income which will never be paid with cash (because it
is paid with shares) must be eliminated when reconciling
from net income to net cash from operations. It is the
Company's belief that its treatment of non-cash interest in
the statement of cash flows is not only in compliance with
the provisions of FAS 95, but appropriately draws attention
to a significant non-cash transaction which the average
reader would expect to be a cash transaction.
40. Increases in the Funding Agreement represent both
non-cash investing activities (capital expenditures, and
related capitalized interest, for the pipeline and wellsite
facilities) and non-cash operating activities (seismic and
overhead expenses, and related interest) financed by the
Funding Agreement. Increases in the Funding Agreement
related to non-cash investing activities are eliminated from
the cash flow statement and separately disclosed in footnote
3 and footnote 6 to the Company's audited financial
statements. The remaining increases in the Funding
Agreement represent non-cash expenses which must be
eliminated in the reconciliation of net income to cash from
operations.
41. Total interest paid is disclosed in accordance
with FAS 95 in footnote 5 to the Company's audited financial
statements.
42. FAS 95, paragraph 32 provides that disclosure of
significant non-cash investing and financing activities may
be provided in either a narrative format or summarized in a
schedule. The following non-cash investing and financing
activities are identified in a narrative format in the
Company's audited financial statements:
(a) Expenditures for wells in progress still in
accounts payable, footnote 3.
(b) Capitalized interest for wells in progress,
footnote 3.
(c) Wellsite facilities and pipeline capital
expenditures financed with the Funding Agreement,
footnote 3.
(d) Non-cash decrease in wells in progress,
wellsite facilities and pipelines, associated with non-
cash decrease in Funding Agreement, footnote 3.
(e) Acquisition of an additional interest in the
Opon contract for shares, footnote 3.
(f) Non-cash interest, footnote 5(b)(3).
(g) Capitalized equity premiums, footnote 6.
Management believes the Company's financial
statements identify all material non-cash transactions
accurately and in accordance with FAS 95. The Company
acknowledges that a revised presentation might be helpful to
a reader's understanding of the financial statements, and
will revise its presentation of non-cash transactions in
future financial statements.
43. SOP 96-1, Environmental Remediation Liabilities,
has had no impact on the Company's financial position,
results of operations, or financial statement disclosures
for 1996 or 1997 and is not expected to have any impact in
future financial statements. Accordingly, disclosure
regarding this newly issued accounting standard would not
appear necessary and is not required by Topic 11M.
FAS 130, Comprehensive Income: the Company does
not presently have items of comprehensive income, as
defined, and does not expect to have them in the future.
This statement is not expected to have any impact on
financial position, results of operations, or financial
statement disclosures. Accordingly, disclosure regarding
this newly issued accounting standard would not appear
necessary and is not required by Topic 11M.
FAS 131, Disclosures about Segments of an
Enterprise and Related Information, will not impact the
Company's financial position or results of operations. The
statement will apply to the Company's disclosures only in
regards to foreign versus domestic operations, and will not
significantly alter the information that is presently
provided. Accordingly, disclosure regarding this newly
issued accounting standard would not appear necessary and is
not required by Topic 11M.
44. Employer contributions for 1997, 1996 and 1995
amounted to $22,000, $23,000, and $27,000, respectively.
These amounts are not material and are not required to be
disclosed by FAS 87.
45. The new loan commitment of $7.0 million given by
Lonrho in December 1997 is disclosed in footnote 5(a) of the
Company's audited financial statements. See also the
response to comment No. 33.
46. Additional wells and other capital projects,
resulting in substantial penalties if the Company were not
to participate, refers to activities which might occur after
fiscal 1998. The Company believes it has the necessary
resources to fund capital projects budgeted by the associate
parties for fiscal 1998. Also, please refer to the response
for comment No. 32.
