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| APAGF > SEC Filings for APAGF > Form 10-K on 16-Mar-2009 | All Recent SEC Filings |
16-Mar-2009
Annual Report
OVERVIEW
We are an international oil and gas exploration and production company with operations in Argentina. As of December 31, 2008, we had interests in seven oil and gas producing concessions and one exploration permit. Although Argentina is where all of our assets are currently located, we have evaluated and are pursing various E&P opportunities in other countries in South America.
During 2008, we made considerable operational progress and spent a record level of capital expenditures ($32.2 million net to our consolidated interests), which we believe will add to Apco's possibilities for long-term profitable growth. Our operational highlights for 2008 include the following:
· Successful development and exploration drilling campaigns in Entre Lomas, Bajada del Palo, and Agua Amarga;
· Initiation of field re-activation efforts in Bajada del Palo;
· Made oil and natural gas discoveries in Agua Amarga, and evaluation of the block's commerciality is underway;
· Formal negotiations for concession extensions were initiated with the province of Neuquén;
· Continued development drilling and completed production facilities infrastructure in Tierra del Fuego; and
· Opened a branch office in Colombia and participated in an exploration acreage bidding process.
The year 2008 also included increased exploration activities including the acquisition of greater amounts of 3D seismic data and the drilling of more exploration wells outside of our core area compared with prior years. We will continue to seek an appropriate balance of development, exploration, and acquisition capital in order to increase production and reserves in the future.
Our net income for 2008 was $23.8 million compared with $31.3 million for 2007 and $40.1 million for 2006. Net income decreased compared with 2007 as the favorable effects of increased oil and LPG sales volumes and higher average sales prices were more than offset by higher costs and expenses and lower equity income from Argentine investments.
Outlook for 2009
Our plan for 2009 is focused on disciplined growth and cash flow maximization. Our objectives for the year are to:
· Maximize cash flow;
· Control operating costs;
· Reduce and optimize capital expenditures in order to preserve cash; and
· Continue a disciplined approach toward seeking investment opportunities during a time when oil prices have decreased sharply and credit markets have tightened.
Our 2009 oil and gas capital expenditure budget including exploration expenditures is $22 million net to our consolidated interests. After taking into consideration the portion of capital expenditures attributable to our equity interest in Petrolera, our combined consolidated and equity capital expenditure budget including exploration expenditures for 2009 is $39 million. We expect to have sufficient cash reserves and internally generated cash flows to fund our capital expenditures. However, throughout 2009, we will review our capital spending program in light of potentially decreasing product prices and, if necessary, will reduce our planned investments in order to preserve cash.
GENERAL BUSINESS REVIEW
Neuquén Basin
In our Neuquén basin properties, we leveraged our collective geological experience with our joint venture partners to conduct successful development and exploration drilling campaigns in Entre Lomas, Bajada del Palo, and Agua Amarga. Apco and its partners used three rigs throughout much of the year for drilling in the areas. Total gross capital and exploration expenditures was $93 million for the year, or $21 million net to our 23 percent direct working interest and $28 million attributable to our equity interest in Petrolera.
In Entre Lomas, 39 gross wells were drilled and completed as producing wells, including two exploratory wells and 37 development wells. We also performed 29 well workovers. In addition to our completed wells, two development wells were in progress at year end, and were subsequently completed as oil producers in 2009.
In Bajada del Palo, Apco and its partners acquired approximately 200 square kilometers of 3D seismic images over the northeast sector of the Bajada del Palo concession, completed an eight-well re-activation program, and drilled three productive development wells and one productive exploration well. Two exploration wells were in progress at year end, and were subsequently completed as oil producers in 2009. Since we acquired our interest in the area, gross production volumes have increased from approximately 180 barrels of oil per day to 1,350 barrels of oil per day.
In Agua Amarga, we drilled and completed six exploration and confirmation wells during 2008, all of which are capable of production. Our successful drilling results have confirmed the existence of hydrocarbon reservoirs with development potential, and we are evaluating the commerciality of the block. In accordance with the investment schedule per the exploration permit, we expect to drill two additional exploratory wells in the area during 2009 and 2010.
