Item 1A. Risk Factors
ITEM
1A. RISK FACTORS
There
are many factors that affect our business and results of operations, some of which are beyond our control. The following is a description
of some of the important factors that could have a material adverse effect on our business, financial position, liquidity and results
of operations. Some of the following risks relate principally to the industry in which we operate and to our business. Other risks relate
principally to the securities markets and ownership of our common stock.
RISKS
RELATED TO OUR BUSINESS AND INDUSTRY
Volatility
of oil and gas prices significantly affects our results and profitability.
Prices
for oil and natural gas fluctuate widely. We cannot predict future oil and natural gas prices with any certainty. Historically, the markets
for oil and gas have been volatile, and they are likely to continue to be volatile. Factors that can cause price fluctuations include
the level of global demand for petroleum products; foreign supply and pricing of oil and gas; the ability of OPEC to set and maintain
oil price and production controls; nature and extent of governmental regulation and taxation, including environmental regulations; level
of domestic and international exploration, drilling and production activity; the cost of exploring for, producing and delivering oil
and gas; speculative trading in crude oil and natural gas derivative contracts; availability, proximity and capacity of oil and gas pipelines
and other transportation facilities; weather conditions; the price and availability of alternative fuels; technological advances affecting
energy consumption; national and international pandemics like the COVID-19; and, overall political and economic conditions in oil producing
countries.
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Increases
and decreases in prices also affect the amount of cash flow available for capital expenditures and our ability to borrow money or raise
additional capital. The amount we can borrow from banks may be subject to redetermination based on changes in prices. In addition, we
may have ceiling test writedowns when prices decline. Lower prices may also reduce the amount of crude oil and natural gas that can be
produced economically. Thus, we may experience material increases or decreases in reserve quantities solely as a result of price changes
and not as a result of drilling or well performance.
Changes
in oil and gas prices impact both estimated future net revenue and the estimated quantity of proved reserves. Any reduction in reserves,
including reductions due to price fluctuations, can reduce the borrowing base under our credit facility and adversely affect the amount
of cash flow available for capital expenditures and our ability to obtain additional capital for our exploration and development activities.
Oil
and natural gas prices do not necessarily fluctuate in direct relationship to each other. Lower prices or lack of storage may have an
adverse affect on our financial condition due to reduction of our revenues, operating income and cash flows; curtailment or shut-in of
our production due to lack of transportation or storage capacity; cause certain properties in our portfolio to become economically unviable;
and, limit our financial condition, liquidity, and/or ability to finance planned capital expenditures and operations.
Our
results of operations may be negatively impacted by current global events such as the coronavirus outbreak.
The
industry has experienced sharp declines in the demand for crude oil and natural gas worldwide, which has resulted in steep declines in
pricing. The global economy and commodity prices are being severely negatively impacted, as economic activity and demand for energy have
declined in response to the COVID-19 pandemic, as well as due to other geopolitical factors. The magnitude of the impact of the COVID-19
pandemic will depend on the duration and extent of the pandemic, including increases in COVID-19 case counts, any additional waves of
the virus, new variants of the virus and the availability and ultimate efficacy of the vaccine on new variants of the virus. The pandemic
could have a material adverse effect on the costs, operations, business and financial condition, and therefore, the results of operations.
Conservation
measures and technological advances could reduce demand for oil and natural gas.
Fuel
conservation measures, alternative fuel requirements, increasing consumer demand for alternatives to oil and natural gas, technological
advances in fuel economy and energy generation devices could reduce demand for oil and natural gas. The impact of the changing demand
for oil and natural gas services and products may have a material adverse effect on our business, financial condition, results of operations
and cash available for distribution.
Changes
in environmental laws could increase our operators’ costs and adversely impact our business, financial condition and cash flows.
