ITEM 1A.
RISK FACTORS
You should consider carefully the following risk factors, as well as the other information set forth in this Form 10-K.
Risks Related to Our Business, Operations and Industry
The risk factors set forth below are not the only risks that may affect our business. Our business could also be affected by additional risks not currently known or that we currently deem to be immaterial. If any of the following risks were actually to occur, our business, financial condition or results of operations could be materially adversely affected.
Oil and gas prices are volatile and change for reasons that are beyond our control. Decreases in the price we receive for our oil and gas production can adversely affect our business, financial condition, results of operations and liquidity and impede our growth.
The oil and gas markets are highly volatile, and we cannot predict future prices. Our revenue, profitability and cash flow depend upon the prices and demand for oil, gas and NGL. The markets for these commodities are very volatile and even relatively modest reductions in prices can significantly affect our financial results and impede our growth. Prices for oil, gas and NGL may fluctuate widely in response to relatively minor changes in the supply of and demand for the commodities, market uncertainty and a variety of additional factors that are beyond our control, such as:
●
domestic and foreign supply of and demand for oil and gas, including as a result of technological advances affecting energy consumption and supply;
●
actions of the Organization of Petroleum Exporting Countries and other state-controlled oil companies relating to oil price and production controls;
●
weather conditions;
●
overall domestic and global political and economic conditions;
●
the price of foreign imports;
●
political and economic conditions in oil producing countries, including the Middle East, Russia and South America;
●
variations between product prices at sales points and applicable index prices;
●
domestic, tribal and foreign governmental regulations and taxation;
●
the effect of energy conservation efforts;
●
the capacity, cost and availability of oil and gas pipelines and other transportation and gathering facilities, and the proximity of these facilities to our wells;
●
the availability of refining and processing capability;
●
factors specific to the local and regional markets where our production occurs; and
●
the price and availability of alternative fuels.
In the past, the price of oil has been extremely volatile, and we expect this volatility to continue. For example, during the twelve months ended December 31, 2014, the NYMEX price for light sweet crude oil ranged from a high of $107.26 per Bbl to a low of $53.27 per Bbl, and declined precipitously in the latter part of the year. For calendar year 2013, the range was from a high of $110.53 per Bbl to a low of $86.68 per Bbl, and for the five years ended December 31, 2014, the price ranged from a high of $113.93 per Bbl to a low of $53.27 per Bbl.
A decline in oil and gas prices can significantly affect many aspects of our business, including financial condition, revenue, results of operations, liquidity, rate of growth, reserves and the carrying value of our oil and gas properties, all of which depend primarily or in part upon those prices. For example, declines in the prices we receive for our oil and gas adversely affect our ability to repay indebtedness, finance capital expenditures, make acquisitions, raise capital and otherwise satisfy our financial obligations. In addition, declines in prices reduce the amount of oil and gas that we can produce economically and, as a result, adversely affect our quantities and present values of proved reserves. Among other things, a reduction in our reserves can limit the capital available to us, as the maximum amount of available borrowing under our Revolving Credit Facility is, and the availability of other sources of capital likely will be, based to a significant degree on the estimated quantities and value of those reserves. Finally, our Revolving Credit Facility and our Secured Term Loan Facility both contain asset coverage maintenance covenants based on the ratios of total proved reserves to
total secured debt and proved developed reserves to total secured debt. A reduction in our reserves can result in events of default under these debt agreements as a result of failure to comply with such ratios.
Availability under our Revolving Credit Facility depends on a borrowing base which is subject to redetermination by our lenders. If our borrowing base is reduced, we may be required to repay amounts outstanding under our Revolving Credit Facility.
Under the terms of our Revolving Credit Facility, our borrowing base is subject to semi-annual redetermination by our lenders based on their evaluation of our proved reserves and their internal criteria. In addition, under certain circumstances, interim redeterminations may be conducted.
The significant recent decline in oil and gas prices has resulted in banks reducing the price decks upon which borrowing bases are set. Our current borrowing base was set using a price deck significantly higher than the current price deck used by the lending institutions in our syndicate. Therefore, it is likely that our borrowing base will be reduced, perhaps significantly, in the regular semi-annual redetermination upcoming in March 2015.
In the event the amount outstanding under our Revolving Credit Facility at any time exceeds the borrowing base at such time, we would be required to repay the amount of our outstanding borrowings exceeding the new borrowing base over the 120 days following the redetermination. If we do not have sufficient funds on hand for repayment, we may be required to seek a waiver or amendment from our lenders, refinance our Revolving Credit Facility, incur additional indebtedness, sell assets or sell additional debt or equity securities in order to cure such borrowing base deficiency. We may not be able to obtain such financing or complete such transactions on terms acceptable to us or at all. Failure to make the required repayment could result in a default under our Revolving Credit Facility and a cross default under our Secured Term Loan Facility and our Senior Notes.
Our substantial indebtedness could adversely affect our business, results of operations and financial condition.
In addition to making it more difficult for us to satisfy our obligations to pay principal and interest on our outstanding indebtedness, our substantial indebtedness could limit our ability to respond to changes in the markets in which we operate and otherwise limit our activities. For example, our indebtedness, and the terms of agreements governing that indebtedness:
●
require us to dedicate a substantial portion of our cash flow from operations to service our existing debt obligations, thereby reducing the cash available to finance our operations and other business activities;
●
increase our vulnerability to economic downturns and impair our ability to withstand sustained declines in oil and gas prices;
●
subject us to covenants that limit our ability to fund future working capital, capital expenditures, exploration costs and other general corporate requirements;
●
may prevent us from borrowing additional funds for operational or strategic purposes (including to fund future acquisitions), disposing of assets or paying cash dividends;
●
limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;
●
require us to devote a substantial portion of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our cash flow to fund exploration and development efforts, working capital, capital expenditures and other general corporate purposes; and
●
place us at a competitive disadvantage relative to our competitors that have less debt outstanding.
Covenants in the indenture governing our Revolving Credit Facility, Secured Term Loan Facility and the Senior Notes, currently impose, and future financing agreements may impose, significant operating and financial restrictions.
The indenture governing our Revolving Credit Facility, Secured Term Loan Facility and the Senior Notes each contain restrictions, and future financing agreements may contain additional restrictions, on our activities, including covenants that restrict our and our restricted subsidiaries’ ability to:
●
incur additional debt;
●
pay dividends on, redeem or repurchase stock;
●
create liens;
●
make specified types of investments;
●
apply net proceeds from certain asset sales and equity offerings other than to repay indebtedness;
●
engage in transactions with our affiliates;
●
engage in sale and leaseback transactions;
●
merge or consolidate;
●
make payments from restricted subsidiaries;
●
sell equity interests of restricted subsidiaries; and
●
sell, assign, transfer, lease, convey or dispose of assets.
Our Revolving Credit Facility will mature in March 2018, unless extended, and is secured by substantially all of our oil and gas properties as well as a pledge of all ownership interests in operating subsidiaries. The Revolving Credit Facility contains various affirmative and negative covenants including but not limited to financial covenants that (i) require us to maintain a consolidated current ratio of at least 1.0 to 1.0 at the end of any fiscal quarter and (ii) do not permit our maximum senior secured leverage ratio (Revolving Credit Facility debt to consolidated Adjusted EBITDA as defined in the Revolving Credit Facility) to exceed 2.5 to 1.0 at the end of each fiscal quarter. The covenants in the Revolving Credit Facility and the Secured Term Loan Facility require, among other things, maintenance of certain ratios, measured on a quarterly basis, as follows: (i) secured debt to Adjusted EBITDA of no more than 3.5 to 1.0, (ii) PV-10 of total proved reserves to total secured debt of at least 1.1 to 1.0, rising over time to 1.5 to 1.0, and (iii) PV-10 of proved developed reserves to total secured debt of at least 1.0 to 1.0.
These restrictions may prevent us from taking actions that we believe would be in the best interest of our business, may require us to sell assets or take other actions to reduce indebtedness to meet our covenants, and may make it difficult for us to successfully execute our business strategy or effectively compete with companies that are not similarly restricted. We may also incur future debt obligations that might subject us to additional restrictive covenants that could affect our financial and operational flexibility. We cannot provide assurance that we will be granted waivers or amendments to these agreements if for any reason we are unable to comply with these agreements, or that we will be able to refinance our debt on terms acceptable to us, or at all.
If we are unable to comply with the restrictions and covenants in the agreements governing the Revolving Credit Facility, Secured Term Loan Facility, Senior Notes and other debt, there could be a default under the terms of these agreements, which could result in an acceleration of payment of funds that we have borrowed and would impact our ability to make principal and interest payments on our debt.
If we are unable to generate sufficient cash flow and are otherwise unable to obtain funds necessary to meet required payments of principal, premium, if any, and interest on our indebtedness, or if we otherwise fail to comply with the various covenants, including financial and operating covenants, in the instruments governing our indebtedness (including our Revolving Credit Facility, our Secured Term Loan Facility or the Senior Notes), we could be in default under the terms of the agreements governing such indebtedness, and any such default could cause a cross-default under the terms of our other indebtedness. In the event of such default, the holders of such indebtedness could elect to declare all the funds borrowed thereunder to be due and payable, together with accrued and unpaid interest, the lenders under our Revolving Credit Facility could elect to terminate their commitments, cease making further loans and our secured lenders could institute foreclosure proceedings against our assets, and we could be forced into bankruptcy or liquidation. We may in the future need to seek to obtain waivers from the required lenders under our Revolving Credit Facility or Secured Term Loan Facility to avoid being in default. If we breach our covenants under our Revolving Credit Facility or Secured Term Loan Facility and seek a waiver, we may not be able to obtain a waiver from the required lenders. If this occurs, we would be in default under our Revolving Credit Facility, Secured Term Loan Facility or Senior Notes, the lenders could exercise their rights as described above, and we could be forced into bankruptcy or liquidation.
In addition, any default under the agreements governing our indebtedness, including a default under our Revolving Credit Facility Credit or Secured Term Loan Facility that is not waived by the required lenders, and the remedies sought by the holders of any such indebtedness, could make us unable to pay principal, premium, if any, and interest on the Senior Notes and other indebtedness and substantially decrease the market value of the Senior Notes.
Inadequate liquidity could materially and adversely affect our business operations.
Our ability to generate cash flow depends upon numerous factors related to our business that may be beyond our control, including:
●
the price at which we sell our oil and gas production and the costs we incur to market our production;
●
the amount of oil and gas we produce;
●
our ability to borrow under our Revolving Credit Facility or future debt agreements;
●
debt service requirements contained in our Revolving Credit Facility, Senior Notes, Secured Term Loan Facility or future debt agreements;
●
the effectiveness of our commodity price hedging strategy;
●
the development of proved undeveloped properties and the success of our enhanced oil recovery activities;
●
the level of our operating and general and administrative costs;
●
our ability to replace produced reserves;
●
prevailing economic conditions;
●
government regulation and taxation;
●
the level of our capital expenditures required to implement our development projects and make acquisitions of additional reserves;
●
fluctuations in our working capital needs; and
●
timing and collectability of receivables.
Failure to maintain adequate liquidity could result in an inability to replace reserves and production, to maintain ownership of undeveloped leasehold and adverse borrowing base determinations. Any or all of the foregoing could materially and adversely affect our business and results of operations.
In addition, our estimate of proved reserves as of December 31, 2014 was based on a pricing methodology required by SEC rules. This commodity price assumption used in calculating our reserves significantly exceeds the current market price of oil and gas. Therefore it is likely that we will have substantial downward adjustments in our estimated proved reserves in the future if the current low commodity price environment persists. Furthermore, if low oil and gas prices result in our having to make substantial downward adjustments to our estimated proved reserves, or if our estimates of development costs increase, production data factors change or drilling results deteriorate, accounting rules may require us to make downward adjustments, as a non-cash impairment charge to earnings, to the carrying value of our oil and gas properties. When we incur impairment charges in the future, we could have a material adverse effect on our results of operations in the period incurred. In addition, a reduction in the future net cash flow from our properties would negatively affect our ability to borrow funds under our Revolving Credit Facility. Finally, because our Revolving Credit facility and our Secured Term Loan facility contain covenants that require us to maintain certain asset coverage ratios, downward adjustments in our estimated proved reserves may result in defaults under such agreements.
We include estimates of quantities of oil and gas using certain terms, such as “resource,” “resource potential,” “EUR,” “oil in place,” or other descriptions of volumes of reserves, which terms include quantities of oil and gas that may not meet the SEC definition of proved, probable and possible reserves, and which the SEC guidelines strictly prohibit us from including in filings with the SEC. These estimates are by their nature more speculative than estimates of proved reserves and accordingly are subject to substantially greater risk of being recovered by Resolute. In addition, 24 hour peak IP rates and 30 day peak IP rates for both our wells and for those wells that are located near to our properties are limited data points in each well’s productive history and not necessarily indicative or predictive of future production rates, EUR or economic rates of return from such wells and should not be relied upon for such purpose.
Our oil production from the Aneth Field Properties is presently connected by pipeline to only one customer, and such sales are dependent on gathering systems and transportation facilities that we do not control. With only one pipeline-connected customer, when these facilities or systems are unavailable, our operations can be interrupted and our revenue reduced.
The marketability of our oil and gas production depends in part upon the availability, proximity and capacity of pipelines, gas gathering systems, and processing facilities owned by third parties. In general, we do not control these facilities and our access to them may be limited or denied due to circumstances beyond our control. A significant disruption in the availability of these facilities could adversely affect our ability to deliver to market the oil and gas we produce, and thereby cause a significant interruption in our operations. In some cases, our ability to deliver to market our oil and gas is dependent upon coordination among third parties who own pipelines, transportation and processing facilities that we use, and any inability or unwillingness of those parties to coordinate efficiently could also interrupt our operations. These are risks for which we generally do not maintain insurance.
With respect to oil produced at our Aneth Field Properties, we operate in a remote part of southeastern Utah, and currently sell all of our oil production to a single customer, Western. On December 31, 2014, the Company entered into an amendment to the purchase agreement with Western dated July 2014, which provides for Resolute to receive a price equal to the NYMEX oil price minus a differential of $8.00 per barrel of oil. The amendment also provides that the term of the purchase agreement shall continue
automatically after December 31, 2014, until March 31, 2015, and thereafter on a month-to-month basis until terminated by a party with ninety days prior notice. If, for any reason, Western is unable to process our oil, there is alternative access to markets through rail and truck facilities or, in early 2015, through the FERC-regulated Texas-New Mexico pipeline owned by Western.
Western refines our oil at their 26,000 barrel per day Gallup refinery in Gallup, New Mexico. Our production is transported to the refinery via the Running Horse oil pipeline owned by NNOGC to the Bisti terminal, approximately 20 miles south of Farmington, New Mexico, that serves the refinery. Our oil has been jointly marketed to Western with NNOGC. The combined volumes were approximately 9,800 barrels of oil per day as of year-end. See “Business and Properties - Marketing and Customers - Aneth Field.” There are presently no pipelines in service that run the entire distance from the Aneth Field Properties to any alternative markets. If Western did not purchase our oil, we would have to transport it to other markets by a combination of the NNOGC pipeline, truck and rail, which would result, in the short term, in a lower price relative to the NYMEX price than we currently receive. In the future we may receive prices with a greater differential to NYMEX than we currently receive, which if not offset by increases in the NYMEX price for oil, could result in a material adverse effect on our financial results.
We would also have to find alternative markets if Western’s refining capacity in the region is temporarily or permanently shut down for any reason or if NNOGC’s pipeline to Western’s refineries is temporarily or permanently shut-in for any reason. We do not have any control over Western’s decisions with respect to its refineries. We would also not have control over similar decisions by any replacement customers.
We customarily ship oil to Western daily and receive payment on the twentieth day of the month following the month of production. As a result, at any given time, Western owes us between 20 and 50 days of production revenue. Based upon average production from Aneth Field during the quarter ended December 31, 2014, and a NYMEX oil price of $70.00 per Bbl, Western could owe us between $6.2 million and $15.6 million. If Western defaults on its obligation to pay us for the oil we have delivered, our income would be materially and negatively affected.
Developing and producing oil and gas are costly and high-risk activities with many uncertainties that could adversely affect our financial condition or results of operations, and insurance may not be available or may not fully cover losses.
There are numerous risks associated with developing, completing and operating a well, and cost factors can adversely affect the economics of a well. Our development and producing operations may be curtailed, delayed or canceled as a result of other factors, including:
●
reductions in oil or gas prices or increases in the differential between index oil or gas prices and prices received;
●
high costs, shortages or delivery delays of rigs, equipment, labor or other services;
●
unexpected operational events and/or conditions;
●
increases in severance taxes;
●
limitations on our ability to sell our oil or gas production;
●
adverse weather conditions and natural disasters;
●
facility or equipment malfunctions, and equipment failures or accidents;
●
pipe or cement failures and casing collapses;
●
compliance with environmental and other governmental requirements;
●
environmental hazards, such as leaks, oil spills, pipeline ruptures and discharges of toxic gases;
●
lost or damaged oilfield development and service tools;
●
unusual or unexpected geological formations, and pressure or irregularities in formations;
●
fires, blowouts, surface craterings and explosions;
●
shortages or delivery delays of supplies, equipment and services;
●
title problems;
●
objections from surface owners and nearby surface owners in the areas where we operate; and
●
uncontrollable flows of oil, gas or well fluids.
Any of these or other similar occurrences could reduce our cash from operations or result in the disruption of our operations, substantial repair costs, significant damage to property, environmental pollution and impairment of our operations. The occurrence of these events could also affect third parties, including persons living near our operations, our employees and employees of our contractors, leading to injuries or death.
Insurance against all operational risk is not available to us, and pollution and environmental risks generally are not fully insurable. Additionally, we may elect not to obtain insurance if we believe that the cost of available insurance is excessive relative to the perceived risks presented. We do not maintain business interruption insurance and also may not maintain insurance on all of our equipment. Losses could, therefore, occur for uninsurable or uninsured risks or in amounts in excess of existing insurance coverage. Moreover, insurance may not be available in the future at commercially reasonable costs and on commercially reasonable terms, and any insurance coverage we do obtain may contain large deductibles or it may not cover all hazards or potential losses. Losses and liabilities from uninsured and underinsured events or a delay in the payment of insurance proceeds could adversely affect our business, financial condition and results of operations.
We and our subsidiary guarantors may be unable to fulfill our debt service obligations under our debt agreements.
We have a substantial amount of indebtedness. As a result, a significant portion of our cash flow will be required to pay interest and principal on our indebtedness, and we may not generate sufficient cash flow from operations, or have future borrowing capacity available, to enable us to pay amounts due on, or pay when due at maturity, our indebtedness, including the Secured Term Loan Facility or the Senior Notes, or to fund other liquidity needs. As of December 31, 2014, we have $785 million in outstanding indebtedness.
Servicing our indebtedness and satisfying our other obligations will require a significant amount of cash. Our cash flow from operating activities and other sources may not be sufficient to fund our liquidity needs. Our ability to pay interest and principal on our indebtedness and to satisfy our other obligations will depend upon our future operating performance and financial condition and the availability of refinancing indebtedness, which will be affected by prevailing economic and industry conditions and financial, business and other factors, many of which are beyond our control. We cannot assure you that our business will generate sufficient cash flow from operations, or that future borrowings will be available to us under our Revolving Credit Facility or otherwise, in an amount sufficient to fund our liquidity needs, including the payment of principal and interest on the Senior Notes or the Secured Term Loan Facility.
The recent decline in product prices has decreased our operating cash flow. That decrease or an increase in our expenses could make it difficult for us to meet debt service requirements and could require us to modify our operations, including curtailing our exploration and drilling programs, selling assets, issuing equity, reducing our capital expenditures, refinancing all or a portion of our existing debt or obtaining additional financing. These alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations. Our ability to restructure or refinance our debt will depend on the condition of the capital markets and our financial condition at such time. Any refinancing of our debt could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict our business operations. In addition, the terms of future debt agreements may, and our Revolving Credit Facility, the Secured Term Loan Facility and the indenture governing the Senior Notes do, restrict us from implementing some of these alternatives. In the absence of such operating results and resources, we could face substantial liquidity problems and might be required to dispose of material assets or operations or issue equity at depressed prices to meet our debt service and other obligations. We may not be able to consummate these dispositions or equity issuances for fair market value or at all. Furthermore, any proceeds that we could realize from any dispositions or equity issuances may not be adequate to meet our debt service obligations then due.
Our estimated proved reserves are based on many assumptions that may turn out to be inaccurate. Any significant inaccuracies in these reserve estimates or underlying assumptions will materially affect the quantities of our proved reserves.
Our estimate of proved reserves at December 31, 2014, is based on the quantities of oil and gas that engineering and geological analyses demonstrate with reasonable certainty to be recoverable from established reservoirs in the future under current operating and economic parameters. NSAI audited the reserve and economic evaluations of all properties that were prepared by us on a well-by-well basis. Oil and gas reserve engineering is not exact; it relies on subjective interpretations of data that may be inaccurate or incomplete and requires predictions and assumptions of future reservoir behavior and economic conditions. Estimates of economically recoverable oil and gas reserves and of future net cash flows depend upon a number of variable factors and assumptions, including:
●
the assumed accuracy of field measurements and other reservoir data;
●
assumptions regarding expected reservoir performance relative to historical analog reservoir performance;
●
the assumed effects of regulations by governmental agencies;
●
assumptions concerning the availability of capital and its costs;
●
assumptions concerning future oil and gas prices; and
●
assumptions concerning future operating costs, severance and excise taxes, development costs and workover and remedial costs.
Because all reserve estimates are to some degree subjective, each of the following items may differ materially from those assumed in estimating reserves:
●
the quantities of oil and gas that are ultimately recovered;
●
the timing of the recovery of oil and gas reserves;
●
the production and operating costs incurred; and
●
the amount and timing of future development expenditures.
Furthermore, different reserve engineers may make different estimates of reserves and cash flows based on the same available data. As a result of all these factors, we may make material changes to reserves estimates to take into account changes in our assumptions and the results of our development activities and actual drilling and production.
If these assumptions prove to be incorrect, our estimates of reserves, the economically recoverable quantities of oil and gas attributable to any particular group of properties, the classifications of reserves based on risk of recovery and our estimates of the future net cash flows from our reserves could change significantly.
We may be required to write down the carrying value of our properties in the future.
We use the full cost accounting method for oil and gas exploitation, development and exploration activities. Under the full cost method rules, we perform a ceiling test and if the net capitalized costs for a cost center exceed the ceiling for the relevant properties, we write down the book value of the properties. Accordingly, we could recognize impairments in the future if oil and gas prices are low, if we have substantial downward adjustments to our estimated proved reserves, if we experience increases in our estimates of development costs or deterioration in our exploration and development results.
Our planned operations, as well as replacement of our production and reserves, will require additional capital that may not be available.
Our business is capital intensive, and requires substantial expenditures to maintain currently producing wells, to make the acquisitions of additional reserves and/or conduct the exploration, exploitation and development program necessary to replace our reserves, to pay expenses and to satisfy our other obligations. These activities will require cash flow from operations, additional borrowings or proceeds from the issuance of additional equity or asset sales, or some combination thereof, which may not be available to us.
For example, based on our SEC-case reserve projections, we expect to spend an additional $840.2 million of capital expenditures (including CO2 purchases) cover the next 29 years to implement and complete our proved developed non-producing and proved undeveloped projects. We expect to incur approximately $624.8 million of these future capital expenditures between 2015 and 2019 based on the capital plan contemplated by our December 2014 SEC reserve report. To the extent our production and reserves decline faster than we anticipate, we will require a greater amount of capital to maintain our production. Our ability to obtain bank financing or to access the capital markets for future equity or debt offerings may be limited by our financial condition at the time of any such financing or offering, the covenants in our Revolving Credit Facility, the Senior Notes or the Secured Term Loan Facility, adverse market conditions or other contingencies and uncertainties that are beyond our control. Our failure to obtain the funds necessary for future activities could materially affect our business, results of operations and financial condition. Even if we are successful in obtaining the necessary funds, the terms of such financings could limit our activities and our ability to pay dividends. In addition, incurring additional debt may significantly increase our interest expense and financial leverage, and issuing additional equity may result in significant equity holder dilution.
Our variable rate indebtedness subjects us to interest rate risk, which could cause our debt service obligations to increase significantly.
Borrowings under our Revolving Credit Facility and our Secured Term Loan Facility bear interest at variable rates and expose us to interest rate risk. If interest rates increase, our debt service obligations on the variable rate indebtedness would increase although the amount borrowed remained the same, and our net income and cash available for servicing our indebtedness would decrease.
Notwithstanding our current indebtedness levels and restrictive covenants, we may still be able to incur substantial additional debt or make certain restricted payments, which could exacerbate the risks described above.
We may be able to incur additional debt in the future. In addition, although the Revolving Credit Facility, the Secured Term Loan Facility and the indenture governing the Senior Notes contain restrictions on our ability to incur indebtedness, those restrictions are subject to a number of exceptions. In particular, we may borrow under our senior credit facilities, including the Revolving Credit Facility. Also, we expect to be able to issue additional notes under the indenture in some circumstances. In addition, if we are able to designate some of our restricted subsidiaries under the indenture as unrestricted subsidiaries, including in connection with the formation of e.g., master limited partnerships, those unrestricted subsidiaries would be permitted to borrow beyond the limitations specified in the indenture and engage in other activities in which restricted subsidiaries may not engage. We may also consider investments in joint ventures or acquisitions that may increase our indebtedness. Also, under the indenture, we will be able to make restricted payments in certain circumstances. Adding new debt to current debt levels or making otherwise restricted payments could intensify the related risks that we and our subsidiaries now face.
Although the Senior Notes are referred to as “senior” rights to receive payments on the Senior Notes is effectively subordinated to the rights of our and our restricted subsidiaries’ existing and future secured creditors.
