Item 2. Management’s Discussion and Analysis
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Unaudited Condensed Consolidated Financial Statements and accompanying notes in “Item 1. Financial Statements” contained herein and in “Item 1A. Risk Factors” of our Annual Report on the Form 10-K for the year ended December 31, 2020 (“2020 Form 10-K”). The following discussion contains forward-looking statements that reflect our future plans, estimates, beliefs and expected performance. The forward-looking statements are dependent upon events, risks and uncertainties that may be outside our control. Our actual results could differ materially from those discussed in these forward-looking statements. See “Cautionary Note Regarding Forward-Looking Statements” in the front of this report.
Overview
We operate in one reportable segment engaged in the acquisition, development, exploitation and production of oil and natural gas properties. Our management evaluates performance based on the reportable business segment as the economic environments are not different within the operation of our oil and natural gas properties. Our business activities are conducted through OLLC, our wholly owned subsidiary, and its wholly owned subsidiaries. Our assets consist primarily of producing oil and natural gas properties and are located in Oklahoma, the Rockies, federal waters offshore Southern California, East Texas / North Louisiana and the Eagle Ford. Most of our oil and natural gas properties are located in large, mature oil and natural gas reservoirs. The Company’s properties consist primarily of operated and non-operated working interests in producing and undeveloped leasehold acreage and working interests in identified producing wells.
Industry Trends and Outlook
In March 2020, the World Health Organization classified the outbreak of COVID-19 as a pandemic. The nature of COVID-19 led to worldwide shutdowns, reductions in commercial and interpersonal activity and changes in consumer behavior. In attempting to control the spread of COVID-19, governments around the world imposed laws and regulations such as shelter-in-place orders, quarantines, executive orders and similar restrictions. As a result, the global economy had been marked by significant slowdown and uncertainty, which in turn led to a precipitous decline in commodity prices in response to decreased demand, further exacerbated by certain actions taken by members of the Organization of Petroleum Exporting Countries (“OPEC”) and other non-OPEC producer nations (collectively with OPEC members, “OPEC+”) beginning in the first quarter of 2020 that maintained high levels of global oil production. As of the first quarter of 2021, commodity prices have recovered to pre-pandemic levels, due in part to the accessibility of vaccines, reopening of economies after the lockdown, and optimism about the economic recovery. The continued spread of COVID-19, including vaccine resistant strains, or repeated deterioration in oil and natural gas prices could result in additional adverse impacts on the Company’s results of operations, cash flows and financial position, including further asset impairments.
Recent Developments
Southern California Pipeline Incident
On October 2, 2021, contractors operating under the direction of Beta Operating Company, LLC (“Beta”), one of our subsidiaries, observed an oil sheen on the water approximately four miles off the coast of Newport Beach, California (the “Incident”). Beta platform personnel were notified and promptly initiated our Oil Spill Response Plan, which was reviewed and approved by the Bureau of Safety and Environmental Enforcement’s Oil Spill Preparedness Division within the United States Department of the Interior, and which included the required notifications of specified regulatory agencies. On October 3, 2021, a Unified Command, consisting of the Company, the U.S. Coast Guard and California Department of Fish and Wildlife’s Office of Spill Prevention and Response, was established to respond to the Incident. We are and have been fully committed to working cooperatively within the Unified Command and with all relevant agencies to respond to the Incident and supporting all associated ongoing investigations.
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On October 5, 2021, the Unified Command announced that reports from its contracted commercial divers and Remotely Operated Vehicle footage indicated that a 4,000-foot section of our pipeline had been displaced with a maximum lateral movement of approximately 105 feet and that the pipeline had a 13-inch split, running parallel to the pipe. On October 14, 2021, the U.S. Coast Guard announced that it had a high degree of confidence the size of the release was approximately 588 barrels of oil, which is below the previously reported maximum estimate of 3,134 barrels. On October 16, 2021, the U.S. Coast Guard announced that it had identified the Mediterranean Shipping Company (DANIT) as a “vessel of interest” in connection with an anchor-dragging incident, which occurred in close proximity to our pipeline, and that additional vessels of interest continue to be investigated. The cause, timing and details regarding the Incident are currently under investigation and any information regarding the Incident is preliminary.
Following the Incident, we deployed contractors so that at the height of the Incident response there were over 1,800 personnel working under the guidance and at the direction of the Unified Command to aid in cleanup operations. As of October 14, 2021, all beaches that had been closed following the Incident have reopened. On October 15, 2021, the Unified Command announced that reports from trained oil observers and beach cleanup contractors working for the Unified Command showed significant progress in cleanup operations. On October 18, 2021, the Unified Command stated that segments of beach are recommended for no further clean-up activities. While the Unified Command has significantly reduced the number of personnel conducting remediation activities from the height of the effort, remediation efforts remain ongoing at November 15, 2021.