We have a 23 percent direct working interest and an effective 29.79 percent equity interest in the wells mentioned above. For a detail of the Company's net development and exploration wells drilled during the year, refer to the "Drilling Activity" table under "Unaudited Supplemental Oil and Gas Information" in the Notes to Consolidated Financial Statements.
Acambuco
In 2008 the Acambuco partners completed drilling of the Cerro Tuyunti x-2 ("CT x-2") exploration well which reached a total depth of 19,324 feet and found the objective Huamampampa formation. During testing, the well produced water with a small quantity of gas. The well was declared non-productive and was abandoned in the third quarter, resulting in a dry-hole expense of $1.2 million net to Apco. We have a 1.5 percent direct working interest in the Acambuco concession.
Tierra del Fuego
Apco and its partners made significant investments to develop the Tierra del Fuego concessions in 2008. The main objectives for the year were to complete production and transportation infrastructure to allow for increased production, and continue the drilling campaign initiated in 2007. We also acquired approximately 135 square kilometers of 3D seismic over the Las Violetas and Angostura concessions.
Throughout 2008, we completed investments to increase treating, compression, and transportation capacity. After constructing a gas pipeline, our joint venture's production facilities were connected from the Las Violetas concession directly to the San Martín pipeline, giving us a physical outlet to transport gas from the island of Tierra del Fuego to continental Argentina, where higher prices are being realized. Deliveries to the continent began in late September and have increased incrementally as compression facilities are completed in stages and new gas sales agreements are executed.
Although the new pipeline completed in 2008 will provide the Company and its partners gas deliverability capacity of 60 million cubic feet per day, additional drilling, treatment facilities, flow lines and compression will be required to produce those volumes. Investments for additional gathering and flow lines are planned to be completed in the first half of 2009 to enable us to increase gross gas production to approximately 42 million cubic feet per day by the middle of 2009 along with a corresponding increase in condensate volumes.
During 2008, the Company and its partners drilled 18 development wells and one exploration well (4.9 total net wells). Six of the development wells are non-productive. Of the productive wells, five are gas producers and seven are oil producers.
In the fourth quarter of 2008, the operator of the Tierra del Fuego concessions informed the drilling contractor of the joint venture's decision to suspend drilling operations. It is our current intention to resume drilling in 2010 to achieve production volumes equivalent to the full capacity of our production facilities. In order to keep the rig available for use on the island of Tierra del Fuego for the period from March 2010 to December 2010 and avoid expensive mobilization and demobilization costs to and from the island of Tierra del Fuego, the joint venture amended the drilling contract and will pay $217,000 per month until March 2010, or until such time that drilling operations are resumed by our drilling contractor.
Marketing natural gas volumes produced from our TDF concessions is challenging. The province is situated on a remote island at the southern tip of the South American continent, and it is located long distances from major industrial gas markets in Argentina. Local gas markets are limited due to sparse population levels and low industrial and economic activity on the island. Natural gas is delivered to markets in continental Argentina by the San Martín gas pipeline which currently has limited excess capacity. Competition with larger gas fields with gas reserves in offshore Tierra del Fuego further complicates the challenge. An available market for gas produced in Tierra del Fuego could be Chile where there is a strong demand for gas in a country with limited hydrocarbon resources. However, the Argentine government has imposed restrictions that limit the export of gas produced in Argentina. Nevertheless, a shortage of natural gas supply in continental Argentina and planned investments to increase capacity of the San Martín pipeline should enable us to deliver more gas volumes to market.
The government of Argentina is leading plans to construct a second gas pipeline crossing the Straight of Magellan that separates the island of Tierra del Fuego from continental Argentina. This planned pipeline should provide more physical capacity to transport natural gas from the island, where non producing gas reserves are plentiful, to the Argentine continent, where there is a shortage of natural gas. The pipeline is expected to be placed in service in 2010, and should provide the Company with greater access to higher priced industrial markets.
Cañadón Ramirez
During 2008, we drilled three exploration wells pursuant to a farm-out agreement with CanAmericas Energy ("CanAmericas") which earned its 49 percent working interest in an area of mutual interest by funding $4.5 million for seismic and drilling costs. Two of the wells were tested by year-end and were determined to be non-productive. Because CanAmericas provided most of the funding for these wells, exploration dry hole expense net to Apco was limited, and we recorded a charge of $141 thousand for expenses incurred through December 31, 2008. The third well was tested in early 2009 and is under evaluation. At the end of 2008, a significant exploration portion of the concession was relinquished to the government. The remaining concession covers 16,800 gross acres, and we hold a 42 percent direct working interest in the area of mutual interest and a direct working interest of 81.82 percent in the remainder.
Capricorn
In early 2008, we drilled the Lomas de Guayacán x-1 ("LdG.x-1") well on the Martínez del Tineo Oeste prospect. During drilling, we encountered oil shows and manifestations of gas in the targeted Yacorite formation. The well was cased, but after an unsuccessful test the well was plugged and abandoned, resulting in an exploration dry hole expense of $1.3 million net to Apco. The Company and its Capricorn partners subsequently relinquished this exploration permit.
Sur Río Deseado Este
Since 2005, Apco has funded various investments for development activities to increase production in the Sur Río Deseado Este concession in the San Jorge basin in southern Argentina and we have earned an option to hold a 17 percent working interest in the block. At the end of 2008, the joint venture participating in the concession relinquished approximately 75 percent of the acreage in lieu of paying the cannon fees to retain certain exploratory acreage on the block (approximately 62,000 acres). Consequently, Apco recorded a charge to exploration expense of $890 thousand for a proportionate share of cash advances made to date. We have also agreed with the joint venture that Apco will earn an 88 percent working interest in the remaining exploration acreage by funding the 2009 cannon payment ($260 thousand) and certain conditional future investments. The concession produces a small volume of oil, but we believe the area has exploration potential due to geologic trends in the surrounding area and successful drilling results in an adjacent concession.
Business Development
Although Argentina is where all of our assets are currently located, future growth plans include diversification into other countries. We have increased the number of employees dedicated to our strategy to build core areas outside of Argentina. We are evaluating exploration and production opportunities in other countries in South America, including drilling farm-in opportunities or acquisitions, which could provide the Company with opportunity for production and reserve growth on favorable economic terms.
Consistent with this strategy, in July 2008, a subsidiary of the Company, Apco Properties Ltd., a Cayman Island company, opened a branch in Colombia, Apco Properties Sucursal de Colombia. The Company has retained a legal representative in Colombia, and is actively searching for strategic partners and investment opportunities in the country. In December 2008, Apco participated in a public bidding process known as "ANH Miniround 2008" for the assignment of certain exploration properties by the government of Colombia. Although the Company did not make a winning bid, we believe there will be opportunities to participate in certain of the recently awarded areas through drilling farm-in arrangements.
Concession Contracts in Argentina
Our right to conduct E&P activities in Argentina is generally derived from participation in concessions granted by the government which have a finite term. The expiration, termination, or extension of our concessions could materially affect the Company's future results. The term of a concession is generally 25 years, and can be extended for 10 years with the consent of the Argentine government. As mentioned elsewhere in this report, substantially all of our concessions have terms ending in 2016.
In general, provincial governments have had full jurisdiction over concession contracts since early 2007, when the Argentine federal government transferred to the provincial governments full ownership and administration rights over all hydrocarbon deposits located within the respective territories of the provinces, including all exploration permits and exploitation concessions originally granted by the federal government. Thus, governmental consent for concession contract extensions is required from the respective provinces in which we do business.
In the second quarter of 2008 the province of Neuquén, in which approximately 50 percent of the Entre Lomas concession is located, and in which the entire Bajada del Palo concession is located, published minimum requirements and an estimated timetable for concession holders to negotiate their respective concession extensions. The basic requirements are that concession holders negotiate, among other things, a cash bonus payment and an increase to provincial production taxes. Concession holders must also propose a future investment program. In October of 2008, the province of Neuquén announced that terms had been agreed and approved by the provincial governor and legislature to extend the concessions held by the largest producer in the province. Other large Neuquén province producers have since obtained their extensions.
On behalf of the Entre Lomas and Bajada del Palo joint venture partners, Petrolera initiated the formal negotiation process with the province of Neuquén. For the Entre Lomas concession, which is located in both the provinces of Neuquén and Río Negro, we expect similar negotiations to take place with the province of Río Negro in 2009. Should we agree to terms with the Neuquén province, we expect to have the concession extensions for the western portion of the Entre Lomas concession and the Bajada del Palo concession approved by mid-2009. Executive and legislative approvals will be required.
The Tierra del Fuego concessions partners have begun discussions with the province of Tierra del Fuego regarding the extension of our three concessions, but the province has not yet formally initiated a process similar to that announced by the province of Neuquén.
Although extensions require governmental consent, we believe they will be obtained but cannot predict when they will be achieved nor the final terms that may be negotiated. If the extensions are granted, it is probable the amended concession terms will be less favorable than those the Company has today.
Oil and Natural Gas Marketing
Oil Prices
Oil prices have a significant impact on our ability to generate earnings, fund capital projects, and pay shareholder dividends. Oil prices are affected by changes in market demands, global economic activity, political events, weather, inventory storage levels, refinery infrastructure capacity, OPEC production quotas, and other factors. Additionally, oil sales price realizations for oil produced and sold in Argentina are significantly influenced by Argentine governmental actions as described in the following paragraphs. As a result, we can not accurately predict future prices, and therefore it is difficult for us to determine what effect increases or decreases in product prices may have on our capital programs, production volumes, or future revenues.
Prior to 2002, the price per barrel for Argentine crude oil was based on the spot market price of West Texas Intermediate crude oil ("WTI") less a discount for differences in gravity and quality. In the wake of the Argentine economic crises of 2002, and as the price of crude oil increased to record levels over the past several years, politically driven mechanisms were implemented to determine the sale price of oil produced and sold in Argentina. To alleviate the impact of higher crude oil prices on Argentina's economy, the Argentine government created an oil export tax and enacted strict price controls over gasoline prices to force producers and refiners to negotiate oil sales prices significantly below international market levels.
WTI continues to be the reference price for oil sold in the country, and gravity and quality discounts still apply. However, producers and refiners have gradually incorporated additional reduction factors into pricing formulas that considerably reduce the sale price net back to Argentine producers such that net back reductions escalate to higher and higher levels as WTI increases. Consequently, increases in oil prices over the past several years have benefited oil producers outside of Argentina more than the Company.
In response to the increase in world oil prices as WTI approached $100 per barrel in the fourth quarter of 2007, the Argentine government issued Resolution 394/2007 in November 2007. The resolution modified how hydrocarbon export taxes are calculated. Prior to the resolution, the maximum export tax rate was 45% of the sales value, such that oil price realizations after deducting the gravity and quality discount and the export tax were approaching $50 per barrel at a WTI level of $90 per barrel. The resolution effectively raised the tax to a rate that established a ceiling of $42 per barrel for export net backs after deducting the tax when WTI is greater than $61 per barrel. The combination of the net back ceiling for exports and strict government controls over Argentine gasoline prices has impacted the net back on the sale of crude oil in the domestic market.
Refiners in Argentina initially interpreted that the resolution set a ceiling of $42 per barrel for oil sold domestically in Argentina. However, throughout 2008, producers and refiners negotiated prices around the $42 per barrel reference price depending on the different qualities of crude oil produced in the country. For our Neuquén basin properties which account for over 90 percent of our total oil revenues, we negotiated sales contracts which allowed sales prices of $45 per barrel for the first five months of the year, and $47 per barrel through January of 2009. We received slightly lower prices for oil sold from our other properties.
The year 2008 was unique for world oil prices as the spot price of WTI reached a peak of $145 per barrel in July and approached a low of $30 per barrel in December. This volatility of world oil prices was not reflected in our results of operations during 2008 due to the price controls and marketing environment in Argentina. Oil producers in Argentina did not benefit from the increases in world oil prices. Likewise, when prices began to fall late in the year, the Company's realized prices were not impacted. As reflected in the "Volume, Price and Cost Statistics" table in "Results of Operations," our oil sales price per barrel for our consolidated interests averaged $46.09 for 2008 compared with $43.62 for 2007 and $43.88 in 2006.