The lenders under our Revolving Credit Facility and Secured Term Loan Facility will have claims that are prior to the claims of holders of the Senior Notes to the extent of the value of the assets securing the Revolving Credit Facility and the Secured Term Loan Facility. The Revolving Credit Facility and the Secured Term Loan Facility are secured by liens on substantially all of our assets and the assets of our restricted subsidiaries. The Senior Notes are effectively subordinated to any secured indebtedness incurred under the Revolving Credit Facility or the Secured Term Loan Facility. In the event of any distribution or payment of our or any guarantor’s assets in any foreclosure, dissolution, winding-up, liquidation, reorganization or other bankruptcy proceeding, holders of secured indebtedness will have prior claim to those of our or our restricted subsidiaries’ assets that constitute their collateral. Holders of Senior Notes will participate ratably with all holders of our unsecured indebtedness that is deemed to be of the same class as such notes, and potentially with all of our or any restricted subsidiary’s other general creditors, based upon the respective amounts owed to each holder or creditor, in our remaining assets. In any of the foregoing events, we cannot assure you that there will be sufficient assets to pay amounts due on the Senior Notes. As a result, holders of Senior Notes may receive less, ratably, than holders of secured indebtedness.
The Senior Notes will be subordinated to all indebtedness of those of our existing or future subsidiaries that are not, or do not become, guarantors of the notes.
Although all of our current subsidiaries are guarantors of the Senior Notes, if any future subsidiaries do not become guarantors of the notes, they will have no obligation, contingent or otherwise, to pay amounts due under the notes or to make any funds available to pay those amounts, whether by dividend, distribution, loan or other payment. The notes will be structurally subordinated to all indebtedness and other obligations of any non-guarantor subsidiary such that, in the event of insolvency, liquidation, reorganization, dissolution or other winding up of any subsidiary that is not a guarantor, all of the subsidiary’s creditors (including trade creditors and preferred stockholders, if any) would be entitled to payment in full out of the subsidiary’s assets before we would be entitled to any payment. In addition, the indenture governing the notes will, subject to some limitations, permit non-guarantor subsidiaries to incur additional indebtedness and will not contain any limitation on the amount of other liabilities, such as trade payables, that may be incurred by these subsidiaries.
We may not be able to repurchase the Senior Notes upon a change of control as required by the indenture governing the notes. A change of control is also an event of default under our Revolving Credit Facility and our Secured Term Loan Facility.
Upon the occurrence of certain kinds of change of control events, we will be required to offer to repurchase all outstanding Senior Notes at 101% of the principal amount thereof plus accrued and unpaid interest, if any, to the date of repurchase, unless all notes have been previously called for redemption. The holders of other debt securities that we may issue in the future, which rank equally in right of payment with the notes, may also have this right. Our failure to purchase tendered notes would constitute an event of default under the indenture governing the notes, which in turn, would constitute an event of default under our Revolving Credit Facility and our Secured Term Loan Facility.
Therefore, it is possible that we may not have sufficient funds at the time of the change of control to make the required repurchase of notes. Moreover, our Revolving Credit Facility and our Secured Term Loan Facility restrict, and any future indebtedness we incur may restrict, our ability to repurchase the notes, including following a change of control event. As a result, following a change of control event, we would not be able to repurchase notes unless we first repay all indebtedness outstanding under our Revolving Credit Facility, our Secured Term Loan Facility and any of our other indebtedness that contains similar provisions, or obtain a waiver from the holders of such indebtedness to permit us to repurchase the notes. We may be unable to repay all of that
indebtedness or obtain a waiver of that type. Any requirement to offer to repurchase outstanding notes may therefore require us to refinance our other outstanding debt, which we may not be able to do on commercially reasonable terms, if at all. These repurchase requirements may also delay or make it more difficult for others to obtain control of us.
In addition, the occurrence of a change of control (as defined under the respective debt agreements) in itself would constitute an event of default under our Revolving Credit Facility and our Secured Term Loan Facility. This may also delay or make it more difficult for others to obtain control of us.
In addition, certain important corporate events, such as leveraged recapitalizations that would increase the level of our indebtedness, may not constitute a “Change of Control” under the indenture.
Following a sale of “substantially all” of our assets, we may not be able to determine if a change of control that would give rise to a right to have the Senior Notes repurchased has occurred or if a change of control that would give rise to an event of default under the Revolving Credit Facility or the Secured Term Loan Facility has occurred.
The definition of change of control in the Revolving Credit Facility, the Secured Term Loan Facility and the Indenture all include a phrase relating to the sale of “all or substantially all” of our assets. There is no precise, established definition of the phrase “substantially all” under applicable law. Accordingly, the ability of a holder of Senior Notes to require us to repurchase its notes, and the occurrence of an event of default under the Revolving Credit Facility and the Secured Term Loan Facility, as a result of a sale of less than all our assets to another person, may be uncertain. Further, a holder or holders of Senior Notes could take the position that a transaction or series of transactions constituted a “sale of substantially all assets” giving rise to the right to have the Senior Notes repurchased.
A significant part of our development plan involves the implementation of our CO2 projects. The supply of CO2 and efficacy of the planned projects is uncertain, and other resources may not be available or may be more expensive than expected, which could adversely impact production, revenue and earnings, and may require a write-down of reserves.
Producing oil and gas reservoirs are depleting assets generally characterized by declining production rates that vary depending upon factors such as reservoir characteristics. A significant part of our business strategy depends on our ability to successfully implement CO2 floods and other development projects we have planned for the Aneth Field Properties in order to counter the natural decline in production from the field. As of December 31, 2014, approximately 55% of our estimated net proved reserves were classified as proved developed non-producing and proved undeveloped, meaning we must undertake additional development activities before we can produce those reserves. These development activities involve numerous risks, including insufficient quantities of CO2, project execution risks and cost overruns, insufficient capital to allocate to these projects, and inability to obtain equipment, manpower and materials that are necessary to successfully implement these projects.
A critical part of our development strategy depends upon our ability to purchase CO2. We are party to a contract to purchase CO2 from Kinder Morgan. All of the CO2 we have under contract comes from McElmo Dome Field. If we are unable to purchase sufficient CO2 under this contract, either because Kinder Morgan is unable or is unwilling to supply the contracted volumes, we would have to purchase CO2 from other owners of CO2 in McElmo Dome Field or elsewhere. In such an event, we may not be able to locate substitute supplies of CO2 at acceptable prices or at all. In addition, certain suppliers of CO2, such as Kinder Morgan, use CO2 in their own tertiary recovery projects. As a result, if we need to purchase additional volumes of CO2, these suppliers may not be willing to sell a portion of their supply of CO2 to us if their own demand for CO2 exceeds their supply. Additionally, even if adequate supplies are available for delivery from the McElmo Dome Field, we could experience temporary or permanent shut-ins of our pipeline that delivers CO2 from that field to the Aneth Field Properties. If we are unable to obtain the CO2 we require and are unable to undertake our development projects or if our development projects are significantly delayed, our recoverable reserves may be less than we currently anticipate, we will not realize our expected incremental production, and our expected decline in the rate of production from the Aneth Field Properties will be accelerated. If our requirements for CO2 were to decrease, we could be required to incur costs for CO2 that we have not purchased or to purchase more CO2 than we could use effectively. For more information about our CO2 development program and minimum financial obligations under the Kinder Morgan contract, please read “Business and Properties - Description of Properties - Aneth Field Properties.”
In addition, our estimate of future development costs, including with respect to our planned CO2 development projects, is based on our current expectation of prices and other costs of CO2, equipment and personnel we will need in the future to implement such projects. Our actual future development costs may be significantly higher than we currently estimate, and delays in executing our development projects could result in higher labor and other costs associated with these projects. If costs become too high, our future development projects may not provide economic results and we may be forced to abandon our development projects.
Furthermore, the results we obtain from our CO2 flood projects may not be the same as we expected when preparing our estimate of net proved reserves. Lower than expected production results or delays in when we first realize additional production as a result of our CO2 flood projects will reduce the value of our reserves, which could reduce our ability to incur indebtedness, require us to use cash to repay indebtedness or to satisfy our derivative obligations, and require us to write-down the value of our reserves. Therefore, our future reserves, production and future cash flow are highly dependent on our success in efficiently developing and exploiting our current estimated net proved undeveloped reserves.
Currently, the majority of our oil producing properties are located on the Navajo Reservation, making us vulnerable to risks associated with laws and regulations pertaining to the operation of oil and gas properties on Navajo tribal lands.
Substantially all of our Aneth Field Properties, which represent approximately 58% of our 2014 oil and gas revenues and 73% of our total net proved reserves at December 31, 2014, are located on the Navajo Reservation in southeastern Utah. Operation of oil and gas interests on Indian lands presents unique considerations and complexities. These arise from the fact that Indian tribes are dependent sovereign nations located within states, but are subject only to tribal laws and treaties with, and the laws and Constitution of, the United States. This creates a potential overlay of three jurisdictional regimes - Indian, federal and state. These considerations and complexities could affect various aspects of our operations, including real property considerations, employment practices, environmental matters and taxes.
For example, we are subject to the Navajo Preference in Employment Act. This law requires that we give preference in hiring to members of the Navajo Nation, or in some cases other Native American tribes, if such a person is qualified for the position, rather than hiring the most qualified person. A further regulatory requirement is imposed by the Navajo Nation Business Opportunity Act which requires us to give preference to Navajo owned businesses when we are hiring contractors. These regulatory restrictions can negatively affect our ability to recruit and retain the most highly qualified personnel or to utilize the most experienced and economical contractors for our projects.
Furthermore, because tribal property is considered to be held in trust by the federal government, before we can take actions such as drilling, pipeline installation or similar actions, we are required to obtain approvals from various federal agencies that are in addition to customary regulatory approvals required of oil and gas producers operating on non-Indian property. We are also required to obtain approvals from the Resources Committee, which is a standing committee of the Navajo Nation Tribal Council, before we can take similar actions with respect to the Aneth Field Properties. These approvals could result in delays in our implementation of, or otherwise prevent us from implementing our development program. These approvals, even if ultimately obtained, could result in delays in our ability to implement our development program.
In addition, under the Native American laws and regulations, we could be held liable for personal injuries, property damage (including site clean-up and restoration costs) and other damages. Failure to comply with these laws and regulations may also result in the suspension or termination of our operations and subject us to administrative, civil and criminal penalties, including the assessment of natural resource damages.
An incident at an ExxonMobil facility in Aneth Field in December 1997 prompted protests by local tribal members and temporary shutdown of the field. The protesters asserted concerns about environmental degradation, health problems, employment opportunities and renegotiating leases. The protest was settled among the local residents, ExxonMobil and the Navajo Nation by the Thirty-Two Point Agreement that provided, among other things, for ExxonMobil to pay partial salaries for two Navajo public liaison specialists, follow Navajo hiring practices, and settle further issues addressed in the Thirty-Two Point Agreement in the Navajo Nation’s “peacemaker” courts, which follow a community-level conflict resolution format. After the Thirty-Two Point Agreement was executed, Aneth Field resumed normal operations. While we did not formally assume the obligations of ExxonMobil under the Thirty-Two Point Agreement when we acquired the ExxonMobil Properties in 2006, it has been our policy to voluntarily comply with this agreement. While we believe that our relations with the Navajo Nation are satisfactory, it is possible that employee relations or community relations degrade to a point where protests and shutdown occur in the future.
For additional information about the legal complexities and considerations associated with operating on the Navajo Reservation, please read “Business and Properties - Laws and Regulations Pertaining to Oil and Gas Operations on Navajo Nation Lands.”
NNOGC has an option to purchase an additional interest in our Aneth Field Properties.
In addition to the options exercised by NNOGC in April 2012 to purchase 10% of our interests in Aneth Field for $100 million, NNOGC also has an option to purchase up to an additional 10% of our interest in the Aneth Field Properties (as it stood prior to the 2012 option exercise and excluding the interest acquired from Denbury and other minority interests). This option is exercisable for cash as of July 2017 at the then fair market value of the interests. If NNOGC exercises its purchase option in full, it could acquire
from us undivided working interests representing a 6.05% working interest in the Aneth Unit, a 7.5% working interest in the McElmo Creek Unit and a 5.9% working current interest in the Ratherford Unit.
The statutory preferential purchase right held by the Navajo Nation to acquire transferred Navajo Nation oil and gas leases and NNOGC’s right of first negotiation could diminish the value we may be able to receive in a sale of our properties.
Nearly all of our Aneth Field Properties are located on the Navajo Reservation. The Navajo Nation has a statutory preferential right to purchase at the offered price any Navajo Nation oil and gas lease or working interest in such a lease at the time a proposal is made to transfer the lease or interest. The existence of this right can make it more difficult to sell a Navajo Nation oil and gas lease because this right may discourage third parties from purchasing such a lease and, therefore, could reduce the value of our leases if we were to attempt to sell them. In addition, under the terms of our Cooperative Agreement with NNOGC, we are obligated to first negotiate with NNOGC to sell our Aneth Field Properties before we may offer to sell such properties to any other third party. This contractual right could make it more difficult for us to sell our Aneth Field Properties. For additional information about the right of first negotiation for the benefit of NNOGC, please read “Business and Properties - Relationship with the Navajo Nation.”
U.S. and global economic recession could have a material adverse effect on our business and operations.
Any or all of the following may occur if the recent crisis in the domestic and global financial and securities markets returns or economic conditions worsen:
●
We may be unable to obtain additional debt or equity financing, which would require us to limit our capital expenditures and other spending. This would lead to lower growth in our production and reserves than if we were able to spend more than our cash flow. Financing costs may significantly increase as lenders may be reluctant to lend without receiving higher fees and spreads.
●
An economic slowdown could lead to lower demand for crude oil and gas by individuals and industries, which may result in lower prices for the oil and gas sold by us, lower revenues and possibly losses.
●
The lenders under our Revolving Credit Facility may become more restrictive in their lending practices or unable or unwilling to fund their commitments, which would limit our access to capital to fund our capital expenditures and operations. This would limit our ability to generate revenues as well as limit our projected production and reserves growth, leading to declining production and possibly losses.
●
The losses incurred by financial institutions as well as the bankruptcy of some financial institutions heightens the risk that a counterparty to our derivative instruments could default on its obligations. These losses and the possibility of a counterparty declaring bankruptcy may affect the ability of the counterparties to meet their obligations to us on derivative transactions, which could reduce our revenues from derivatives at a time when we are also receiving a lower price for our gas and oil sales. As a result, our financial condition could be materially adversely affected.
●
Our Revolving Credit Facility and our Secured Term Loan Facility bear floating interest rates based on the London Interbank Offered Rate, or LIBOR. If LIBOR were to increase, this would cause higher interest expense for unhedged levels of LIBOR-based borrowings.
●
Our Revolving Credit Facility requires the lenders to re-determine our borrowing base semi-annually. The redeterminations are based on our proved reserves using price assumptions determined by each lender, with effect given to our derivative positions. It is possible that the lenders could reduce their price assumptions used to determine reserves for calculating our borrowing base and our borrowing base could be reduced. This would reduce our funds available to borrow and could require us to repay any amounts outstanding in excess of the then-determined borrowing base.
●
Bankruptcies of purchasers of our oil and gas could lead to the delay or failure of us to receive the revenues from those sales.
A financial failure by us or our subsidiaries may result in the assets of any or all of those entities becoming subject to the claims of all creditors of those entities.
A financial failure by us or our subsidiaries could affect payment of the Revolving Credit Facility, the Secured Term Loan Facility and the Senior Notes if a bankruptcy court were to substantively consolidate us and our subsidiaries. If a bankruptcy court substantively consolidated us and our subsidiaries, the assets of each entity would become subject to the claims of creditors of all entities. This would expose holders of Senior Notes not only to the usual impairments arising from bankruptcy, but also to potential dilution of the amount ultimately recoverable because of the larger creditor base. Furthermore, forced restructuring of the Senior Notes could occur through the “cramdown” provisions of the bankruptcy code. Under these provisions, the notes could be restructured over the objections of holders as to their general terms, primarily interest rate and maturity.
Exploration and development drilling may not result in commercially productive reserves.
We may not encounter commercially productive reservoirs through our drilling operations. The new wells we drill or participate in may not be productive and we may not recover all or any portion of our investment in such wells. The seismic data and other technologies we use do not allow us to know conclusively prior to drilling whether we will find oil or gas or, if found, that the hydrocarbons will be produced economically. The cost of drilling, completing and operating a well is often uncertain, and cost factors can adversely affect the economics of a project. Our efforts will be unprofitable if we drill dry wells or wells that are productive but do not produce enough reserves to return a profit after drilling, operating and other costs. Further, our drilling operations may be curtailed, delayed or canceled as a result of a variety of factors, including:
●
increases in the cost of, or shortages or delays in the availability of, drilling rigs and equipment;
●
unexpected drilling conditions;
●
title problems;
●
pressure or irregularities in formations;
●
equipment failures or accidents;
●
adverse weather conditions; and
●
compliance with environmental and other governmental requirements.
Part of our strategy involves using some of the latest available horizontal drilling and completion techniques, which involve risks and uncertainties in their application.
Our operations involve utilizing some of the latest drilling and completion techniques as developed by us and our service providers. Risks that we face while drilling horizontal wells include, but are not limited to, the following:
●
landing our wellbore in the desired drilling zone;
●
staying in the desired drilling zone while drilling horizontally through the formation;
●
running our casing the entire length of the wellbore; and
●
being able to run tools and other equipment consistently through the horizontal wellbore.
Risks that we face while completing our wells include, but are not limited to, the following:
●
the ability to fracture stimulate the planned number of stages;
●
the ability to run tools the entire length of the wellbore during completion operations; and
●
the ability to successfully clean out the wellbore after completion of the final fracture stimulation stage.
The drilling process and the results of our drilling in new or emerging formations are more uncertain initially than drilling results in areas that are more developed and have a longer history of established production. Newer or emerging formations and areas have limited or no drilling or production history and, consequently, we are more limited in assessing future drilling costs and results in these areas. If our drilling costs are greater or our results are less than anticipated, the return on our investment for a particular project may not be as attractive as we anticipated and we could incur material write-downs of unevaluated properties and the value of our undeveloped acreage could decline in the future.
Our identified drilling locations are scheduled out over many years, making them susceptible to uncertainties that could materially alter the occurrence or timing of their drilling. In addition, we may not be able to raise the substantial amount of capital that would be necessary to drill such locations.
Our management team has specifically identified and scheduled certain drilling locations as an estimation of our future multi-year drilling activities on our existing acreage. These drilling locations represent a significant part of our growth strategy. Our ability to drill and develop these locations depends on a number of uncertainties, including oil and gas prices, the availability and cost of capital, drilling and production costs, availability of drilling services and equipment, drilling results, lease expirations, gathering system and pipeline transportation constraints, access to and availability of water sourcing and distribution systems, regulatory approvals and other factors. Because of these uncertain factors, we do not know if the numerous drilling locations we have identified will ever be drilled or if we will be able to produce gas or oil from these or any other drilling locations. In addition, unless production is established within the spacing units covering the undeveloped acres on which some of the drilling locations are obtained, the leases for such acreage will expire. As such, our actual drilling activities may materially differ from those presently identified.
The development of our estimated PUDs may take longer and may require higher levels of capital expenditures than we currently anticipate. Therefore, our estimated PUDs may not be ultimately developed or produced.
As of December 31, 2014, 44% of our total estimated proved reserves were classified as proved undeveloped. Development of these undeveloped reserves may take longer and require higher levels of capital expenditures than we currently anticipate. Delays in the development of our reserves, increases in costs to drill and develop such reserves or decreases in commodity prices will reduce the value of our estimated PUDs and future net revenues estimated for such reserves and may result in some projects becoming uneconomic. In addition, delays in the development of reserves as a result of such factors or otherwise could cause us to have to reclassify our PUDs as unproved reserves. Further, we may be required to write down our PUDs if we do not drill those wells within five years after their respective dates of booking.
Shortages of qualified personnel or field supplies, equipment and services could affect our ability to execute our plans on a timely basis, reduce our cash flow and adversely affect our results of operations.
The demand for qualified and experienced geologists, geophysicists, engineers, field operations specialists, landmen, financial experts and other personnel in the oil and gas industry can fluctuate significantly, often in correlation with oil and gas prices, causing periodic shortages. From time to time, there have also been shortages of drilling rigs and other field supplies, equipment and services, as demand for rigs and equipment increased along with the number of wells being drilled. These factors can also result in significant increases in costs for equipment, services, supplies and personnel. Higher oil and gas prices generally stimulate increased demand and result in increased prices for drilling rigs, crews and associated supplies, equipment and services. Although oil and gas prices have recently declined significantly, making such shortages less impactful at the present time, we could experience such difficulties in the future. In that event, our profit margin, cash flow and operating results could be adversely affected and our ability to conduct our operations in accordance with our plans and budgets could be restricted.
We are a party to a contract that requires us to pay for a minimum quantity of CO2. This contract limits our ability to curtail costs if our requirements for CO2 decrease.
Our contract with Kinder Morgan requires us to take, or pay for if not taken, a minimum volume of CO2 monthly. The take-or-pay obligations result in minimum financial obligations during the contract term. The take-or-pay provisions in this contract allow us to subsequently apply take-or-pay payments made to volumes subsequently taken, but these provisions have limitations and we may not be able to utilize all such amounts paid if the limitations apply or if we do not subsequently take sufficient volumes to utilize the amounts previously paid.
We are subject to complex federal, state, tribal, local and other laws and regulations that could adversely affect the cost, manner or feasibility of doing business.
Exploration, exploitation, development, production and marketing operations in the oil and gas industry are regulated extensively at the federal, state and local levels. In addition, substantially all of our current leases in Aneth Field are regulated by the Navajo Nation. Some of our future leases may be regulated by Native American tribes. Environmental and other governmental laws and regulations have increased the costs to plan, design, drill, install, operate and properly abandon oil and gas wells and other recovery operations. Under these laws and regulations, we could also be liable for personal injuries, property damage and other damages. Failure to comply with these laws and regulations may result in the suspension or termination of our operations or denial or revocation of permits and subject us to administrative, civil and criminal penalties.
Part of the regulatory environment in which we operate includes, in some cases, federal requirements for obtaining environmental assessments, environmental impact statements and/or plans of development before commencing exploration and production activities. In addition, our activities are subject to regulation by oil and gas producing states and the Navajo Nation regarding conservation practices, protection of correlative rights and other concerns. These regulations affect our operations and could limit the quantity of oil and gas we may produce and sell. A risk inherent in our CO2 flood project is the need to obtain permits from federal, state, local and Navajo Nation tribal authorities. Delays or failures in obtaining regulatory approvals or permits or the receipt of an approval or permit with unreasonable conditions or costs could have a material adverse effect on our ability to exploit our properties. Additionally, the oil and gas regulatory environment could change in ways that might substantially increase the financial and managerial costs to comply with the requirements of these laws and regulations and, consequently, adversely affect our profitability. Proposed expansion of GHG mandatory reporting rules (MRR) and proposed GHG cap-and-trade legislation are two examples of proposed changes in the regulatory climate that would affect us. Also, the EPA has announced a comprehensive strategy for further reducing methane emissions from oil and gas operations, with a proposed rule expected in 2015 and a final rule in 2016. We may be placed at a competitive disadvantage to larger companies in the industry with respect to such expanded regulatory requirements, which can spread these additional costs over a greater number of wells and larger operating staff. Please read “Business
and Properties - Environmental, Health and Safety Matters and Regulation” and “Business and Properties - Other Regulation of the Oil and Gas Industry” for a description of the laws and regulations that affect us.
In addition, President Obama’s budget and other legislative proposals would terminate various tax incentives currently available to companies engaged in oil and gas development and production. These changes include (i) the elimination of the current deduction for intangible drilling and development costs and for qualified tertiary injectant expenses, (ii) the repeal of the percentage depletion allowance for oil and gas wells, (iii) the elimination of the domestic manufacturing deduction, and (iv) the extension of the amortization period for certain geological and geophysical expenditures. The passage of this legislation or any similar changes in U.S. federal income tax laws could increase the cost of exploration and development of oil and gas resources. Any such changes could have an adverse effect on our financial position, results of operations and cash flows.
Proposed federal and state legislation and regulatory initiatives relating to hydraulic fracturing could result in increased costs and additional operating restrictions or delays.
Hydraulic fracturing is a common process in our industry of creating artificial cracks, or fractures, in deep underground rock formations through the pressurized injection of water, sand and other additives to enable fluids (including oil and gas) to move more easily through the rock to a production well. This process often is necessary to produce commercial quantities of oil and gas from many reservoirs, especially shale rock formations. We routinely utilize hydraulic fracturing techniques in many of our reservoirs. Current regulation of hydraulic fracturing primarily is conducted at the state level through permitting and other compliance requirements, but proposed regulations at the federal level are being considered by EPA, BLM and OSHA. The U.S. Congress currently is also considering legislation that would amend the SDWA to eliminate an existing exemption from federal regulation of hydraulic fracturing activities and require the disclosure of chemical additives used by the oil and gas industry in the hydraulic fracturing process. If adopted, the proposed amendment to the SDWA or these federal agencies’ possible expansion of their regulatory programs affecting hydraulic fracturing could result in additional regulations and permitting requirements at the federal level. In addition, various states and localities are also studying or considering various additional regulatory measures related to hydraulic fracturing and public referendums for moratoriums or additional restrictions on fracing have recently been presented in many state and local jurisdictions. Additional regulations and permitting requirements could lead to significant operational delays and increased operating costs, and make it more difficult to perform hydraulic fracturing.
If we are unable to acquire adequate supplies of water for our drilling operations or are unable to dispose of the water we use at a reasonable cost and within applicable environmental rules, our ability to produce oil and gas commercially and in commercial quantities could be impaired.
We use a substantial amount of water in our drilling operations. Our inability to locate sufficient amounts of water, or treat and dispose of water after drilling, could adversely impact our operations. Moreover, the imposition of new environmental initiatives and regulations could include restrictions on our ability to conduct certain operations such as hydraulic fracturing or disposal of waste, including, but not limited to, produced water, drilling fluids and other wastes associated with the exploration, development or production of oil and gas. Furthermore, future environmental regulations and permit requirements governing the withdrawal, storage and use of surface water or groundwater necessary for hydraulic fracturing of wells could increase operating costs and cause delays, interruptions or termination of operations, the extent of which cannot be predicted, all of which could have an adverse effect on our operations and financial performance.
The standardized measure of future net cash flows from our net proved reserves is based on many assumptions that may prove to be inaccurate. Any material inaccuracies in our reserve estimates or underlying assumptions will materially affect the quantities and present value of our proved reserves.
Actual future net cash flows from our oil and gas properties will be determined by the actual prices we receive for oil and gas, our actual operating costs in producing oil and gas, the amount and timing of actual production, the amount and timing of our capital expenditures, supply of and demand for oil and gas and changes in governmental regulations or taxation, which may differ from the assumptions used in creating estimates of future cash flows.
The timing of our production and our incurrence of expenses in connection with the development and production of oil and gas properties will affect the timing of actual future net cash flows from proved reserves, and thus their actual present value. In addition, the 10% discount factor we use when calculating discounted future net cash flows in compliance with guidance from the FASB 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 oil and gas industry in general.
Our plans for future strategic acquisitions may require substantial capital, which we may be unable to obtain on favorable terms and which is likely to require us to incur additional financing indebtedness.
Our industry is capital intensive, and one component of our strategy has been to grow our reserves and production by acquiring domestic onshore properties. We actively evaluate the acquisition of properties that are prospective for production of oil and NGL, particularly in the Permian Basin and Rocky Mountain regions. Future acquisitions that we may pursue may require us to incur additional financing indebtedness and leverage our existing assets. To date, we have financed such acquisitions primarily with proceeds from bank borrowings under our Revolving Credit Facility, cash generated by operations and the issuance of the Senior Notes. We could finance future acquisitions utilizing similar financing sources, which may include amending our Revolving Credit Facility and expanding the borrowing base and the sale of equity or debt securities. There can be no assurance as to the availability of any additional financing or that the terms will be acceptable to us. Our inability to obtain additional financing or sufficient financing on favorable terms may adversely affect our growth, competitiveness and profitability. Further, the incurrence of additional indebtedness could have material adverse effects on our financial condition and liquidity and limit our future flexibility and growth opportunities.
Any acquisitions we complete are subject to substantial risks that could negatively affect our financial condition and results of operations.
Even if we do make acquisitions that we believe will enhance our growth, financial condition or results of operations, any acquisition involves potential risks including, among other things:
●
the validity of our assumptions about the acquired properties’ or company’s reserves, future production, the future prices of oil and gas, infrastructure requirements, environmental and other liabilities, revenue and costs;
●
an inability to integrate successfully the properties and businesses we acquire;
●
a decrease in our liquidity to the extent we use a significant portion of our available cash or borrowing capacity to finance acquisitions or operations of the acquired properties;
●
a significant increase in our interest expense or financial leverage if we incur debt to finance acquisitions or operations of the acquired properties;
●
the assumption of unknown liabilities, losses or costs for which we are not indemnified or for which our indemnity is inadequate;
●
the diversion of management’s attention from other business concerns;
●
an inability to hire, train or retain qualified personnel to manage and operate our growing business and assets;
●
unforeseen difficulties encountered in operating in new geographic areas; and
●
customer or key employee losses at the acquired businesses.
Our decision to acquire a property or business will depend in part on the evaluation of data obtained from production reports and engineering studies, geophysical and geological analyses and seismic and other information, the results of which are often inconclusive and subject to various interpretations.
Also, our review of acquired properties is inherently incomplete because it is generally not feasible to perform an in-depth review of the individual properties involved in each acquisition. Even a detailed review of records and properties may not necessarily reveal existing or potential problems, nor will it permit us to become sufficiently familiar with the properties to assess fully their deficiencies and potential problems. Inspections may not always be performed on every well, and environmental problems, such as ground water contamination, are not necessarily observable even when an inspection is undertaken. The potential risks in making acquisitions could adversely affect our ability to achieve anticipated levels of cash flows from the acquired businesses or realize other anticipated benefits of those acquisitions.
If we do not make acquisitions of reserves on economically acceptable terms, our future growth and ability to maintain production will be limited to only the growth we may achieve through the development of our proved developed non-producing and proved undeveloped reserves and exploration of our non-proved leaseholds.
Producing oil and gas reservoirs are generally characterized by declining production rates that vary depending upon reservoir characteristics and other factors. The rate of decline we have projected for our existing wells may be different than the decline rate actually realized. Our future oil and gas reserves and production and, therefore, our cash flow and income are highly dependent upon
our success in efficiently developing and exploiting our current reserves and economically finding or acquiring additional recoverable reserves.
We intend to grow by bringing our proved developed non-producing reserves into production, developing our proved undeveloped reserves and exploring for and finding additional reserves on our unproved properties. Our ability to further grow depends in part on our ability to make acquisitions, particularly in the event NNOGC exercises its option to purchase an additional working interest in the Aneth Field Properties. We may be unable to make such acquisitions because we are:
●
unable to identify attractive acquisition candidates or negotiate acceptable purchase contracts with the seller;
●
unable to obtain financing for these acquisitions on economically acceptable terms; or
●
outbid by competitors.
If we are unable to acquire properties containing proved reserves at acceptable costs, our total level of proved reserves and associated future production will decline as a result of the ongoing production of our reserves.
We operate producing properties that are located in a limited number of geographic areas, making us vulnerable to risks associated with lack of geographic diversification.
Approximately 58% of our 2014 oil and gas revenues and 73% of our total proved reserves at December 31, 2014, are located in our Aneth Field Properties in the southeast Utah portion of the Paradox Basin in the Four Corners area of the southwestern United States. Essentially all of the remainder of our sales of oil and gas and total proved reserves are attributable to the Permian and Wyoming properties. As a result of our lack of diversification in asset type and location, any delays or interruptions of production caused by such factors as governmental regulation, transportation capacity constraints, curtailment of production or interruption of transportation, price fluctuations, natural disasters or shutdowns of the pipelines connecting our production to refineries would have a significantly greater impact on our results of operations than if we possessed more diverse assets and locations.
The prices we receive for our oil and gas production are affected by the geographic region in which that production is located. Prices are determined to a significant extent by factors affecting the regional supply of and demand for oil and gas, including the adequacy of the pipeline and processing infrastructure in the region to transport or process our production and that of other producers. Those factors result in basis differentials between the published indices generally used to establish the price received for regional oil and gas production and the actual (frequently lower) price we may receive for our production.
Certain of our undeveloped leasehold acreage is subject to leases that will expire over the next several years unless production is established on units containing the acreage or the leases are extended.
As of December 31, 2014, we had approximately 9,100 net acres in the Permian Basin, and 33,400 net acres in the Big Horn Basin that are not currently held by production. Unless production in paying quantities is established on units containing these leases during their primary terms or we obtain extensions of the leases, these leases will expire. If our leases expire, we will lose our right to develop the related properties.
Our drilling plans for these areas are subject to change based on various factors, including factors that are beyond our control, including drilling results, oil and gas prices, the availability and cost of capital, drilling and production costs, availability of drilling services and equipment, gathering system and pipeline transportation constraints, and regulatory approvals.
We have limited control over activities on properties we do not operate, which could reduce our production and revenues, affect the timing and amounts of capital requirements and potentially result in a dilution of our respective ownership interest in the event we are unable to make any required capital contributions.
We do not operate all of the properties in which we have an interest. As a result, we may have a limited ability to exercise influence over normal operating procedures, expenditures or future development of underlying properties and their associated costs. For all of the properties that are operated by others, we are dependent on their decision-making with respect to day-to-day operations over which we have little control. The failure of an operator of wells in which we have an interest to adequately perform operations, or an operator’s breach of applicable agreements, could reduce production and revenues we receive from that well. The success and timing of our drilling and development activities on properties operated by others depend upon a number of factors outside of our control, including the timing and amount of capital expenditures, the available expertise and financial resources, the inclusion of other participants and the use of technology.
If the expenses associated with the operator’s activity exceed our expectations we may be required to make significantly higher capital contributions to satisfy our proportionate share of the costs. If such capital contributions are required, we may not be able to satisfy our obligations or we may have to reallocate our anticipated capital expenditure budget. In the event that we do not participate in future capital contributions with respect to a joint operating agreement or any other agreements relating to properties we do not operate, our respective ownership interest could be diluted or forfeited.
Our derivative activities could reduce our net income.
To achieve more predictable cash flow and to reduce our exposure to adverse changes in the price of oil and gas, we have entered into, and plan to enter into in the future, derivative arrangements covering a significant portion of our oil and gas production. These derivative arrangements could result in both realized and mark-to-market derivative losses. Our derivative instruments are subject to mark-to-market accounting treatment, and the change in fair market value of the instrument is reported in our consolidated statements of income each quarter, which have resulted in, and will in the future likely result in, significant mark-to-market net gains or losses. We expect to continue to use derivative arrangements to reduce commodity price risk with respect to our estimated production from producing properties. Please read - “Management’s Discussion and Analysis of Financial Condition and Results of Operations - How We Evaluate Our Operations” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Quantitative and Qualitative Disclosures About Market Risk.”
Our actual future production during a period may be significantly higher or lower than we estimate at the time we enter into derivative transactions for such period. If the actual amount is higher than we estimate, we will have more unhedged production and therefore greater commodity price exposure than we intended. If the actual amount is lower than the nominal amount that is subject to our derivative financial instruments, whether due to issues with our sales to purchasers, natural declines in production and the failure to develop new reserves, the efficacy of our CO2 project or other factors, we might be forced to satisfy all or a portion of our derivative transactions in cash without the benefit of the cash flow from our sale of the underlying physical commodity, resulting in a substantial reduction of our liquidity. As a result of these factors, our derivative activities may not be as effective as we intend in reducing the volatility of our cash flows, and in certain circumstances may actually increase the volatility of our cash flows.
In addition, our derivative activities are subject to the risk that a counterparty may not perform its obligation under the applicable derivative instrument. If derivative counterparties are unable to make payments to us under their derivative arrangements, our results of operations, financial condition and liquidity would be adversely affected.
The effectiveness of derivative transactions to protect us from future oil and gas price declines will be dependent upon oil and gas prices at the time we enter into future derivative transactions as well as our future levels of hedging, and as a result our future net cash flow may be more sensitive to commodity price changes.
As our derivatives expire, more of our future production will be sold at market prices unless we enter into additional derivative transactions. Our Revolving Credit Facility and our Secured Term Loan Facility require us to enter into derivative agreements covering at least 70% of our anticipated production from proved properties on a rolling twenty four month basis, but prohibit us from entering into derivative arrangements for more than (i) 85% of our anticipated production from proved properties in the next two years and (ii) the greater of 75% of our anticipated production from proved properties or 85% of our production from projected proved developed producing reserves using economic parameters specified in our Revolving Credit Facility. The prices at which we hedge our production in the future will be dependent upon commodity prices at the time we enter into these transactions, which may be substantially lower than current prices. Accordingly, our commodity price hedging strategy will not protect us from significant and sustained declines in oil and gas prices received for our future production. Conversely, our commodity price hedging strategy may limit our ability to realize cash flow from commodity price increases. It is also possible that a larger percentage of our future production will not be hedged as our derivative policies may change, which would result in our oil and gas revenue becoming more sensitive to commodity price changes.
Legislation and regulation affecting derivative instruments could adversely affect our ability to hedge oil and gas prices which may increase our costs and adversely affect our profitability.
In July 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”). Dodd-Frank imposes restrictions on the use and trading of certain derivatives, including our oil and gas derivative instruments. The nature and scope of those restrictions will be determined in significant part through implementing regulations to be adopted by the SEC, the Commodities Futures Trading Commission and other regulators. We continue to assess the potential impact of the Dodd-Frank derivatives provisions on our operations and this assessment will be ongoing as the regulatory process contemplated by Dodd-Frank is further implemented. The effect of such future regulations on our business is uncertain.
In particular, note the following:
●
Depending on the rules and definitions adopted by regulators, we could be required to post significant amounts of cash collateral with our dealer counterparties for our derivative transactions, which would likely make it impracticable to implement our current hedging strategy.
●
If our ability to enter into derivative transactions is decreased as a result of Dodd-Frank, we would be exposed to additional risks related to commodity price volatility. Commodity price decreases would then have an immediate significant adverse effect on our profitability and revenues. Reduced derivative transactions may also impair our ability to have certainty with respect to a portion of our cash flow, which could lead to decreases in capital spending and, therefore, decreases in future production and reserves.
●
We expect that the cost to enter into derivative transactions will increase as a result of a reduction in the number of counterparties in the market and the pass-through of increased counterparty costs, thereby increasing the costs of derivative instruments. Our derivatives counterparties may be subject to significant new capital, margin and business conduct requirements imposed as a result of the new legislation.
●
Dodd-Frank contemplates that most swaps will be required to be cleared through a registered clearing facility and traded on a designated exchange or swap execution facility. There are some exceptions to these requirements for entities that use swaps to hedge or mitigate commercial risk. While we may ultimately be eligible for such exceptions, the scope of these exceptions currently is uncertain, pending further definition through rule making proceedings.
●
The above factors could also affect the pricing of derivatives and make it more difficult for us to enter into hedging transactions on favorable terms.
The nature of our assets expose us to significant costs and liabilities with respect to environmental and operational safety matters. We are also responsible for costs associated with the removal and remediation of the decommissioned Aneth Gas Processing Plant.
We may incur significant costs and liabilities as a result of environmental, health and safety requirements applicable to our oil and gas exploration, production and other activities. These costs and liabilities could arise under a wide range of environmental, health and safety laws and regulations, including agency interpretations thereof and governmental enforcement policies, which have tended to become increasingly strict over time. Failure to comply with these laws and regulations may result in the assessment of administrative, civil and criminal penalties, the imposition of investigatory, cleanup and site restoration costs and liens, the denial or revocation of permits or other authorizations and the issuance of injunctions to limit or cease operations. Compliance with these laws and regulations also increases the cost of our operations and may prevent or delay the commencement or continuance of a given operation. In addition, claims for damages to persons or property may result from environmental and other impacts of our operations.
We have an interest in the Aneth Gas Processing Plant, which is currently being decommissioned. Under our purchase agreement with Chevron, Chevron is responsible for indemnifying us against the decommissioning and clean-up or remediation costs allocable to the 39% interest we purchased from it. Under our purchase agreement with ExxonMobil, however, we are responsible for the decommissioning and clean-up or remediation cost allocable to the interests we purchased from ExxonMobil, which is 25% of the total cost of the project. If Chevron fails to pay its share of the decommissioning costs in accordance with the purchase agreement, we could be held responsible for 64% of the total costs to decommission and remediate the Aneth Gas Processing Plant. Chevron is managing the decommissioning process and, based on our current estimate, the total cost of the decommissioning is $26.3 million. $25.7 million has already been incurred and paid for as of December 31, 2014. This estimate does not include any costs for any possible subsurface clean-up or remediation of the site, as well as minor additional demolition and removal activities associated with buried piping and concrete foundations, which may be significant.
The Aneth Gas Processing Plant site was previously evaluated by the U.S. EPA for possible listing on the National Priorities List (“NPL”) of sites contaminated with hazardous substances with the highest priority for clean-up under CERCLA. Based on its investigation, the EPA concluded no further investigation was warranted and that the site was not required to be listed on the NPL. The Navajo Nation Environmental Protection Agency now has primary jurisdiction over the Aneth Gas Processing Plant site, however, and we cannot predict whether it will require further investigation and possible clean-up, and the ultimate cleanup liability may be affected by the recent enactment by the Navajo Nation of the Navajo CERCLA. In some matters, the Navajo CERCLA imposes broader obligations and liabilities than the federal CERCLA. We have been advised by Chevron that a significant portion of the subsurface clean-up or remediation costs, if any, would be covered by an indemnity from the prior owner of the plant, and Chevron has provided us with a copy of the pertinent purchase agreement that appears to support Chevron’s position. We cannot predict whether any subsurface remediation will be required or what the costs of the subsurface clean-up or remediation could be. Additionally, we cannot be certain whether any of such costs will be reimbursable to us pursuant to the indemnity of the prior owner. To the extent any such costs are incurred and not reimbursed pursuant to the indemnity from the prior owner, we would be liable for
25% of such costs as a result of our acquisition of the ExxonMobil Properties. Please read “Business and Properties - Aneth Gas Processing Plant” for additional information about this liability.
Strict or joint and several liability to remediate contamination may be imposed under certain environmental laws, which could cause us to become liable for the conduct of others or for consequences of our own actions that were in compliance with all applicable laws at the time those actions were taken. New or modified environmental, health or safety laws, regulations or enforcement policies could be more stringent and impose unforeseen liabilities or significantly increase compliance costs. Please read “Business and Properties - Environmental, Health and Safety Matters and Regulation” for more information.
We may be unable to compete effectively with larger companies, which may adversely affect our operations and ability to generate and maintain sufficient revenue.
The oil and gas industry is intensely competitive, and we compete with companies that have greater resources, including an increased ability to attract, compensate and retain quality employees. Many of these companies not only explore for and produce oil and gas, but also refine and market petroleum and other products on a regional, national or worldwide basis. These companies may be able to pay more for oil and gas properties and exploratory prospects or identify, evaluate, bid for and purchase a greater number of properties and prospects than our financial or human resources permit. In addition, these companies may have a greater ability to continue exploration or exploitation activities during periods of low oil and gas market prices. Our larger competitors may be able to absorb the burden of present and future federal, state, local and other laws and regulations more easily than we can, which would adversely affect our competitive position. Our ability to acquire additional properties and to discover reserves in the future will depend upon our ability to evaluate and select suitable properties and to consummate transactions in this highly competitive environment.
Possible regulation related to global warming and climate change could have an adverse effect on our operations and demand for oil and gas.
Certain studies have suggested that human-caused emissions of GHG, including CO2 and methane, may be contributing to warming of the Earth’s atmosphere. In response to such studies, the U.S. Congress has considered, and in the future may consider, legislation to reduce emissions of GHG. In addition, several states have already taken legal measures to reduce emissions of GHG. As a result of the U.S. Supreme Court’s decision on April 2, 2007, in Massachusetts v. EPA and subsequent decisions, the EPA also may regulate GHG emissions from mobile and stationary sources even if Congress does not adopt new legislation specifically authorizing such regulation. Most recently, in June 2014, the United States Supreme Court invalidated part of the EPA’s stationary source GHG program in Utility Air Regulatory Group v. EPA, but the Supreme Court also ruled that major sources subject to the PSD or Title V programs because of non-GHG pollutant emissions could be subjected to certain “best available control technology” requirements imposed to curb their GHG emissions, and EPA is proceeding to develop regulations for power plants based on this GHG regulatory authority identified in that decision. Further, the EPA has announced a comprehensive strategy for further reducing methane emissions from oil and gas operations, with a proposed rule expected in 2015 and a final rule in 2016. Other nations already have agreed to regulate emissions of GHG, pursuant to the United Nations Framework Convention on Climate Change, and the subsequent “Kyoto Protocol,” an international treaty pursuant to which participating countries (not including the United States) agreed to reduce their emissions of GHG to below 1990 levels by 2012. A successor treaty to the Kyoto Protocol has not been developed to date. Passage of state or federal climate control legislation or other regulatory initiatives or the adoption of regulations by the EPA and state agencies that restrict emissions of GHG in areas in which we conduct business could have an adverse effect on our operations and demand for oil and gas.
Recently approved final rules regulating air emissions from gas processing operations could cause us to incur increased capital expenditures and operating costs, which may be significant.
On April 17, 2012, the EPA issued final rules that established new source performance standard air emission controls for oil and gas production and gas processing operations. After several parties challenged these regulations in court, the EPA administratively reconsidered certain requirements. As a result of such administrative reconsideration, the EPA issued final amendments to the regulations in September 2013 and December 2014, and is evaluating whether further reconsideration is warranted. Specifically, the EPA’s rule package currently includes New Source Performance Standards to address emissions of sulfur dioxide and VOC and a separate set of emission standards to address hazardous air pollutants frequently associated with oil and gas production and processing activities. The final rule includes a 95% reduction in VOC emitted by requiring the use of reduced emission completions or “green completions” on all hydraulically-fractured gas wells constructed or refractured after January 1, 2015. The rules also establish specific new requirements regarding emissions from compressors, controllers, dehydrators, storage tanks and other production equipment. On December 17, 2014, the EPA also proposed to revise and lower the existing 75 ppb national ambient air quality standard (‘‘NAAQS’’) for ozone under the federal Clean Air Act to a range within 65-70 ppb, and taking public comment on whether the ozone standard should be revised as low as 60 ppb. A lowered ozone NAAQS in a range of 60-70 ppb could result in a significant expansion of ozone
nonattainment areas across the United States, including areas in which we operate. Oil and natural gas operations in ozone nonattainment areas would likely be subject to increased regulatory burdens in the form of more stringent emission controls, emission offset requirements for new sources, and increased permitting delays and costs. These rules and standard revisions could require a number of modifications to our operations, including the installation of new equipment to control emissions from our wells.. Compliance with such rules could result in significant costs, including increased capital expenditures and operating costs, and could adversely impact our business.
We depend on a limited number of key personnel who would be difficult to replace.
We depend substantially on the performance of our executive officers and other key employees. We have entered into employment agreements with certain of these employees, but we do not maintain key personnel life insurance policies on any of these employees. The loss of any member of the senior management team or other key employees could negatively affect our ability to execute our business strategy.
Work stoppages, protests or other labor issues at our facilities could adversely affect our business, financial position, results of operations, or cash flows.
As of December 31, 2014, 47 of our field level employees were represented by the USW, and covered by a collective bargaining agreement, which is in the process of renewal negotiations. Although we believe that our relations with our employees are generally satisfactory, if we are unable to reach agreement with any of our unionized work groups on future negotiations regarding the terms of their collective bargaining agreements, or if additional segments of our workforce become unionized, we may be subject to work interruptions or stoppages. In addition, work stoppages have occurred in the past as a result of protests by local tribal members. Work stoppages at the facilities of our customers or suppliers may also negatively affect our business. If any of our customers experience a material work stoppage, the customer may halt or limit the purchase of our products. Moreover, if any of our suppliers experience a work stoppage, our operations could be adversely affected if an alternative source of supply is not readily available. Any of these events could be disruptive to our operations and could adversely affect our business, financial position, results of operations, or cash flows.
Terrorist attacks aimed at our facilities or operations could adversely affect our business.
The U.S. government has issued warnings that U.S. energy assets may be the future targets of terrorist organizations. These developments have subjected our operations to increased risks. Any terrorist attack at our facilities, or those of our customers or suppliers, could have a material adverse effect on our business.
We are subject to cyber security risks.
A cyber incident could occur and result in information theft, data corruption, operational disruption and/or financial loss. The oil and gas industry has become increasingly dependent on digital technologies to conduct certain exploration, development, production, processing, distribution and accounting activities. For example, we depend on digital technologies to interpret seismic data, manage drilling rigs, production equipment and gathering transportation systems, conduct reservoir modeling and reserves estimation, and process and record financial and operating data. Pipelines, refineries, power stations and distribution points for both fuels and electricity are becoming interconnected by computer systems. At the same time, cyber incidents, including deliberate attacks or unintentional events, have increased. Our technologies, systems, networks, and those of our vendors, suppliers and other business partners may become the target of cyber attacks or information security breaches that could result in unauthorized release, gathering, monitoring, misuse, loss or destruction of proprietary and other information, or other disruption of business operations. In addition, certain cyber incidents may remain undetected for an extended period. Our systems and insurance coverage for protecting against cyber security risks may not be sufficient. Although to date we have not experienced any material losses relating to cyber attacks, we may suffer such losses in the future. We may be required to expend significant resources to continue to modify or enhance our protective measures or to investigate and remediate any information security vulnerabilities.
Conservation measures and technological advances could reduce demand for oil and gas.
Fuel conservation measures, alternative fuel requirements, increasing consumer demand for alternatives to oil and gas, technological advances in fuel economy and energy generation devices could reduce demand for oil and gas. The impact of the changing demand for oil and gas could have a material adverse effect on our business, financial condition, results of operations and cash flows.
Restrictions on drilling activities intended to protect certain species of wildlife may adversely affect our ability to conduct drilling activities in some of the areas where we operate.
The Endangered Species Act restricts activities that may affect endangered or threatened species or their habitats. Oil and gas activities in our operating areas can be adversely affected by seasonal or permanent restrictions on drilling activities designed to protect various species and their habitat. The U.S. Fish and Wildlife Service in May 2014 proposed a rule to alter how it identifies critical habitat for endangered and threatened species. It is unclear when this rule will be finalized. Seasonal restrictions could limit our ability to operate in protected areas and can intensify competition for drilling rigs, oilfield equipment, services, supplies and qualified personnel, which could lead to periodic shortages when drilling is allowed. These constraints and the resulting shortages or high costs could delay our operations and materially increase our operating and capital costs. Permanent restrictions imposed to protect endangered species could prohibit drilling in certain areas or require the implementation of expensive mitigation measures. The designation of previously unprotected species in areas where we operate as threatened or endangered could cause us to incur increased costs arising from species protection measures and could result in limitations on our exploration and production activities that could have an adverse impact on our ability to develop and produce our reserves.
Compliance with the Sarbanes-Oxley Act of 2002 and other obligations of being a public company requires substantial financial and management resources.
Section 404 of the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”) requires that we evaluate and report on our system of internal controls. If we fail to maintain the adequacy of our internal controls, we could be subject to regulatory scrutiny, civil or criminal penalties and/or stockholder litigation. Any inability to provide reliable financial reports could harm our business. Section 404 of the Sarbanes-Oxley Act also requires that our independent registered public accounting firm report on management’s evaluation of the Company’s system of internal controls. Any failure to maintain the adequacy of our internal controls could harm our operating results or cause us to fail to meet our reporting obligations. Inferior internal controls could also cause investors to lose confidence in our reported financial information that could have a negative effect on the trading price of the shares of our common stock.
Delaware law and our amended and restated charter documents could impede or discourage a takeover that our stockholders may consider favorable.
Our amended and restated charter and bylaws have provisions that could deter, delay or prevent a third party from acquiring us. These provisions include:
●
limitations on the ability of stockholders to amend our charter documents, including stockholder supermajority voting requirements;
●
the inability of stockholders to act by written consent or to call special meetings;
●
a classified board of directors with staggered three-year terms;
●
the authority of our board of directors to issue, without stockholder approval, up to 1,000,000 shares of preferred stock with such terms as the board of directors may determine and to issue additional shares of our common stock; and
●
advance notice procedures with respect to stockholder proposals and the nomination of candidates for election as directors.
Stock prices of equity securities can be volatile, and there is no assurance that a holder of our common stock will be able to resell the common stock purchased at a price in excess of the purchase price.
The stock prices of companies on the U.S. securities markets have been volatile, increasing or decreasing not in response to the company financial or operating results, but the general economic trends or events. In addition, stock prices of companies in the oil and gas industry are significantly affected by commodity prices for oil and gas. In particular, our stock price was very volatile during 2014, trading between $9.65 and $1.00 per share. All of these factors are beyond our control, and could have drastic impacts occurring within short periods of time. These factors could cause a decrease in the stock price following purchase, and a purchaser of our stock may not be able to sell their common stock for a price exceeding the purchase price.
We are currently not in compliance with the New York Stock Exchange’s requirements for continued listing, and therefore may be delisted, which may decrease our stock price and would have a material adverse effect on our liquidity and our business.
On February 3, 2015, we received a letter from the New York Stock Exchange (“NYSE”) notifying us that we no longer met the NYSE’s requirements for continued listing under New York Stock Exchange Listed Company Manual Rule 802.01C (the “Stock Price Rule”), because the average closing price our common stock did not equal or exceed $1.00 per share over a period of 30
consecutive trading days prior to the date of the notification letter. Per the NYSE Listed Company Manual Rule 802.01C, we were afforded six months to regain compliance with the Stock Price Rule. However, if we are not able to regain compliance in the applicable time period, the NYSE will provide written notification to us that our common stock would be subject to delisting from the NYSE.
While we intend to monitor the closing price and average closing price of our common stock and consider available options if our common stock does not trade at a level likely to result in us regaining compliance with the Stock Price Rule by [August 3, 2015] or within any applicable extension period, no assurances can be made that we will in fact be able to comply and that our common stock will remain listed on the NYSE. If our common stock is delisted from the NYSE, such delisting could negatively impact the market price of our common stock, reduce the number of investors willing to hold or acquire our common stock, and limit our ability to issue additional securities or obtain additional financing in the future, and might negatively impact our reputation and, as a consequence, our business.
If our common stock were delisted and determined to be a “penny stock,” a broker-dealer may find it more difficult to trade our common stock and an investor may find it more difficult to acquire or dispose of our common stock in the secondary market.
If our common stock were removed from listing on the NYSE, it may be subject to the so-called “penny stock” rules. The SEC has adopted regulations that define a “penny stock” to be any equity security that has a market price per share of less than $5.00, subject to certain exceptions, such as any securities listed on a national securities exchange. For any transaction involving a “penny stock,” unless exempt, the rules impose additional sales practice requirements on broker-dealers, subject to certain exceptions. If our common shares were delisted and determined to be a “penny stock,” a broker-dealer may find it more difficult to trade our common stock and an investor may find it more difficult to acquire or dispose of our common stock in the secondary market. These factors could significantly negatively affect the market price of our common stock and our ability to raise capital.
Future sales of our common stock in the public or private markets could adversely affect the trading price of our common stock, substantially dilute existing stockholders and our ability to continue to raise funds in new equity offerings.
Future sales of our common stock, or securities convertible into or exercisable for, our common stock in public or private offerings could result in substantial dilution to existing stockholders, could potentially adversely affect the trading price of our common stock and could impair our ability to raise capital through future offerings of securities. This is particularly true if such sales occur at depressed stock prices, such as those currently existing. In addition, the perceived risk of dilution may cause some stockholders to sell their shares, which may further reduce the market price of our common stock.
ITEM 1B.
ITEM 1B.
UNRESOLVED STAFF COMMENTS
None.
ITEM 3.
ITEM 3.
LEGAL PROCEEDINGS
We are not a party to any material pending legal or governmental proceedings, other than ordinary routine litigation incidental to our business. While the ultimate outcome and impact of any proceeding cannot be predicted with certainty, our management believes that the resolution of any of our pending proceedings will not have a material adverse effect on our financial condition or results of operations.
ITEM 4.
ITEM 4.
MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Price Range of Common Stock and Number of Holders
Our common stock is listed on the New York Stock Exchange under the symbol “REN”. The following table sets forth the high and the low sale prices per share of our common stock for the twelve months ended December 31, 2014 and 2013. The closing price of the common stock on February 27, 2015 was $1.06.
As of February 27, 2015, there were approximately 245 record holders of our common stock.
Our warrants were listed on the New York Stock Exchange under the symbol “RENWS.” However, at December 31, 2014, no warrants remain outstanding as all warrants expired on September 25, 2014.
Issuer Purchases of Equity Securities
In connection with the vesting of company restricted common stock under the 2009 Long Term Performance Incentive Plan (“Incentive Plan”), we retain shares of common stock at the election of the recipients of such awards in satisfaction of withholding tax obligations. These shares are retired by the Company.
1)
All shares purchased in 2014 were to offset tax withholding obligations that occur upon the vesting and delivery of outstanding common shares under the terms of the Incentive Plan.
2)
As of December 31, 2014, the maximum number of shares that may yet be purchased would not exceed the employees’ portion of taxes withheld on unvested shares (3,529,080 common shares), shares yet to be granted under the Incentive Plan (2,030,560 shares) and potential Outperformance Shares (827,985 shares).
Dividend Policy
We have not declared any cash dividends on our common stock since inception and have no plans to do so in the foreseeable future. The ability of our Board of Directors to declare any dividend is subject to limits imposed by the terms of our credit agreements and our indenture covering the Senior Notes, which currently prohibit us from paying dividends on our common stock. Our ability to pay dividends is also subject to limits imposed by Delaware law. In determining whether to declare dividends, the Board of Directors will consider the limits imposed by the Revolving Credit Facility, Secured Term Loan, Senior Notes, financial condition, results of operations, working capital requirements, future prospects and other factors it considers relevant.
Comparison of Cumulative Return
The following graph compares the cumulative return on a $100 investment in Resolute common stock on the New York Stock Exchange over the five-year period ended December 31, 2014, to that of the cumulative return on a $100 investment in the Russell
2000 Index and the S&P 500 Energy Index for the same period. In calculating the cumulative return, reinvestment of dividends, if any, is assumed. The indices are included for comparative purpose only. This graph is not “soliciting material,” is not deemed filed with the SEC and is not to be incorporated by reference in any of our filings under the Securities Act or the Exchange Act, whether made before or after the date hereof and irrespective of any general incorporation language in any such filing.
COMPARISON OF CUMULATIVE TOTAL RETURN
AMONG RESOLUTE ENERGY CORPORATION, THE RUSSELL 2000 INDEX
AND THE S&P 500 ENERGY INDEX
ITEM 6.
ITEM 6.
SELECTED FINANCIAL DATA
The following table presents our selected historical financial data for each of the four years ended December 31, 2014. Future results may differ substantially from historical results because of changes in oil and gas prices, production increases or declines and other factors. This information should be read in conjunction with our consolidated financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” presented elsewhere in this report.
ITEM 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
The following discussion and analysis should be read in conjunction with the consolidated financial statements and the related notes contained elsewhere in this report. We are an independent oil and gas company engaged in the acquisition, exploration, development and production of oil, gas and hydrocarbon liquids.
As of December 31, 2014, we estimated net proved reserves were approximately 74.2 MMBoe, of which approximately 45% were proved developed producing reserves and approximately 86% were oil. The standardized measure of our estimated net proved reserves as of December 31, 2014, was $833 million. Our future earnings and cash flow from existing operations are dependent on a variety of factors including commodity prices, exploitation and recovery activities and our ability to manage our overall cost structure at a level that allows for profitable operation.
In view of the current depressed oil and gas price environment, we have adopted an operating and financial plan for 2015 that holds production essentially flat, while preserving capital and paying down debt. We expect to fund our 2015 capital expenditures exclusively from internally generated cash flow. We also continue to explore alternative means to increase activity within our asset base including ongoing evaluation of opportunities in light of the commodity price environment and the evolving drilling, completion and operating cost structure. We also may enter into joint ventures to drill wells on the Company’s acreage.
Outstanding indebtedness at December 31, 2014, consisted of $235 million in Revolving Credit Facility debt, $150 million under the Secured Term Loan Facility and $400 million of Senior Notes. As of December 31, 2014, our Revolving Credit Facility had a borrowing base of $330 million. We expect that this borrowing base will be reduced, perhaps significantly, at the next borrowing base redetermination, which is expected to occur on or about March 31, 2015. We will pursue such actions as are necessary to preserve our liquidity and to remain in compliance with the terms and conditions of our Revolving Credit Facility, Secured Term Loan Facility, and Senior Notes, including additional second lien borrowings, non-core asset sales, sales of other debt or equity securities, and other transactions.
How We Evaluate Our Operations
Our management uses a variety of financial and operational measurements to analyze our operating performance, including but not limited to, production levels, pricing and cost trends, reserve trends, operating and general and administrative expenses, operating cash flow and Adjusted EBITDA (defined below).
Production Levels, Trends and Prices. Oil and gas revenue is the result of our production multiplied by the price that we receive for that production. Because the price that we receive is highly dependent on many factors outside of our control, except to the extent that we have entered into derivative arrangements that can influence our net price either positively or negatively, production is the primary revenue driver over which we have some influence. Although we cannot greatly alter reservoir performance, we can aggressively implement exploitation activities that can increase production or diminish production declines relative to what would have been the case without intervention. Examples of activities that can positively influence production include minimizing production downtime due to equipment malfunction, well workovers and cleanouts, recompletions of existing wells in new parts of the reservoir and expanded secondary and tertiary recovery programs.
The price of oil has been extremely volatile, and we expect that volatility to continue. Given the inherent volatility of oil prices, we plan our activities and budget based on sales price assumptions that we believe to be reasonable. We use derivative contracts to provide a measure of stability to our cash flows in an environment of volatile oil and gas prices and currently have such contracts in place through 2016. These instruments limit our exposure to declines in prices, but also limit our ability to receive the benefit of price increases. Changes in the price of oil or gas will result in the recognition of a non-cash gain or loss recorded in other income or expense due to changes in the future fair value of the derivative contracts. Recognized gains or losses only arise from payments made or received on monthly settlements of derivative contracts or if a derivative contract is terminated prior to its expiration. We typically enter into derivative contracts that cover a significant portion of our estimated future oil and gas production.
Reserve Trends. We acquired the majority of our Aneth Field Properties through two significant purchases from Chevron and ExxonMobil in November 2004 and April 2006, respectively. We acquired our Wyoming Properties in July 2008, our Permian Properties in 2011 and 2012 and Denbury’s interest in the Aneth Field Properties in 2012. Over that period of time, we have added reserves by initiating a complex CO2 tertiary enhanced recovery project in Aneth Field and by drilling vertical, horizontal and slant-hole wells in our various operating areas. In a better product pricing environment, we will seek to add reserves through similar means.
We believe that our knowledge of various domestic onshore operating areas, strong management and staff and solid industry relationships will allow us to locate, capitalize on and integrate strategic acquisition opportunities.
At December 31, 2014, we have estimated net proved reserves of approximately 40.5 MMBoe that were classified as proved developed non-producing and proved undeveloped, as compared to 25.7 MMBoe at December 31, 2013. An estimated 27.6 MMBoe, or 68%, of those reserves at year-end 2014 are attributable to recoveries associated with expansions, extensions and processing of the tertiary recovery CO2 floods that are in operation on the Aneth Field Properties. Approximately 21.1 MMBoe have been added as proved undeveloped, comprised of four CO2 injection projects in the Aneth Field Properties. Additionally, the Permian and Powder River basin properties had active drilling programs in 2014, resulting in 1.7 MMBoe added to proved developed producing from successful drilling of non-proved locations. Furthermore, these successful wells created additional proved undeveloped offset locations carrying 6.0 MMBoe reserves.
Operating Expenses. Operating expenses consist of costs associated with the operation of oil and gas properties and production and ad valorem taxes. Direct labor, repair and maintenance, workovers, utilities, rental equipment, fluids and chemicals and contract services comprise the most significant portion of lease operating expenses. We monitor our operating expenses in relation to production amounts and the number of wells operated. Some of these expenses are relatively independent of the volume of hydrocarbons produced, but may fluctuate depending on the activities performed during a specific period. Other expenses, such as taxes and utility costs, are more directly related to production volumes or reserves. Severance taxes, for example, are charged based on production revenue and therefore are based on the product of the volumes that are sold and the related price received. Ad valorem taxes are generally based on the value of reserves. Because we operate on the Navajo Reservation, we also pay a possessory interest tax, which is effectively an ad valorem tax assessed by the Navajo Nation. Our largest utility expense is for electricity that is used primarily to power the pumps in producing wells and the compressors behind the injection wells. The more fluid that is moved, the greater the amount of electricity that is consumed. Volatility in commodity prices can also lead to changes in demand for drilling rigs, workover rigs, operating personnel and field supplies and services, which in turn can impact the costs of those goods and services.
General and Administrative Expenses. We monitor our general and administrative expenses carefully, attempting to balance costs against the benefits of, among other things, hiring and retaining highly qualified staff who can add value to our asset base. General and administrative expenses include, among other things, salaries and benefits, share-based compensation, general corporate overhead, fees paid to independent auditors, lawyers, petroleum engineers and other professional advisors, costs associated with shareholder reports, investor relations activities, registrar and transfer agent fees, director and officer liability insurance costs and director compensation.
Operating Cash Flow. Operating cash flow is the cash directly derived from our oil and gas properties, before considering such things as administrative expenses and interest costs. Operating cash flow per unit of production is a measure of field efficiency, and can be compared to results obtained by operators of oil and gas properties with characteristics similar to ours in order to evaluate relative performance. Aggregate operating cash flow is a measure of our ability to sustain overhead expenses and costs related to capital structure, including interest expenses.
Adjusted EBITDA. We define Adjusted EBITDA (a non-GAAP measure) as consolidated net income adjusted to exclude interest expense, interest income, income taxes, depletion, depreciation and amortization, impairment expense, accretion of asset retirement obligation, change in fair value of derivative instruments, non-cash share-based compensation expense and noncontrolling interest amounts. Adjusted EBITDA is a financial measure that we report to our lenders and is used as a gauge for compliance with some of the financial covenants under our Revolving Credit Facility and Secured Term Loan Facility.
Adjusted EBITDA is also used as a supplemental liquidity or performance measure by our management and by external users of our financial statements such as investors, commercial banks, research analysts and others, to assess:
●
the ability of our assets to generate cash sufficient to pay interest costs;
●
the financial metrics that support our indebtedness;
●
our ability to finance capital expenditures;
●
financial performance of the assets without regard to financing methods, capital structure or historical cost basis;
●
our operating performance and return on capital as compared to those of other companies in the exploration and production industry, without regard to financing methods or capital structure; and
●
the viability of acquisitions and capital expenditure projects and the overall rates of return on alternative investment opportunities.
Adjusted EBITDA should not be considered an alternative to, or more meaningful than, net income, operating income, cash flows from operating activities or any other measure of financial performance presented in accordance with principles generally accepted in the United States (“GAAP”) as measures of operating performance, liquidity or ability to service debt obligations. Because we have borrowed money to finance our operations, interest expense is a necessary element of our costs and our ability to generate gross margins. Because we use capital assets, depletion, depreciation and amortization are also necessary elements of our costs. Therefore, any measures that exclude these elements have material limitations. To compensate for these limitations, we believe that it is important to consider both net income and net cash provided by operating activities determined under GAAP, as well as Adjusted EBITDA, when evaluating our financial performance and liquidity. Adjusted EBITDA excludes some, but not all, items that affect net income, operating income and net cash provided by operating activities and these measures may vary among companies. Our Adjusted EBITDA may not be comparable to Adjusted EBITDA of any other company because other entities may not calculate Adjusted EBITDA in the same manner.
Factors That Significantly Affect Our Financial Results
Revenue, cash flow from operations and future growth depend on many factors beyond our control, such as economic, political and regulatory developments and competition from other sources of energy. Historical oil prices have been volatile and are expected to fluctuate widely in the future. Sustained periods of low prices for oil could materially and adversely affect our financial position, our results of operations, the quantities of oil and gas that we can economically produce, and our ability to obtain capital.
Like all businesses engaged in the exploration for and production of oil and gas, we face the challenge of natural production declines. As initial reservoir pressures are depleted, oil and gas production from a given well decreases. Thus, an oil and gas exploration and production company depletes part of its asset base with each unit of oil or gas it produces. We attempt to overcome this natural decline by developing existing properties, implementing secondary and tertiary recovery techniques and by acquiring more reserves than we produce. Our future growth will depend on our ability to enhance production levels from existing reserves and to continue to add reserves in excess of production through exploration, development and acquisition. We will maintain our focus on costs necessary to produce our reserves as well as the costs necessary to add reserves through production enhancement, drilling and acquisitions. Our ability to make capital expenditures to increase production from existing reserves and to acquire more reserves is dependent on availability of capital resources, and can be limited by many factors, including the ability to obtain capital in a cost-effective manner and to obtain permits and regulatory approvals in a timely manner.
2015 Guidance
The following table summarizes our current financial and operational estimates for 2015.
(1)
Excludes non-cash items.
2015 Capital Expenditures. As described in the above-table, Resolute expects to invest between $45 million and $50 million in 2015 in the plan, including completions, minimal facilities construction and upgrades, purchase of CO2, leasing and other corporate capital. Approximately 42 percent of that capital budget will be spent in the Permian Basin, 36 percent in Aneth Field (including CO2
purchases) and 22 percent in the Powder River Basin, leasing and other corporate capital. The Company expects to fund 2015 capital expenditures exclusively from internally generated cash flow.
Resolute will evaluate its capital expenditures in relation to its cash flow and may adjust its activity and capital spending levels based on changes in commodity prices, the cost of goods and services, production results and other considerations.
Please read “Quantitative and Qualitative Disclosures about Market Risk - Commodity Price Risk and Derivative Arrangements” which summarizes our derivative positions for 2015.
Results of Operations
For the purposes of management’s discussion and analysis of the results of operations, management has analyzed the operational results for the twelve months ended December 31, 2014, in comparison to results for the twelve months ended December 31, 2013 and 2012.
The following table presents our sales volumes, revenues and operating expenses, and sets forth our sales prices, costs and expenses on a Boe basis for 2014, 2013 and 2012.
Year Ended December 31, 2014, Compared to the Year Ended December 31, 2013
Revenue. Revenue from oil and gas activities decreased to $329.4 million during 2014, from $349.8 million during 2013. The $20.4 million decrease in revenue was attributable to $34.4 million in commodity price decreases ($70.90 per Boe in 2014 versus $78.30 per Boe in 2013) offset by increased production of $14.0 million. Sales volumes increased 4% to 4,645 during 2014 as compared to 4,467 MBoe during 2013 primarily due to drilling activities during 2014.
Operating Expenses. Lease operating expenses increased to $112.7 million during 2014, from $103.3 million during 2013. The $9.4 million, or 9%, increase was primarily due to additional operating expenses associated with increased operational activity in the Permian Basin. On a unit of production basis, lease operating expense increased 5% to $24.26 per Boe in 2014 from $23.12 per Boe in 2013.
Production and ad valorem taxes decreased by 8% to $37.2 million during 2014, versus $40.4 million during 2013, mainly due to comparatively greater revenues generated in areas with lower tax rates. Production and ad valorem taxes were 11% of total revenue in 2014 and 12% in 2013.
General and administrative expenses increased to $40.0 million during 2014, as compared to $35.6 million during 2013. The $4.4 million, or 12%, increase resulted from additional personnel expense from short-term incentive compensation, as the Company met or exceeded its guidance metrics during 2014, offset by overhead billings and capitalized expense. Cash-based general and administrative expense was $24.5 million, or $5.27 per Boe in 2014, compared to $21.7 million, or $4.85 per Boe in 2013. Share-based compensation expense represented $15.5 million, or $3.34 per Boe, during 2014 and $14.0 million, or $3.13 per Boe, during 2013.
Depletion, depreciation, amortization and accretion expenses increased to $132.2 million during 2014, as compared to $116.3 million during 2013. The $15.9 million, or 14%, increase is principally attributable to an increase in the depletion, depreciation and amortization rate due to an increase in future development costs included in the 2014 amortization base and the 4% increase in 2014 production. On a per unit basis depreciation, amortization and accretion expenses increased to $28.45 per Boe in 2014 from $26.04 per Boe in 2013.
Pursuant to full cost accounting rules, we perform ceiling tests each quarter on our proved oil and gas assets. We recorded a $120 million and $188 million non-cash impairment of the carrying value of our proved oil and gas properties at December 31, 2014 and 2013, respectively, as a result of the ceiling test limitation. The 2014 impairment resulted primarily from lower oil prices realized during the fourth quarter of 2014, while the 2013 impairment resulted primarily from the SEC “five year rule” for PUD properties. In addition, our estimate of proved reserves as of December 31, 2014 was based on a pricing methodology required by SEC rules. This commodity price assumption used in calculating our reserves significantly exceeds the current market price of oil and gas. Therefore it is likely that we will have substantial downward adjustments in our estimated proved reserves in the future if the current low commodity price environment persists.
Other Income (Expense). All oil and gas derivative instruments are accounted for under mark-to-market accounting rules, which provide for the fair value of the contracts to be reflected as either an asset or a liability on the balance sheet. The change in the fair value during an accounting period is reflected in the income statement for that period. During 2014 the gain on oil and gas commodity derivatives was $118.1 million. This amount included $123.1 million of mark-to-market gains on oil and gas derivatives offset by $5.0 million of derivative settlement losses. During 2013 the loss on oil and gas commodity derivatives totaled $15.3 million. This amount included $35.8 million of derivative settlement losses offset by $20.5 million of mark-to-market gains.
Interest expense was $31.5 million during 2014 as compared to $29.3 million during 2013. The $2.2 million, or 7%, increase is attributable to $1.5 million of increased interest expense due to increased levels of borrowings and $0.9 million of decreased capitalized interest due to lower unproved oil and gas property balances during 2014. The components of our interest expense are as follows (in thousands):
Income Tax Benefit (Expense). Income tax benefit recognized during 2014 was $4.1 million, or 16% of the loss before income taxes, as compared to income tax benefit of $64.7 million, or 36% of the loss before income taxes in 2013. The decrease in the effective tax rate over 2013 is the result of permanent differences related to share-based compensation. Income tax expense differs from the amount that would be provided by applying the statutory U.S. federal income tax rate of 35% due to state income taxes and estimated permanent differences. We carried a $1 million non-current deferred tax asset at December 31, 2014, for which no valuation allowance was recorded as it is more likely than not that the asset will be realized due to projected future taxable income.
Year Ended December 31, 2013, Compared to the Year Ended December 31, 2012
Revenue. Revenue from oil and gas activities increased to $349.8 million during 2013, from $258.3 million during 2012. The $91.5 million increase in revenue was attributable to $80.2 million in increased production and $11.3 million in commodity price increases ($75.77 per Boe in 2012 versus $78.30 per Boe in 2013). Sales volumes in 2013 increased 31% as compared to 2012, from 3,409 MBoe to 4,467 MBoe, primarily due to wells associated with the Permian Acquisitions and drilling activities during 2013.
Operating Expenses. Lease operating expenses increased to $103.3 million during 2013, from $79.9 million during 2012. The $23.4 million, or 29%, increase was due to additional operating expenses associated with the Permian Acquisitions and increased operational activity in the Permian Basin, offset by decreased lease operating expenses related to our Wyoming Properties and properties divested in North Dakota. On a unit of production basis, lease operating expense decreased 1% from $23.45 per Boe in 2012 to $23.12 per Boe in 2013.
Production and ad valorem taxes increased by 13% to $40.4 million during 2013, versus $35.7 million during 2012, mainly due to the increase in production during 2013. Production and ad valorem taxes were 12% of total revenue in 2013 and 14% in 2012.
General and administrative expenses increased to $35.6 million during 2013, as compared to $24.0 million during 2012. The $11.6 million, or 48%, increase resulted from increases in salaries and burdens associated with expanded operations, share-based compensation expense, corporate overhead and professional services fees, offset by increased overhead billings and capitalized expense. Cash-based general and administrative expense was $21.7 million, or $4.85 per Boe in 2013, compared to $15.3 million, or $4.49 per Boe in 2012. Share-based compensation expense represented $14.0 million, or $3.13 per Boe, during 2013 and $8.7 million, or $2.56 per Boe, during 2012.
Depletion, depreciation, amortization and accretion expenses increased to $116.3 million during 2013, as compared to $78.4 million during 2012. The $37.9 million, or 48%, increase is principally due to a higher depletable base, higher finding costs and the 31% increase in production during 2013.
Pursuant to full cost accounting rules, we perform ceiling tests each quarter on our proved oil and gas assets. We recorded a $188 million non-cash impairment of the carrying value of our proved oil and gas properties at December 31, 2013, as a result of the ceiling test limitation. No provision for impairment was recorded in 2012.
Other Income (Expense). All oil and gas derivative instruments are accounted for under mark-to-market accounting rules, which provide for the fair value of the contracts to be reflected as either an asset or a liability on the balance sheet. The change in the fair value during an accounting period is reflected in the income statement for that period. During 2013 the loss on oil and gas commodity derivatives was $15.3 million. This amount included $35.8 million of derivative settlements, including $10.7 million paid to restructure or terminate certain derivative contracts, offset by $20.5 million of mark-to-market gains on oil and gas derivatives. During 2012 the loss on oil and gas commodity derivatives totaled $5.2 million, including $22.9 million of derivative settlements, of which $3.4 million was related to partial terminations of certain derivative contracts, offset by $28.1 million of mark-to-market gains.
Interest expense was $29.3 million during 2013 as compared to $15.5 million during 2012. The $13.8 million, or 89%, increase is attributable to a partial year of interest expense related to the Senior Notes issuances in 2012 versus a full year of interest expense in 2013 and a higher average debt balance during 2013. The components of our interest expense are as follows (in thousands):
Income Tax Benefit (Expense). Income tax benefit recognized during 2013 was $64.7 million, or 36% of loss before income taxes, as compared to income tax expense of $11.9 million, or 40% of income before income taxes in 2012. The decrease in the effective tax rate over 2012 is the result of the weighted change in tax jurisdictions in which we currently operate combined with permanent differences related to share-based compensation. Income tax expense differs from the amount that would be provided by applying the statutory U.S. federal income tax rate of 35% due to state income taxes and estimated permanent differences. We carried an $8.3 million current deferred tax asset at December 31, 2013, for which no valuation allowance was recorded as it is more likely than not that the asset will be realized due to projected future taxable income.
Liquidity and Capital Resources
Our primary sources of liquidity have been cash generated from operations, amounts available under our Revolving Credit Facility, proceeds from the issuance of debt and equity securities and sales of oil and gas properties. For purposes of Management’s Discussion and Analysis of Liquidity and Capital Resources, we have analyzed our cash flows and capital resources for the years ended December 31, 2014, 2013 and 2012.
Net cash provided by operating activities during 2014 was $143.5 million, as compared to $133.3 million during 2013 and $76.8 million during 2012. The increase in net cash provided by operating activities in 2014 over 2013 was primarily due to changes in working capital. The increase in 2013 over 2012 was primarily due to an increase in revenue from oil and gas activities and changes in working capital. In 2015, reflecting the current product pricing environment, we expect to limit our capital expenditures to cash flow generated by our operations.
Net cash used in investing activities was $175.9 million during 2014 as compared to $405.5 million during 2013 and $447.4 million during 2012. The primary investing activity in 2014 was cash used for capital expenditures of $183.6 million. Capital expenditures consisted primarily of $25.6 million in compression and facility and drilling projects in Aneth Field, $16.3 million in CO2 acquisition, $122.9 million in drilling activities and infrastructure projects in the Permian Basin of west Texas and $18.5 million in drilling and completion activities in our Wyoming Properties. Capital divestitures included $6.6 million of proceeds from the sale of certain operated properties in the Bakken trend of North Dakota and $4.4 million of proceeds from the sale of certain interests in the Delaware basin. The primary investing activity for 2013 was cash used for capital expenditures of $519.7 million. Capital expenditures consisted of $258 million paid to acquire additional Permian Properties, $46.0 million in compression facility and drilling projects in Aneth field, $20.0 million in CO2 acquisition, $135.1 million in drilling activities and infrastructure projects in the Permian Basin, $13.2 million in additional acreage acquisition in the Permian Basin, $34.6 million in drilling and completion activities in the Bakken trend of North Dakota and $12.5 million in drilling and recompletion activities in our Wyoming properties. Capital divestitures include $50.2 million received from NNOGC for the sale of certain working interests in the Aneth Field Properties, $70.1 million of proceeds from the sale of certain properties in the Bakken trend of North Dakota and $1.0 million for the sale of certain working interests in other Permian properties. The primary investing activity in 2012 was cash used for capital expenditures of $498.8 million. Capital expenditures consisted of $248.0 million paid to acquire the additional Permian Properties, $37.7 million paid for the Denbury Acquisition, $47.9 million in compression, facility and drilling projects in Aneth Field, $16.2 million in CO2 acquisition, $82.3 million in drilling activities and infrastructure projects in the Permian Basin, $69.2 million in drilling and completion activities in the Bakken Properties and $12.6 million in recompletion and drilling activities in our Wyoming properties. Capital divestitures include $49.5 million received from NNOGC for the sale of certain working interests in the Aneth Field Properties. A portion of these capital costs are accrued and not paid at period end.
Net cash provided by financing activities was $36.8 million in 2014 as compared to $271.3 million in 2013 and $370.5 million in 2012. The primary financing activity in 2014 was $139.5 million in net proceeds from the issuance of the Secured Term Loan Facility and $100 million in net repayment of borrowings under the Revolving Credit Facility. The primary financing activities in 2013 were net borrowings of $173.0 million under the Revolving Credit Facility and $101.8 million in net proceeds received from the issuance of common stock. The primary financing activities in 2012 were $401.9 million in proceeds received from the issuance of the Senior Notes, partially offset by $8.0 million in net payments under the Revolving Credit Facility and $10.0 million paid to retire a portion of our warrants.
If cash flow from operating activities does not meet expectations, we may reduce our expected level of capital expenditures and/or fund a portion of our capital expenditures using borrowings under our Revolving Credit Facility (if available), issuances of additional second lien debt or other debt or equity securities or from other sources, such as asset sales. We have in place an effective shelf registration statement, with a remaining capacity of $394 million; however our ability to access this capacity may be substantially limited by applicable shelf eligibility rules. There can be no assurance that needed capital will be available on acceptable terms or at all. Our ability to raise funds through the incurrence of additional indebtedness could be limited by the covenants in our Revolving Credit Facility, Secured Term Loan Facility, or Senior Notes. If we are unable to obtain funds when needed or on acceptable terms, we may not be able to complete acquisitions that may be favorable to us or finance the capital expenditures necessary to maintain production or proved reserves.
Our Revolving Credit Facility and our Secured Term Loan Facility require us to enter into derivative agreements covering at least 70% of our anticipated production from proved properties on a rolling twenty four month basis, but prohibit us from entering into derivative arrangements for more than (i) 85% of our anticipated production from proved properties in the next two years and (ii) the greater of 75% of our anticipated production from proved properties or 85% of our production from projected proved developed producing reserves using economic parameters specified in our Revolving Credit Facility.
We plan to continue our practice of hedging a significant portion of our production through the use of various commodity derivative transactions. Our existing derivative transactions have not been designated as cash flow hedges, and we anticipate that future transactions will receive similar accounting treatment. Derivative settlements usually occur within five days of the end of the month. As is typical in the oil and gas industry, however, we do not generally receive the proceeds from the sale of our oil production until the 20th day of the month following the month of production. As a result, when commodity prices increase above the fixed price in the derivative contacts, we will be required to pay the derivative counterparty the difference between the fixed price in the derivative contract and the market price before receiving the proceeds from the sale of the hedged production. If this occurs, we may use working capital or borrowings under the credit facility to fund our operations.
Revolving Credit Facility
Our Revolving Credit Facility is with a syndicate of banks led by Wells Fargo Bank, National Association, as Administrative Agent, and Bank of Montreal, as Syndication Agent with Resolute as the borrower. The Revolving Credit Facility specifies a maximum borrowing base as determined by the lenders. The determination of the borrowing base takes into consideration the estimated value of our oil and gas properties in accordance with the lenders’ customary practices for oil and gas loans. The borrowing base is redetermined semi-annually, and the amount available for borrowing could be increased or decreased as a result of such redeterminations. We expect that the current borrowing base of $330 million will be reduced, perhaps significantly, at the next borrowing base redetermination, which will be effective on or about March 31, 2015. Under certain circumstances, either the Company or the lenders may request an interim redetermination.
In March 2013 we entered into the Sixth Amendment, which among other things, also extended the maturity date of the Revolving Credit Facility from April 2017 to March 2018. On March 7, 2014, we entered into the Ninth Amendment to the amended and restated Revolving Credit Facility which redefined and adjusted the Maximum Leverage Ratio to (a) 4.90:1.00 for the fiscal quarters ending March 31, 2014, and June 30, 2014, (b) 4.75:1.00 for the fiscal quarters ending September 30, 2014, and December 31, 2014, and (c) 4.00:1.00 for all quarters thereafter. The Ninth Amendment also provided that as of the last day of each fiscal quarter in 2014 the ratio of senior secured debt as of such date to Adjusted EBITDA as defined in the Revolving Credit Facility for the four quarter period ending on such date may not exceed 2.75:1.00.
In December 2014 we entered into the Eleventh Amendment to the amended and restated Revolving Credit Facility agreement. In connection with the Eleventh Amendment, the borrowing base was set at $330 million and certain other amendments were made, including eliminating the total debt-to-EBITDA covenant and conforming the covenant package in the Revolving Credit Facility to that of the Secured Term Loan Facility. The covenants require, among other things, maintenance of certain ratios, measured on a quarterly basis, as follows: (i) secured debt to EBITDA of no more than 3.5 to 1.0, (ii) PV-10 of total proved reserves to total secured debt of at least 1.1 to 1.0, rising over time to 1.5 to 1.0, and (iii) PV-10 of proved developed reserves to total secured debt of at least 1.0 to 1.0. Our Revolving Credit Facility and our Secured Term Loan Facility also require us to enter into derivative agreements covering at least 70% of our anticipated production from proved properties on a rolling twenty four month basis, but prohibit us from entering into derivative arrangements for more than (i) 85% of our anticipated production from proved properties in the next two years and (ii) the greater of 75% of our anticipated production from proved properties or 85% of our production from projected proved developed producing reserves using economic parameters specified in our Revolving Credit Facility.
Each base rate borrowing under the Revolving Credit Facility accrues interest at either (a) the London Interbank Offered Rate, plus a margin which varies from 1.50% to 2.50% or (b) the alternative Base Rate defined as the greater of (i) the Administrative
Agent’s Prime Rate (ii) the Federal Funds effective Rate plus 0.5% or (iii) an adjusted London Interbank Offered Rate (“LIBOR”) plus a margin which ranges from 0.50% to 1.50%. Each such margin is based on the level of utilization under the borrowing base.
As of December 31, 2014, outstanding borrowings were $235 million under the borrowing base of $330 million. The borrowing base availability is reduced by $3.1 million in conjunction with letters of credit issued to vendors at December 31, 2014. To the extent that the borrowing base, as adjusted from time to time, exceeds the outstanding balance, no repayments of principal are required prior to maturity. However, should the borrowing base be set at a level below the outstanding balance, we would be required to eliminate that excess over the 120 days following that determination. The Revolving Credit Facility is guaranteed by all of our subsidiaries and is collateralized by substantially all of the proved oil and gas assets of Resolute Aneth, LLC, Resolute Wyoming, Inc. and Resolute Natural Resources Southwest, LLC, which are wholly-owned subsidiaries of the Company.
As of December 31, 2014, the weighted average interest rate on the outstanding balance under the Credit Facility was 2.17%. The recorded value of the Credit Facility approximates its fair market value because the interest rate of the Credit Facility is variable over the term of the loan (See Note 5 to the Consolidated Financial Statements).
The Credit Facility includes customary terms and covenants that place limitations on certain types of activities, the payment of dividends, and require satisfaction of certain financial tests. We were in compliance with all terms and covenants of the Credit Facility at December 31, 2014.
Resolute Energy Corporation, the stand-alone parent entity, has insignificant independent assets and no operations. There are no restrictions on our ability to obtain cash dividends or other distributions of funds from our subsidiaries, except those imposed by applicable law.
Secured Term Loan Agreement
On December 30, 2014, we and certain of our subsidiaries, as guarantors, entered into a second lien Secured Term Loan Agreement with Bank of Montreal, as administrative agent, and the lenders party thereto, pursuant to which we borrowed $150 million. Funding of the Secured Term Loan Facility occurred on December 31, 2014. The Secured Term Loan Facility will mature on the date that is six months after the maturity of our existing Revolving Credit Facility, but in no event later than November 1, 2019.
Net proceeds from the Secured Term Loan Facility, approximately $135 million after payment of transaction-related fees, expenses and discounts, were used to repay outstanding amounts under the Revolving Credit Facility.
Obligations under the Secured Term Loan Facility are guaranteed by certain of our subsidiaries and secured by second priority liens on substantially all of our assets and our subsidiaries that serve as collateral under the Revolving Credit Facility.
Borrowings under the Secured Term Loan Facility will bear interest at adjusted LIBOR plus 10%, with a 1% LIBOR floor. The covenants in the Secured Term Loan Facility require, among other things, maintenance of certain ratios, measured on a quarterly basis, as follows: (i) secured debt to EBITDA of no more than 3.5 to 1.0, (ii) PV-10 of total proved reserves to total secured debt of at least 1.1 to 1.0, rising over time to 1.5 to 1.0, and (iii) PV-10 of proved developed reserves to total secured debt of at least 1.0 to 1.0. In addition, the Secured Term Loan facility contains certain covenants relating to commodity price hedging described above under “Revolving Credit facility.”
We may prepay all or a portion of the Secured Term Loan Facility at any time. The Secured Term Loan Facility is subject to mandatory prepayments of 75% of the net cash proceeds from asset sales, subject to a limited right to reinvest proceeds in oil and gas activities. Prepayments made out of proceeds from asset sales are not subject to prepayment premiums. Mandatory repayments are required of 100% of the net cash proceeds of certain debt or equity issuances. Such prepayments are subject to a premium of between 10% declining to 2% during the first 36 months after closing. To the extent not otherwise achieved, aggregate repayments that substantially pay off principal amounts under the Secured Term Loan Facility shall include an additional payment sufficient to ensure that the lenders achieve a 1.25 to 1.0 minimum multiple of their invested capital.
Senior Notes
In April 2012 we consummated a private placement of senior notes with a principal amount of $250 million, and a follow on issuance of senior notes with a principal amount of $150 million. The Senior Notes are due May 1, 2020, and bear an annual interest rate of 8.50% with the interest on the notes is payable semiannually in cash on May and November 1 of each year.
The Senior Notes were issued under an Indenture (the “Indenture”) among the Company, our existing subsidiaries (the “Guarantors”) and U.S. Bank National Association, as trustee (the “Trustee”) in a private transaction not subject to the registration requirements of the Securities Act of 1933. In March 2013, the Company registered the Senior Notes with the Securities and Exchange Commission by filing an amendment to the registration statement on Form S-4 enabling holders of the Senior Notes to exchange the privately placed Notes for publically registered Notes with substantially identical terms. The Indenture contains affirmative and negative covenants that, among other things, limit our and the Guarantors’ ability to make investments, incur additional indebtedness or issue preferred stock, create liens, sell assets, enter into agreements that restrict dividends or other payments by restricted subsidiaries, consolidate, merge or transfer all or substantially all of our assets, engage in transactions with our affiliates, pay dividends or make other distributions on capital stock or prepay subordinated indebtedness and create unrestricted subsidiaries. The Indenture also contains customary events of default. Upon occurrence of events of default arising from certain events of bankruptcy or insolvency, the Senior Notes shall become due and payable immediately without any declaration or other act of the Trustee or the holders of the Senior Notes. Upon the occurrence of certain other events of default, the Trustee or the holders of the Senior Notes may declare all outstanding Senior Notes to be due and payable immediately. We were in compliance with all financial covenants under our Senior Notes as of December 31, 2014.
The Senior Notes are general unsecured senior obligations of the Company and guaranteed on a senior unsecured basis by the Guarantors. The Senior notes rank equally in right of payment with all existing and future senior indebtedness of the Company, will be subordinated in right of payment to all existing and future senior secured indebtedness of the Guarantors, will rank senior in right of payment to any future subordinated indebtedness of the Company and will be fully and unconditionally guaranteed by the Guarantors on a senior basis.
The Senior Notes are redeemable by us on or after May 1, 2016, on not less than 30 or more than 60 days prior notice, at redemption prices set forth in the Indenture. In addition, at any time prior to May 1, 2015, we may use the net proceeds from equity offerings and warrant exercises to redeem up to 35% of the principal amount of notes issued under the Indenture at a redemption price equal to 108.50% of the principal amount of the notes redeemed, plus accrued and unpaid interest. The Senior Notes may also be redeemed at any time prior to May 1, 2016, at the option of the Company at a redemption price equal to 100% of the principal amount of the notes redeemed plus the applicable premium, and accrued and unpaid interest and additional interest, if any, to the applicable redemption date as set forth in the Indenture. If a change of control occurs, each holder of the Notes will have the right to require that we purchase all of such holder’s Notes in an amount equal to 101% of the principal of such Notes, plus accrued and unpaid interest, if any, to the date of the purchase.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet financing arrangements other than operating leases and have not guaranteed any debt or commitments of other entities or are party to any options on non-financial assets.
Contractual Obligations
We had the following contractual obligations and commitments for the next five years as of December 31, 2014:
1)
Represents the outstanding principal amount under our Revolving Credit Facility. This table does not include future commitment fees, interest expense or other fees because the Revolving Credit Facility is a floating rate instrument, and we cannot determine with accuracy the timing of future loan advances, repayments or future interest rates to be charged.
2)
Operating equipment leases consist of compressors and other oil and gas field equipment used in the CO2 project.
3)
Under the terms of our purchase agreement with ExxonMobil, we are obligated to make annual deposits into an escrow account that will be used to fund plugging and abandonment liabilities associated with the ExxonMobil Properties.
4)
Represents purchase commitments in effect at December 31, 2014, related to construction projects in the Aneth Field Properties.
5)
Represents the minimum take-or-pay quantities associated with our existing CO2 purchase contracts. For purposes of calculating the future purchase obligation under these contracts, we have assumed the purchase price over the term of the contract was the price in effect as of December 31, 2014.
6)
Total contractually obligated payment commitments do not include the anticipated settlement of derivative contracts, obligations to taxing authorities or amounts relating to our asset retirement obligations, which include plugging and abandonment obligations, due to the uncertainty surrounding the ultimate settlement amounts and timing of these obligations.
Critical Accounting Policies
The discussion and analysis of our financial condition and results of operations is based upon the consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosure of contingent assets and liabilities. The application of accounting policies involve judgments and uncertainties to such an extent that there is reasonable likelihood that materially different amounts could have been reported under different conditions, or if different assumptions had been used. We evaluate estimates and assumptions on a regular basis. We base estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ, perhaps materially, from these estimates and assumptions used in the preparation of our financial statements. Provided below is an expanded discussion of our most significant accounting policies, estimates and judgments used in the preparation of the financial statements.
Oil and Gas Properties. We use the full cost method of accounting for oil and gas producing activities. All costs incurred in the acquisition, exploration and development of properties, including costs of unsuccessful exploration, costs of surrendered and abandoned leaseholds, delay lease rentals and the fair value of estimated future costs of site restoration, dismantlement and abandonment activities, improved recovery systems and a portion of general and administrative and operating expenses are capitalized on a country wide basis (the “Cost Center”).
We conduct tertiary recovery projects on a portion of our oil and gas properties in order to recover additional hydrocarbons that are not recoverable from primary or secondary recovery methods. Under the full cost method, all development costs are capitalized at the time incurred. Development costs include charges associated with access to and preparation of well locations, drilling and
equipping development wells, test wells, and service wells including injection wells; acquiring, constructing, and installing production facilities and providing for improved recovery systems. Improved recovery systems include all related facility development costs and the cost of the acquisition of tertiary injectants, primarily purchased CO2. The development cost related to CO2 purchases are incurred solely for the purpose of gaining access to incremental reserves not otherwise recoverable. The accumulation of injected CO2, in combination with additional purchased and recycled CO2, provide future economic value over the life of the project.
In contrast, other costs related to the daily operation of the improved recovery systems are considered production costs and are expensed as incurred. These costs include, but are not limited to, costs incurred to maintain reservoir pressure, compression, electricity, separation, and re-injection of recovered CO2 and water.
Capitalized general and administrative and operating costs include salaries, employee benefits, costs of consulting services and other specifically identifiable capital costs and do not include costs related to production operations, general corporate overhead or similar activities.
Investments in unproved properties are not depleted, pending determination of the existence of proved reserves. Unproved properties are periodically evaluated for impairment. Unproved properties whose costs are individually significant are assessed individually by considering the primary lease terms of the properties, the holding period of the properties, and geographic and geologic data obtained relating to the properties. Properties are grouped for purposes of assessing impairment when it is not practicable to assess the amount of impairment of properties on an individual basis. The amount of impairment assessed is added to the costs to be amortized.
Pursuant to full cost accounting rules, we must perform a ceiling test each quarter on our proved oil and gas assets. The ceiling test provides that capitalized costs less related accumulated depletion and deferred income taxes for each Cost Center may not exceed the sum of (1) the present value of future net revenue from estimated production of proved oil and gas reserves using current prices, excluding the future cash outflows associated with settling asset retirement obligations that have been accrued on the balance sheet, and a discount factor of 10%; plus (2) the cost of properties not being amortized, if any; plus (3) the lower of cost or estimated fair value of unproved properties included in the costs being amortized, if any; less (4) income tax effects related to differences in the book and tax basis of oil and gas properties. Should the net capitalized costs for a Cost Center exceed the sum of the components noted above, an impairment charge would be recognized to the extent of the excess capitalized costs.
No gain or loss is recognized upon the sale or abandonment of undeveloped or producing oil and gas properties unless the sale represents a significant portion of oil and gas properties and the gain significantly alters the relationship between capitalized costs and proved oil reserves of the Cost Center.
Depletion and amortization of oil and gas properties is computed on the unit-of-production method based on proved reserves. Amortizable costs include estimates of asset retirement obligations and future development costs of proved reserves, including, but not limited to, costs to drill and equip development wells, constructing and installing production and processing facilities, and improved recovery systems including the cost of required future CO2 purchases.
Oil and Gas Reserve Quantities. Our estimate of proved reserves is based on the quantities of oil and gas that engineering and geological analyses demonstrate, with reasonable certainty, to be recoverable from established reservoirs in the future under current operating and economic parameters. Reserves and their relation to estimated future net cash flows affect our depletion and impairment calculations. As a result, adjustments to depletion and impairment are made concurrently with changes to reserves estimates. We prepare reserves estimates, and the projected cash flows derived from these reserves estimates, in accordance with SEC and FASB guidelines. The accuracy of our reserves estimates is a function of many factors including but not limited to the following: the quality and quantity of available data, the interpretation of that data, the accuracy of various mandated economic assumptions and the judgments of the individuals preparing the estimates. Our proved reserves estimates are a function of many assumptions, any or all of which could deviate significantly from actual results. As such, reserves estimates may vary materially from the ultimate quantities of oil, gas and NGL eventually recovered.
Derivative Instruments. We enter into commodity derivative contracts to manage our exposure to oil and gas price volatility and these contracts may take the form of swaps, puts, calls, collars and other such arrangements. Derivative instruments are recognized on the balance sheet as either assets or liabilities measured at fair value. We have not elected to apply cash flow hedge accounting. Consequently, we recognize gains and losses in earnings rather than deferring such amounts in other comprehensive income as would be allowed under cash flow hedge accounting. Realized gains and losses on derivative instruments are recognized in the period in which the related contract is settled. Both the realized and mark-to-market gains and losses on derivative instruments are reflected in other income (expense) in the consolidated statements of income. Cash flows from derivatives are reported as cash flows from operating activities.
Asset Retirement Obligations. Asset retirement obligations relate to future costs associated with the plugging and abandonment of oil and gas wells, removal of equipment and facilities from leased acreage and returning such land to its original condition. The fair value of a liability for an asset retirement obligation is recorded in the period in which it is incurred (typically when the asset is installed at the production location), and the cost of such liability increases the carrying amount of the related long-lived asset by the same amount. The liability is accreted each period and the capitalized cost is depleted on a units-of-production basis as part of the full cost pool. Revisions to estimated retirement obligations result in adjustments to the related capitalized asset and corresponding liability.
Our estimated asset retirement obligation liability is based on estimated economic lives, estimates as to the cost to abandon the wells in the future, and federal and state regulatory requirements. The liability is discounted using a credit-adjusted risk-free rate estimated at the time the liability is incurred or revised. Revisions to the liability could occur due to changes in estimated abandonment costs or well economic lives, or if federal or state regulators enact new requirements regarding the abandonment of wells.
Business Combinations. We account for all business combinations using the acquisition method which involves the use of significant judgment. Under the acquisition method of accounting, a business combination is accounted for based on the fair value of the consideration given. The assets and liabilities acquired are measured at fair value and the purchase price is allocated to the assets and liabilities based on these fair values. The excess of the cost of an acquisition, if any, over the fair value of the assets acquired and liabilities assumed is recognized as goodwill. The excess of the fair value of assets acquired and liabilities assumed over the cost of an acquisition, if any, is recognized immediately in earnings as a gain. Determining the fair values of the assets and liabilities acquired involves the use of judgment since fair values are not always readily determinable. Different techniques may be used to determine fair values, including market prices (where available), appraisals, comparisons to transactions for similar assets and liabilities and the present value of estimated future cash flows, among others.
Share-Based Compensation. Share-based compensation expense is measured at the estimated grant date fair value of the awards and is amortized over the requisite service period (usually the vesting period). We estimate forfeitures in calculating the cost related to share-based compensation as opposed to recognizing these forfeitures and the corresponding reduction in expense as they occur.
Revenue Recognition. Oil and gas revenue is recognized when production is sold to a purchaser at a fixed or determinable price, when delivery has occurred and title has transferred and the collectability of the revenue is probable. Oil and gas revenue is recorded using the sales method.
Income taxes. Deferred tax assets and liabilities are recorded to account for the expected future tax consequences of events that have been recognized in the financial statements and tax returns. The ability to realize the deferred tax assets is routinely assessed. If the conclusion is that it is more likely than not that some portion or all of the deferred tax assets will not be realized, the tax asset would be reduced by a valuation allowance. The future taxable income is considered when making such assessments. Numerous judgments and assumptions are inherent in the determination of future taxable income, including factors such as future operating conditions (particularly as related to prevailing oil and gas prices). Income tax positions are also required to meet a more-likely-than-not recognition threshold to be recognized in the financial statements. Tax positions that previously failed to meet the more-likely-than-not threshold are recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not threshold are derecognized in the first subsequent financial reporting period in which that threshold is no longer met.
ITEM 7A.
ITEM 7A.
QUANTITIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Commodity Price Risk and Derivative Arrangements
Our major market risk exposure is in the pricing applicable to oil and gas production. Realized pricing on our unhedged volumes of production is primarily driven by the spot market prices applicable to oil production and the prevailing price for gas. Oil and gas prices have been volatile and unpredictable for several years, and we expect this volatility to continue in the future. The prices we receive for unhedged production depend on many factors outside of our control.
We employ derivative instruments such as swaps, puts, calls, collars and other such agreements. The purpose of these instruments is to manage our exposure to commodity price risk in order to provide a measure of stability to our cash flows in an environment of volatile oil and gas prices.
Under the terms of our Revolving Credit Agreement and our Secured Term Loan Agreement the form of derivative instruments to be entered into is at our discretion, but require us to enter into derivative agreements covering at least 70% of our anticipated production from proved properties on a rolling twenty four month basis not to exceed (i) 85% of our anticipated production from proved properties in the next two years and (ii) the greater of 75% of our anticipated production from proved properties or 85% of our anticipated production from proved developed producing properties utilizing economic parameters specified in our credit agreement, including escalated prices and costs.
By removing the price volatility from a significant portion of our oil and gas production, we have mitigated, but not eliminated, the potential effects of volatile prices on cash flow from operations for the periods hedged. While mitigating negative effects of falling commodity prices, certain of these derivative contracts also limit the benefits we would receive from increases in commodity prices. It is our policy to enter into derivative contracts only with counterparties that are major, creditworthy financial institutions deemed by management as competent and competitive market makers. Resolute is exposed to credit risk to the extent of nonperformance by the counterparties in the derivative contracts discussed above. All counterparties are lenders under our Revolving Credit Facility. Accordingly, Resolute is not required to provide any credit support to its counterparties other than cross collateralization with the properties securing the Credit Facility. Resolute’s derivative contracts are documented with industry standard contracts known as a Schedule to the Master Agreement and International Swaps and Derivative Association, Inc. Master Agreement (“ISDA”). Typical terms for each ISDA include credit support requirements, cross default provisions, termination events, and set-off provisions. Resolute has set-off provisions with its lenders that, in the event of counterparty default, allow Resolute to set-off amounts owed under the Credit Facility or other general obligations against amounts owed for derivative contract liabilities.
Our management has determined that the benefit of cash flow hedge accounting, which may allow for our derivative instruments to be reflected as cash flow hedges in other comprehensive income, is not commensurate with the administrative burden required to support that treatment.
Derivative instruments are recognized on the balance sheet as either assets or liabilities measured at fair value. We mark our derivative instruments to fair value on the consolidated balance sheets and recognize the changes in fair market value in earnings. As of December 31, 2014, the fair value of our commodity derivatives was a net asset of $112.6 million.
The following table represents our commodity swap contracts as of December 31, 2014:
The following table represents our two-way commodity collar contracts as of December 31, 2014:
The following table represents our three-way gas collar contracts as of December 31, 2014:
Interest Rate Risk
At December 31, 2014, we had $235 million and $150 million of outstanding debt under the Revolving Credit Facility and Secured Term Loan Facility, respectively. Interest is calculated under the terms of the agreements based on a LIBOR spread. A 10% increase in LIBOR would result in an estimated $0.1 million increase in annual interest expense. We do not currently have any derivative arrangements to protect against fluctuations in interest rates applicable to our outstanding indebtedness.
Credit Risk and Contingent Features in Derivative Instruments
We are exposed to credit risk to the extent of nonperformance by the counterparties in the derivative contracts discussed above. All counterparties are also lenders under our Revolving Credit Facility. For these contracts, we are not required to provide any credit support to our counterparties other than cross collateralization with the properties securing the Revolving Credit Facility. Our derivative contracts are documented with industry standard ISDA contracts . Typical terms for the ISDAs include credit support requirements, cross default provisions, termination events, and set-off provisions. We have set-off provisions with our Revolving Credit Facility lenders that, in the event of counterparty default, allow us to set-off amounts owed under the Revolving Credit Facility or other general obligations against amounts owed for derivative contract liabilities.
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item is included in “Item 15. Exhibits, Financial Statement Schedules”.
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
Attached as exhibits to this report are certifications of our CEO and CFO required pursuant to Rule 13a-14 under the Exchange Act. This section includes information concerning the controls and procedures evaluation referred to in the certifications. Included in this report is the report of KPMG LLP, our independent registered public accounting firm, regarding its audit of our internal control over financial reporting. This section should be read in conjunction with the certifications and the KPMG LLP report for a more complete understanding of the topics presented.
Evaluation of Disclosure Controls and Procedures. We conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of December 31, 2014. This evaluation was conducted under the supervision and with the participation of management, including our CEO and CFO. Based on this evaluation, our CEO and CFO have concluded that as of December 31, 2014, our disclosure controls and procedures were effective to provide reasonable assurance that the information required to be disclosed by us in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified by the rules and forms of the SEC. We also concluded that our disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed in the reports filed or submitted under the Exchange Act is accumulated and communicated to our management, including our CEO and CFO, to allow timely decisions regarding disclosure.
Management’s Annual Report on Internal Control over Financial Reporting. Management is responsible for establishing and maintaining adequate internal controls over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). Management assessed our internal control over financial reporting as of December 31, 2014, and has concluded that the Company maintained effective internal control over financial reporting as of December 31, 2014. This assessment was based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Changes in Internal Control over Financial Reporting. There have been no significant changes in our internal control over financial reporting during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
ITEM 9B.
OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Information relating to this item will be included in an amendment to this report or in the proxy statement for our 2015 annual stockholders’ meeting and is incorporated by reference in this report.
ITEM 11.
ITEM 11.
EXECUTIVE COMPENSATION
Information relating to this item will be included in an amendment to this report or in the proxy statement for our 2015 annual stockholders’ meeting and is incorporated by reference in this report.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Information relating to this item will be included in an amendment to this report or in the proxy statement for our 2015 annual stockholders’ meeting and is incorporated by reference in this report.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
Information relating to this item will be included in an amendment to this report or in the proxy statement for our 2015 annual stockholders’ meeting and is incorporated by reference in this report.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTING FEE AND SERVICES
Information relating to this item will be included in an amendment to this report or in the proxy statement for our 2015 annual stockholders’ meeting and is incorporated by reference in this report.
PART IV
ITEM 15.
ITEM 15.
EXHIBITS, FINANCIAL STATEMENT SCHEDULES
See “Index to Consolidated Financial Statements” on page.
Exhibit
Number
Description of Exhibits
2.1†
Purchase and IPO Reorganization Agreement, dated as of August 2, 2009, among Hicks Acquisition Company I, Inc., Resolute Energy Corporation, Resolute Subsidiary Corporation., Resolute Holdings, LLC, Resolute Holdings Sub, LLC, Resolute Aneth, LLC and HH-HACI, L.P., (incorporated by reference to Annex A to the Registration Statement on Form S-4 filed with the SEC on August 6, 2009 (File. No 33-161076)(“Initial S-4”)).
2.2
Letter Agreement amending Purchase and IPO Reorganization Agreement, dated as of September 9, 2009, among Hicks Acquisition Company I, Inc., Resolute Energy Corporation, Resolute Subsidiary Corporation., Resolute Holdings, LLC, Resolute Holdings Sub, LLC, Resolute Aneth, LLC and HH-HACI, L.P., (incorporated by reference to Annex A to the Initial S-4).
2.3†
Purchase and Sale Agreement between Exxon Mobil Corporation, ExxonMobil Oil Corporation, Mobil Exploration and Producing North America Inc., Mobil Producing Texas & New Mexico Inc. and Mobil Exploration & Producing U.S. Inc. and Resolute Aneth, LLC - 75% and Navajo Nation Oil and Gas Company - 25% dated January 1, 2005 (incorporated by reference to Exhibit 2.2 to the Initial S-4).
2.4†
Asset Sale Agreement Aneth Unit, Ratherford Unit and McElmo Creek Unit, San Juan County, Utah between Chevron U.S.A. Inc. (as seller) and Resolute Natural Resources Company and Navajo Nation Oil and Gas Company, Inc. (as buyer) dated October 22, 2004 (incorporated by reference to Exhibit 2.3 to the Initial S-4).
2.5†
Stock Purchase Agreement dated June 24, 2008, between Primary Natural Resources, Inc. (as seller) and Resolute Acquisition Company, LLC (as buyer) (incorporated by reference to Exhibit 2.4 to the Initial S-4).
2.6
Purchase and Sale Agreement between Celero Energy II, LP and Caprock Land & Cattle, LLC, as sellers, Resolute Natural Resources Southwest, LLC, as buyer, and Resolute Energy Corporation, as guarantor, dated December 1, 2012 (incorporated by reference to Exhibit 2.1 to the current report on Form 8-K filed on December 5, 2012). Schedules, exhibits and similar attachments to the Purchase and Sale Agreement have been omitted pursuant to Item 601(b)(2) of Regulation S-K. The Registrant will furnish supplementally a copy of any omitted schedule, exhibit or similar attachment to the Securities and Exchange Commission upon request.
2.6.1
Amendment to Purchase and Sale Agreement, by and among Celero Energy II, LP and Caprock Land & Cattle, LLC, as Sellers, Resolute Natural Resources Southwest, LLC, as Buyer, and Resolute Energy Corporation, as Guarantor, dated December 21, 2012 (incorporated by reference to Exhibit 2.1 to the current report on Form 8-K filed on December 26, 2012).
2.7
Purchase, Sale and Option Agreement dated December 28, 2012, by and among RSP Permian LLC, Wallace Family Partnership, LP, and Ted Collins, Jr., as Sellers, and Resolute Natural Resources Southwest, LLC, as Buyer (incorporated by reference to Exhibit 2.1 to the current report on Form 8-K filed on December 31, 2012). Schedules, exhibits and similar attachments to the Purchase and Sale Agreement have been omitted pursuant to Item 601(b)(2) of Regulation S-K. The Registrant will furnish supplementally a copy of any omitted schedule, exhibit or similar attachment to the Securities and Exchange Commission upon request.
3.1
Amended and Restated Certificate of Incorporation of Resolute Energy Corporation, filed September 25, 2009 (incorporated by reference to Exhibit 3.1 to the Annual Report on Form 10-K of Resolute Energy Corporation filed on March 30, 2010).
3.2
Amended and Restated Bylaws of Resolute Energy Corporation (incorporated by reference to Exhibit 3.2 to the Annual Report on Form 10-K of Resolute Energy Corporation filed on March 30, 2010).
4.1
Registration Rights Agreement dated September 25, 2009, among Resolute Energy Corporation and certain holders (incorporated by reference as Exhibit 4.4 to Amendment No.2 to the Initial S-4 filed on September 8, 2009).
4.2
Indenture, dated April 25, 2012, among Resolute Energy Corporation, the Guarantors named therein and U.S. Bank National Association, as Trustee, relating to the 8.50% Senior Notes due 2020 (incorporated by reference to Exhibit 4.1 to the current report on Form 8-K filed on April 26, 2012).
Exhibit
Number
Description of Exhibits
4.3
Registration Rights Agreement, dated April 25, 2012, among Resolute Energy Corporation, the Guarantors, and the Purchase relating to the 8.50% Senior Notes due 2020 (incorporated by reference to Exhibit 10.2 to the current report on Form 8-K filed on April 26, 2012).
4.4
Registration Rights Agreement, dated December 10, 2012, among Resolute Energy Corporation, the Guarantors, and the Purchase relating to the 8.50% Senior Notes due 2020 (incorporated by reference to Exhibit 10.2 to the current report on Form 8-K filed on December 11, 2012).
4.5
Registration Rights agreement dated May 29, 2013, by and among Resolute Energy Corporation, a Delaware corporation (the “Company”), and SPO Advisory Partners, L.P., San Francisco Partners, L.P. and Phoebe Snow Foundation, Inc. (the “Holders”) whereas the Company and the Holders desire to enter into this Agreement to provide the Holders with certain rights relating to the registration of the Securities (incorporated by reference as Exhibit 10.1 to the current report on Form 8-K filed on May 31, 2013).
4.6
Equity Incentive Grant Agreement between Resolute Energy Corporation and certain participants (incorporated by reference as Exhibit 4.1 to the current report on Form 8-K filed on March 14, 2013).
4.7
Restricted Stock Agreement between Resolute Energy Corporation and certain participants (incorporated by reference as Exhibit 4.1 to the current report on Form 8-K filed on March 14, 2013).
10.1
Second Amended and Restated Credit Agreement dated March 30, 2010, between Resolute Energy Corporation as Borrower and certain of its Subsidiaries as Guarantors, Wells Fargo Bank, National Association, as Administrative Agent, Bank of Montreal as Syndication Agent, Deutsche Bank Securities Inc., UBS Securities LLC and Union Bank, N.A. as Co-Documentation Agents, and The Lenders Party Hereto, Wells Fargo Securities, LLC and BMO Capital Markets as Joint Bookrunners and Joint Lead Arrangers (incorporated by reference to Exhibit 10.1 to the Annual Report on Form 10-K of Resolute Energy Corporation filed on March 30, 2010).
10.1.1
First Amendment to Second Amended and Restated Credit Agreement, dated as of April 18, 2011, between Resolute Energy Corporation as Borrower, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (incorporated by reference as Exhibit 10.1 to the current report on Form 8-K filed on April 16, 2012).
10.1.2
Second Amendment to Second Amended and Restated Credit Agreement, dated as of April 25, 2011, between Resolute Energy Corporation as Borrower, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (incorporated by reference as Exhibit 10.2 to the current report on Form 8-K filed on April 16, 2012).
10.1.3
Third Amendment to Second Amended and Restated Credit Agreement, dated as of April 13, 2012, between Resolute Energy Corporation as Borrower and certain of its Subsidiaries as Guarantors, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (incorporated by reference to Exhibit 10.3 to the current report on Form 8-K filed on April 16, 2012).
10.1.4
Fourth Amendment, dated as of December 7, 2012, to the Second Amended and Restated Credit Agreement, by and among Resolute Energy Corporation, as Borrower, and certain of its Subsidiaries as Guarantors, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (incorporated by reference to Exhibit 10.3 to the current report on Form 8-K filed on December 11, 2012).
10.1.5
Fifth Amendment to Second Amended and Restated Credit Agreement dated December 27, 2012, among Resolute Energy Corporation, as Borrower, and certain of its Subsidiaries as Guarantors, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (incorporated by reference to Exhibit 10.3 to the current report on Form 8-K filed on December 31, 2012).
10.1.6
Sixth Amendment to Second Amended and Restated Credit Agreement dated as of March 22, 2013, between Resolute Energy Corporation, as Borrower, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (incorporated by reference as Exhibit 10.1 to the current report on Form 8-K filed on March 25, 2013).
10.1.7
Seventh Amendment to Second Amended and Restated Credit Agreement dated as of April 15, 2013, between Resolute Energy Corporation, as Borrower, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (incorporated by reference as Exhibit 10.1 to the current report on Form 8-K filed on April 15, 2013).
10.1.8
Eighth Amendment to Second Amended and Restated Credit Agreement dated as of December 13, 2013, between Resolute Energy Corporation, as Borrower, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (incorporated by reference as Exhibit 10.1 to the current report on Form 8-K filed on December 19, 2013).
Exhibit
Number
Description of Exhibits
10.1.9
Ninth Amendment to Second Amended and Restated Credit Agreement dated as of March 7, 2014, between Resolute Energy Corporation, as Borrower, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (incorporated by reference as Exhibit 10.1 to the Annual Report on Form 10-K filed on March 10, 2014).
10.1.10
Tenth Amendment to Second Amended and Restated Credit Agreement dated as of March 14, 2014, between Resolute Energy Corporation, as Borrower, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (incorporated by reference as Exhibit 10.1 to the current report on Form 8-K filed on March 19, 2014).
10.1.11
Eleventh Amendment to Second Amended and Restated Credit Agreement dated as of December 30, 2014, between Resolute Energy Corporation, as Borrower, Wells Fargo National Bank, National Association, as Administrative Agent, and the Lenders party thereto (incorporated by reference as Exhibit 10.1 to the current report on Form 8-K filed on December 31, 2014).
10.2#
2009 Performance Incentive Plan (incorporated by reference as Exhibit 10.7 to Amendment No.1 to the Initial S-4 filed on August 31, 2009).
10.2.1#
Amendment No. 1 to 2009 Performance Incentive Plan (incorporated by reference to Exhibit A to the Proxy Statement on Schedule 14A as filed with the SEC on April 25, 2011).
10.3#
Form of Indemnification Agreement between Resolute Energy Corporation and each executive officer and independent director of the Company (incorporated by reference as Exhibit 10.8 to Amendment No. 1 to the initial S-4 filed on August 31, 2009).
10.4††
Cooperative Agreement between Resolute Natural Resources Company and Navajo Nation Oil and Gas Company dated October 22, 2004 (incorporated by reference by Exhibit 10.9 to the Initial S-4).
10.4.1
First Amendment of Cooperative Agreement between Resolute Aneth, LLC and Navajo Nation Oil and Gas Company, Inc. dated October 21, 2005 (incorporated by reference as Exhibit 10.10 to the Initial S-4).
10.4.2
Second Amendment of Cooperative Agreement between Resolute Aneth, LLC and Navajo Nation Oil and Gas Company, Inc. dated April 9, 2012 (incorporated by reference as Exhibit 10.1 to the current report on Form 8-K filed on April 12, 2012).
10.5††
Carbon Dioxide Sale and Purchase Agreement by and between ExxonMobil Gas & Power Marketing Company (a division of Exxon Mobil Corporation), as agent for Mobil Producing Texas & New Mexico, Inc. (Seller) and Resolute Aneth, LLC (Buyer) dated July 1, 2006, as amended July 21, 2006 (incorporated by reference as Exhibit 10.11 to Amendment No. 1 to the Initial S-4 filed on August 31, 2009).
10.6††
Product Sale and Purchase Contract by and between Resolute Natural Resources Company (Buyer) and Kinder Morgan CO 2 Company, L.P. (Seller) dated July 1, 2007, as amended October 1, 2007, January 1, 2009 and October 5, 2010 (incorporated by reference as Exhibit 10.12 to Amendment No. 1 to the Initial S-4 filed on August 31, 2009 and Exhibit 99.1 to the Current Report on Form 8-K filed on October 7, 2010).
10.6.1
Amendment No. 4 to Product Sale and Purchase contract dated July 1, 2007 by and between Resolute Natural Resources Company, LLC and Kinder Morgan CO2 Company, LP (incorporated by reference to Exhibit 10.1 to the 10-Q filed on November 7, 2011).
10.7
Gas Sales and Purchase Contract - Conventional & Residue Gas dated April 12, 1995, between Rim Offshore, Inc., as producer, and Western Gas Resources, Inc., as processor (Contract #6690), as amended July 27, 2006 and March 6, 2009 (incorporated by reference as Exhibit 10.13 to Amendment No.1 to the Initial S-4 filed on August 31, 2009 ).
10.8
Consent Decree, entered into June 2005, relating to alleged violations of the federal Clean Air Act (incorporated by reference as Exhibit 10.16 to the Initial S-4).
10.9
Consent Decree, entered into August 2004, relating to alleged violations of the federal Clean Water Act (incorporated by reference as Exhibit 10.17 to the Initial S-4).
10.10
Crude Oil Purchase Agreement dated August 31, 2011 between Western Refining Southwest, Inc., as purchaser, and Resolute Natural Resources Company, LLC as seller (incorporated by reference to the current report on Form 8-K filed on September 7, 2011).
Exhibit
Number
Description of Exhibits
10.10.1
Crude Oil Purchase Agreement dated July 7, 2014 between Western Refining Southwest, Inc., as purchaser, and Resolute Natural Resources Company, LLC as seller (incorporated by reference to the Exhibit 10.1 on Form 8-K filed on July 11, 2014) that supersedes the Crude Oil Purchase Agreement dated August 31, 2011 between Western Refining Southwest, Inc., as purchaser, and Resolute Natural Resources Company, LLC, as seller (the “Original Agreement”) which Original Agreement was incorporated by reference to the current report on Form 8-K filed on September 7, 2011.
10.10.2
Crude Oil Purchase Agreement dated as of June 1, 2014, regarding Additional Volumes, and as of July 1, 2014, regarding Base Volumes for the sale and purchase of crude oil between Western Refining Southwest, Inc., as purchaser, and Resolute Natural Resources Company, LLC as seller (incorporated by reference to the Exhibit 10.1 on Form 8K filed on July 11, 2014) that supersedes the Crude Oil Purchase Agreement dated August 31, 2011 between Western Refining Southwest, Inc., as purchaser, and Resolute Natural Resources Company, LLC, as seller (the “Original Agreement”) which Original Agreement was incorporated by reference to the current report on Form 8-K filed on September 7, 2011.
10.10.3
First Amendment to Crude Oil Purchase Agreement dated as of December 31, 2014, between Resolute Energy Corporation as seller, and Western Refining Southwest, Inc. as purchaser (incorporated by reference to the Exhibit 10.1 on Form 8-K filed on December 31, 2014).
10.11
Form of Retention Award Agreement between Resolute Energy Corporation and certain award recipients (incorporated by reference as Exhibit 10.19 to Amendment No.2 to the Initial S-4 filed on September 8, 2009).
10.12
Form of Restricted Stock Award Agreement for Non-employee Directors (incorporated by reference to Exhibit 10.13 to the Annual Report on Form 10-K of Resolute Energy Corporation filed on March 30, 2010).
10.13#
Form of Confidentiality and Non Compete Agreement among Resolute Holdings, LLC and certain employees dated as of January 23, 2004 (incorporated by reference to Exhibit 10.14# to the Annual Report on Form 10-K of Resolute Energy Corporation filed on March 30, 2010).
10.14#
Form of Restricted Stock Agreement for Employees (incorporated by referenced as Exhibit 10.1 to the 10-Q filed on May 11, 2010).
10.15#
Form of Stock Appreciation Right Agreement for Non-employee Directors (incorporated by reference as Exhibit 10.2 to the 10-Q filed on May 11, 2010).
10.16#
Employment Agreement, effective as of April 1, 2011, by and between the Company and Nicholas J. Sutton (incorporated by reference as Exhibit 10.1 to the current report on Form 8-K filed on April 26, 2011).
10.17#
Employment Agreement, effective as of April 1, 2011, by and between the Company and James M. Piccone (incorporated by reference as Exhibit 10.2 to the current report on Form 8-K filed on April 26, 2011).
10.18#
Employment Agreement, effective as of April 1, 2011, by and between the Company and Theodore Gazulis (incorporated by reference as Exhibit 10.3 to the current report on Form 8-K filed on April 26, 2011).
10.19#
Employment Agreement, effective as of April 1, 2011, by and between the Company and Richard F. Betz (incorporated by reference as Exhibit 10.4 to the current report on Form 8-K filed on April 26, 2011).
10.20#
Employment Agreement, effective as of April 1, 2011, by and between the Company and Bobby D. Brady, Jr. (incorporated by reference as Exhibit 10.5 to the current report on Form 8-K filed on April 26, 2011).
10.21
Purchase Agreement, dated April 20, 2012, among Resolute Energy Corporation, the Guarantors and the Purchasers relating to the 8.50% Senior Notes due 2020 (incorporated by reference to Exhibit 10.1 to the current report on Form 8-K filed on April 26, 2012).
10.22
Purchase Agreement, dated December 5, 2012, among Resolute Energy Corporation, the Guarantors and the Purchasers relating to the 8.50% Senior Notes due 2020 (incorporated by reference to Exhibit 10.1 to the current report on Form 8-K filed on December 11, 2012).
10.23
Secured Term Loan Agreement dated December 30, 2014, between Resolute Energy Corporation as Borrower and certain of its Subsidiaries as Guarantors, Bank of Montreal, as Administrative Agent and the Lenders Party thereto, BMO Capital Markets Corp as Sole Lead Book Runner and Sole Lead Arranger, and Barclays and KeyBanc Capital Markets Inc. as Co-Syndication Agents (as incorporated by reference to Exhibit 10.1 to the current report on Form 8-K filed on December 31, 2014).
Exhibit
Number
Description of Exhibits
12.1
Statement of Ratio of Earnings to Fixed Charges.
List of Subsidiaries of Resolute Energy Corporation.
23.1
Consent of KPMG LLP.
23.2
Consent of Netherland, Sewell & Associates, Inc.
31.1
Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes Oxley Act of 2002.
Certification of the Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.1
Report of Netherland, Sewell & Associates, Inc. regarding the registrant’s reserves as of December 31, 2014.
The following materials are filed herewith: (i) XBRL Instance Document, (ii) XBRL Taxonomy Extension Schema Document, (iii) XBRL Taxonomy Extension Calculation Linkbase Document, (iv) XBRL Taxonomy Extension Labels Linkbase Document, (v) XBRL Taxonomy Extension Presentation Linkbase Document, and (vi) XBRL Taxonomy Extension Definition Linkbase Document.
†
The Purchase and IPO Reorganization Agreement filed as Exhibit 2.1, the Purchase and Sale Agreement filed as Exhibit 2.3, the Asset Sale Agreement filed as Exhibit 2.4, the Purchase and Sale Agreement filed as Exhibit 2.5 and the Cooperative Agreement file as Exhibit 10.4 omit certain of the schedule and exhibits to each of the Purchase and IPO Reorganization Agreement, Purchase and Sale Agreements, the Asset Sale Agreement and the Cooperative Agreement in accordance with Item 601 (b)(2) of Regulation S-K. A list briefly identifying the contents of all omitted schedules and exhibits is included with each of the Purchase and Sale Agreement, the Asset Sale Agreement and the Cooperative Agreement filed as Exhibit 2.1, 2.3, 2.4, 2.5 and 10.4, respectively. Resolute agrees to furnish supplementally a copy of any omitted schedule or exhibit to the Securities and Exchange Commission upon request.
††
Portions of this exhibit have been omitted pursuant to a request for confidential treatment.
#
Management Contract, Compensation Plan or Agreement.
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.
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 and on the dates indicated.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
RESOLUTE ENERGY CORPORATION
Reports of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2014 and 2013
Consolidated Statements of Operations for the years ended December 31, 2014, 2013 and 2012
Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2014, 2013 and 2012
Consolidated Statements of Cash Flows for the years ended December 31, 2014, 2013 and 2012
Notes to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of
Resolute Energy Corporation:
We have audited the accompanying consolidated balance sheets of Resolute Energy Corporation and subsidiaries (the Company) as of December 31, 2014 and 2013, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2014. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Resolute Energy Corporation and subsidiaries as of December 31, 2014 and 2013, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2014, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Resolute Energy Corporation’s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 5, 2015 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
/s/ KPMG LLP
Denver, Colorado
March 5, 2015
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of
Resolute Energy Corporation:
We have audited Resolute Energy Corporation and subsidiaries’ (the Company) internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). The Company’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of the 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.
In our opinion, Resolute Energy Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control - Integrated Framework (2013) issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Resolute Energy Corporation as of December 31, 2014 and 2013, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2014, and our report dated March 5, 2015 expressed an unqualified opinion on these consolidated financial statements.
/s/ KPMG LLP
Denver, Colorado
March 5, 2015
RESOLUTE ENERGY CORPORATION
Consolidated Balance Sheets
(in thousands, except share amounts)
See notes to consolidated financial statements
RESOLUTE ENERGY CORPORATION
Consolidated Statements of Operations
(in thousands, except per share data)
See notes to consolidated financial statements
RESOLUTE ENERGY CORPORATION
Consolidated Statements of Stockholders’ Equity
(in thousands)
See notes to consolidated financial statements
RESOLUTE ENERGY CORPORATION
Consolidated Statements of Cash Flows
(in thousands)
See notes to consolidated financial statements
RESOLUTE ENERGY CORPORATION
Notes To Consolidated Financial Statements
Note 1 - Organization and Nature of Business
Resolute Energy Corporation (“Resolute” or the “Company”), is an independent oil and gas company engaged in the exploitation, development, exploration for and acquisition of oil and gas properties. The Company’s asset base in comprised primarily of properties in Aneth Field located in the Paradox Basin in southeast Utah (the “Aneth Field Properties” or “Aneth Field”), the Permian Basin in west Texas and southeast New Mexico and the Powder River and Big Horn Basins in Wyoming. The Company conducts all of its activities in the United States of America.
Note 2 - Basis of Presentation and Summary of Significant Accounting Policies
Basis of Presentation
The consolidated financial statements include Resolute and its subsidiaries, and have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). All significant intercompany transactions have been eliminated upon consolidation.
In connection with the preparation of the consolidated financial statements, Resolute evaluated subsequent events that occurred after the balance sheet date, through the date of filing.
Assumptions, Judgments and Estimates
The preparation of the consolidated financial statements in conformity with GAAP requires management to make various assumptions, judgments and estimates to determine the reported amounts of assets, liabilities, revenue and expenses, and in the disclosures of commitments and contingencies. Changes in these assumptions, judgments and estimates will occur as a result of the passage of time and the occurrence of future events. Accordingly, actual results could differ from amounts previously established.
Significant estimates with regard to the consolidated financial statements include proved oil and gas reserve volumes and the related present value of estimated future net cash flows used in the ceiling test applied to capitalized oil and gas properties; asset retirement obligations; valuation of derivative assets and liabilities; the estimated fair value and allocation of the purchase price related to business combinations; share-based compensation expense; depletion depreciation, and amortization; accrued liabilities; revenue and related receivables and income taxes.
Fair Value of Financial Instruments
The carrying amount of the majority of Resolute’s financial instruments, namely cash and cash equivalents, accounts receivable and accounts payable, approximate their fair value because of the short-term nature of these instruments. The revolving credit facility (see Note 5) has a recorded value that approximates its fair market value while the fair value of the $400 million in principal senior notes due May 1, 2020 (the “Senior Notes” or the “Notes”) and the $150 million in the second lien secured term loan due March 2018 (the “Secured Term Loan Facility”) are based on data from independent market makers or price received at measurement date. The fair value of derivative instruments (see Note 10) is estimated based on market conditions in effect at the end of each reporting period.
Industry Segment and Geographic Information
Resolute conducts oil, gas and natural gas liquids (“NGL”) exploration and production operations in one segment. All of Resolute’s operations and assets are located in the United States, and all of its revenue is attributable to domestic customers. Resolute considers gathering, processing and marketing functions as supportive of its oil and gas producing activities, and accordingly, they are not reported as separate segments.
Cash and Cash Equivalents
Resolute considers all highly liquid investments with original maturities of three months or less at the date of purchase to be cash equivalents. Resolute periodically maintains cash and cash equivalents in bank deposit accounts and money market funds which may be in excess of federally insured amounts. Resolute has not experienced any losses in such accounts and believes it is not exposed to any significant credit risk on such accounts.
Accounts Receivable
The Company’s accounts receivable consist of the following for the periods indicated (in thousands):
The Company’s accounts receivable consist mainly of receivables from oil, gas, and NGL purchasers and from joint interest owners on properties the Company operates. For receivables from joint interest owners, the Company typically has the ability to withhold future revenue disbursements to recover non-payment of joint interest billings. Generally, the Company’s oil and gas receivables are due within fifteen days and are collected in less than two months, and the Company has had minimal bad debts.
The Company routinely assesses the recoverability of all material trade and other receivables to determine their collectability. As of December 31, 2014 and 2013, the Company had no allowance for doubtful accounts recorded.
Deferred Financing Costs
Deferred financing costs are amortized over the estimated life of the related obligation. The Company incurred $4.8 million in deferred financing costs in 2014, $1.9 million in 2013 and $12.3 million in 2012, and amortized $2.5 million, $2.7 million and $1.7 million to interest expense during 2014, 2013 and 2012, respectively.
Capitalized Interest
Interest is capitalized when associated with significant investments in unproved properties and major development projects that are excluded from current depletion, depreciation and amortization calculations and on which exploration or development activities are in progress. Capitalized interest is calculated by multiplying the Company’s weighted-average interest rate on debt by the amount of qualified costs. Costs excluded from the depletion, depreciation and amortization calculations are classified as unproved properties along with any associated capitalized interest. Capitalized interest totaled $14.9 million, $15.9 million and $4.7 million during 2014, 2013 and 2012, respectively.
Concentration of Credit Risk
Financial instruments that potentially subject Resolute to concentrations of credit risk consist primarily of trade, production and derivative settlement receivables. Resolute derived approximately 62% and 14% of its total 2014 revenue from Western Refining, Inc. (“Western”) and Plains Marketing LP, respectively; 61% and 15% of its total 2013 revenue from Western and Plains Marketing LP, respectively and 78% of its total 2012 revenue from Western. If Resolute was compelled to sell its oil to an alternative market, costs associated with the transportation of its production may increase, and such increase could materially and negatively affect its operations. The concentration of credit risk in the oil and gas industry affects the overall exposure to credit risk because customers may be similarly affected by changes in economic or other conditions. The creditworthiness of customers and other counterparties is subject to continuing review, including the use of master netting agreements where appropriate. Commodity derivative contracts expose Resolute to the credit risk of non-performance by the counterparty to the contracts. This exposure is diversified among major investment grade financial institutions, all of which participate in Resolute’s Revolving Credit Facility (see Note 5).
Oil and Gas Properties
The Company uses the full cost method of accounting for oil and gas producing activities. All costs incurred in the acquisition, exploration and development of properties, including costs of unsuccessful exploration, costs of surrendered and abandoned leaseholds, delay lease rentals and the fair value of estimated future costs of site restoration, dismantlement and abandonment activities, improved recovery systems and a portion of general and administrative and operating expenses are capitalized on a country wide basis (the “Cost Center”).
Resolute conducts tertiary recovery projects on certain of its oil and gas properties in order to recover additional hydrocarbons that are not recoverable from primary or secondary recovery methods. Under the full cost method, all development costs are capitalized at the time incurred. Development costs include charges associated with access to and preparation of well locations, drilling and equipping development wells, test wells, and service wells including injection wells, and acquiring, constructing, and
installing production facilities and providing for improved recovery systems. Improved recovery systems include all related facility development costs and the cost of the acquisition of tertiary injectants, primarily purchased carbon dioxide (“CO2”). The development costs related to CO2 purchases are incurred solely for the purpose of gaining access to incremental reserves not otherwise recoverable. The accumulation of injected CO2, in combination with additional purchased and recycled CO2, provides future economic value over the life of the project.
In contrast, other costs related to the daily operation of the improved recovery systems are considered production costs and are expensed as incurred. These costs include, but are not limited to, compression, electricity, separation, re-injection of recovered CO2 and water and reservoir pressure maintenance.
Capitalized general and administrative and operating costs include salaries, employee benefits, costs of consulting services and other specifically identifiable capital costs and do not include costs related to production operations, general corporate overhead or similar activities. Resolute capitalized general and administrative and operating costs related to its acquisition, exploration and development activities of $9.8 million during 2014, $8.4 million during 2013 and $6.0 million during 2012.
Investments in unproved properties are not depleted, pending determination of the existence of proved reserves. The Company’s investments in unproved properties are related to exploration plays in the Permian Basin in Texas and southeast New Mexico. The Company expects to evaluate these locations for the existence of proved reserves in the next 1 to 3 years, although volatility in commodity prices may impact the timing of the evaluation. Unproved properties are assessed at least annually to determine whether impairment has occurred. Unproved properties whose costs are individually significant are assessed individually by considering the primary lease terms of the properties, the holding period of the properties and geographic and geologic data obtained relating to the properties. Where it is not practicable to assess individually the amount of impairment of properties for which costs are not individually significant, such properties are grouped for purposes of assessing impairment. The amount of impairment assessed is added to the costs to be amortized.
No gain or loss is recognized upon the sale or abandonment of undeveloped or producing oil and gas properties unless the sale represents a significant portion of the Company’s oil and gas properties and the gain or loss significantly alters the relationship between the capitalized costs and proved reserves of the cost center.
Depletion of oil and gas properties is computed on the unit-of-production method based on proved reserves. Depletable costs include estimates of asset retirement obligations and future development costs of proved reserves, including, but not limited to, costs to drill and equip development wells, construct and install production and processing facilities, and improved recovery systems, including the cost of required future CO2 purchases.
Pursuant to full cost accounting rules, accounting rules require Resolute to perform a quarterly “ceiling test” calculation to test its oil and gas properties for possible impairment. The primary components impacting the calculation are commodity prices, reserve quantities added and produced, overall exploration and development costs and depletion expense. If the net capitalized cost of the Company’s oil and gas properties subject to the amortization (the “carrying value”) exceeds the ceiling limitation, the excess would be charged to expense. The ceiling limitation is equal to the sum of the present value discounted at 10% of estimated future net cash flows from proved reserves, the cost of properties not being amortized, the lower of cost or estimated fair value of unproven properties included in the costs being amortized, and all related income tax effects.
During 2014 and 2013, the Company recorded a $120 million and $188 million, respectively, non-cash impairment of the carrying value of its oil and gas properties as a result of the ceiling test limitation. Recent steep declines in commodity prices may require further impairment in the future.
Business Combinations
The Company accounts for all business combinations using the acquisition method which involves the use of significant judgment. Under the acquisition method of accounting, a business combination is accounted for based on the fair value of the consideration given. The assets and liabilities acquired are measured at fair value and the purchase price is allocated to the assets and liabilities based on these fair values. The excess of the cost of an acquisition, if any, over the fair value of the assets acquired and liabilities assumed is recognized as goodwill. The excess of the fair value of assets acquired and liabilities assumed over the cost of an acquisition, if any, is recognized immediately in earnings as a gain. Determining the fair values of the assets and liabilities acquired involves the use of judgment since fair values are not always readily determinable. Different techniques may be used to determine fair values, including market prices (where available), appraisals, comparisons to transactions for similar assets and liabilities and the present value of estimated future cash flows, among others.
Other Property and Equipment
Other property and equipment are recorded at cost. Costs of renewals and improvements that substantially extend the useful lives of the assets are capitalized. Maintenance and repair costs which do not extend the useful lives of property and equipment are charged to expense as incurred. Depreciation and amortization is calculated using the straight-line method over the estimated useful lives of the assets. Office furniture, automobiles, and computer hardware and software are depreciated over three to five years. Field offices and partial ownership of aircraft are depreciated over fifteen to twenty years. Leasehold improvements are depreciated, using the straight line method, over the shorter of the lease term or the useful life of the asset. When other property and equipment is sold or retired, the capitalized costs and related accumulated depreciation and amortization are removed from the accounts.
Impairment of Long-Lived Assets Other than Oil and Gas Properties
Resolute evaluates long-lived assets other than oil and gas properties for impairment when indicators of possible impairment are present. Resolute performs an analysis of the anticipated undiscounted future net cash flows of the related long-lived assets and if the carrying value of the related asset exceeds the undiscounted cash flows, the carrying value is reduced to the asset’s fair value and an impairment loss is recorded against the long-lived asset. There have been no provisions for impairment recorded for the years ended December 31, 2014, 2013 and 2012.
Asset Retirement Obligations
Asset retirement obligations relate to future costs associated with the plugging and abandonment of oil and gas wells, removal of equipment and facilities from leased acreage and returning such land to its original condition. The fair value of a liability for an asset retirement obligation is recorded in the period in which it is incurred and the cost of such liability is recorded as an increase in the carrying amount of the related long-lived asset by the same amount. The liability is accreted each period and the capitalized cost is depleted as part of the full cost pool. Revisions to estimated asset retirement obligations result in adjustments to the related capitalized asset and corresponding liability.
The restricted cash of $19.9 million located on the Company’s consolidated balance sheet in non-current other assets at December 31, 2014, is legally restricted for the purpose of settling asset retirement obligations of Aneth Field.
Derivative Instruments
Resolute utilizes derivative instruments to manage its exposure to oil and gas price volatility and these instruments may take the form of swaps, puts, calls, collars and other such arrangements. Derivative instruments are recognized on the balance sheet as either assets or liabilities measured at fair value. Resolute has not elected to apply cash flow hedge accounting, and consequently, recognizes gains and losses in earnings rather than deferring such amounts in other comprehensive income as allowed under cash flow hedge accounting. Realized gains and losses on derivative instruments are recognized in the period in which the related contract is settled. Both the realized and mark-to-market gains and losses on derivative instruments are reflected in other income (expense) in the consolidated statements of income. Cash flows from derivatives are reported as cash flows from operating activities.
Revenue Recognition
Oil and gas revenue is recognized when production is sold to a purchaser at a fixed or determinable price, when delivery has occurred and title has transferred and the collectability of the revenue is probable. Oil and gas revenue is recorded using the sales method.
General and Administrative Expenses
General and administrative expenses are reported net of amounts capitalized to oil and gas properties and of reimbursements of overhead costs that are billed to working interest owners of the oil and gas properties operated by Resolute.
Share-Based Compensation Expense
Share-based compensation expense is measured at the estimated grant date fair value of the awards and is amortized over the requisite service period (usually the vesting period). The Company estimates forfeitures in calculating the cost related to share-based compensation as opposed to recognizing these forfeitures and the corresponding reduction in expense as they occur.
Income Taxes
Income taxes and uncertain tax positions are accounted for in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 740, Accounting for Income Taxes. Deferred income taxes are provided for the differences between the bases of assets and liabilities for financial reporting and income tax purposes. A valuation allowance is established when necessary to reduce deferred tax assets to the amount expected to be realized. Tax positions meeting the more-likely-than-not recognition threshold are measured pursuant to the guidance set forth in FASB ASC Topic 740.
Note 3 - Acquisitions and Divestitures
Permian Property Acquisitions
On December 21, 2012, the Company purchased properties in Denton Field in the Northwest Shelf in Lea County, New Mexico, and in the Spraberry trend in the Midland Basin portion of the Permian Basin in Howard County, Texas, for a purchase price of approximately $117 million. Additionally, on December 28, 2012, the Company purchased properties in the Wolfberry play in the Midland Basin portion of the Permian Basin in Midland and Ector counties, Texas, for a purchase price of approximately $133 million. Concurrently with the latter transaction, the Company acquired, for additional consideration of $6 million, the option to buy the balance of the working interest in and operatorship of the properties under substantially the same terms as the initial transaction, (the “Option Properties”). On March 22, 2013, the Company exercised the option and acquired the Option Properties for $258 million, net of the option fee after customary purchase price adjustments, which were estimated at closing. Revenue and expenses related to the acquired properties are included in the consolidated statement of operations beginning on the closing date of the respective transaction. The properties acquired under the December and March acquisitions, which the Company refers to as the “Permian Acquisitions,” were accounted for using the acquisition method.
The purchase price of the Permian Acquisitions was comprised of the following (in thousands):
The Company has completed its assessment of the fair values of the assets acquired and liabilities assumed. Accordingly, the following table presents the final purchase price allocation of the Permian Acquisitions at December 31, 2013 and 2012, based on the fair values of assets acquired and liabilities assumed (in thousands):
Pro Forma Financial Information
The unaudited pro forma consolidated financial information in the table below summarizes the results of operations of the Company as though the purchase of the Option Properties in March 2013 had occurred on January 1, 2012, and the purchase of the properties in the Permian Basin in December 2012 had occurred on January 1, 2012. The pro forma financial information is presented for informational purposes only and is not indicative of the results of operations that would have been achieved if the Permian Acquisitions had taken place at the beginning of the earliest periods presented or that may result in the future. The pro forma adjustments made utilize certain assumptions that Resolute believes are reasonable based on the available information.
The unaudited pro forma financial information for the years ended December 31, 2013 and 2012 combine the historical results of the Permian Acquisitions and Resolute (in thousands, except per share amounts):
Aneth Field Transactions
During the second quarter of 2012, Resolute and Navajo Nation Oil and Gas Company (“NNOGC”) entered into two transactions regarding the Aneth Field Properties.
In the first transaction, effective January 1, 2012, Resolute and NNOGC together, on a 50%/50% basis, acquired from affiliates of Denbury Resources Inc. (“Denbury”) a 13% working interest in the Aneth Unit and an 11% working interest in the Ratherford Unit for a total cash consideration of $75 million. The acquisition from Denbury was accounted for using the acquisition method. After closing adjustments, the $37.7 million net purchase price was allocated to proved oil and gas properties. Revenue and expenses associated with the acquired interests are included in the consolidated statements of income concurrent with the closing of the transaction in April 2012.
Contemporaneously with this transaction, Resolute and NNOGC also entered into an amendment to their Cooperative Agreement. Among other changes, this amendment allowed NNOGC to exercise options to purchase 10% of the Company’s interest in the Aneth Field Properties, as they existed before giving effect to the Denbury transaction discussed above. These options were exercised for cash consideration of $100 million. Resolute entered into a purchase and sale agreement relating to the exercise of the options which provided that the transaction be closed and paid for in two equal transfers, each for 5% of Resolute’s interest in the properties. The first transfer took place in July 2012 and the second transfer took place in January 2013, each with an effective date of January 1, 2012.
The Cooperative Agreement amendment also provides for the cancellation of a second set of options held by NNOGC to purchase an additional 10% interest in the Aneth Field Properties and stipulates that NNOGC has one remaining option to purchase an additional 10% of Resolute’s interest in the Aneth Field Properties. The remaining option is exercisable in July 2017 at the then current fair market value of such interest at that time. No gain or loss was recognized upon these sales as it did not represent a significant portion of the Company’s oil and gas properties and did not significantly alter the relationship of capitalized costs and proved reserves.
The net effect of the acquisition of properties from Denbury and the sale of properties to NNOGC, following full consummation, is that the Company’s working interests in the Aneth Unit and the Ratherford Unit remain essentially unchanged at 62% and 59%, respectively, and its working interest in the McElmo Creek Unit was reduced from 75% to 67.5%. Resolute remains the operator of its Aneth Field Properties.
Sale of New Home Properties
On June 27, 2013, the Company entered into a purchase and sale agreement with HRC Energy, LLC, a Colorado limited liability company, and a wholly-owned subsidiary of Halcón Resources Corporation, a Delaware corporation, effective March 1, 2013, to dispose of certain Bakken properties located in Williams County, North Dakota (the “New Home Properties”) and other non-operated Bakken properties for proceeds of $70.1 million. The transaction closed on July 15, 2013 and net proceeds received were recorded as a reduction to the capitalized costs of the Company’s oil and gas properties.
Note 4 - Earnings per Share
The Company computes basic net income (loss) per share using the weighted average number of shares of common stock outstanding during the period. Diluted net income (loss) per share is computed using the weighted average number of shares of common stock and, if dilutive, potential shares of common stock outstanding during the period. Potentially dilutive shares consist of the incremental shares issuable under the Company’s 2009 Performance Incentive Plan (the “Incentive Plan”). The treasury stock method is used to measure the dilutive impact of potentially dilutive shares.
The following table details the potential weighted average dilutive and anti-dilutive securities for the periods presented (in thousands):
The following table sets forth the 2014, 2013 and 2012 computation of basic and diluted net income (loss) per share of common stock for the periods presented (in thousands, except per share amounts):
A summary of the activity associated with warrants during 2014, 2013 and 2012 is as follows (in thousands):
Note 5 - Long Term Debt
The Company’s long-term debt consists of the following (in thousands):
For the years ended December 31, 2014, 2013, and 2012, the Company incurred interest expense on long-term debt of $46.4 million, $45.2 million and $20.2 million, respectively. The Company capitalized $14.9 million, $15.9 million and $4.7 million of interest expense during the years ended December 31, 2014, 2013 and 2012, respectively.
Revolving Credit Facility
Resolute’s revolving credit facility is with a syndicate of banks led by Wells Fargo Bank, National Association, as Administrative Agent, and Bank of Montreal, as Syndication Agent (the “Revolving Credit Facility”) with Resolute as the borrower. The Revolving Credit Facility specifies a maximum borrowing base as determined by the lenders. The determination of the borrowing base takes into consideration the estimated value of Resolute’s oil and gas properties in accordance with the lenders’ customary practices for oil and gas loans. The borrowing base is redetermined semi-annually, and the amount available for borrowing could be increased or decreased as a result of such redeterminations. Under certain circumstances, either Resolute or the lenders may request an interim redetermination.
In March 2013 we entered into the Sixth Amendment, which among other things, extended the maturity date of the Revolving Credit Facility from April 2017 to March 2018. On March 7, 2014, the Company entered into the Ninth Amendment to the amended and restated Revolving Credit Facility which redefined and adjusted the Maximum Leverage Ratio to (a) 4.90:1.00 for the fiscal quarters ending March 31, 2014 and June 30, 2014, (b) 4.75:1.00 for the fiscal quarters ending September 30, 2014 and December 31, 2014, and (c) 4.00:1.00 for all quarters thereafter. The Ninth Amendment also provided that as of the last day of each fiscal quarter in 2104, the ratio of senior secured debt as of such date to Adjusted EDITDA for the four quarter period ending on such date may not exceed 2.75:1.00.
In December 2014 we entered into the Eleventh Amendment to the amended and restated Revolving Credit Facility agreement. In connection with the Eleventh Amendment, the borrowing base was set at $330 million and certain other amendments were made, including eliminating the total debt-to-EBITDA covenant and conforming the covenant package in the Revolving Credit Facility to
that of the Secured Term Loan Facility. The covenants require, among other things, maintenance of certain ratios, measured on a quarterly basis, as follows: (i) secured debt to EBITDA of no more than 3.5 to 1.0, (ii) PV-10 of total proved reserves to total secured debt of at least 1.1 to 1.0, rising over time to 1.5 to 1.0, and (iii) PV-10 of proved developed reserves to total secured debt of at least 1.0 to 1.0. Our Revolving Credit Facility and our Secured Term Loan Facility also require us to enter into derivative agreements covering at least 70% of our anticipated production from proved properties on a rolling twenty four month basis, but prohibit us from entering into derivative arrangements for more than (i) 85% of our anticipated production from proved properties in the next two years and (ii) the greater of 75% of our anticipated production from proved properties or 85% of our production from projected proved developed producing reserves using economic parameters specified in our Revolving Credit Facility.
Each base rate borrowing under the Revolving Credit Facility accrues interest at either (a) the London Interbank Offered Rate, plus a margin which varies from 1.50% to 2.50% or (b) the alternative Base Rate defined as the greater of (i) the Administrative Agent’s Prime Rate (ii) the Federal Funds effective Rate plus 0.5% or (iii) an adjusted London Interbank Offered Rate (“LIBOR”) plus a margin which ranges from 0.50% to 1.50%. Each such margin is based on the level of utilization under the borrowing base.
As of December 31, 2014, outstanding borrowings were $235 million under the borrowing base of $330 million. The borrowing base availability is reduced by $3.1 million in conjunction with letters of credit issued to vendors at December 31, 2014. To the extent that the borrowing base, as adjusted from time to time, exceeds the outstanding balance, no repayments of principal are required prior to maturity. However, should the borrowing base be set at a level below the outstanding balance, we would be required to eliminate that excess over the 120 days following that determination. The Revolving Credit Facility is guaranteed by all of Resolute’s subsidiaries and is collateralized by substantially all of the proved oil and gas assets of Resolute Aneth, LLC, Resolute Wyoming, Inc. and Resolute Natural Resources Southwest, LLC, which are wholly-owned subsidiaries of the Company.
As of December 31, 2014, the weighted average interest rate on the outstanding balance under the Revolving Credit Facility was 2.17%. The recorded value of the Revolving Credit Facility approximates its fair market value because the interest rate of the Revolving Credit Facility is variable over the term of the loan (Level 2 fair value measurement).
The Revolving Credit Facility includes customary terms and covenants that place limitations on certain types of activities, the payment of dividends, and require satisfaction of certain financial tests. Resolute was in compliance with all terms and covenants of the Revolving Credit Facility at December 31, 2014.
Resolute Energy Corporation, the stand-alone parent entity, has insignificant independent assets and no operations. There are no restrictions on the Company’s ability to obtain cash dividends or other distributions of funds from its subsidiaries, except those imposed by applicable law.
Secured Term Loan Agreement
On December 30, 2014, Resolute and certain of its subsidiaries, as guarantors, entered into a second lien Secured Term Loan Agreement with Bank of Montreal, as administrative agent, and the lenders party thereto, pursuant to which the Company borrowed $150 million. Funding of the Secured Term Loan Facility occurred on December 31, 2014. The Secured Term Loan Facility will mature on the date that is six months after the maturity of the Company’s existing Revolving Credit Facility, but in no event later than November 1, 2019.
Net proceeds from the Secured Term Loan Facility, approximately $135 million after payment of transaction-related fees, expenses and discounts, were used to repay outstanding amounts under the Revolving Credit Facility.
Obligations under the Secured Term Loan Facility are guaranteed by certain of the Company’s subsidiaries and secured by second priority liens on substantially all of the assets of the Company and its subsidiaries that serve as collateral under the Revolving Credit Facility.
Borrowings under the Secured Term Loan Facility will bear interest at adjusted LIBOR plus 10%, with a 1% LIBOR floor. The covenants in the Secured Term Loan Facility require, among other things, maintenance of certain ratios, measured on a quarterly basis, as follows: (i) secured debt to EBITDA of no more than 3.5 to 1.0, (ii) PV-10 of total proved reserves to total secured debt of at least 1.1 to 1.0, rising over time to 1.5 to 1.0, and (iii) PV-10 of proved developed reserves to total secured debt of at least 1.0 to 1.0.
The Company may prepay all or a portion of the Secured Term Loan Facility at any time. The Secured Term Loan Facility is subject to mandatory prepayments of 75% of the net cash proceeds from asset sales, subject to a limited right to reinvest proceeds in oil and gas activities. Prepayments made out of proceeds from asset sales are not subject to prepayment premiums. Mandatory repayments are required of 100% of the net cash proceeds of certain debt or equity issuances. Such prepayments are subject to a premium of between 10% declining to 2% during the first 36 months after closing. To the extent not otherwise achieved, aggregate
repayments that substantially pay off principal amounts under the second lien facility shall include an additional payment sufficient to ensure that the lenders achieve a 1.25 to 1.0 minimum multiple of their invested capital.
The fair value of the Secured Term Loan Facility at December 31, 2014, was estimated to be $139.5 million based on the cash received as of the transaction date (Level 1 fair value measurement).
Senior Notes
In April 2012 the Company consummated a private placement of senior notes with a principal amount of $250 million, and in December 2012 placed a follow-on issuance of senior notes with a principal amount of $150 million. The Senior Notes are due May 1, 2020 and bear an annual interest rate of 8.50% with the interest on the Notes payable semiannually in cash on May 1 and November 1 of each year. Resolute used the $250 million of proceeds from the May 2012 issuance to repay outstanding borrowings under the Revolving Credit Facility, with the remainder reserved for general corporate purposes, including capital expenditures. The Company used the $150 million of proceeds from the December 2012 issuance to partially finance the Permian Acquisitions.
The Senior Notes were issued under an Indenture (the “Indenture”) among the Company, the Company’s existing subsidiaries (the “Guarantors”) and U.S. Bank National Association, as trustee (the “Trustee”) in a private transaction not subject to the registration requirements of the Securities Act of 1933. In March 2013, the Company registered the Senior Notes with the Securities and Exchange Commission by filing an amendment to the registration statement on Form S-4 enabling holders of the Senior Notes to exchange the privately placed Notes for publically registered Notes with substantially identical terms. The Indenture contains affirmative and negative covenants that, among other things, limit the Company’s and the Guarantors’ ability to make investments, incur additional indebtedness or issue preferred stock, create liens, sell assets, enter into agreements that restrict dividends or other payments by restricted subsidiaries, consolidate, merge or transfer all or substantially all of the assets of the Company, engage in transactions with the Company’s affiliates, pay dividends or make other distributions on capital stock or prepay subordinated indebtedness and create unrestricted subsidiaries. The Indenture also contains customary events of default. Upon occurrence of events of default arising from certain events of bankruptcy or insolvency, the Senior Notes shall become due and payable immediately without any declaration or other act of the Trustee or the holders of the Senior Notes. Upon the occurrence of certain other events of default, the Trustee or the holders of the Senior Notes may declare all outstanding Senior Notes to be due and payable immediately. The Company was in compliance with all financial covenants under its Senior Notes as of December 31, 2014.
The Senior Notes are general unsecured senior obligations of the Company and guaranteed on a senior unsecured basis by the Guarantors. The Senior Notes rank equally in right of payment with all existing and future senior indebtedness of the Company, will be subordinated in right of payment to all existing and future senior secured indebtedness of the Guarantors, will rank senior in right of payment to any future subordinated indebtedness of the Company and will be fully and unconditionally guaranteed by the Guarantors on a senior basis.
The Senior Notes are redeemable by the Company on or after May 1, 2016 on not less than 30 or more than 60 days’ prior notice, at redemption prices set forth in the Indenture. In addition, at any time prior to May 1, 2015, the Company may use the net proceeds from equity offerings and warrant exercises to redeem up to 35% of the principal amount of Notes issued under the Indenture at a redemption price equal to 108.50% of the principal amount of the Notes redeemed, plus accrued and unpaid interest. The Senior Notes may also be redeemed at any time prior to May 1, 2016 at the option of the Company at a redemption price equal to 100% of the principal amount of the Notes redeemed plus the applicable premium, and accrued and unpaid interest and additional interest, if any, to the applicable redemption date as set forth in the Indenture. If a change of control occurs, each holder of the Notes will have the right to require that the Company purchase all of such holder’s Notes in an amount equal to 101% of the principal of such Notes, plus accrued and unpaid interest, if any, to the date of the purchase.
The fair value of the Senior Notes at December 31, 2014, was estimated to be $194.0 million based upon data from independent market makers (Level 2 fair value measurement).
Note 6 - Income Taxes
The following table summarizes the components of the provision for income taxes (in thousands):
The provision for income taxes for the years ended December 31, 2014, 2013 and 2012 differs from the amount that would be provided by applying the statutory U.S. federal income tax rate of 35% to income before income taxes. This difference relates primarily to state income taxes and estimated permanent differences as follows (in thousands):
The tax effects of temporary differences that give rise to significant portions of the deferred income tax assets and liabilities are presented below (in thousands):
The Company has U.S. net operating loss carry forwards of $264.8 million at December 31, 2014, which will begin expiring in 2026. A valuation allowance against deferred tax assets at December 31, 2014 is not considered necessary because in the Company’s opinion it is more likely than not that the deferred tax asset will be fully realized.
The Company previously adopted the accounting for uncertain tax positions per FASB ASC Topic 740, Accounting for Income Taxes. This guidance prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This guidance requires that the Company recognize in the consolidated financial statements, only those tax positions that are “more-likely-than-not” of being sustained, based on the technical merits of the position. This guidance had no effect on the Company’s financial position, cash flows or results of operations for 2014, 2013 or 2012 as the Company had no unrecognized tax benefits. The Company’s policy is to recognize interest and penalties related to uncertain tax positions in income tax expense. The Company has no accrued interest or penalties related to uncertain tax positions as of December 31, 2014, 2013 or 2012.
The Company is subject to the following material taxing jurisdictions: U.S. federal, Colorado, Texas and Utah. The tax years that remain open to examination by the Internal Revenue Service are the years 2011 through 2014. The tax years that remain open to examination by state taxing authorities are 2010 through 2014.
Note 7 - Stockholders’ Equity and Equity Based Awards
Preferred Stock
The Company is authorized to issue up to 1,000,000 shares of preferred stock, par value $0.0001 with such designations, voting and other rights and preferences as may be determined from time to time by the Board of Directors. No shares were issued and outstanding as of December 31, 2014 or December 31, 2013.
Common Stock
The authorized common stock of the Company consists of 225,000,000 shares. The holders of the common shares are entitled to one vote for each share of common stock. In addition, the holders of the common stock are entitled to receive dividends when, as and if declared by the Board of Directors. At December 31, 2014 and 2013, the Company had 77,634,737 and 76,228,055 shares of common stock issued and outstanding, respectively.
During the second quarter 2013, the Company issued 13.3 million shares of common stock in a public offering at $8.00 per share for net proceeds of $101.8 million, after underwriting discounts and commissions. The net proceeds were used to repay outstanding borrowings under the Revolving Credit Facility.
During 2014 and 2013, no warrants were repurchased. During the second quarter of 2012 the Company repurchased 9,634,821 warrants for aggregate consideration of approximately $10.0 million in a private transaction at an average price of $1.04 per warrant. During 2014, 2013 and 2012, no warrants were exercised. At December 31, 2014, no warrants remain outstanding as all warrants expired on September 25, 2014.
Share-Based Compensation
The Company accounts for share-based compensation in accordance with FASB ASC Topic 718, Stock Compensation.
On July 31, 2009, the Company adopted the Incentive Plan, providing for long-term share-based awards intended as a means for the Company to attract, motivate, retain and reward directors, officers, employees and other eligible persons through the grant of awards and incentives for high levels of individual performance and improved financial performance of the Company. The share-based awards are also intended to further align the interests of award recipients and the Company’s stockholders. The maximum number of shares of common stock that may be issued under the Incentive Plan is 9,157,744.
Time-Based Awards
Shares of time-based restricted stock generally vest in three or four year increments at specified dates based on continued employment.
The compensation expense to be recognized for the time-based awards was measured based on the Company’s closing stock price on the dates of grant, utilizing estimated forfeiture rates between 8% and 10% which are updated periodically based on actual employee turnover. During the year ended December 31, 2014, the Company granted 1,595,535 shares of time-based restricted stock to employees and directors, pursuant to the Incentive plan.
During 2014, 2013 and 2012, the Company recorded $12.1 million, $11.0 million and $7.2 million of share-based compensation expense related to time-based awards, net of amounts billed to partners, respectively. There was unrecognized compensation expense of approximately $16.7 million at December 31, 2014, which is expected to be recognized over a weighted-average period of 1.7 years. The following table summarizes the changes in non-vested time-based awards for the periods presented:
Performance-Based Awards
For grants made through year-end 2012, performance-based shares generally vest in equal tranches beginning on December 31 of the year of the grant if there has been a 10% annual appreciation in the trading price of the Company’s common stock, compounded annually, from the twenty trading day average stock price ended on December 31 of the year prior to the grant (which was $14.227 for 2011 grants and $11.639 for 2012 grants). At the end of each year, the twenty trading day average stock price will be measured, and if the 10% threshold is met, the stock subject to the performance criteria will vest. If the 10% threshold is not met, shares that have not vested will be carried forward to the following year subject to a four year maximum vesting period. These awards are referred to as “Stock Appreciation Awards.” At December 31, 2014 and 2013, 156,793 and 390,174 of the Stock Appreciation Awards, respectively, were forfeited by their holders as the four year maximum vesting period for the grants had expired and the 10% threshold had not been met.
During 2014, 2013 and 2012, the Company recorded share-based compensation expense related to the Stock Appreciation Awards of $0.2 million, $0.8 million and $2.2 million, respectively. There was unrecognized compensation expense for the Stock Appreciation Awards of approximately $0.1 million at December 31, 2014, which is expected to be recognized over a weighted-average period of 1.0 year. The following table summarized changes in non-vested Stock Appreciation Awards for the periods presented:
In 2014 and 2013, the Compensation Committee awarded 487,819 and 354,517 performance-based restricted shares, respectively, to executive officers of the Company under the Incentive Plan. The restricted stock grants vest only upon achievement of thresholds of cumulative total shareholder return (“TSR”) as compared to a specified peer group (the “Performance-Vested Shares”). A TSR percentile (the “TSR Percentile”) is calculated based on the change in the value of the Company’s common stock between the grant date and the applicable vesting date, including any dividends paid during the period, as compared to the respective TSRs of a specified group of seventeen peer companies. The Performance-Vested Shares vest in three installments to the extent that the applicable TSR Percentile ranking thresholds are met upon the one-, two- and three-year anniversaries of the grant date. Performance-Vested Shares that are eligible to vest on a vesting date, but do not qualify for vesting, become eligible for vesting again on the next vesting date. All Performance-Vested Shares that do not vest as of the final vesting date will be forfeited on such date.
The Compensation Committee also granted rights to earn additional shares of common stock upon achievement of a higher TSR Percentile (“Outperformance Shares”). The Outperformance Shares are earned in increasing increments based on a TSR Percentile attained over a specified threshold. Outperformance Shares may be earned on any vesting date to the extent that the applicable TSR Percentile ranking thresholds are met in three installments on the one-, two- and three-year anniversaries of the grant date. Outperformance Shares that are earned at a vesting date will be issued to the recipient; however, prior to such issuance, the recipient is not entitled to stockholder rights with respect to Outperformance Shares. Outperformance Shares that are eligible to be earned but remain unearned on a vesting date become eligible to be earned again on the next vesting date. The right to earn any theretofore unearned Outperformance Shares terminates immediately following the final vesting date. The Performance-Vested Shares and the Outperformance Shares are referred to as the “TSR Awards.”
The compensation expense to be recognized for the TSR Awards and Stock Appreciation Awards was measured based on the estimated fair value at the date of grant using a Monte Carlo simulation model and utilizes estimated forfeiture rates between 4% and 15% which are updated periodically based on actual employee turnover.
The valuation model for the Performance-Based Awards used the following assumptions:
During 2014 and 2013, the Company recorded share-based compensation expense related to the TSR Awards of $4.0 million and $3.1 million, respectively. There was unrecognized compensation expense for TSR Awards of approximately $4.5 million at December 31, 2014, which is expected to be recognized over a weighted-average period of 1.8 years. The following table summarized changes in non-vested TSR Awards for the periods presented:
Note 8 - Asset Retirement Obligation
Resolute’s estimated asset retirement obligation liability is based on estimated economic lives, estimates as to the cost to abandon the wells in the future, and federal and state regulatory requirements. The liability is discounted using a credit-adjusted risk-free rate estimated at the time the liability is incurred or revised that ranges between 7% and 12%. Revisions to the liability could occur due to changes in estimated abandonment costs or well economic lives, or if federal or state regulators enact new requirements regarding the abandonment of wells. Asset retirement obligations are valued utilizing Level 3 fair value measurement inputs.
The following table provides a reconciliation of Resolute’s asset retirement obligations for the periods presented, (in thousands):
Note 9 - Derivative Instruments
Resolute enters into commodity derivative contracts to manage its exposure to oil and gas price volatility. Resolute has not elected to designate derivative instruments as hedges under the provisions of FASB ASC Topic 815, Derivatives and Hedging. As a result, these derivative instruments are marked to market at the end of each reporting period and changes in the fair value are recorded in the accompanying consolidated statements of operations. Gains and losses on commodity derivative instruments from Resolute’s price risk management activities are recognized in other income (expense). The cash flows from derivatives are reported as cash flows from operating activities unless the derivative contract is deemed to contain a financing element. Derivatives deemed to contain a financing element are reported as financing activities in the condensed consolidated statement of cash flows.
The Company utilizes fixed price swaps, basis swaps, option contracts and two- and three-way collars. These instruments generally entitle Resolute (the floating price payer in most cases) to receive settlement from the counterparty (the fixed price payer in most cases) for each calculation period in amounts, if any, by which the settlement price for the scheduled trading days applicable to each calculation period is less than the fixed strike price or floor price. The Company would pay the counterparty if the settlement price for the scheduled trading days applicable to each calculation period exceeds the fixed strike price or ceiling price. The amount payable by Resolute, if the floating price is above the fixed or ceiling price, is the product of the notional contract quantity and the excess of the floating price over the fixed or ceiling price per calculation period. The amount payable by the counterparty, if the floating price is below the fixed or floor price, is the product of the notional contract quantity and the excess of the fixed or floor price over the floating price per calculation period. A three-way collar consists of a two-way collar contract combined with a put option contract sold by the Company with a strike price below the floor price of the two-way collar. The Company receives price protection at the purchased put option floor price of the two-way collar if commodity prices are above the sold put option strike price. If commodity prices fall below the sold put option strike price, the Company receives the cash market price plus the variance between the two put option strike prices. This type of instrument captures more value in a rising commodity price environment, but limits the benefits in a downward commodity price environment. Basis swaps, when used in connection with fixed price swaps, fix the price differential between the NYMEX commodity price and the index price at which the production is sold.
As of December 31, 2014, the fair value of the Company’s commodity derivatives was a net asset of $112.6 million (Level 2 fair value measurement).
The following table represents Resolute’s commodity swap contracts as of December 31, 2014:
The following table represents Resolute’s two-way commodity collar contracts as of December 31, 2014:
The following table represents Resolute’s three-way gas collar contracts as of December 31, 2014:
Resolute does not offset the fair value amounts of derivative assets and liabilities with the same counterparty for financial reporting purposes. See Note 10 for the location and fair value amounts of Resolute’s commodity derivative instruments reported in the consolidated balance sheets at December 31, 2014 and 2013.
The table below summarizes the location and amount of commodity derivative instrument gains and losses reported in the consolidated statements of income (in thousands):
Credit Risk and Contingent Features in Derivative Instruments
Resolute is exposed to credit risk to the extent of nonperformance by the counterparties in the derivative contracts discussed above. All counterparties are lenders under Resolute’s Credit Facility. Accordingly, Resolute is not required to provide any credit support to its counterparties other than cross collateralization with the properties securing the Credit Facility. Resolute’s derivative contracts are documented with industry standard contracts known as a Schedule to the Master Agreement and International Swaps and Derivative Association, Inc. Master Agreement (“ISDA”). Typical terms for each ISDA include credit support requirements, cross default provisions, termination events, and set-off provisions. Resolute has set-off provisions with its lenders that, in the event of counterparty default, allow Resolute to set-off amounts owed under the Credit Facility or other general obligations against amounts owed for derivative contract liabilities.
The maximum amount of loss in the event of all counterparties defaulting is $112.6 million as of December 31, 2014, due to the set off provisions noted above.
Note 10 - Fair Value Measurements
FASB ASC Topic 820, Fair Value Measurements and Disclosures, defines fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. The guidance establishes market or observable inputs as the preferred sources of values, followed by assumptions based on hypothetical transactions in the absence of market inputs. The guidance establishes a hierarchy for determining the fair values of assets and liabilities, based on the significance level of the following inputs:
●
Level 1 - Quoted prices in active markets for identical assets or liabilities.
●
Level 2 - Quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar instruments in markets that are not active and model-derived valuations whose inputs are observable or whose significant value drivers are observable.
●
Level 3 - Significant inputs to the valuation model are unobservable.
An asset or liability subject to the fair value requirements is categorized within the hierarchy based on the lowest level of input that is significant to the fair value measurement. Resolute’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability. Following is a description of the valuation methodologies used by Resolute as well as the general classification of such instruments pursuant to the hierarchy.
As of December 31, 2014, Resolute’s commodity derivative instruments were required to be measured at fair value on a recurring basis. Resolute used the income approach in determining the fair value of its derivative instruments, utilizing present value techniques for valuing its swaps and basis swaps and option-pricing models for valuing its options. Inputs to these valuation techniques include published forward index prices, volatilities, and credit risk considerations, including the incorporation of published interest rates and credit spreads. Substantially all of these inputs are observable in the marketplace throughout the full term of the contract, can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace and are therefore designated as Level 2 within the valuation hierarchy.
The following is a listing of Resolute’s commodity derivative assets and liabilities required to be measured at fair value on a recurring basis and where they are classified within the hierarchy as of December 31, 2014 and December 31, 2013 (in thousands):
Note 11 - Commitments and Contingencies
CO2 Take-or-Pay Agreements
Resolute is party to a take-or-pay purchase agreement with Kinder Morgan CO2 Company L.P., under which Resolute has committed to buy specified volumes of CO2. The purchased CO2 is for use in Resolute’s enhanced tertiary recovery projects in Aneth Field. Resolute is obligated to purchase a minimum daily volume of CO2 or pay for any deficiencies at the price in effect when delivery was to have occurred. The ultimate CO2 volumes planned for use on the enhanced recovery projects exceed the minimum daily volumes provided in these take-or-pay purchase agreements. Although the Company may incur deficiency payments from time to time, Resolute expects to avoid any permanent payments for deficiencies over the term of the agreement.
Future minimum CO2 purchase commitments as of December 31, 2014, under this purchase agreement, based on prices and volumes in effect at December 31, 2014, are as follows (in thousands):
Operating Leases
For 2014, 2013 and 2012, month-to-month office facilities rental payments charged to expense were approximately $1.6 million, $2.0 million and $1.5 million, respectively. The Company is also party to several field equipment and compressor leases used in the CO2 project as well as various vehicle lease agreements. For 2014, 2013 and 2012, the Company’s net rental expense related to these leases was $2.6 million, $2.9 million and $2.6 million, respectively.
Future payments for the Company’s office facilities, equipment leases and vehicle leases under these operating lease agreements, as of December 31, 2014, are as follows (in thousands):
Escrow Funding Agreement
Under the terms of Resolute’s predecessor Company’s purchase of working interests in Greater Aneth from ExxonMobil Corporation (the “ExxonMobil Properties”) in 2006, Resolute and NNOGC were required to fund an escrow account sufficient to complete abandonment, well plugging, site restoration and related obligations arising from ownership of the acquired interests. The contribution net to the Company’s working interest, is included in “other assets: restricted cash” in the consolidated balance sheets at December 31, 2014 and 2013. The Company is required to make additional deposits to the escrow account annually. From 2015 through 2016, Resolute must fund approximately $1.6 million per year. In years after 2016, the Company must fund additional payments averaging approximately $0.9 million per year until 2031. Total contributions from the date of acquisition through 2031 will aggregate $26.0 million. Annual interest earned in the escrow account, if any, becomes part of the balance and reduces the payment amount required for funding the escrow account each year. As of December 31, 2014, the Company has funded the 2014 annual contractual amount of approximately $1.6 million required to meet its future obligation.
NNOGC Purchase Options
Resolute’s purchase of the Aneth Field Properties was facilitated by the predecessor Company’s strategic alliance with NNOGC and, through NNOGC, the Navajo Nation. This strategic alliance with NNOGC is embodied in a Cooperative Agreement consummated with NNOGC in 2004 to facilitate the joint acquisition of working interests in Greater Aneth from Chevron Corporation and its affiliates (the “Chevron Properties”). The agreement was amended subsequently to facilitate the joint acquisition of the ExxonMobil Properties and was amended again in conjunction with the sale of 10% of the Company’s interest in Aneth Field to NNOGC during the second quarter of 2012.
Under the original terms of the Cooperative Agreement, NNOGC was granted three separate but substantially similar purchase options. Each purchase option entitled NNOGC to purchase from Resolute up to 10% of the undivided working interests in the Chevron Properties or the ExxonMobil Properties, as applicable, as to each unit in the Aneth Field Properties. The Cooperative Agreement amendment executed in 2012 provides for the cancellation of the second set of options held by NNOGC to purchase an additional 10% interest in the Aneth Field Properties and stipulates that NNOGC has one remaining option to purchase an additional 10% of the Company’s interest in the Aneth Field Properties (as it stood prior to the current option exercise and excluding the interest acquired from Denbury and certain other minority interests). The remaining option is exercisable in July 2017 at the then current fair market value of such interest. The exercise by NNOGC of its remaining purchase option in full would not give it the right to remove Resolute as operator of any of the Aneth Field Properties.
Note 12 - Supplemental Oil and Gas Information (unaudited)
Costs Incurred in Oil and Gas Property Acquisition, Exploration, and Development Activities
Costs incurred during 2014, 2013 and 2012 related to oil and gas property acquisition, exploration and development activities, including the fair value of oil and gas properties acquired are summarized as follows (in thousands):
*Includes $16.3 million, $20.0 million and $16.2 million of acquired CO2 during 2014, 2013 and 2012, respectively.
Capitalized Costs of Oil and Gas Properties
Net capitalized costs related to Resolute’s oil and gas producing activities at December 31, 2014 and December 31, 2013 were as follows (in thousands):
Oil and Gas Reserve Quantities
The reserve data as of December 31, 2014 was prepared by Resolute. Netherland, Sewell & Associates, Inc. (“NSAI”), independent petroleum engineers, audited all properties. Users of this information should be aware that the process of estimating quantities of proved oil and gas reserves is very complex, requiring significant subjective decisions to be made in the evaluation of 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. As a result, revisions to existing reserves estimates may occur from time to time. Although every reasonable effort is made to ensure reserves estimates reported represent the most accurate assessments possible, the subjective decisions and variances in available data for various reservoirs make these estimates generally less precise than other estimates included in the financial statement disclosures.
Presented below is a summary of the changes in estimated reserves (in thousands):
1)
In accordance with SEC and Financial Accounting Standards Board (“FASB”) requirements, our estimated net proved reserves and standardized measure at December 31, 2014 and 2013, utilized prices (subsequently adjusted for quality and basis differentials) of an average NYMEX West Texas Intermediate oil price of $94.99 and $96.94 per Bbl for the Aneth Properties and Plains Marketing, L.P. West Texas Intermediate oil price of $91.48 and $93.42 per Bbl for the Permian and Wyoming Properties, and an average Henry Hub spot marketing gas price of $4.35 and $3.67 per one MMBtu of gas, respectively. At December 31, 2012, we used an average NYMEX West Texas Intermediate oil price of $94.71 per Bbl, and an average Henry Hub spot market gas price of $2.76 per MMBtu.
2)
Extensions, discoveries and other additions in 2014 are primarily associated with reinstatement of CO2 enhanced recovery projects that were removed for year-end 2013 reporting to comply with the SEC five-year rule pertaining to undeveloped reserves. Approximately 21.1 MMBoe have been reinstated as proved undeveloped all comprised of four named CO2 injection projects identified in the Aneth Field Properties: 8.9 MMBoe for Aneth Unit Phase 4 CO2 injection, 3.0 MMBoe for McElmo Unit DCIIC CO2 injection, 4.9 MMBoe for Ratherford DCIA CO2 injection and 4.3 MMBoe for Ratherford DCIIC CO2 injection. Additionally, the Permian and Powder River Basin properties held active drilling programs in 2014 resulting in 1.7 MMBoe added to proved developed producing from successful drilling of non-proved locations. Furthermore, these successful wells created additional proved undeveloped offset locations carrying 6.0 MMBoe reserves.
3)
Decreases in proved reserves associated with revisions of previous estimates resulted from management’s decision to allocate more of its 2014 capital expenditures towards exploitation drilling of higher expected rates-of-return horizontal wells in the Permian Basin and less capital towards development projects in Aneth Field. Deferral of these projects to 2015 and beyond decreased proved undeveloped reserves by approximately 25 MMBoe, as these projects were no longer expected to be converted to developed reserves within five years after their initial recognition as proved reserves as required under SEC rules, offset by approximately 3 MMBoe converted to proved developed during 2013. The deferred will be again eligible as proved undeveloped reserves in the future, at such time as management adopts a definitive plan to complete the projects.
Standardized Measure of Discounted Future Net Cash Flows Relating to Proved Oil and Gas Reserves:
The following summarizes the policies used in the preparation of the accompanying oil and gas reserves disclosures, standardized measures of discounted future net cash flows from proved oil and gas reserves and the reconciliations of standardized measures at December 31, 2014. The information disclosed is an attempt to present the information in a manner comparable with industry peers.
The information is based on estimates of proved reserves attributable to Resolute’s interest in oil and gas properties as of December 31, 2014. Proved reserves are estimated quantities of oil and gas that geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions.
The standardized measure of discounted future net cash flows from production of proved reserves was developed as follows:
1)
Estimates were made of quantities of proved reserves and future periods during which they are expected to be produced based on year-end economic conditions.
2)
The estimated future cash flows were compiled by applying average annual prices of oil and gas relating to Resolute’s proved reserves to the year-end quantities of those reserves.
3)
The future cash flows were reduced by estimated production costs, costs to develop and produce the proved reserves and abandonment costs, all based on year-end economic conditions.
4)
Future income tax expenses were based on year-end statutory tax rates giving effect to the remaining tax basis in the oil and gas properties, other deductions, credits and allowances relating to Resolute’s proved oil and gas reserves.
5)
Future net cash flows were discounted to present value by applying a discount rate of 10%.
The standardized measure of discounted future net cash flows does not purport, nor should it be interpreted, to present the fair value of Resolute’s oil and gas reserves. An estimate of fair value would also take into account, among other things, the recovery of reserves not presently classified as proved, anticipated future changes in prices and costs and a discount factor more representative of the time value of money and the risks inherent in reserve estimates. The following summary sets forth Resolute’s future net cash flows relating to proved oil and gas reserves based on the standardized measure prescribed by FASB ASC Topic 932:
The principal sources of change in the standardized measure of discounted future net cash flows are:
Note 13 - Quarterly Financial Data (unaudited)
The following is a summary of the unaudited financial data for each quarter for the years ended December 31, 2014 and 2013 (in thousands except per share data):