President
Biden has indicated that he is supportive of, and has issued executive orders promoting various programs and initiatives designed to,
among other things, curtail climate change, control the release of methane from new and existing oil and natural gas operations, and
decarbonize electric generation and the transportation sector. It remains unclear what additional actions President Biden will take and
what support he will have for any potential legislative changes from Congress. Further, it is uncertain to what extent any new environmental
laws or regulations, or any repeal of existing environmental laws or regulations, may affect our or our operators’ business. However,
such actions could significantly increase our operators’ costs or impair their ability to explore and develop other projects, which
could adversely impact our business, financial condition and cash flows.
Lower
oil and gas prices and other factors may cause us to record ceiling test writedowns.
Lower
oil and gas prices increase the risk of ceiling limitation write-downs. We use the full cost method to account for oil and gas operations.
Accordingly, we capitalize the cost to acquire, explore for and develop crude oil and natural gas properties including the cost of
abandoned properties, dry holes, geophysical costs and annual lease rentals. Sales or other dispositions of oil and natural gas properties
are accounted for as adjustments to capitalized costs, with no gain or loss recorded. Depletion of evaluated oil and natural gas properties
is computed in the units of production method, whereby capitalized costs are amortized over total proved reserves. Under the full
cost accounting rules, the net capitalized cost of crude oil and natural gas properties may not exceed a “ceiling limit”
which is based upon the present value of estimated future net cash flows from proved reserves, discounted at 10% plus the lower of cost
or fair market value of unproved properties. If net capitalized costs of oil and natural gas properties exceed the ceiling limit, we
must charge the amount of the excess against earnings. This is called a “ceiling test writedown.” We use the unweighted
arithmetic average first day of the month price for oil and natural gas for the 12-month period preceding the calculation date in estimating
discounted future net reserves. Under the accounting rules, we are required to perform a ceiling test each quarter. A ceiling test
writedown does not impact cash flow from operating activities, but does reduce stockholders’ equity and earnings. The risk that
we will be required to write down the carrying value of oil and natural gas properties increases when oil and natural gas prices are
low. We incurred impairment charges during fiscal 2016 and may incur additional impairment charges in the future, particularly if commodity
prices decline, which could have a material adverse effect on our results of operations for the periods in which such charges are taken.
There were no ceiling test impairments on our oil and gas properties during fiscal 2022 and 2021.
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We
must replace reserves we produce.
Our
future success depends upon our ability to find, develop or acquire additional, economically recoverable oil and gas reserves. Our proved
reserves will generally decline as reserves are depleted, except to the extent that we can find, develop or acquire replacement reserves.
One offset to the obvious benefits afforded by higher product prices especially for small to mid-cap companies in this industry, is that
quality domestic oil and gas reserves are hard to find.
Approximately
37% and 32% of our total estimated net proved reserves at March 31, 2022 and 2021, respectively, were undeveloped, and those reserves
may not ultimately be developed.
Recovery
of undeveloped reserves requires significant capital expenditures and successful drilling. Our reserve data assumes that we can and will
make these expenditures and conduct these operations successfully. These assumptions, however, may not prove correct. Delays in the
development of our reserves, increases in costs to develop such reserves, or decreases in commodity prices will reduce the future net
revenues or our estimated proved undeveloped reserves and may result in some projects becoming uneconomical. In addition, if we or
the outside operators of our properties choose not to spend the capital to develop these reserves, or if we are not able to successfully
develop these reserves, we will be required to write-off these reserves. Any such write-offs of our reserves could reduce our ability
to borrow money and could reduce the value of our common stock.
Information
concerning our reserves and future net revenues estimates is inherently uncertain.
Estimates
of oil and gas reserves, by necessity, are projections based on engineering data, and there are uncertainties inherent in the interpretation
of such data as well as the projection of future rates of production and the timing of development expenditures. Reserve engineering
is a subjective process of estimating underground accumulations of oil and gas that are difficult to measure. Estimates of economically
recoverable oil and gas reserves and of future net cash flows depend upon a number of variable factors and assumptions, such as future
production, oil and gas prices, operating costs, development costs and remedial costs, all of which may vary considerably from actual
results. As a result, estimates of the economically recoverable quantities of oil and gas and of future net cash flows expected therefrom
may vary substantially. As required by the SEC, the estimated discounted future net cash flows from proved reserves are based on a twelve
month un-weighted first-day-of-the-month average oil and gas prices for the twelve months prior to the date of the report. Actual future
prices and costs may be materially higher or lower.