We are currently subject to a number of ongoing investigations related to the Incident by certain federal and state agencies. The outcomes of these investigations and the nature of any remedies pursued will depend on the discretion of the relevant authorities and may result in regulatory or other enforcement actions, as well as civil and criminal liability.
As of November 5, 2021, we and certain of our subsidiaries were named defendants in approximately 13 putative class action suits filed in the United States District Court for the Central District of California, and one complaint for damages was filed against us and one of our subsidiaries in the Superior Court of the State of California, County of Orange - Civil Division, which we removed to the United States District Court for the Central District of California. All of the actions generally allege that we caused a discharge of oil off the Southern California coast in early October 2021. The plaintiffs seek unspecified monetary damages, and certain plaintiffs seek various forms of injunctive relief. We understand that certain plaintiffs intend to file one or more amended consolidated complaints, and the matters may be consolidated into a single action. Regarding all 14 matters, we deny the allegations and intends to vigorously defend against them. As of November 5, 2021, there have been no responsive pleadings filed, discovery schedules ordered, or trial dates set in any of the 14 matters. We are also participating in a related claims process organized under the Oil Pollution Act of 1990, 33 U.S.C. S 2701 et seq. (“OPA 90”).
Future litigation may be necessary, among other things, to defend ourselves by determining the scope, enforceability, and validity of claims. The results of any current or future litigation cannot be predicted with certainty, and regardless of the outcome, litigation can have an adverse impact on us because of defense and settlement costs, diversion of management resources, and other factors.
Under the OPA 90, our pipeline was designated by the United States Coast Guard as the source of the oil discharge and therefore we are financially responsible for remediation and for certain costs and economic damages as provided for in OPA 90, as well as certain natural resource damages associated with the spill and certain costs determined by federal and state trustees engaged in a joint assessment of such natural resource damages. We are currently processing covered claims under OPA 90 as expeditiously as possible. We may, in the future, seek contribution from any third parties, including any vessels that may have played a role in the causes of the Incident, that are liable or potentially liable under OPA or any other law in connection with the Incident.
For additional discussion of the legal proceedings associated with the Incident, see “Part I - Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Part II - Item 1A. Risk Factors — Risks Related to the Southern California Pipeline Incident.”
We are unable to estimate total costs for remediation efforts with respect to the Incident because remediation and related activity are still ongoing and because the evaluation and approval of certain incurred third-party and contractor claims related to remediation efforts are in progress. As of November 11, 2021, we have paid or authorized to pay approximately $17.3 million in costs related to remediation efforts regarding the Incident, of which $3.8 million has been received as a reimbursement by our insurance carriers and the remaining $13.5 million has been approved for reimbursement by our insurance carriers, less the applicable deductible.
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There is substantial uncertainty surrounding the full impact that the Incident will have on our financial condition and cash flow generation going forward. We have incurred and will continue to incur costs as a result of the Incident, and we anticipate that the suspension of production from Beta will lead to a material reduction in revenue from these assets. We carry customary industry insurance policies, including loss of production income insurance, which we expect will cover a material portion of the total aggregate costs associated with the Incident, including loss of revenue resulting from suspended operations. However, we can provide no assurance that our coverage will adequately protect us against liability from all potential consequences, damages and losses related to the Incident. Given the timing of the Incident, no obligation related to the Incident was recorded for the quarter ended September 30, 2021. Additionally, due to the limited time that has elapsed since the Incident, the ongoing remediation efforts, and the progress of current investigations, we cannot reasonably estimate the total aggregate costs related to the Incident at this time. For additional discussion of the risks associated with the Incident, see “Item 1A. Risk Factors — Risks Related to the Southern California Pipeline Incident.”
In accordance with customary insurance practice, we maintain insurance policies, including loss of production income insurance, against many potential losses or liabilities arising from our operations and at costs that we believe to be economic. We regularly review our risk of loss and the cost and availability of insurance and revise our insurance accordingly. Our insurance does not cover every potential risk associated with our operations. While we expect our insurance policies will cover a material portion of the total aggregate costs associated with the Incident, including defense costs and loss of revenue resulting from suspended operations, we can provide no assurance that our coverage will adequately protect us against liability from all potential consequences, damages and losses related to the Incident and such view and understanding is preliminary and subject to change.
In response to the Incident, all operations have been suspended and the pipeline has been shut-in until the we receive the required regulatory approvals to begin operations. On October 4, 2021, the Pipeline and Hazardous Materials Safety Administration (PHMSA), Office of Pipeline Safety (OPS) issued a Corrective Action Order (CAO) pursuant to 49 U.S.C. § 60112, which makes clear that no restart of the affected pipeline may occur until PHMSA has approved a written restart plan. We are working expeditiously and cooperatively to comply with the requirements of the CAO in order to gain such approvals and any other regulatory approvals that are necessary to restart operations. At present, given that the pipeline to shore is not operational, no operations are underway in the Beta field.
Borrowing Base Reaffirmation
On November 10, 2021, we completed our scheduled semi-annual borrowing base redetermination process, pursuant to which the borrowing base under the Revolving Credit Facility was reaffirmed at $245.0 million; provided that, beginning on February 28, 2022, the borrowing base will be reduced by $5.0 million per month on the last calendar day of each month until the next regularly scheduled redetermination, which is expected to occur in April 2022.
Business Environment and Operational Focus
We use a variety of financial and operational metrics to assess the performance of our oil and natural gas operations, including: (i) production volumes; (ii) realized prices on the sale of our production; (iii) cash settlements on our commodity derivatives; (iv) lease operating expense; (v) gathering, processing and transportation; (vi) general and administrative expense; and (vii) Adjusted EBITDA (as defined below).
Sources of Revenues
Our revenues are derived from the sale of natural gas and oil production, as well as the sale of NGLs that are extracted from natural gas during processing. Production revenues are derived entirely from the continental United States. Natural gas, NGL and oil prices are inherently volatile and are influenced by many factors outside our control. In order to reduce the impact of fluctuations in natural gas and oil prices on revenues, we intend to periodically enter into derivative contracts that fix the future prices received. At the end of each period the fair value of these commodity derivative instruments are estimated and because hedge accounting is not elected, the changes in the fair value of unsettled commodity derivative instruments are recognized in earnings at the end of each accounting period.
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Critical Accounting Policies and Estimates
A discussion of our critical accounting policies and estimates is included in our 2020 Form 10-K. Significant estimates include, but are not limited to, oil and natural gas reserves; depreciation, depletion and amortization of proved oil and natural gas properties; future cash flows from oil and natural gas properties; impairment of long-lived assets; fair value of derivatives; fair value of equity compensation; fair values of assets acquired and liabilities assumed in business combinations and asset retirement obligations. These estimates, in our opinion, are subjective in nature, require the use of professional judgment and involve complex analysis.
When used in the preparation of our consolidated financial statements, such estimates are based on our current knowledge and understanding of the underlying facts and circumstances and may be revised as a result of actions we take in the future. Changes in these estimates will occur as a result of the passage of time and the occurrence of future events. Subsequent changes in these estimates may have a significant impact on our consolidated financial position, results of operations and cash flows.
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Results of Operations
The results of operations for the three and nine months ended September 30, 2021 and 2020 have been derived from our consolidated financial statements. The following table summarizes certain of the results of operations for the periods indicated.
For the Three Months Ended
For the Nine Months Ended
September 30,
September 30,
2021
2020
2021
2020
($ In thousands except per unit amounts)
Oil and natural gas sales
$
96,841
$
52,488
$
249,510
$
145,163
Lease operating expense
34,486
27,639
92,045
91,190
Gathering, processing and transportation
5,047
5,256
14,676
14,998
Taxes other than income
6,024
3,761
15,708
9,942
Depreciation, depletion and amortization
7,000
7,950
21,736
31,129
Impairment expense
—
—
—
455,031
General and administrative expense
6,448
6,443
19,399
21,551
Accretion of asset retirement obligations
1,665
1,565
4,918
4,617
Loss (gain) on commodity derivative instruments
46,653
14,352
145,139
(74,196)
Interest expense, net
(3,078)
(3,362)
(9,327)
(17,218)
Gain on extinguishment of debt
—
—
5,516
—
Income tax expense
—
—
—
(85)
Net loss
(13,470)
(17,685)
(67,821)
(426,220)
Oil and natural gas revenues:
Oil sales
$
63,172
$
36,868
$
169,377
$
101,682
NGL sales
11,839
5,537
28,386
14,002
Natural gas sales
21,830
10,083
51,747
29,479
Total oil and natural gas revenues
$
96,841
$
52,488
$
249,510
$
145,163
Production volumes:
Oil (MBbls)
939
997
2,763
2,294
NGLs (MBbls)
369
430
1,080
1,319
Natural gas (MMcf)
6,023
6,706
17,944
21,149
Total (MBoe)
2,312
2,545
6,833
7,768
Average net production (MBoe/d)
25.1
27.7
25.0
28.3
Average sales price (excluding commodity derivatives):
Oil (per Bbl)
$
67.30
$
36.98
$
61.30
$
34.78
NGL (per Bbl)
32.05
12.89
26.30
10.62
Natural gas (per Mcf)
3.62
1.50
2.88
1.39
Total (per Boe)
$
41.89
$
20.63
$
36.51
$
18.69
Average unit costs per Boe:
Lease operating expense
$
14.92
$
10.86
$
13.47
$
11.74
Gathering, processing and transportation
2.18
2.07
2.15
1.93
Taxes other than income
2.61
1.48
2.30
1.28
General and administrative expense
2.79
2.53
2.84
2.77
Depletion, depreciation and amortization
3.03
3.12
3.18
4.01
For the Three Months Ended September 30, 2021 Compared to the Three Months Ended September 30, 2020
Net losses of $13.5 million and $17.7 million were recorded for the three months ended September 30, 2021 and 2020, respectively.
