EMPIRE PETROLEUM CORP 10-Q

Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL TO ALL PERIODS RESULTS OF OPERATIONS The Company's primary business is the exploration and development of oil and natural gas interests. The Company has incurred significant losses from operations, and there is no assurance that it will achieve profitability or obtain the funds necessary to finance its operations. For all periods presented, the Company's effective tax rate is 0%. The Company has generated net operating losses since inception, which would normally reflect a tax benefit in the statement of operations and a deferred asset on the balance sheet. However, because of the current uncertainty as to the Company's ability to achieve profitability, a valuation reserve has been established that offsets the amount of any tax benefit available for each period presented in the statements of operations. The following table sets forth a summary of our production and operating data for the three and nine month periods ended September 30, 2020. Because of normal production declines, increased or decreased drilling activities, fluctuations in commodity prices and the effects of acquisitions or divestitures, the historical information presented below should not be interpreted as being indicative of future results. Three months ended September 30, Nine months ended September 30, 2020 2019 2020 2019 Production and operating data: Net Production volumes: Oil (Bbl) (a) 43,126 34,276 117,186 76,687 Natural gas (Mcf) (b) 70,875 10,501 128,738 33,555 Total (Boe) (c) 54,938 36,026 138,648 82,280 Average price per unit: Oil (Bbl) (a) 40.58 52.92 42.39 54.03 Natural gas (Mcf) (b) 1.44 3.14 1.62 2.98 Total (Boe) (c) 33.72 51.27 37.34 51.57 (a) Bbl - One stock tank barrel, of 42 U.S. gallons liquid volume, used herein in reference to oil, condensate or natural gas liquids. (b) Mcf - One thousand cubic feet of natural gas. (c) Boe - One barrel of oil equivalent, a standard convention used to express oil and natural gas volumes on a comparable oil equivalent basis. Natural gas equivalents are determined under the relative energy content method by using the ratio of 6.0 Mcf of natural gas to 1.0 Bbl of oil or condensate. Three months ended September 30, Nine months ended September 30, 2 020 2019 2020 2019 Operating costs and expenses per Boe: Oil and natural gas production $ 23.42 $ 43.79 $ 25.07 $ 36.11 Production taxes $ 1.61 $ 3.05 $ 1.68 $ 3.15 Depreciation, depletion, amortization and accretion $ 4.63 $ 23.11 $ 7.28 $ 21.67 Impairment of oil and natural gas properties $ — $ — $ 5.77 $ — General and administrative $ 23.27 $ 13.04 $ 26.85 $ 38.00 THREE-MONTH PERIOD ENDED SEPTEMBER 30, 2020 COMPARED TO THREE-MONTH PERIOD ENDED SEPTEMBER 30, 2019. For the three months ended September 30, 2020 and 2019, revenues from oil and natural gas sales were $ 1,645,403 and $1,695,264 respectively. In 2020, due to COVID and other economic factors, prices of oil and natural gas declined, resulting in the Company reducing volumes produced. Operating expenses, production taxes, depreciation and depletion and amortization and accretion decreased to $1,905,055 cumulatively for the three months ended September 30, 2020 from $2,519,942 for the same period in 2019. The decrease was due to a decrease in costs associated with oil and natural gas production, which was constrained during the period due to management’s reduction of production in response to lower prices. Net realized and unrealized gain (loss) on derivatives decreased to $(103,166) for the three months ended September 30, 2020, from $492,862 in the same period 2019 due primarily to decreases in oil prices since June 30, 2020 and increases in oil prices during the same period in 2019, respectively, for those contracts in existence at that date. - 17 - General and administrative expenses increased by $808,875 to $1,278,667 for the three months ended September 30, 2020, from $469,792 for the same period in 2019. The increase was primarily due to an increased number of employees and professional fees related to the Pardus acquisition. For the three month period in 2020, expenses included the $75,000 loss for the acquisition deposit on the Ovintiv properties. Interest expense was $124,887 and $145,345 for the three months ended September 30, 2020 and 2019, respectively. The decrease in interest expense of $20,458 resulted primarily from lower interest rates in 2020. For the reasons discussed above, the previous period net loss increased by $694,419 from $(946,953) for the three months ended September 30, 2019 to net loss of $(1,641,372) for the three months ended September 30, 2020. NINE-MONTH PERIOD ENDED SEPTEMBER 30, 2020 COMPARED TO NINE-MONTH PERIOD ENDED SEPTEMBER 30, 2019 For the nine months ended September 30, 2020 and 2019, revenues from oil and natural gas sales were $ 3,954,332 and $4,016,232 respectively. The Company purchased significant oil and natural gas properties in the second quarter of 2019 which were not included in 2019 revenues. In the second and third quarter of 2020, due to COVID and other economic factors, prices of oil and natural gas declined, resulting in the Company reducing volumes produced. Operating expenses, production taxes, depreciation and depletion and amortization and accretion, excluding impairment, increased to $5,349,655 cumulatively for the nine months ended September 30, 2020 from $5,013,319 for the same period in 2019. The increase was due primarily to only a partial period of production in 2019 because of the EnergyQuest acquisition March 2019 and lower production volumes in 2020. Impairment of oil and natural gas properties expense increased to $800,452 for the nine months ended September 30, 2020 from $0 for the same period in 2019. The increase was due to the change in market prices for oil and natural gas in 2020. Net realized and unrealized gain on derivatives increased to $2,003,505 for the nine months ended September 30, 2020, from $925,231 in the same period 2019 due to decrease in oil prices since the agreements were entered into or since December 31, 2020 and 2019 respectively, for those contracts in existence at that date, to the date of maturity or the balance sheet date. General and administrative expenses increased by $595,654 to $3,722,057 for the nine months ended September 30, 2020, from $3,126,403 for the same period in 2019. The increase was primarily due to $800,000 allowance for the acquisition deposit on the Ovintiv properties in 2020 offset by options and warrants issued and professional fees and travel related to the acquisition of oil and natural gas properties in 2019. Interest expense was $380,975 and $342.256 for the nine months ended September 30, 2020 and 2019, respectively. The increase in interest expense of $38,719 resulted primarily from the debt issued to acquire oil and natural gas properties in the second quarter of 2019 and lower interest rates in 2020. For the reasons discussed above, the previous period net loss decreased by $513,973 from $(3,540,515) for the nine months ended September 30, 2019 to net loss of $(3,026,542) for the nine months ended September 30, 2020. LIQUIDITY AND CAPITAL RESOURCES GENERAL As of September 30, 2020, the Company had $134,374 of cash. The Company expects to incur costs related to future oil and natural gas acquisitions for the foreseeable future. It is expected that management will attempt to raise additional capital for future investment and working capital opportunities. OUTLOOK See Notes 3 through 8 to the financial statements for information regarding the purchase and development agreements the Company entered into in 2019 and 2020 to purchase and develop existing oil and natural gas properties and mineral interests. The Company is also actively pursuing the acquisition of other operated and non-operated oil and natural gas properties. It is anticipated that such acquisitions will be financed through equity or debt transactions. Lower oil and natural gas prices present challenges to our industry and our Company. The economic impact of the COVID-19 pandemic have caused oil price volatility in 2020. In the first three quarters of 2020, gains on settled derivatives offset a large portion of the impact of the recent decline in prices and slower production, and we currently have derivative positions in place for a substantial amount of our expected remaining 2020 production. There can be no assurance that we will be able to add derivative positions to cover the remainder of our expected production at favorable prices. - 18 - The Impact of COVID-19 on Our Business During the first three quarters of 2020, we did not experience any material impact to our ability to operate or market our production due to the direct or indirect impacts of the COVID-19 pandemic. The Cybersecurity and Infrastructure Security Agency in the U.S. Department of Homeland Security classifies individuals engaged in and supporting exploration for and production of natural gas, oil and NGLs as “essential critical infrastructure workforce,” and to date, state and local governments where our wells are located have followed this guidance and exempted these activities from business closures. Should this situation change, our access to supplies or workers to drill, complete and operate wells could be materially and adversely affected. However, as decreased transportation, manufacturing and general economic activity levels prompted by COVID-19 and related governmental and societal actions have reduced the demand for oil-based products such as gasoline, jet fuel and other refined products, space to store oil and condensate production is reaching or may reach capacity in some areas, which is prompting purchasers of oil and condensate to reduce future purchase levels and, in some cases, to claim force majeure for purchases already contracted. These situations may lead to production greater than storage capacity later in the year, depending on weather and other seasonal factors. In addition, commodity pricing challenges may cause our production costs to exceed the revenues associated with such production. To the extent that this decreased demand for our commodities continues and our margins are not at acceptable levels or storage for our production is not available, we may have to reduce production from or completely shut in portions of our currently producing wells. The inability to sell our production or the decision to potentially reduce or shut in our production could materially and adversely affect our operating results and our ability to comply with the financial covenants under our credit facility. There is uncertainty around the extent and duration of the disruption. The degree to which the COVID-19 pandemic or any other public health crisis adversely impacts our results will depend on future developments, which are highly uncertain and cannot be predicted, including, but not limited to, the duration and spread of the outbreak, its severity, the actions to contain the virus or treat its impact, its impact on the economy and market conditions, and how quickly and to what extent normal economic and operating conditions can resume. Therefore, while we expect this matter will likely disrupt our operations, the degree of the adverse financial impact cannot be reasonably estimated at this time. FORWARD-LOOKING INFORMATION This Quarterly Report on Form 10-Q, including this section, includes certain statements that may be deemed "forward-looking statements" within the meaning of federal securities laws. All statements, other than statements of historical facts, that address activities, events or developments that the Company expects, believes or anticipates will or may occur in the future, including future sources of financing and other possible business developments, are forward-looking statements. Such statements are subject to a number of assumptions, risks and uncertainties and could be affected by a number of different factors, including the Company's failure to secure short and long-term financing necessary to sustain and grow its operations, increased competition, changes in the markets in which the Company participates and the technology utilized by the Company and new legislation regarding environmental matters. These risks and other risks that could affect the Company's business are more fully described in reports the Company files with the SEC, including its Form 10-K for the year ended December 31, 2019. Actual results may vary materially from the forward-looking statements. The Company undertakes no duty to update any of the forward-looking statements in this Form 10-Q. MATERIAL RISKS The Company has incurred significant losses from operations and there is no assurance that it will achieve profitability or obtain the funds necessary to finance continued operations. For other material risks, see the Company's Form 10-K for the year ended December 31, 2019, which was filed on March 30, 2020. Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable.