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Item 1A. Risk Factors

2021-03-16 compared with 2020-03-16 · 154 added, 113 removed, 144 unchanged (65% of the section changed)

The following risks and uncertainties may affect our performance, results of operations and the trading price of our common stock.

Risks Relating to the Oil and Natural Gas Industry and Our Business

Risks Relating to Our Business, Operations and Strategy

Part of our strategy involves using some of the latest available horizontal drilling and completion techniques, which involve additional risks and uncertainties in their application if compared to conventional drilling.

Our operations utilize some of the latest horizontal drilling and completion techniques as developed by us, other oil and natural gas exploration and production companies and our service providers.

The additional risks that we face while drilling horizontally include, but are not limited to, the following:

● drilling wells that are significantly longer and/or deeper than wells drilled by others;

● landing our wellbore in the desired drilling zone;

● staying in the desired drilling zone while drilling horizontally through the formation;

● running our casing the entire length of the wellbore;

● being able to run tools and other equipment consistently through the horizontal wellbore.

Risks that we face while completing our wells include, but are not limited to, the following:

● the ability to fracture or stimulate the planned number of stages in a horizontal or lateral wellbore;

● the ability to run tools the entire length of the wellbore during completion operations;

● the ability to successfully clean out the wellbore after completion of the final fracture stimulation stage.

If our assessments of purchased properties are materially inaccurate, it could have a significant impact on future operations and earnings.

The successful acquisition of producing properties requires assessments of many factors, which are inherently inexact and may be inaccurate, including the following:

● the amount of recoverable reserves;

● future oil and natural gas prices;

● estimates of operating costs;

● estimates of future development costs;

● estimates of the costs and timing of plugging and abandonment;

● potential environmental and other liabilities.

Our assessment will not reveal all existing or potential problems, nor will it permit us to become familiar enough with the properties to assess fully their capabilities and deficiencies.

We plan to undertake further development of our properties through the use of cash flow from existing production.

Therefore, a material deviation in our assessments of these factors could result in less cash flow being available for such purposes than we presently anticipate, which could either delay future development operations (and delay the anticipated conversion of reserves into cash) or cause us to seek alternative sources to finance development activities.

Prospects that we decide to drill may not yield oil or natural gas in commercially viable quantities.

Our prospects are in various stages of evaluation, ranging from prospects that are currently being drilled to prospects that will require substantial additional seismic data processing and interpretation.

There is no way to predict in advance of drilling and testing whether any particular prospect will yield oil or natural gas in sufficient quantities to recover drilling or completion costs or to be economically viable.

This risk may be enhanced in our situation, due to the fact that a significant percentage (43%) of our proved reserves is currently proved undeveloped reserves.

The use of seismic data and other technologies and the study of producing fields in the same area will not enable us to know conclusively prior to drilling whether oil or natural gas will be present or, if present, whether oil or natural gas will be present in commercial quantities.

We cannot assure you that the analogies we draw from available data obtained by analyzing other wells, more fully explored prospects or producing fields will be applicable to our drilling prospects.

A substantial percentage of our proved properties are undeveloped;

therefore, the risk associated with our success is greater than would be the case if the majority of our properties were categorized as proved developed producing.

Because a substantial percentage of our proved properties are proved undeveloped (approximately 43%), we will require significant additional capital to develop such properties before they may become productive.

Further, because of the inherent uncertainties associated with drilling for oil and gas, some of these properties may never be developed to the extent that they result in positive cash flow.

Even if we are successful in our development efforts, it could take several years for a significant portion of our undeveloped properties to be converted to positive cash flow.

While our current business plan is to fund the development costs with cash flow from our other producing properties, if such cash flow is not sufficient we may be forced to seek alternative sources for cash, through the issuance of additional equity or debt securities, increased borrowings or other means.

Hedging transactions may limit our potential gains.

To reduce our exposure to commodity price uncertainty and increase cash flow predictability relating to the marketing of our crude oil and natural gas, we may enter into crude oil and natural gas price hedging arrangements with respect to a portion of our expected production in order to economically hedge a portion of our forecasted oil and natural gas production.

Additionally, our credit facility requires us to hedge a portion of our production.

In addition, these derivative contracts may limit the benefit we would otherwise receive from increases in the prices for oil and natural gas.

As of December 31, 2020, the Company has in place derivative contracts covering 9,000 and 1,750 barrels of oil per day for the calendar years 2021 and 2022, respectively, and covering 6,000 and 5,000 MMBTU of natural gas per day for the calendar years 2021 and 2022, respectively.

For 2021, contracts covering 4,500 of the 9,000 barrels of oil are in the form of costless collars of WTI Crude Oil prices.

“Costless collars” are the combination of two options, a put option (floor) and a call option (ceiling) with the options structured so that the premium paid for the put option will be offset by the premium received from selling the call option.

These collars have floors ranging from $40.00 to $45.00, with an averaged floor of $42.22 and have ceilings ranging between $52.71 and $55.35 per barrel, with an average ceiling of $54.57.

The remaining 4,500 barrels of oil in 2021 and all of the 1,750 barrels of oil in 2022 are in the form of swaps of WTI Crude Oil prices.

The oil swap prices for 2021 range from $45.00 to $45.96, with an average of $45.42.

The oil swap prices for 2022 range from $44.22 to $45.98, with an average of $44.84.

All of the contracts for natural gas for both 2021 and 2022 are in the form of swaps of Henry Hub.

The swap prices for 2021 and 2022 are $2.991 and $2.7255, respectively.

Hedging transactions may expose us to risk of financial loss.

While intended to reduce the effects of volatile crude oil and natural gas prices, such derivative contracts expose us to risk of financial loss in some circumstances, including when there is a change in the expected differential between the underlying price in the hedging agreement and actual prices received, or when the counterparty to the derivative contract is financially constrained and defaults on its contractual obligations.

It is also possible that sales volumes fall below the hedged volumes leaving a portion of our position uncovered.

The phaseout of the London Interbank Offered Rate (LIBOR), or the replacement of LIBOR with a different reference rate, may adversely affect interest rates.

On July 27, 2017, the Financial Conduct Authority (the authority that regulates LIBOR) announced that it would phaseout LIBOR by the end of 2021.

It is unclear whether new methods of calculating LIBOR will be established such that it continues to exist after 2021, or if the alternative rates or benchmarks will be adopted.

Changes in the method of calculating LIBOR, or the replacement of LIBOR with an alternative rate or benchmark, may adversely affect interest rates and result in higher borrowing costs.

This could materially and adversely affect the Company’s results of operations, cash flow and liquidity.

We cannot predict the effect of the potential changes to LIBOR or the establishment and use of alternative rates or benchmarks.

If changes are made to the method of calculating LIBOR or LIBOR ceases to exist, we may need to amend certain contracts and cannot predict what alternative rate or benchmark would be negotiated.

This may result in an increase to our interest expense.

We may be adversely affected by natural disasters, pandemics (including the recent coronavirus outbreak) and other catastrophic events, and by man-made problems such as terrorism, that could disrupt our business operations.

Natural disasters, adverse weather conditions, floods, pandemics (including the recent coronavirus outbreak), acts of terrorism and other catastrophic or geo-political events may cause damage or disruption to our operations and the global economy, or could result in market disruption, any of which could have an adverse effect on our business, operating results, and financial condition.

The ongoing coronavirus outbreak at the beginning of 2020 has impacted various businesses throughout the world, including an impact on the global demand for oil and natural gas, travel restrictions and the extended shutdown of certain businesses in impacted geographic regions.

If the coronavirus outbreak situation should worsen, it could have a material adverse impact on our business operations, operating results and financial condition.

The ongoing COVID-19 pandemic, and the relations of and agreements between OPEC+ producers, could disrupt our operations and adversely impact our business and financial results.

The COVID-19 pandemic has 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 regulations such as shelter-in-place orders, quarantines, executive orders and similar restrictions.

