Item 1A. Risk Factors
ITEM
1A.
RISK FACTORS
The
Company is subject to various risks and uncertainties in the ordinary course of business. The following summarizes significant risks
and uncertainties that may adversely affect our business, financial condition or results of operations. We could also face additional
risks and uncertainties not currently known to us or that we currently deem to be immaterial. If any of these risks actually occurs,
it could materially harm our business, financial condition or results of operations and the trading price of our shares could decline.
Investors should carefully consider each of the following risk factors and all of the other information set forth in this Annual Report
on Form 10-K.
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 actions of OPEC, its members and other
state-controlled oil companies relating to 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; and, overall political and economic
conditions in oil producing countries.
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.
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Our
results of operations may be negatively impacted by current global events.
The
United States and certain countries in Europe and Asia are facing economic struggles or slowing economic growth. If these conditions
worsen, combined with a decline in economic growth in other parts of the world, there could be a significant adverse effect on global
financial markets and commodity prices. In addition, continued hostilities in the Middle East and the occurrence or threat of terrorist
attacks in the United States or other countries could adversely affect the global economy. Global or national health concerns may adversely
affect the Company by (i) reducing demand for its oil, NGLs and gas because of reduced global or national economic activity, (ii) impairing
its supply chain (for example, by limiting manufacturing of materials used in operations) and (iii) affecting the health of its workforce,
rendering employees unable to work or travel. Deteriorating economic climate in the United States or abroad due to inflation, rising
interest rates or otherwise, demand for petroleum products could diminish or stagnate, which could depress the prices at which the Company
could sell its oil, NGLs and gas, affect the ability of the Company’s vendors, suppliers and customers to continue operations and
ultimately decrease the Company’s cash flows and profitability. In addition, reduced worldwide demand for debt and equity securities
issued by oil and gas companies may make it more difficult for the Company to raise capital to fund its operations or refinance its debt
obligations.
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. In recent years the U.S. Congress has considered legislation to reduce
emissions of GHGs, including methane, a primary component of natural gas, and carbon dioxide, a byproduct of the burning of natural gas.
For example, the Inflation Reduction Act of 2022 (the “IRA”), which appropriates significant federal funding for renewable
energy initiatives and, for the first time ever, imposes a fee on GHG emissions from certain facilities, was signed into law in August
2022. The emissions fee and funding provisions of the law could increase operating costs within the oil and gas industry and accelerate
the transition away from fossil fuels, which could in turn adversely affect our business and results of operations.
Governmental,
scientific and public concern over the threat of climate change arising from GHG emissions has resulted in increasing political risks
in the United States, including climate change related pledges made by certain candidates elected to public office. President Biden has
issued several executive orders focused on addressing climate change, including items that may impact costs to produce, or demand for,
oil and gas.
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. There were no ceiling test impairments on our oil and gas
properties during fiscal 2024 and 2023.
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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
33% and 26% of our total estimated net proved reserves at March 31, 2024 and 2023, 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 2024, differentials
averaged $2.68 per Bbl of oil and ($0.15) 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
own non-operating interests in properties developed and operated by third parties and, as a result, we are unable to control the operation
and profitability of such properties.
We participate in the drilling and completion of wells with third-party operators that exercise exclusive control
over such operations. As a participant, we rely on third-party operators to successfully operate these properties pursuant to joint operating
agreements and other similar contractual arrangements. As a participant in these operations, we may not be able to maximize the value
associated with these properties in the manner we believe appropriate, or at all. For example, we cannot control the success of drilling
and development activities on properties operated by third-parties, which depend on a number of factors under the control of a third-party
operator, including such operator’s determinations with respect to, among other things, the nature and timing of drilling and operational
activities, the timing and amount of capital expenditures and the selection of suitable technology. In addition, the third-party operator’s
operational expertise and financial resources and its ability to gain the approval of other participants in drilling wells will impact
the timing and potential success of drilling and development activites in a manner that we are unable to control. A third-party operator’s
failure to adequately perform operations, breach of the applicable agreements or failure to act in ways that are favorable to us could
reduce our production and revenues, negatively impact our liquidity and cause us to spend capital in excess of our current plans, and
have a material adverse effect on our financial condition and results of operations.
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.
Our
effective tax rate may change in the future, which could adversely impact us.
The
Tax Cuts and Jobs Act of 2017 (“TCJA”) significantly changed the U.S. federal income taxation of U.S. corporations, including
by reducing the U.S. corporate tax rate, limiting interest deductions and certain deductions for executive compensation, permitting immediate
expensing of certain capital expenditures, and revising the rules governing net operating losses. The TCJA remains unclear in some respects
and continues to be subject to potential amendments and technical corrections. The U.S. Treasury Department and the IRS have issued significant
guidance since the TCJA was enacted, interpreting the TCJA and clarifying some the uncertainties, and are continuing to issue new guidance.
There are still significant aspects of the TCJA for which further guidance is expected, and both the timing and contents of any such
future guidance are uncertain.
Further,
changes to the U.S. federal income tax laws are proposed regularly and there can be no assurance that, if enacted, any such changes would
not have an adverse impact on us. For example, President Biden has suggested the reversal or modification of some portions of the TCJA
and certain of these proposals, if enacted, could increase our effective tax rate. There can be no assurance that any such proposed changes
will be introduced as legislation or, if introduced, later enacted and, if enacted, what form such enacted legislation would take. Such
changes could potentially have retroactive effect. In light of these factors, there can be no assurance that our effective tax rate will
not change in future periods. If the effective tax rates were to increase as a result of the future legislation, our business could be
adversely affected.
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, 2024, 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.
We
may be affected by one substantial shareholder.
Nicholas
C. Taylor beneficially owns approximately 45% 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.
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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.
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, 2024, our executive officers and directors beneficially owned approximately 48% 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.