The important aspects of the Opon Association
Contract, the Operating Agreement with Amoco Colombia, and
the two contracts for sale of production are described in
Item 1 to the Form 10-K. Many of those disclosures are
repeated in Item 7 of the Form 10-K. The Company believes
it is not necessary for the terms of these agreements to be
disclosed in footnote 1 to the Company's audited financial
statements in order for the reader to understand the nature
of the Company's business, and its ability to continue as a
going concern.
47. The conversion prices were both set at 110% of the
closing price on the day before each debt agreement was
executed. The basis for the conversion price of the option
granted in 1996, and approved by the Company's shareholders
in March 1997, was disclosed in the Company's proxy
statement for the March 1997 meeting. That option expired
on December 31, 1997, and therefore is no longer a
disclosure concern. The basis for the conversion price of
the July 2, 1997 option was disclosed in the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30,
1997, the Form 10-K, the Form 10-Q, and the Company's proxy
statement for the March 1998 meeting.
The Company does not believe that the basis for
determining the conversion prices is a required disclosure
under generally accepted accounting principles if the
conversion price is fixed. The Company believes its
disclosures on this topic have been adequate.
48. The total amount of interest costs incurred and
charged to expense during the period is disclosed on the
Statement of Operations. Interest costs capitalized are
disclosed in footnote 3 and footnote 6 of the Company's
audited financial statements.
49. Equity premiums computed on the 22% annualized
interest rate option do not differ significantly from
interest costs. It is difficult to characterize a one-time
payment of 125% of the ending principal balance (which
accumulated over a three year period) as interest. The
terminology arose on the advice of our accountants in Bogota
(Ernst & Young) to insure deductibility of the transaction
under Colombian law.
50. Disclosure of the cancellation and regrant of
58,000 stock options during 1997 is not required by FAS 123.
The stock options were cancelled and regranted before they
had vested and before they had been described in any public
filing. The granting of 58,000 stock options at the second,
and lower price, is included in footnote 8 to the Company's
audited financial statements. Accordingly, the Company
believes that the disclosure is adequate.
51. Pricing of all stock options granted under this
plan is set at market, or higher, on the date of grant.
Therefore, all stock option grants under the plan are
noncompensatory. Accordingly, EITF 87-33 does not apply.
52. The Company assumes the Staff is referring to the
IRC Section 382 limitations on the use of net operating loss
carryforwards. These rules have been monitored for several
years. To date, there have been no limitations of the
Company's ability to utilize its loss carryforwards.
Further, the Company does not believe the limitations will
come into play under the present ownership structure.
Accordingly, the Company does not believe disclosure about
this limitation is necessary.
53. No shares relating to Lonrho's option to convert
indebtedness have been included in the "Security Ownership
and Certain Beneficial Owners of the Company" table because
Lonrho's December 1996 option to convert $13.5 million of
indebtedness into common stock expired on December 31, 1997,
before the record date, and Lonrho's July 1997 option to
convert $7.0 million of indebtedness into common stock is
subject to shareholder approval at the Company's March 12,
1998 annual meeting. Lonrho has agreed to vote the shares
held by it and its affiliates in proportion to the shares
voted by persons not affiliated with Lonrho. Therefore, the
option to convert is not presently exercisable (or
exercisable within 90 days after the record date) as
provided in Rule 13d-3.
The Company believes that, except as explained above,
the Company has addressed the Staff's comments in the Form 10-Q
filed by the Company and incorporated by reference in the
Amendment. Accordingly, the Company proposes not to amend its
Form 10-K to make the changes it has made in the Form 10-Q.
In response to the Staff's letter dated February 12,
1998, enclosed under separate cover is the report of Netherland,
Sewell & Associates, Inc. regarding the Company's reserves.
Should you have any additional questions or comments,
please contact the undersigned at (213) 669-6643 or by fax at
(213) 669-6407.
Very truly yours,
/s/ RICHARD A. BOEHMER
Richard A. Boehmer
of O'MELVENY & MYERS LLP
RAB:emd
cc: Mr. J. Evan Calio
Ms. Jill Davis
Ms. Anna Martin