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Oil, natural gas and NGL revenues were $96.8 million and $52.5 million for the three months ended September 30, 2021 and 2020, respectively. Average net production volumes were approximately 25.1 MBoe/d and 27.7 MBoe/d for the three months ended September 30, 2021 and 2020, respectively. The change in production volumes was primarily due to natural decline. The average realized sales price was $41.89 per Boe and $20.63 per Boe for the three months ended September 30, 2021 and 2020, respectively. The increase in average realized sales price was primarily due to the increase in commodity prices. Commodity prices were depressed in the third quarter of 2020 due to the impact of the pandemic and the effects of OPEC production related to supply and demand decisions.
Lease operating expense was $34.5 million and $27.6 million for the three months ended September 30, 2021 and 2020, respectively. The change in lease operating expense is primarily due to platform structure inspections at our Beta properties which are performed approximately every 10 years and increase workover expenses. On a per Boe basis, lease operating expense was $14.92 and $10.86 for the three months ended September 30, 2021 and 2020, respectively. The increase in lease operating expense on a per Boe basis is primarily driven by higher costs and lower production.
Gathering, processing and transportation was $5.0 million and $5.3 million for the three months ended September 30, 2021 and 2020, respectively. On a per Boe basis, gathering, processing and transportation was $2.18 and $2.07 for the three months ended September 30, 2021 and 2020, respectively. The change in gathering, processing and transportation on a per Boe basis is due to higher costs and lower production.
Taxes other than income were $6.0 million and $3.8 million for the three months ended September 30, 2021 and 2020, respectively. The increase in taxes other than income is due to an increase in production taxes as a result of the increase in commodity prices. On a per Boe basis, taxes other than income were $2.61 and $1.48 for the three months ended September 30, 2021 and 2020, respectively. The change in taxes other than income on a per Boe basis was primarily due to the increase in commodity prices.
Depreciation, depletion & amortization (“DD&A expense”) was $7.0 million and $8.0 million for the three months ended September 30, 2021 and 2020, respectively. The change in DD&A expense was primarily due to a decrease in production from natural decline.
Impairment expense. No impairment expense recorded for the three months ended September 30, 2021 and 2020, respectively.
General and administrative expense was $6.4 million and $6.4 million for the three months ended September 30, 2021 and 2020, respectively. The change in general and administrative expense was primarily related to a decrease of $0.3 million in legal expenses and a decrease of $0.1 million in professional services partially offset by an increase of $0.3 million in stock compensation expense.
Net losses (gains) on commodity derivative instruments of $46.7 million were recognized for the three months ended September 30, 2021, consisting of $24.1 million decrease in the fair value of open positions and $22.6 million of cash settlements paid on expired positions. Net losses on commodity derivative instruments of $14.4 million were recognized for the three months ended September 30, 2020, consisting of a $28.4 million decrease in the fair value of open positions offset by $14.1 million of cash settlement received on expired positions.
Given the volatility of commodity prices, it is not possible to predict future reported mark-to-market net gains or losses and the actual net gains or losses that will ultimately be realized upon settlement of the hedge positions in future years. If commodity prices at settlement are lower than the prices of the hedge positions, the hedges are expected to partially mitigate the otherwise negative effect on earnings of lower oil, natural gas and NGL prices. However, if commodity prices at settlement are higher than the prices of the hedge positions, the hedges are expected to dampen the otherwise positive effect on earnings of higher oil, natural gas and NGL prices and will, in this context, be viewed as having resulted in an opportunity cost.
Interest expense, net was $3.1 million and $3.4 million for the three months ended September 30, 2021 and 2020, respectively. The change in interest expense is primarily related to a decrease of $0.4 million in interest expense primarily due to lower interest rates related to our Revolving Credit Facility.
Average outstanding borrowings under our Revolving Credit Facility were $234.9 million and $274.5 million for the three months ended September 30, 2021 and 2020, respectively.
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Gain on extinguishment of debt. No gain on extinguishment of debt recorded for the three months ended September 30, 2021 and 2020.
For the Nine Months Ended September 30, 2021 Compared to the Nine Months Ended September 30, 2020
Net losses of $67.8 million and $426.2 million were recorded for the nine months ended September 30, 2021 and 2020, respectively.
Oil, natural gas and NGL revenues were $249.5 million and $145.2 million for the nine months ended September 30, 2021 and 2020, respectively. Average net production volumes were approximately 25.0 MBoe/d and 28.3 MBoe/d for the nine months ended September 30, 2021 and 2020, respectively. The change in production volumes was primarily due to natural decline and the impact of Winter Storm Uri that caused a severe freeze in areas where we operate, including Texas, Oklahoma and Louisiana, resulting in shut-ins for wells, pipelines and plants for approximately two weeks in February 2021. The average realized sales price was $36.51 per Boe and $18.69 per Boe for the nine months ended September 30, 2021 and 2020, respectively. The increase in average realized sales price was primarily due to the increase in commodity prices. Commodity prices were depressed in the first half of 2020 due to the impact of the pandemic and the effects of OPEC production related to supply and demand decisions.
Lease operating expense was $92.0 million and $91.2 million for the nine months ended September 30, 2021 and 2020, respectively. The change in lease operating expense was primarily related to an increase for 2021 projects compared to 2020 offset by the employee retention credit received of $2.0 million for the first and second quarters of 2021, and natural decline in production. On a per Boe basis, lease operating expense was $13.47 and $11.74 for the nine months ended September 30, 2021 and 2020, respectively. The change in lease operating expense on a per Boe basis was due mainly to higher cost and lower production.
Gathering, processing and transportation was $14.7 million and $15.0 million for the nine months ended September 30, 2021 and 2020, respectively. The decrease in gathering, processing and transportation was primarily driven by the decrease in production in first quarter 2021 from Winter Storm Uri partially offset by additional fees from our non-operated wells offset by fee increases from our processing plants and minimum volume commitments. On a per Boe basis, gathering, processing and transportation was $2.15 and $1.93 for the nine months ended September 30, 2021 and 2020, respectively. The change in gathering, processing and transportation on a per Boe basis was due to higher costs and lower production.
Taxes other than income were $15.7 million and $9.9 million for the nine months ended September 30, 2021 and 2020, respectively. The increase in taxes other than income is due to an increase in production taxes as a result of the increase in commodity prices. On a per Boe basis, taxes other than income were $2.30 and $1.28 for the nine months ended September 30, 2021 and 2020, respectively. The change in taxes other than income on a per Boe basis was primarily due to the increase in commodity prices.
DD&A expense was $21.7 million and $31.1 million for the nine months ended September 30, 2021 and 2020, respectively. The change in DD&A expense was primarily due to a decrease in production and a decrease in our DD&A rate.
Impairment expense was $455.0 million for the nine months ended September 30, 2020. We recognized $405.7 million of impairment expense on proved properties for the nine months ended September 30, 2020. The estimated future cash flows expected from these properties were compared to their carrying values and determined to be unrecoverable primarily as a result of declining commodity prices in 2020. We recognized $49.3 million of impairment expense on unproved properties for the nine months ended September 30, 2020, which was related to expiring leases and the evaluation of qualitative and quantitative factors related to the decline in commodity prices in 2020. No impairment expense was recorded for the nine months ended September 30, 2021.
General and administrative expense was $19.4 million and $21.6 million for the nine months ended September 30, 2021 and 2020, respectively. The change in general and administrative expense was primarily related to (1) the employee retention credit received of $0.8 million for the first and second quarters of 2021; (2) a decrease of $0.8 million in salaries and other payroll benefits, (3) a decrease of $0.7 million in professional services, and (4) a decrease of $0.7 million in legal expenses. The decreases in general and administrative expense were offset with an increase of $1.0 million in stock compensation expense.
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Net losses (gains) on commodity derivative instruments of $145.1 million were recognized for the nine months ended September 30, 2021, consisting of $95.0 million decrease in the fair value of open positions and $50.1 million of cash settlements paid on expired positions. Net gains on commodity derivative instruments of $74.2 million were recognized for the nine months ended September 30, 2020, consisting of $2.3 million increase in the fair value of open positions and $53.9 million of cash settlement paid on expired positions and $18.0 million of cash settlements received on terminated positions.
Interest expense, net was $9.3 million and $17.2 million for the nine months ended September 30, 2021 and 2020, respectively. Interest expense included $0.5 million and $3.1 million for the amortization and write-off of deferred financing costs for the nine months ended September 30, 2021 and 2020, respectively. Furthermore, we had a loss position on our interest rate swaps of less than $0.1 million for the nine months ended September 30, 2021, compared to a loss position on interest rate swaps of $4.0 million for the nine months ended September 30, 2020. In addition, we had a decrease of $1.1 million in interest expense due to lower borrowings on our Revolving Credit Facility.
Average outstanding borrowings under our Revolving Credit Facility were $243.6 million and $285.6 million for the nine months ended September 30, 2021 and 2020, respectively.
Gain on extinguishment of debt was $5.5 million for the nine months ended September 30, 2021 which is related to the forgiveness of the PPP Loan. See Note 7 of the Notes to Unaudited Condensed Consolidated Financial Statements included under “Item 1. Financial Statements” of this quarterly report for additional information regarding the PPP Loan.
Adjusted EBITDA
We include in this report the non-GAAP financial measure of Adjusted EBITDA and provide our reconciliation of Adjusted EBITDA to net income (loss) and net cash flows from operating activities, our most directly comparable financial measures calculated and presented in accordance with GAAP. We define Adjusted EBITDA as net income (loss):
Plus:
● Interest expense;
● Income tax expense;
● DD&A;
● Impairment of goodwill and long-lived assets (including oil and natural gas properties);
● Accretion of AROs;
● Loss on commodity derivative instruments;
● Cash settlements received on expired commodity derivative instruments;
● Amortization of gain associated with terminated commodity derivatives;
● Losses on sale of assets;
● Share-based compensation expenses;
● Exploration costs;
● Acquisition and divestiture related expenses;
● Reorganization items, net;
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● Severance payments; and
● Other non-routine items that we deem appropriate.
Less:
● Interest income;
● Income tax benefit;
● Gain on commodity derivative instruments;
● Cash settlements paid on expired commodity derivative instruments;
● Gains on sale of assets and other, net; and
● Other non-routine items that we deem appropriate.
We believe that Adjusted EBITDA is useful because it allows us to more effectively evaluate our operating performance and compare the results of our operations from period to period without regard to our financing methods or capital structure.
Adjusted EBITDA should not be considered as an alternative to, or more meaningful than, net income (loss) or cash flows from operating activities as determined in accordance with GAAP or as an indicator of our operating performance or liquidity. Certain items excluded from Adjusted EBITDA are significant components in understanding and assessing a company’s financial performance, such as a company’s cost of capital and tax structure, as well as the historic costs of depreciable assets, none of which are components of Adjusted EBITDA. Our computations of Adjusted EBITDA may not be comparable to other similarly titled measures of other companies. We believe that Adjusted EBITDA is a widely followed measure of operating performance and may also be used by investors to measure our ability to meet debt service requirements.
In addition, management uses Adjusted EBITDA to evaluate actual cash flow available to develop existing reserves or acquire additional oil and natural gas properties.
The following tables present our reconciliation of the Company’s net income (loss) and cash flows from operating activities to Adjusted EBITDA, our most directly comparable GAAP financial measures, for each of the periods indicated.
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Reconciliation of Net Income (Loss) to Adjusted EBITDA
For the Three Months Ended
For the Nine Months Ended
September 30,
September 30,
2021
2020
2021
2020
(In thousands)
Net income (loss)
$
(13,470)
$
(17,685)
$
(67,821)
$
(426,220)
Interest expense, net
3,078
3,362
9,327
17,218
Income tax expense
—
—
—
85
DD&A
7,000
7,950
21,736
31,129
Impairment expense
—
—
—
455,031
Accretion of AROs
1,665
1,565
4,918
4,617
Losses (gains) on commodity derivative instruments
46,653
14,352
145,139
(74,196)
Cash settlements received (paid) on expired commodity derivative instruments
(22,595)
14,067
(50,086)
53,862
Amortization of gain associated with terminated commodity derivatives
4,066
—
14,017
—
Acquisition and divestiture related expenses
—
152
19
677
Share-based compensation expense
676
456
1,910
(84)
Exploration costs
9
5
32
24
Loss on settlement of AROs
—
113
73
113
Bad debt expense
14
218
108
469
Gain on extinguishment of debt
—
—
(5,516)
—
Reorganization items, net
—
180
6
532
Severance payments
—
25
—
54
Other
(16)
—
—
—
Adjusted EBITDA
$
27,080
$
24,760
$
73,862
$
63,311
Reconciliation of Net Cash from Operating Activities to Adjusted EBITDA
For the Three Months Ended
For the Nine Months Ended
September 30,
September 30,
2021
2020
2021
2020
(In thousands)
Net cash provided by operating activities
$
18,884
$
20,609
$
55,287
$
63,598
Changes in working capital
783
(217)
(6,465)
5,094
Interest expense, net
3,078
3,362
9,327
17,218
Gain (loss) on interest rate swaps
(47)
20
(3)
(4,035)
Cash settlements paid (received) on interest rate swaps
485
462
1,425
786
Cash settlements paid (received) on terminated derivatives
—
—
—
(17,977)
Amortization of gain associated with terminated commodity derivatives
4,066
—
14,017
—
Amortization and write-off of deferred financing fees
(133)
(135)
(493)
(3,134)
Acquisition and divestiture related expenses
—
152
19
677
Income tax expense - current portion
—
—
—
85
Exploration costs
9
5
32
24
Plugging and abandonment cost
—
312
235
312
Reorganization items, net
—
180
6
532
Severance payments
—
25
—
54
Other
(45)
(15)
475
77
Adjusted EBITDA
$
27,080
$
24,760
$
73,862
$
63,311
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Liquidity and Capital Resources
Overview. Our ability to finance our operations, including funding capital expenditures and acquisitions, meet our indebtedness obligations, refinance our indebtedness or meet our collateral requirements will depend on our ability to generate cash in the future. Our primary sources of liquidity and capital resources have historically been cash on hand, cash flows provided by operating activities and borrowings under our Revolving Credit Facility. For the remainder of 2021, we expect our primary funding sources to be cash flows provided by operating activities, cash on hand and available borrowing capacity under our Revolving Credit Facility.
Impact of the Southern California Pipeline Incident. There is substantial uncertainty surrounding the full impact that the Incident will have on our financial condition and cash flow generation going forward. We have incurred and will continue to incur costs as a result of the Incident, and we anticipate that the suspension of production from Beta will lead to a material reduction in revenue from these assets. Although we carry customary insurance policies, including loss of production income insurance, which we expect will cover a material portion of the total aggregate costs associated with the Incident, including loss of revenue resulting from suspended operations, we can provide no assurance that our coverage will adequately protect us against liability from all potential consequences, damages and losses related to the Incident.
Additionally, as discussed in greater detail below, on November 10, 2021, the Company completed its scheduled semi-annual borrowing base redetermination process, pursuant to which the borrowing base under the Revolving Credit Facility was reaffirmed at $245.0 million; provided that, beginning on February 28, 2022, the borrowing base will be reduced by $5.0 million per month on the last calendar day of each month until the next regularly scheduled redetermination, which is expected to occur in April 2022. This impact on our borrowing base may limit our liquidity position and may impact our ability to finance our operations.
Capital Markets. We do not currently anticipate any near-term capital markets activity, but we will continue to evaluate the availability of public debt and equity for funding potential future growth projects and acquisition activity.
Hedging. Commodity hedging has been and remains an important part of our strategy to reduce cash flow volatility. Our hedging activities are intended to support oil, NGL and natural gas prices at targeted levels and to manage our exposure to commodity price fluctuations. We intend to enter into commodity derivative contracts at times and on terms desired to maintain a portfolio of commodity derivative contracts covering at least 30%-65% of our estimated production from total proved developed producing reserves over a one-to-three year period at any given point of time to satisfy the hedging covenants in our Revolving Credit Facility and pursuant to our internal policies. We may, however, from time to time, hedge more or less than this approximate amount. Additionally, we may take advantage of opportunities to modify our commodity derivative portfolio to change the percentage of our hedged production volumes when circumstances suggest that it is prudent to do so. The current market conditions may also impact our ability to enter into future commodity derivative contracts.
We evaluate counterparty risks related to our commodity derivative contracts and trade credit. Should any of these financial counterparties not perform, we may not realize the benefit of some of our hedges under lower commodity prices. We sell our oil and natural gas to a variety of purchasers. Non-performance by a customer could also result in losses.
Capital Expenditures. Our total capital expenditures were approximately $27.3 million for the nine months ended September 30, 2021, which were primarily related to capital workovers, maintenance and facilities located in Oklahoma, the Rockies and California and non-operated completion activities in the Eagle Ford.
Working Capital. We expect to fund our working capital needs primarily with operating cash flows. Furthermore, our expected capital expenditures and debt service requirements are expected to be funded by operating cash flows. See Note 7 of the Notes to Unaudited Condensed Consolidated Financial Statements included under “Item 1. Financial Statements” and “—Overview” of this quarterly report for additional information.
As of September 30, 2021, we had a working capital deficit of $69.3 million primarily due to short-term derivatives of $83.6 million, accrued liabilities of $28.2 million, revenues payable of $21.1 million, and accounts payable of $9.2 million offset by accounts receivable of $44.7 million, cash on hand of $17.3 million and prepaid expenses of $10.7 million.
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Revolving Credit Facility. On November 2, 2018, OLLC as borrower, entered into the Revolving Credit Facility (as amended and supplemented to date) with Bank of Montreal, as administrative agent. Our borrowing base under our Revolving Credit Facility is subject to redetermination on at least a semi-annual basis primarily based on a reserve engineering report.
On June 16, 2021, the Company completed its scheduled semi-annual borrowing base redetermination process, pursuant to which the borrowing base under the Revolving Credit Facility was decreased from $260.0 million to $245.0 million. Additionally, the administrative agent under the Revolving Credit Facility agreement was changed from Bank of Montreal to KeyBank.
As of September 30, 2021, we had approximately $245.0 million of available borrowings under our Revolving Credit Facility. See Note 7 of the Notes to Unaudited Condensed Consolidated Financial Statements included under “Item 1. Financial Statements” of this quarterly report for additional information regarding our Revolving Credit Facility.
As of September 30, 2021, we were in compliance with all the financial (current ratio and total leverage ratio) and other covenants associated with our Revolving Credit Facility.
On November 10, 2021, the Company completed its scheduled semi-annual borrowing base redetermination process, pursuant to which the borrowing base under the Revolving Credit Facility was reaffirmed at $245.0 million; provided that, beginning on February 28, 2022, the borrowing base will be reduced by $5.0 million per month on the last calendar day of each month until the next regularly scheduled redetermination, which is expected to occur in April 2022. This impact on our borrowing base may limit our liquidity position and may impact our ability to finance our operations. See Note 7 of the Notes to Unaudited Condensed Consolidated Financial Statements included under “Item 1. Financial Statements” of this quarterly report for additional information regarding our Revolving Credit Facility.
COVID-19 Relief Funding. On June 22, 2021, the Company was notified by the bank that the PPP Loan was approved for full and complete forgiveness by the Small Business Association. For the nine months ended September 30, 2021, the Company recorded a gain on extinguishment of debt for $5.5 million in the Unaudited Condensed Consolidated Statements of Operations.
Under the Consolidated Appropriations Act 2021 passed by the U.S. Congress and signed by the President on December 27, 2020, provisions of the CARES Act were extended and modified making the Company eligible for the employee retention credit subject to meeting certain criteria. The Company met the criteria for the first and second quarters of 2021 and recognized a $2.8 million employee retention credit during the nine months ended September 30, 2021, which is included as a credit to general and administrative expense and to lease operating expense in the Unaudited Condensed Consolidated Statements of Operations.
Cash Flows from Operating, Investing and Financing Activities
The following table summarizes our cash flows from operating, investing and financing activities for the periods indicated. The cash flows for the nine months ended September 30, 2021 and 2020 have been derived from our Unaudited Condensed Consolidated Financial Statements. For information regarding the individual components of our cash flow amounts, see the Unaudited Condensed Consolidated Statements of Cash Flows included under “Item 1. Financial Statements” of this quarterly report.
For the Nine Months Ended
September 30,
2021
2020
(In thousands)
Net cash provided by operating activities
$
55,287
$
63,598
Net cash used in investing activities
(23,253)
(32,062)
Net cash used in financing activities
(25,054)
(18,340)
Operating Activities. Key drivers of net operating cash flows are commodity prices, production volumes and operating costs. Net cash provided by operating activities was $55.3 million and $63.6 million for the nine months ended September 30, 2021 and 2020, respectively. Production volumes were approximately 25.0 MBoe/d and 28.3 MBoe/d for the nine months ended September 30, 2021 and 2020, respectively. The average realized sales price was $36.51 per Boe and $18.69 per Boe for the nine months ended September 30, 2021 and 2020, respectively. The change in average realized sales price was primarily due to the increase in commodity prices.
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Net cash provided by operating activities for the nine months ended September 30, 2021 included $51.5 million of cash paid on expired derivative instruments compared to $53.1 million of cash receipts on expired derivatives and $18.0 million of cash receipts on terminated derivative instruments for the nine months ended September 30, 2020. For the nine months ended September 30, 2021, we had net losses on derivative instruments of $145.1 million compared to a net gains of $70.2 million for the nine months ended September 30, 2020.
In addition, the Company recorded a $5.5 million gain on extinguishment of debt related to the forgiveness of the PPP Loan. See Note 7 of the Notes to Unaudited Condensed Consolidated Financial Statements included under “Item 1. Financial Statements” of this quarterly report for additional information regarding the PPP Loan.
Investing Activities. Net cash used in investing activities for the nine months ended September 30, 2021 was $23.3 million, of which $23.1 million was used for additions to oil and natural gas properties. Net cash provided by investing activities for the nine months ended September 30, 2020 was $32.1 million, of which $31.2 million was used for additions to oil and natural gas properties.
Financing Activities . The Company had net repayments of $25.0 million and $20.0 million for the nine months ended September 30, 2021 and 2020, respectively, related to our Revolving Credit Facility.
For the nine months ended September 30, 2020, the Company paid out $3.8 million in dividends on March 30, 2020 to stockholders of record at the close of business on March 16, 2020. The board of directors subsequently suspended quarterly dividends. Future dividends, if any, are subject to debt covenants under our Revolving Credit Facility and discretionary approval by the board of directors.
As noted above, the Company received forgiveness for the $5.5 million PPP Loan received in April 2020.
Off–Balance Sheet Arrangements
As of September 30, 2021, we had no off–balance sheet arrangements.
Recently Issued Accounting Pronouncements
For a discussion of recent accounting pronouncements that will affect us, see Note 2 of the Notes to Unaudited Condensed Consolidated Financial Statements included under “Item 1. Financial Statements” of this quarterly report for additional information.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
We are a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and are not required to provide the information under this item.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.