As a result, the global economy has been marked by significant slowdown and uncertainty, which in turn has led to a precipitous decline in oil prices in response to decreased demand, further exacerbated by the OPEC+ price war during the first quarter 2020 and global storage shortages.

The confluence of these events has resulted in a significantly weaker outlook for oil and natural gas producers, including reduced operating and capital budgets as well as diminished market confidence in overall industry viability.

While OPEC+ producers have agreed to cut oil production to a limited extent, downward pressure on commodity prices has remained and could continue for the foreseeable future.

We currently are unable to predict the duration or severity of the spread of COVID-19 or the adverse effects thereof, including a global economic recession resulting from the pandemic, or the continuance or effectiveness of the OPEC+ voluntary production adjustments (or the terms thereof or compliance therewith).

If economic and industry conditions do not improve, these factors will adversely impact our financial condition and results of operations.

The current environment may make it even more difficult to comply with our covenants and other restrictions in our credit facility, and a lack of confidence in our industry on the part of the financial markets may result in one or more of the following, any of which could lead to reduced liquidity:

a lack of access to capital;

an event of default under our credit facility;

the possible acceleration of our repayment of outstanding debt under our credit facility;

the exercise of certain remedies by our lenders;

or a limited or total inability to refinance our debt.

The loss of key members of management or failure to attract and retain other highly qualified personnel could, in the future, affect the Company’s business results.

The Company’s success depends on its ability to attract, retain and motivate a highly-skilled and diverse management team and workforce.

In the last six months, the Company has experienced significant leadership changes, including appointing a new Chief Executive Officer, Executive Vice President of Operations, a new Executive Vice President of Engineering and Corporate Strategy, a new Vice President of Compliance, a new Executive Vice President of Land, Legal, Human Resources and Marketing along with the appointment of new directors to the Board of Directors.

Executive leadership transitions can be difficult to manage and could cause disruption to our business.

Failure to ensure that the Company has the depth and breadth of management and personnel with the necessary skill set and experience could impede its ability to deliver growth objectives and execute its operational strategy.

As the Company continues to expand, it will need to promote or hire additional staff, and, as a result of increased compensation and benefit mandates, it may be difficult to attract or retain such individuals without incurring significant additional costs.

Risks Relating to the Oil and Natural Gas Industry

A substantial or extended decline in oil and natural gas prices may adversely affect our business, financial condition or results of operations and our ability to meet our capital expenditure obligations and financial commitments.

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● the price and availability of alternative fuels.

Lower oil and natural gas prices may not only decrease our revenues on a per unit basis but also may reduce the amount of oil and natural gas that we can produce economically.

Lower oil and natural gas prices may not only decrease our revenues on a per BOE basis but also may reduce the amount of oil and natural gas that we can produce economically.

Lower prices also negatively impact the value of our proved reserves.

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A substantial or extended decline in oil or natural gas prices may materially and adversely affect our future business, financial condition, results of operations, liquidity or ability to finance planned capital expenditures.

A substantial percentage of our proven properties are undeveloped;

therefore, the risk associated with our success is greater than would be the case if the majority of our properties were categorized as proved developed producing.

Because a substantial percentage of our proven properties are proved undeveloped (approximately 42%) or proved developed non-producing (approximately 5%), we will require significant additional capital to develop such properties before they may become productive.

Further, because of the inherent uncertainties associated with drilling for oil and gas, some of these properties may never be developed to the extent that they result in positive cash flow.

Even if we are successful in our development efforts, it could take several years for a significant portion of our undeveloped properties to be converted to positive cash flow.

Drilling for and producing oil and natural gas are high risk activities with many uncertainties that could adversely affect our business, financial condition or results of operations.

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Our oil and natural gas exploration and production activities are subject to numerous risks beyond our control, including the risk that drilling will not result in commercially viable oil or natural gas production.

For example, on January 20, 2021, the Biden Administration placed a 60-day moratorium on new oil and gas leasing and drilling permits on federal land, and on January 27, 2021, the Department of Interior acting pursuant to an Executive Order from President Biden suspended the federal oil and gas leasing program indefinitely.

While we do not have a significant federal lands acreage position at 240 net acres, these actions could have a material adverse effect on the Company and our industry.

Our decisions to purchase, explore, develop or otherwise exploit prospects or properties will depend in part on the evaluation of data obtained through geophysical and geological analyses, production data and engineering studies, the results of which are often inconclusive or subject to varying interpretations.

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and limitations in the market for oil and natural gas.

Our operations utilize some of the latest horizontal drilling and completion techniques as developed by us, other oil and natural gas exploration and production companies and our service providers.

The additional risks that we face while drilling horizontally include, but are not limited to, the following:

● drilling wells that are significantly longer and/or deeper than more conventional wells;

● landing our wellbore in the desired drilling zone;

● staying in the desired drilling zone while drilling horizontally through the formation;

● running our casing the entire length of the wellbore;

● being able to run tools and other equipment consistently through the horizontal wellbore.

Risks that we face while completing our wells include, but are not limited to, the following:

● the ability to fracture or stimulate the planned number of stages in a horizontal or lateral wellbore;

● the ability to run tools the entire length of the wellbore during completion operations;

● the ability to successfully clean out the wellbore after completion of the final fracture stimulation stage.

If our assessments of recently purchased properties are materially inaccurate, it could have a significant impact on future operations and earnings.

We have aggressively expanded our base of producing properties.

The successful acquisition of producing properties requires assessments of many factors, which are inherently inexact and may be inaccurate, including the following:

● the amount of recoverable reserves;

● future oil and natural gas prices;

● estimates of operating costs;

● estimates of future development costs;

● estimates of the costs and timing of plugging and abandonment;

● potential environmental and other liabilities.

Our assessment will not reveal all existing or potential problems, nor will it permit us to become familiar enough with the properties to assess fully their capabilities and deficiencies.

We plan to undertake further development of our properties through the use of cash flow from existing production.

Therefore, a material deviation in our assessments of these factors could result in less cash flow being available for such purposes than we presently anticipate, which could either delay future development operations (and delay the anticipated conversion of reserves into cash), or cause us to seek alternative sources to finance development activities.

Decreases in oil and natural gas prices may require us to take write-downs of the carrying values of our oil and natural gas properties, potentially requiring earlier than anticipated debt repayment and negatively impacting the trading value of our securities.

Decreases in oil and natural gas prices may require us to take write-downs of the carrying values of our oil and natural gas properties which could negatively impact the trading value of our securities.

Accounting rules require that we review periodically the carrying value of our oil and natural gas properties for possible impairment.

Based on specific market factors and circumstances at the time of prospective impairment reviews, and the continuing evaluation of development plans, production data, economics and other factors, we may be required to write down the carrying value of our oil and natural gas properties.

Because our properties serve as collateral for advances under our credit facility, a write-down in the carrying values of our properties could require us to repay any outstanding debt earlier than we would otherwise be required.

A write-down could also constitute a non-cash charge to earnings.

The cumulative effect of a write-down could also negatively impact the trading price of our securities.

In 2018, the Company recorded a non-cash write-down of its proved oil and natural gas properties of approximately $14.2 million.

The Company did not have any write-downs for the year-ended December 31, 2019.

We follow the full cost method of accounting for our oil and natural gas properties.

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The net book value is compared to the ceiling on a quarterly basis.

The excess, if any, of the net book value above the ceiling is required to be written off as an expense.

We did not record a write down during 2019.

The excess, if any, of the net book value above the ceiling is required to be written off as an impairment expense.

During the year ended December 31, 2020, we recorded a non-cash write down of $277.5 million.

We did not record a write down during 2019.

Under SEC full cost accounting rules, any write-off recorded may not be reversed even if higher oil and natural gas prices increase the ceiling applicable to future periods.

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It is difficult to predict with reasonable certainty the amount of expected future impairments given the many factors impacting the ceiling test calculation including, but not limited to, future pricing, operating costs, upward or downward reserve revisions, reserve adds, and tax attributes.

Decreases in oil and natural gas prices may affect our borrowing base, potentially requiring earlier than anticipated debt repayment, which could negatively impact the trading value of our securities.

Decreases in oil and natural gas prices could also result in reductions in the borrowing base of our Credit Facility, thus requiring earlier than anticipated repayment of debt.

Reserve estimates depend on many assumptions that may turn out to be inaccurate.

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If future values decline or costs increase it could negatively impact our ability to finance operations, and individual properties could cease being commercially viable, affecting our decision to continue operations on producing properties or to attempt to develop properties.

All of these factors would have a negative impact on earnings and net income, and most likely the trading price of our securities.

All of these factors would have a negative impact on earnings and net income,

and most likely the trading price of our securities.

These factors could also result in the acceleration of debt repayment and a reduction in our borrowing base under our credit facility.

Prospects that we decide to drill may not yield oil or natural gas in commercially viable quantities.

This risk may be enhanced in our situation, due to the fact that a significant percentage (42%) of our proved reserves is currently proved undeveloped reserves.

We cannot assure you that the analogies we draw from available data obtained by analyzing other wells, more fully explored prospects or producing fields will be applicable to our drilling prospects.

We may incur substantial losses and be subject to substantial liability claims as a result of our oil and natural gas operations.

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If a significant accident or other event occurs and is not fully covered by insurance, then it could materially and adversely affect us.

Unless we replace our oil and natural gas reserves, our reserves and production will decline as reserves are produced.

Unless we conduct successful development, exploitation and exploration activities or acquire properties containing proved reserves, our proved reserves will decline as those reserves are produced.

Producing oil and natural gas reservoirs generally are characterized by declining production rates that vary depending upon reservoir characteristics and other factors.

Our future oil and natural gas reserves and production, and, therefore, our cash flow and income, are highly dependent on our success in efficiently developing and exploiting our current reserves and economically finding or acquiring additional recoverable reserves.

If we are unable to develop, exploit, find or acquire additional reserves to replace our current and future production, our cash flow and income will decline as production declines, until our existing properties would be incapable of sustaining commercial production.

Competition is intense in the oil and natural gas industry.

We operate in a highly competitive environment for acquiring properties and marketing oil and natural gas.

Our competitors include multinational oil and natural gas companies, major oil and natural gas companies, independent oil and natural gas companies, individual producers, financial buyers as well as participants in other industries that supply energy and fuel to consumers.

Many of our competitors have greater and more diverse resources than we do.

Additionally, competition for acquisitions may significantly increase the cost of available properties.

We compete for the personnel and equipment required to explore, develop and operate properties.

Our competitors also may have established long-term strategic positions and relationships in areas in which we may seek to enter.

Consequently, our competitors may be able to address these competitive factors more effectively than we can.

If we are not successful in our competition for oil and natural gas reserves or in our marketing of production, then our financial condition and operation results may be adversely affected.

If our access to markets is restricted, it could negatively impact our production, our income and our ability to retain our leases.

Market conditions or the unavailability of satisfactory oil and natural gas transportation arrangements may hinder our access to oil and natural gas markets or delay our production.

The availability of a ready market for our oil and natural gas production depends on a number of factors, including the demand for and supply of oil and natural gas and the proximity of reserves to pipelines and terminal facilities.

Our ability to market our production depends in substantial part on the availability and capacity of gathering systems, pipelines and processing facilities owned and operated by third parties.

Our failure to obtain such services on acceptable terms could materially harm our business.

Currently, the majority of our production is sold to marketers and other purchasers that have access to nearby pipeline facilities.

However, as we further develop our properties, we may find production in areas with limited or no access to pipelines, thereby necessitating delivery by other means, such as trucking or requiring compression facilities.

Such restrictions on our ability to sell our oil or natural gas could have several adverse effects, including higher transportation costs, fewer potential purchasers (thereby potentially resulting in a lower selling price) or, in the event we were unable to market and sustain production from a particular lease for an extended time, possibly causing us to lose a lease due to lack of production.

Risks Relating to Legal, Regulatory, Privacy and Tax Matters

We are subject to complex laws that can affect the cost, manner or feasibility of doing business.

Exploration, development, production and sale of oil and natural gas are subject to extensive federal, state, local and international regulation.

It is not possible to predict how or when regulations affecting our operations might change.

The Biden Administration’s January 20, 2021 issuance of a 60-day moratorium on new oil and gas leasing and drilling permits on federal land, and the related January 27, 2021 Executive Order suspending the federal oil and gas leasing program are examples of the uncertainties our Company and the industry faces with respect to regulation at the federal level.

Similarly, at the state level, New Mexico’s consideration of legislation to prohibit certain uses of freshwater in fracking operations, implement new disclosure requirements, and increase penalties may affect the cost and feasibility of our business.

We may be required to make large expenditures to comply with governmental regulations.

Matters subject to regulation include:

Other matters subject to regulation include:

discharge permits for drilling operations;

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Under these environmental laws and regulations, we could be held strictly liable for the removal or remediation of previously released materials or property contamination regardless of whether we were responsible for the release or if our operations were standard in the industry at the time they were performed.

The amount of additional future costs is not fully determinable due to such factors as the unknown magnitude of possible contamination, the unknown timing and extent of the corrective actions or compliance efforts that may be required, the determination of the company’s liability in proportion to other responsible parties, and the extent to which such costs are recoverable from third parties.

Legislative and regulatory initiatives related to global warming and climate change could have an adverse effect on our operations and the demand for oil and natural gas.

Congress and the EPA, in addition to some state and regional authorities, have in recent years considered legislation or regulations to reduce emissions of greenhouse gases, or GHGs.

These efforts have included consideration of cap-and-trade programs, carbon taxes, GHG reporting and tracking programs, and regulations that directly limit GHG emissions from certain sources.

In the absence of federal GHG-limiting legislation, the EPA has determined that GHG emissions present a danger to public health and the environment and has adopted regulations that, among other things, restrict emissions of GHGs under existing provisions of the U.S.

For example, the EPA has adopted and implemented regulations under existing provisions of the CAA that, among other things,

establish permitting requirements for GHG, require that certain facilities meet “best available control technology” standards, and mandate annual reporting of GHG emissions.

The EPA also sought to address climate change through its GHG NSPS regulations, which the current administration intends to review, pursuant to the Executive Order on Protecting Public Health and the Environment and Restoring Science to Tackle the Climate Crisis.

Many state governments have established rules aimed at reducing greenhouse gas emissions, including greenhouse gas cap and trade programs.

Most of these cap-and-trade programs work by requiring major sources of emissions to acquire and surrender emission allowances.

It is difficult to predict the timing and certainty of such government actions and their ultimate effect, which could depend on, among other things, the type and extent of greenhouse gas reductions required, the availability and price of emissions allowances or credits, the availability and price of alternative fuel sources, the energy sectors covered, and the ability to recover the costs incurred through our operating agreements or the pricing of oil, natural gas, and other products.

On an international level, the United States is one of almost 200 nations that agreed in December 2015 to the Paris Agreement.

However, the Paris Agreement does not impose any binding obligations on the United States.

In June 2017, President Trump announced that the United States would withdraw from the Paris Agreement, which became effective November 4, 2020.

President Biden announced on January 20, 2021 that the United States will rejoin the Paris Agreement.

Further, several states, including New Mexico, and local governments remain committed to the principles of the Paris Agreement in their effectuation of policy and regulations.

It is not possible at this time to predict how or when the United States might impose restrictions on GHGs as a result of the Paris Agreement.

Risks Relating to Our Capital Structure

If our indebtedness increases, it could reduce our financial flexibility.

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● a high level of debt could impair our ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions, general corporate or other purposes.

In addition, our bank borrowing base is subject to quarterly redeterminations.

In addition, our bank borrowing base is subject to semi-annual redeterminations.

We could be required to repay a portion of our bank borrowings due to redeterminations of our borrowing base.

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Any such actions could have a material adverse effect on our business and financial results.