An
increase in the differential between NYMEX and the reference or regional index price used to price our oil and gas would reduce our cash
flow from operations.
Our
oil and gas is priced in the local markets where it is produced based on local or regional supply and demand factors. The prices we receive
for our oil and gas are typically lower than the relevant benchmark prices, such as The New York Mercantile Exchange (“NYMEX”).
The difference between the benchmark price and the price we receive is called a differential. Numerous factors may influence local pricing,
such as refinery capacity, pipeline capacity and specifications, upsets in the midstream or downstream sectors of the industry, trade
restrictions and governmental regulations. Additionally, insufficient pipeline capacity, lack of demand in any given operating area or
other factors may cause the differential to increase in a particular area compared with other producing areas. During fiscal 2022, differentials
averaged $2.80 per Bbl of oil and $0.51 per Mcf of gas. Increases in the differential between the benchmark prices for oil and gas and
the wellhead price we receive could significantly reduce our revenues and our cash flow from operations.
Drilling
and operating activities are high risk activities that subject us to a variety of factors that we cannot control.
These
factors include availability of workover and drilling rigs, well blowouts, cratering, explosions, fires, formations with abnormal pressures,
pollution, releases of toxic gases and other environmental hazards and risks. Any of these operating hazards could result in substantial
losses to us. In addition, we incur the risk that no commercially productive reservoirs will be encountered, and there is no assurance
that we will recover all or any portion of our investment in wells drilled or re-entered.
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We
may not be able to fund the capital expenditures that will be required for us to increase reserves and production.
We
must make capital expenditures to develop our existing reserves and to acquire new reserves. Historically, we have used our cash flow
from operations and borrowings under our credit facility to fund our capital expenditures, however, lower oil and gas prices may prevent
these options. Volatility in oil and gas prices, the timing of our drilling programs and drilling results will affect our cash flow from
operations. Lower prices and/or lower production will also decrease revenues and cash flow, thus reducing the amount of financial resources
available to meet our capital requirements, including reducing the amount available to pursue our drilling opportunities.
The
borrowing base under our credit facility will be determined from time to time by the lender. Reductions in estimates of oil and gas reserves
could result in a reduction in the borrowing base, which would reduce the amount of financial resources available under the credit facility
to meet our capital requirements. Such a reduction could be the result of lower commodity prices and/or production, inability to drill
or unfavorable drilling results, changes in oil and gas reserve engineering, the lender’s inability to agree to an adequate borrowing
base or adverse changes in the lender’s practices regarding estimation of reserves.
If
cash flow from operations or our borrowing base decrease for any reason, our ability to undertake exploration and development activities
could be adversely affected. As a result, our ability to replace production may be limited.
Our
identified drilling locations are scheduled out over several years, making them susceptible to uncertainties that could materially alter
the occurrence or timing of their drilling.
Our
management and outside operators have specifically identified and scheduled drilling locations as an estimation of our future multi-year
drilling activities on our existing acreage. These drilling locations represent a significant part of our growth strategy. Our ability
to drill and develop these locations depends on a number of uncertainties, including crude oil and natural gas prices, the availability
of capital, costs, drilling results, regulatory approvals and other factors. If future drilling results in these projects do not establish
sufficient reserves to achieve an economic return, we may curtail drilling in these projects. Because of these uncertainties, we do not
know if the numerous potential drilling locations we have identified will ever be drilled or if we will be able to produce crude oil
or natural gas from these or any other potential drilling locations.
Our
business depends on oil and natural gas transportation facilities which are owned by others.
The
marketability of our production depends in part on the availability, proximity and capacity of natural gas gathering systems, pipelines
and processing facilities. Federal and state regulation of oil and gas production and transportation, tax and energy policies, changes
in supply and demand and general economic conditions could all affect our ability to produce and market our oil and gas.
We
have limited control over activities on properties we do not operate, which could reduce our production and revenues.
All
of our business activities are conducted through joint operating or other agreements under which we own working and royalty interests
in natural gas and oil properties in which we do not operate. As a result, we have a limited ability to exercise influence over normal
operating procedures, expenditures or future development of underlying properties and their associated costs. The failure of an operator
of our wells to adequately perform operations could reduce our revenues and production.
Acquiring
reserves in the oil and gas industry is highly competitive.
Competition
for oil and gas reserve acquisitions is significant. We may compete with major oil and gas companies, other independent oil and gas companies
and individual producers and operators, some of which have financial and personnel resources substantially in excess of those available
to us. As a result, we may be placed at a competitive disadvantage. Our ability to acquire and develop additional properties in the future
will depend upon our ability to select and acquire suitable producing properties and prospects for future development activities.
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We
may not be insured against all of the operating hazards to which our business is exposed.
Our
operations are subject to all the risks inherent in the exploration for, and development and production of oil and gas including blowouts,
fires and other casualties. We maintain insurance coverage customary for operations of a similar nature, but losses could arise from
uninsured risks or in amounts in excess of existing insurance coverage.
Certain
U.S. federal income tax deductions currently available with respect to crude oil and natural gas exploration and development may be eliminated
as a result of proposed legislation.
Legislation
previously has been proposed that would, if enacted into law, make significant changes to U. S. federal income tax laws, including the
elimination of certain key U.S. federal income tax incentives currently available to crude oil and natural gas exploration and production
companies. These changes include, but are not limited to: (1) the repeal of the percentage depletion allowance for crude oil and natural
gas properties, (2) the elimination of current deductions for intangible drilling and development costs, (3) the elimination of the deduction
for certain U.S. domestic production activities, and (4) an extension of the amortization period for certain geological and geophysical
expenditures. It is unclear whether any such changes will be enacted and, if enacted, how soon any such changes could become effective.
The passage of this type of legislation or any other similar changes in U.S. federal income tax laws could eliminate or postpone certain
tax deductions that are currently available with respect to crude oil and natural gas exploration and development, and any such change
could have an adverse effect on the value of an investment in our Common Stock as well as our financial position, results of operations
and cash flows.
We
are dependent on electrical power, internet and telecommunication infrastructure and information and computer systems. If any of these
systems are compromised or unavailable, our business could be adversely affected.
We
are dependent on electric power, internet and telecommunication infrastructure and our information systems and computer based programs.
If any of such infrastructure, systems or programs were to fail or become unavailable or compromised, or create erroneous information
in our hardware or software network infrastructure, our ability to safely and effectively conduct our business will be limited and any
such consequence could have a material adverse effect on our business.
Our
reliance on information technology, including those hosted by third parties, exposes us to cyber security risks that could affect our
business, financial condition or reputation.
The
oil and natural gas industry has become increasingly dependent on digital technologies to conduct certain exploration, development, production,
and processing activities, including digital technologies to interpret seismic data, manage drilling rigs, production equipment and gathering
systems, conduct reservoir modeling and reserves estimation, and process and record financial and operating data. At the same time, cyber
incidents, including deliberate attacks or unintentional events, have increased. The U.S. government has issued public warnings that
indicate energy assets might be specific targets of cyber security threats. Our and our operators’ technologies, systems, networks,
and those of vendors, suppliers and other business partners, may become the target of cyberattacks or information security breaches that
could result in the unauthorized release, gathering, monitoring, misuse, loss or destruction of proprietary and other information, or
other disruption of business activities. In addition, certain cyber incidents, such as surveillance, may remain undetected for an extended
period. Our systems for protecting against cyber security risks may not be sufficient. As cyber incidents continue to evolve, we may
be required to expend additional resources to continue to modify or enhance our protective measures or to investigate and remediate any
vulnerability to cyber incidents.
The
loss of our chief executive officer or president could adversely impact our ability to execute our business strategy.
We
depend, and will continue to depend in the foreseeable future, upon the continued services of our Chief Executive Officer, Nicholas C.
