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 condensed consolidated statement of operations and a deferred asset on the condensed consolidated 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 condensed consolidated 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, 2021 and 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, 2021 2020 2021 2020 Production and operating data: Net Production volumes: Oil (Bbl) (a) 114,495 43,126 220,780 117,186 Natural gas (Mcf) (b) 224,118 70,875 379,600 128,738 Natural gas liquids (Gal) (c) 1,699,112 — 2,598,655 — Total (Boe) (d) 192,303 54,938 345,920 138,648 Average price per unit: Oil (Bbl) (a) $ 64.98 $ 40.58 $ 59.80 $ 42.39 Natural gas (Mcf) (b) 3.82 1.44 4.05 1.62 Natural gas liquids (Gal) (c) 0.85 — 0.74 — Total (Boe) (d) $ 50.11 $ 33.72 $ 50.10 $ 37.34 (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) Gal – One gallon of natural gas liquid (d) 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, 2021 2020 2021 2020 Operating costs and expenses per Boe: Oil and natural gas production $ 18.75 $ 23.42 $ 21.18 $ 25.07 Production taxes $ 3.53 $ 1.61 $ 3.66 $ 1.68 Depreciation, depletion, amortization and accretion $ 8.35 $ 4.63 $ 8.41 $ 7.28 Impairment of oil and natural gas properties $ — $ — $ — $ 5.77 General and administrative $ 9.95 $ 23.27 $ 17.46 $ 26.85 THREE-MONTH PERIOD ENDED SEPTEMBER 30, 2021 COMPARED TO THREE-MONTH PERIOD ENDED SEPTEMBER 30, 2020. For the three months ended September 30, 2021 and 2020, revenues from oil, natural gas, and other products sales were $10,127,933 and $1,645,403 respectively. In 2020, due to COVID and other economic factors, prices of oil and natural gas declined, resulting in the Company reducing volumes produced. In 2021, the Company included revenue from the XTO properties for a portion of the period, which were not owned in 2020. Operating expenses, production taxes, depreciation and depletion and amortization and accretion increased to $5,881,971 cumulatively for the three months ended September 30, 2021 from $1,905,055 for the same period in 2020. The increase was primarily due to increased production attributable to the addition of the XTO properties for a portion of the period in 2021. Net realized and unrealized gain (loss) on derivatives decreased to $(32,271) for the three months ended September 30, 2021, from $(103,166) in the same period 2020 due primarily to the timing and type of contracts in existence at each quarter-end. - 21 - General and administrative expenses increased by $635,659 to $1,914,326 for the three months ended September 30, 2021, from $1,278,667 for the same period in 2020. The increase was primarily due to an increased number of employees and related to the XTO asset acquisition in 2021 and professional fees incurred as a result of filings in the third quarter. Interest expense was $4,467,679 and $124,887 for the three months ended September 30, 2021 and 2020, respectively. The increase in interest expense of $4,342,792 resulted from interest and amortization of debt issue costs for the convertible notes issued in 2021. For the reasons discussed above, the previous period net loss increased by $2,084,853 from $(1,641,372) for the three months ended September 30, 2020 to net loss of $(3,726,225) for the three months ended September 30, 2021. NINE-MONTH PERIOD ENDED SEPTEMBER 30, 2021 COMPARED TO NINE-MONTH PERIOD ENDED SEPTEMBER 30, 2020 For the nine months ended September 30, 2021 and 2020, revenues from oil, natural gas, and other products sales were $17,485,855 and $3,954,332 respectively. In the second quarter of 2020, due to COVID and other economic factors, prices of oil and natural gas declined, resulting in the Company reducing volumes produced. In 2021, the Company included revenue from the XTO properties for the period from close (May 2021) through September 30, 2021and the Pardus assets for all of 2021 which were only owned for a portion of the 2020 period. Operating expenses, production taxes, depreciation and depletion and amortization and accretion increased to $11,501,919 for the nine months ended September 30, 2021 from $5,349,655 for the same period in 2020. The increase was primarily due to increased production attributable to the XTO properties for the period from close (May 2021) through September 30, 2021and the Pardus assets for all of 2021 which were only owned for a portion of the 2020 period. Impairment of oil and natural gas properties expense decreased to $-0- for the nine months ended September 30, 2021 from $800,452 for the same period in 2020. This change was primarily attributable to the change in market prices for oil and natural gas in 2021. Loss on derivatives increased to $(572,220) for the nine months ended September 30, 2021, from a gain of $2,003,505 in the same period 2020 due to an increase in oil prices since the agreements were entered into, the types of contracts in existence at each period-end, and the time to the date of maturity or the balance sheet date. General and administrative expenses increased by $2,318,418 to $6,040,475 for the nine months ended September 30, 2021, from $3,722,057 for the same period in 2020. The increase was primarily due to an increased number of employees and professional fees related to the XTO asset acquisitions in 2021 and the $989,115 “right to buy” expense in conjunction with the issuance of the unsecured convertible notes. In 2020, expenses included the $725,000 allowance for the acquisition deposit on the Ovintiv properties. Interest expense was $7,373,113 and $380,975 for the nine months ended September 30, 2021 and 2020, respectively. The increase in interest expense of $6,992,138 resulted primarily from interest and amortization of debt issue costs for the convertible notes in 2021. For the reasons discussed above, the previous period net loss increased by $6,968,825 from $(3,026,542) for the nine months ended September 30, 2020 to net loss of $(9,995,367) for the nine months ended September 30, 2021. LIQUIDITY AND CAPITAL RESOURCES GENERAL The Company’s primary sources of short-term liquidity are cash and cash equivalents, net cash provided by operating activities, and issuance of debt and equity securities. The Company’s short- and long-term liquidity requirements consist primarily of capital expenditures, acquisitions of oil and natural gas properties, payments of contractual obligations, and working capital obligations. Funding for these requirements may be provided by any combination of the Company’s sources of liquidity. Although the Company expects that its sources of funding will be adequate to fund its 2021 liquidity requirements, no assurance can be given that such funding sources will be adequate to meet the Company’s future needs. During the nine months ended September 31, 2021, the Company enhanced its liquidity position by modifying its senior secured notes and extending the maturity of these notes to June 30, 2023, with the combined objective of increasing liquidity, extending the Company’s debt maturities, and lowering the Company’s future cash interest expense on long-term debt. - 22 - OUTLOOK See Notes 5, 6 and 9 to the financial statements for information regarding the purchase and development agreements the Company entered into in 2020 and 2021 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 has caused oil price volatility in 2020. In the first three quarters of 2020, gains on settled derivatives offset a substantial portion of the impact of the recent decline in prices and slower production, and we currently have derivative positions in place for a portion of our expected remaining 2021 production. O il and gas prices have improved in 2021; there can be no assurance that these higher prices will remain at current levels in the future. 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 . The Impact of COVID-19 on Our Business In 2020, there was a global outbreak of COVID-19 which has resulted in changes in global supply and demand of certain mineral and energy products. Decreased transportation, manufacturing and general economic activity levels prompted by COVID-19 and related governmental and societal actions reduced the demand for oil-based products such as gasoline, jet fuel and other refined products, which prompted purchasers of oil and condensate to reduce purchase levels. These situations led to production greater than storage capacity at certain points during the year. 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 continuing 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 continue to 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, which 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 distinct 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, 2020. 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. Related Party Shareholder Concentration Certain material related party transactions have resulted in concentrated ownership of the Company and could impact future operations. Green Tree New Mexico Spin-off One such instance of a potential future impact relates to the Company’s best efforts to spin-off to stockholders Green Tree New Mexico on or before December 31, 2022 (See Note 9). It is unknown how this would affect the Company’s liquidity should such a spin-off occur. For other material risks, see the Company's Form 10-K for the year ended December 31, 2020, which was filed on March 31, 2021. Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable.