PRIMEENERGY RESOURCES CORPORATION The following discussion is intended to assist you in understanding our results of operations and our present financial condition. Our Consolidated Financial Statements and the accompanying Notes to the Consolidated Financial Statements included elsewhere in this Report contains additional information that should be referred to when reviewing this material. Our subsidiaries are listed in Note 1 to the Consolidated Financial Statements.
Overview:
We are an independent oil and natural gas company engaged in acquiring, developing and producing oil and natural gas. We presently own producing and non-producing properties located primarily inTexas ,Oklahoma andWest Virginia . In addition, we own a substantial amount of well servicing equipment. All our oil and gas properties and interests are located inthe United States . Assets in our principal focus areas include mature properties with long-lived reserves and significant development opportunities as well as newer properties with development and exploration potential. We believe our balanced portfolio of assets and our ongoing hedging program position us well for both the current commodity price environment and future potential upside as we develop our attractive resource opportunities. Our primary sources of liquidity are cash generated from our operations and our credit facility. 41
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We attempt to assume the position of operator in all acquisitions of producing properties and will continue to evaluate prospects for leasehold acquisitions and for exploration and development operations in areas in which we own interests. We continue to actively pursue the acquisition of producing properties. To diversify and broaden our asset base, we will consider acquiring the assets or stock in other entities and companies in the oil and gas business. Our main objective in making any such acquisitions will be to acquire income producing assets to build stockholder value through consistent growth in our oil and gas reserve base on a cost-efficient basis. Our cash flows depend on many factors, including the price of oil and gas, the success of our acquisition and drilling activities and the operational performance of our producing properties. We use derivative instruments to manage our commodity price risk. This practice may prevent us from receiving the full advantage of any increases in oil and gas prices above the maximum fixed amount specified in the derivative agreements and subjects us to the credit risk of the counterparties to such agreements. Since all our derivative contracts are accounted for under mark-to-market accounting, we expect continued volatility in gains and losses on mark-to-market derivative contracts in our consolidated statement of operations as changes occur in the NYMEX price indices. OnJanuary 30, 2020 , theWorld Health Organization ("WHO") announced a global health emergency due to the COVID-19 outbreak, which originated inWuhan, China , and the risks to the international community as the virus spreads globally beyond its point of origin. InMarch 2020 , the WHO classified the COVID-19 outbreak as a pandemic, based on the rapid increase in exposure globally. In addition, inMarch 2020 , members ofOPEC failed to agree on production levels which has caused an increased supply and has led to a substantial decrease in oil prices and an increasingly volatile market. The oil price war ended with a deal to cut global petroleum output but did not go far enough to offset the impact of COVID-19 on demand. There has been an increase in supply which has pushed prices down further since March. If the depressed pricing continues for an extended period it will lead to i) further reductions in the borrowing base under our credit facility which would require us to make additional borrowing base deficiency payments, ii) reductions in reserves, and iii) additional impairment of proved and unproved oil and gas properties. We also expect disclosures of supplemental oil and gas information to be impacted by price declines. In response to recent commodity prices our efforts to reduce costs include reducing operating costs and electing to shut-in marginal wells. The Company will continue to review field operations to minimize costs and identify wells for short term shut-ins through May and June. The Company has also implemented a reduction in workforce to further reduce general and administrative costs. The full impact of the COVID-19 outbreak and the decline in oil prices continues to evolve as of the date of this report. As such, it is uncertain as to the full magnitude that these events will have on the Company's financial condition, liquidity, and future results of operations. Management is actively monitoring the global situation on its financial condition, liquidity, operations, suppliers, industry, and workforce. Given the daily evolution of the COVID-19 outbreak and the global responses to curb its spread, the Company is not able to estimate the effects of the COVID-19 outbreak on its results of operations, financial condition, or liquidity for fiscal year 2020. These matters may have a continued material adverse impact on economic and market conditions and trigger a period of global economic slowdown, which may impair the Company's asset values, including reserve estimates. Further, consumer demand has decreased since the spread of the outbreak and new travel restrictions placed by governments in an effort to curtail the spread of the coronavirus. Although the Company cannot estimate the length or gravity of the impacts of these events at this time, if the pandemic and/or decreased oil prices continue, they may have a material adverse effect on the Company's results of future operations, financial position, and liquidity in fiscal year 2020.
Market Conditions and Commodity Prices:
Our financial results depend on many factors, particularly the price of natural gas and crude oil and our ability to market our production on economically attractive terms. Commodity prices are affected by many
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factors outside of our control, including changes in market supply and demand, which are impacted by weather conditions, pipeline capacity constraints, inventory storage levels, basis differentials and other factors. In addition, our realized prices are further impacted by our derivative and hedging activities. We derive our revenue and cash flow principally from the sale of oil, natural gas and NGLs. As a result, our revenues are determined, to a large degree, by prevailing prices for crude oil, natural gas and NGLs. We sell our oil and natural gas on the open market at prevailing market prices or through forward delivery contracts. Because some of our operations are located outside major markets, we are directly impacted by regional prices regardless ofHenry Hub , WTI or other major market pricing. The market price for oil, natural gas and NGLs is dictated by supply and demand; consequently, we cannot accurately predict or control the price we may receive for our oil, natural gas and NGLs. The price of oil and natural gas has fallen significantly since the beginning of 2020, due in part to failedOrganization of Petroleum Exporting Countries ("OPEC") negotiations as well as concerns about the COVID-19 pandemic and its impact on the worldwide economy and global demand for oil and gas. The resulting precipitous decline in oil and gas pricing experienced duringMarch 2020 , through the date of this report, if prolonged. or a further deterioration of the market price for oil and natural gas, will negatively impact our cash flows.
Critical Accounting Estimates:
Proved Oil and Gas Reserves
Proved oil and gas reserves directly impact financial accounting estimates, including depreciation, depletion and amortization. Proved reserves represent estimated quantities of natural gas, crude oil, condensate, and natural gas liquids that geological and engineering data demonstrate, with reasonable certainty, to be recoverable in future years from known reservoirs under economic and operating conditions existing at the time the estimates were made. The process of estimating quantities of proved oil and gas reserves is very complex, requiring significant subjective decisions in the evaluation of all available geological, engineering and economic data for each reservoir. The data for a given reservoir may also change substantially over time as a result of numerous factors including, but not limited to, additional development activity, evolving production history and continual reassessment of the viability of production under varying economic conditions. Consequently, material revisions (upward or downward) to existing reserve estimates may occur from time to time.
Depreciation, Depletion and Amortization for
The quantities of estimated proved oil and gas reserves are a significant component of our calculation of depletion expense and revisions in such estimates may alter the rate of future expense. Holding all other factors constant, if reserves were revised upward or downward, earnings would increase or decrease respectively. Depreciation, depletion and amortization of the cost of proved oil and gas properties are calculated using the unit-of-production method. The reserve base used to calculate depletion, depreciation or amortization is the sum of proved developed reserves and proved undeveloped reserves for leasehold acquisition costs and the cost to acquire proved properties. The reserve base includes only proved developed reserves for lease and well equipment costs, which include development costs and successful exploration drilling costs. Estimated future dismantlement, restoration and abandonment costs, net of salvage values, are taken into account.
Liquidity and Capital Resources:
Our primary sources of liquidity are cash generated from our operations, through our producing oil and gas properties, field services business and sales of acreage.
Net cash provided by operating activities for the year endedDecember 31, 2019 was$27.2 million , compared to$39.1 million in the prior year. Excluding the effects of significant unforeseen expenses or other income, our cash flow from operations fluctuates primarily because of variations in oil and gas production and prices or changes in working capital accounts. Our oil and gas production will vary based on actual well performance but may be curtailed due to factors beyond our control. 43
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Our realized oil and gas prices vary due to world political events, supply and demand of products, product storage levels, and weather patterns. We sell the majority of our production at spot market prices. Accordingly, product price volatility will affect our cash flow from operations. To mitigate price volatility, we sometimes lock in prices for some portion of our production through the use of derivatives. If our exploratory drilling results in significant new discoveries, we will have to expend additional capital to finance the completion, development, and potential additional opportunities generated by our success. We believe that, because of the additional reserves resulting from the successful wells and our record of reserve growth in recent years, we will be able to access sufficient additional capital through bank financing. Maintaining a strong balance sheet and ample liquidity are key components of our business strategy. For 2019, we will continue our focus on preserving financial flexibility and ample liquidity as we manage the risks facing our industry. Our 2020 capital budget is reflective of commodity prices and has been established based on an expectation of available cash flows, with any cash flow deficiencies expected to be funded by borrowings under our revolving credit facility. As we have done historically to preserve or enhance liquidity we may adjust our capital program throughout the year, divest assets, or enter into strategic joint ventures. We are actively in discussions with financial partners for funding to develop our asset base and, if required, pay down our revolving credit facility should our borrowing base become limited due to the deterioration of commodity prices. The Company maintains a Credit Agreement with a maturity date ofFebruary 15, 2021 , providing for a credit facility totaling$300 million , with a borrowing base of$72 million . As ofApril 15, 2020 , the Company has$53.5 million in outstanding borrowings and$18.5 million in availability under this facility. The bank reviews the borrowing base semi-annually and, at their discretion, may decrease or propose an increase to the borrowing base relative to a re-determined estimate of proved oil and gas reserves. The next borrowing base review is scheduled forJune 2020 . Our oil and gas properties are pledged as collateral for the line of credit and we are subject to certain financial and operational covenants defined in the agreement. We are currently in compliance with these covenants and expect to be in compliance over the next twelve months. If we do not comply with these covenants on a continuing basis, the lenders have the right to refuse to advance additional funds under the facility and/or declare all principal and interest immediately due and payable. Our borrowing base may decrease as a result of lower natural gas or oil prices, operating difficulties, declines in reserves, lending requirements or regulations, the issuance of new indebtedness or for other reasons set forth in our revolving credit agreement. In the event of a decrease in our borrowing base due to declines in commodity prices or otherwise, our ability to borrow under our revolving credit facility may be limited and we could be required to repay any indebtedness in excess of the re-determined borrowing base.
Our credit agreement required us to hedge a portion of our production as forecasted for the PDP reserves included in our borrowing base review engineering reports. Accordingly the Company has in place the following swap and put agreements for oil and natural gas.
2020 2021 2020 2021
Swap Agreements
Natural Gas (MMBTU) 180,000 951,000 $ 2.95 $ 2.41
Oil (barrels) 225,500 $ 58.43
2020 2021 2020 2021
Put Agreements
Natural Gas (MMBTU) 1,849,000 500,000 $ 2.25 $ 2.00
Oil (barrels) 95,400 66,000 $ 48.27 $ 35.00
On March 27, 2020 , President Trump signed into law the Coronavirus Aid, Relief,
and Economic Security Act (the "CARES Act"). The CARES Act, among other things,
includes provisions relating to refundable payroll tax credits, deferment of
employer side social security payments, net operating loss carryback periods,
alternative minimum tax credit refunds, modifications to the net interest
deduction limitations, increased limitations on
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qualified charitable contributions, and technical corrections to tax depreciation methods for qualified improvement property.
It also appropriated funds for the SBA Paycheck Protection Program loans that are forgivable in certain situations to promote continued employment, as well as Economic Injury Disaster Loans to provide liquidity to small businesses harmed by COVID-19. We have applied for assistance under this program however due to the volume of applications there is no assurance we will be able to obtain funds under them. We continue to examine the opportunity that the CARES Act may have to benefit our business. The Company's activities include development and exploratory drilling. Our strategy is to develop a balanced portfolio of drilling prospects that includes lower risk wells with a high probability of success and higher risk wells with greater economic potential. In 2016, based upon the results of horizontal wells and historical vertical well performance, we decided to reduce the number of vertical wells in our drilling program and focus primarily on horizontal well drilling. We believe horizontal development of our resource base provides superior returns relative to vertical development, due to the ability of horizontals to come in contact with and drain from a greater volume of reservoir rock over more acreage, with less infrastructure, and thus at a lower cost of development per acre. We participated in 18 gross (1.6 net) horizontal wells drilled and completed in 2019, all of which were producing at year-end. In addition, 14 gross (4.63 net) wells that had been completed at year-end 2018 and in which we had participated, were also brought on-line in 2019. Of the total 18 wells completed in 2019, three are located inWest Texas , while 13 are in our Oklahoma Scoop-Stack horizontal development program. The three wells drilled inWest Texas in 2019 added significantly to our reserve base, as these probable undeveloped locations were the initial test wells in intervals above the Middle Wolfcamp: one in the Wolfcamp "A", one in theJo Mill and one in the Lower Spraberry, and have proved up these reservoirs for the 1,300 acre block in which they were drilled. Our share of the cost of these three wells is approximately$9.2 million . Not only did these wells add proved developed reserves, but as a result, nine additional locations in these reservoirs were proven for horizontal development. Six of the nine horizontals were drilled as ofApril 15, 2020 . The successful development of these reservoirs has also proved-uplocations to be drilled on our nearby 2,600-acre block in which the Company holds between 14% and 56% interest. It is anticipated that development of as many as 54 additional horizontal wells on this 2,600-acre block will occur over the coming years. The cost of such development would be approximately$370.6 million with the Company's share being approximately$170.8 million . The actual number of wells that will be drilled, the cost, and the timing of drilling will vary based upon many factors, including commodity market conditions. In early 2020, as mentioned above, the Company participated in the drilling of six wells inUpton County, Texas , operated by Apache Corporation. These wells are expected to be completed in the fourth quarter of 2020 with a total anticipated investment of$21 million . Also inUpton County, Texas , in early 2020, we participated for 7.7% interest in the horizontal drilling of a well operated by Pioneer Natural Resources that is expected to be completed in the fourth quarter of 2020. Our total net expenditure for this well is estimated to be$580,400 . Additional drilling and future development plans will be established based on an expectation of available cash flows from operations and availability of funds under our revolving credit facility. The Exploration, Development and Recent Activities section in Part I above describes in more detail the recent activities of the Company. The focus of our future activity will be on the continued development of our resource's potential in theWest Texas horizontal drilling program as well as our Scoop-Stack horizontal drilling program acreage inOklahoma in order to maximize cash flow and return on investment. The Company maintains an acreage position of 19,910 gross (12,560 net) acres in thePermian Basin inWest Texas , primarily inReagan ,Upton ,Martin andMidland counties and we believe this acreage has significant resource potential in as many as 10 reservoirs, including benches of the Spraberry,Jo Mill , and Wolfcamp that support the potential drilling of as many as 180 additional horizontal wells. 45
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InOklahoma , the Company's horizontal activity is primarily focused in Canadian,Grady ,Kingfisher ,Garfield ,Major , andGarvin counties where we have approximately 3,460 net leasehold acres. We believe this acreage has significant additional resource potential that could support the drilling of as many as 52 new horizontal wells based on an estimate of six wells per section: three in the Mississippian and three in theWoodford Shale . Should we choose to participate in future development, our share of the capital expenditures would be approximately$40 million at an average 10% ownership level; the Company will otherwise sell its rights for cash, or cash plus a royalty or working interest.
To supplement cash flow and finance our drilling program during 2019, the
Company sold or farmed-out leasehold rights through several transactions,
receiving gross proceeds of approximately
The majority of our capital spending is discretionary, and the ultimate level of expenditures will be dependent on our assessment of the oil and gas business environment, the number and quality of oil and gas prospects available, the market for oilfield services, and oil and gas business opportunities in general. The Company has in place both a stock repurchase program and a limited partnership interest repurchase program. Spending under these programs in 2019 and 2018 was$5.9 and$8 million , respectively. The Company expects continued spending under these programs in 2020.
Results of Operations:
2019 and 2018 Compared
We reported net income for 2019 of$3.5 million , or$1.72 per share, compared to$14.5 million , or$6.95 per share for 2018. This decrease was due to increases in oil, NGL and natural gas production and sales offset by lower average prices for all products during 2019 as compared to 2018 offset by gains on the sale of acreage. The significant components of net income are discussed below. Oil, NGL and gas sales decreased$9.2 million , or 9.9% to$84.0 million for the year endedDecember 31, 2019 from$93.2 million for the year endedDecember 31, 2018 . Crude oil, NGL and natural gas sales vary due to changes in volumes of production sold and realized commodity prices. Our realized prices at the well head decreased an average of$5.42 per barrel, or 9.0% on crude oil, decreased an average of$11.92 per barrel, or 42.9% on NGL and decreased$0.81 per Mcf, or 35.3% on natural gas during 2019 as compared to 2018. Our crude oil production increased by 55,000 barrels, or 4.6% to 1,242,000 barrels for the year endedDecember 31, 2019 from 1,187,000 barrels for the year endedDecember 31, 2018 . Our NGL production increased by 111,000 or 24% to 574,000 for the year endedDecember 31, 2019 from 463,000 barrels for the year endedDecember 31, 2018 . Our natural gas production increased by 662 MMcf, or 17.7% to 4,397 MMcf for the year endedDecember 31, 2019 from 3,735 MMcf for the year endedDecember 31, 2018 . The increase in crude oil, NGL and natural gas production volumes are a result our continued drilling success in theWest Texas andOklahoma regions as we place new wells into production offset by the natural decline of existing properties. 46
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The following table summarizes the primary components of production volumes and average sales prices realized for the years endedDecember 31, 2019 and 2018 (excluding realized gains and losses from derivatives). Twelve months ended December 31, Increase / Increase / 2019 2018 (Decrease) (Decrease) Barrels of Oil Produced 1,242,000 1,187,000 55,000 4.6% Average Price Received$ 55.04 $ 60.46 $ (5.42 ) (9.0)% Oil Revenue (In 000's)$ 68,366 $ 71,766 $ (3,400 ) (4.7)% Mcf of Gas Sold 4,397,000 3,735,000 662,000 17.7% Average Price Received$ 1.49 $ 2.30
Gas Revenue (In 000's)$ 6,539 $ 8,590
Barrels of Natural Gas Liquids Sold 574,000 463,000 111,000 24.0% Average Price Received$ 15.87 $ 27.79
Natural Gas Liquids Revenue (In 000's)
Total Oil & Gas Revenue (In 000's)
(9.9)%
Oil, Natural Gas and NGL Derivatives We do not apply hedge accounting to any of
our commodity based derivatives, thus changes in the fair market value of
commodity contracts held at the end of a reported period, referred to as
mark-to-market adjustments, are recognized as unrealized gains and losses in the
accompanying condensed consolidated statements of operations. As oil and natural
gas prices remain volatile, mark-to-market accounting treatment creates
volatility in our revenues.
The following table summarizes the results of our derivative instruments for the
twelve months ended
Twelve months ended
December 31,
2019 2018
Oil derivatives - realized (losses) $ (1,814 ) $ (3,642 )
Oil derivatives - unrealized gains (losses) (2,776 ) 5,600
Total gains (losses) on oil derivatives$ (4,590 ) $ 1,958 Natural gas derivatives - realized gains (losses) 90 (278 ) Natural gas derivatives - unrealized gains (losses) 123
(394 )
Total gains (losses) on natural gas derivatives$ 213 $ (672 ) NGL derivatives - realized gains (losses) 353 (175 ) NGL derivatives - unrealized gains (losses) (124 )
124
Total gains (losses) on NGL derivatives$ 229
Total gains (losses) on oil, natural gas and NGL derivatives
Prices received for the twelve months ended
Increase / Increase /
2019 2018 (Decrease) (Decrease)
Oil Price $ 53.58 $ 57.39 $ (3.81 ) (6.60 )%
Gas Price $ 1.51 $ 3.37 $ (1.86 ) (55.30 )%
NGL Price $ 16.49 $ 27.40 $ (10.91 ) (39.80 )%
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Field service income increased$1.4 million , or 8.4% to$19.2 million for the year endedDecember 31, 2019 from$17.7 million for the year endedDecember 31, 2018 . Rates on our workover rigs and hot oiler services improved during 2019 and our SWD income increased reflecting increased utilization of the pipeline and capacity upgrades added in prior years. Lease operating expenses decreased$1.5 million , or 4.4% to$33.5 million for the year endedDecember 31, 2019 from$35 million for the year endedDecember 31, 2018 . This decrease was due to a reduction of$2.9 million in work-over, marketing, transportation and production taxes expense off-set by$1.4 million in increased in property taxes and recurring lease operating expenses. Field service expense increased$0.9 million , or 6.7% to$15.4 million for the year endedDecember 31, 2019 from$14.5 million for the year endedDecember 31, 2018 . Field service expenses primarily consist of salaries and vehicle operating expenses which have increased during 2019 related to increased utilization of our equipment services. Depreciation, depletion, amortization and accretion on discounted liabilities decreased$1.6 million , or 4.2% to$36.1 million for the year endedDecember 31, 2019 from$37.7 million for the year endedDecember 31, 2018 . The DD&A expense is primarily attributable to our properties inWest Texas andOklahoma , reflecting the declining cost basis of those properties.
General and administrative expense increased
Gain on sale and exchange of assets of$4.5 million for the year endedDecember 31, 2019 and$3.7 million for the year endedDecember 31, 2018 consists of sales of non-producing acreage and oil and gas interests and non-essential field service equipment. Interest expense increased$0.2 million , or 6.5% to$3.6 million for the year endedDecember 31, 2019 from$3.4 million for the year endedDecember 31, 2018 . This minor increase relates to an increase in weighted average interest rates throughout the year combined with reduced overall debt for 2019 as compared to 2018. The average interest rate paid on outstanding bank borrowings under its revolving credit facility during 2019 and 2018 were 5.34% and 5.33%, respectively. As ofDecember 31, 2019 and 2018, the total outstanding borrowings under its revolving credit facility were$53.5 million and$65.5 million , respectively. Tax expense of$1.4 and$3.0 million was recorded for the years endedDecember 31, 2019 and 2018, respectively. The change in our income tax provision was primarily due to the decrease in pre-tax income for the year endedDecember 31, 2019 and the change in the deferred income tax assets and liabilities related to Alternative Minimum Tax Credit refunds and Marginal Well Credit carry forwards.
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