Taylor and our President and Chief Financial Officer, Tamala L. McComic, who have extensive experience and expertise in evaluating and
analyzing producing oil and gas properties and drilling prospects, maximizing production from oil and gas properties and developing and
executing acquisitions and financing. As of March 31, 2022, we do not have key-man insurance on the lives of Mr. Taylor and Ms. McComic.
The unexpected loss of the services of one or more of these individuals could, therefore, significantly and adversely affect our operations.
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We
may be affected by one substantial shareholder.
Nicholas
C. Taylor beneficially owns approximately 44% of the outstanding shares of our common stock. Mr. Taylor is also our Chairman of the Board
and Chief Executive Officer. As a result, Mr. Taylor has significant influence in matters voted on by our shareholders, including the
election of our Board members. Mr. Taylor participates in all facets of our business and has a significant impact on both our business
strategy and daily operations. The retirement, incapacity or death of Mr. Taylor, or any change in the power to vote shares beneficially
owned by Mr. Taylor, could result in negative market or industry perception and could have an adverse effect on our business.
RISKS
RELATED TO OUR COMMON STOCK
We
may issue additional shares of common stock in the future, which could cause dilution to all shareholders.
We
may seek to raise additional equity capital in the future. Any issuance of additional shares of our common stock will dilute the percentage
ownership interest of all shareholders and may dilute the book value per share of our common stock.
We
have not and do not anticipate paying any cash dividends on our common stock in the foreseeable future.
We
have paid no cash dividends on our common stock to date and it is not anticipated that any will be paid to holders of our common stock
in the foreseeable future. The terms of our existing credit facility restricts the payment of dividends without the prior written consent
of the lenders. We currently intend to retain all future earnings to fund the development and growth of our business. Any payment of
future dividends will be at the discretion of our board of directors and will depend on, among other things, our earnings, financial
condition, capital requirements, level of indebtedness, statutory and contractual restrictions applying to the payment of dividends and
other considerations that our board of directors deems relevant. Stockholders must rely on sales of their common stock after price appreciation,
which may never occur, as the only way to realize a return on their investment.
Control
by our executive officers and directors may limit your ability to influence the outcome of matters requiring stockholder approval and
could discourage our potential acquisition by third parties.
As
of March 31, 2022, our executive officers and directors beneficially owned approximately 47% of our common stock. These stockholders,
if acting together, would be able to influence significantly all matters requiring approval by our stockholders, including the election
of our board of directors and the approval of mergers or other business combination transactions.
The
price of our common stock has been volatile and could continue to fluctuate substantially.
Mexco
common stock is traded on the New York Stock Exchange’s NYSE American. The market price of our common stock has and could continue
to experience volatility due to reasons unrelated to our operating performance. These reasons include: supply and demand for oil and
natural gas; political conditions in oil and natural gas producing regions; demand for our common stock and limited trading volume; investor
perception of our industry; fluctuations in commodity prices; variations in our results of operations; legislative or regulatory changes;
general trends in the oil and natural gas industry; market conditions and analysts’ estimates; and, other events in the oil and
gas industry.
Many
of these factors are beyond our control, and we cannot predict their potential effects on the price of our common stock. We cannot assure
you that the market price of our common stock will not fluctuate or decline significantly in the future. In addition, the stock markets
in general can experience considerable price and volume fluctuations.
Failure
of the Company’s internal control over financial reporting could harm its business and financial results.
The
management of Mexco is responsible for establishing and maintaining effective internal control over financial reporting. Internal control
over financial reporting is a process to provide reasonable assurance regarding the reliability of financial reporting for external purposes
in accordance with accounting principles generally accepted in the United States. Internal control over financial reporting includes
maintaining records that in reasonable detail accurately and fairly reflect Mexco’s transactions; providing reasonable assurance
that transactions are recorded as necessary for preparation of the financial statements; providing reasonable assurance that receipts
and expenditures are made in accordance with management authorization; and providing reasonable assurance that unauthorized acquisition,
use or disposition of our assets that could have a material effect on the financial statements would be prevented or detected on a timely
basis.
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ITEM
1B. UNRESOLVED STAFF COMMENTS
None.