As previously mentioned, we cannot predict how world oil prices will evolve in 2009 and beyond, but as a result of the global financial crisis that occurred in the fourth quarter of 2008, demand for crude oil has decreased in Argentina. Early in 2009, the WTI price has fluctuated around $40 per barrel. Should WTI remain at current levels for an extended period of time, we can expect that our average realized price in 2009 will be lower than the average prices we have received over the past three years.
Oil Market Concentration
The Company's sales to a refinery owned by Petrobras Energía represent 76.5 percent of its total operating revenues. In Argentina there are five active refiners operating in the country that constitute 99 percent of the total market. The largest of these five refines mostly its own production, while the smallest of the five operates only in the northwest basin of Argentina. Decisions to sell to these customers are based on advantages presented by the commercial terms negotiated with each customer. Today, producers of Medanito crude oil, a term used to describe crude oil produced in the Entre Lomas region of the Neuquén basin, are selling to Argentine refiners. Refer to Note 5, of Notes to Consolidated Financial Statements, for a description of the Company's major customers over the last three years. Oil sales contract prices negotiated with Petrobras Energía throughout 2008 were competitive with those received by other producers of Medanito crude oil in the Neuquén basin.
Natural Gas Prices
The Company sells its gas to Argentine customers pursuant to peso denominated contracts and spot market sales. As a consequence of the strong growth in Argentina's economy over the past several years, and stimulated by low gas prices resulting from a natural gas price freeze implemented by the Argentine government in 2002, demand for natural gas in Argentina has grown significantly. However, the unfavorable gas price environment for producers has acted to discourage gas development activities. Without significant development of gas reserves in Argentina, supplies of gas in the country have failed to keep up with increased demand for gas. The result is a natural gas and power supply shortage in the country. Since the beginning of 2004, the Argentine government has taken several steps to prevent shortages in the domestic market. Gas exports to Chile have been curtailed and the country entered into agreements to import natural gas from Bolivia at prices exceeding $6.00 per Mcf, or significantly greater than sales prices for gas produced in Argentina. As described in the following paragraphs, Resolution 599/2007 is designed to supply natural gas in the domestic market and provide a framework for natural gas prices in Argentina.
In 2007, the Argentine Secretary of Energy issued Resolution 599/2007 to regulate the supply of natural gas in the domestic market for the period 2007 to 2011 through a natural gas supply agreement referred to as the "Acuerdo 2007-2011."
The resolution is intended to provide for equitable sharing of all sectors of the internal gas market among producers and establishes a mechanism for doing so based on average natural gas volumes produced from 2002 to 2004. The resolution determines which sectors of the market will have priority during periods of peak demand. During such periods, the residential market will have first priority. With respect to the lower-priced residential market, each producer's share of the residential market will be distributed based on an allocation of its volumes produced during the period 2002 to 2004, while natural gas production in excess of those volumes can be sold to electric power generators at regulated prices, and industrial customers at freely negotiated prices.
Producers that increased natural gas production since 2004 are at an advantage compared to those producers whose production decreased because natural gas prices to residential customers remain frozen at less than 50 cents per Mcf. The resolution allows producers to choose to participate in the Acuerdo 2007-2011 gas supply agreement or not. However, if a producer chooses not to participate, then during periods of peak demand, or when there is a shortage of gas in the country, the government can force non-participating producers to be the first to supply excess residential volume demand above the base-line demand as projected in the Acuerdo 2007-2011, regardless of the non-participating producer's contractual commitments.
In general, resolution 599/2007 should have a slightly positive impact on natural gas sales prices in Acambuco and Tierra del Fuego, but, during peak demand periods, it could negatively impact natural gas sales prices in Entre Lomas. Nevertheless, because Entre Lomas gas revenues represent approximately three percent of the Company's total operating revenues on an annual basis, the overall impact of the resolution is not expected to be material to our cash flows or results of operations. The table "Volume, Price and Cost Statistics" in "Results of Operations" reflects that the Company's average natural gas sale price per Mcf, including its equity interests, averaged $1.43 in 2008, $1.50 in 2007, and $1.36 during 2006.
Seasonality
Of the products sold by the Company, only natural gas is subject to seasonal demand. Demand for natural gas in Argentina is reduced during the warmer months of October through April, with generally lower natural gas prices during this off-peak period. During 2008, natural gas sales represented 10 percent of our total operating revenues compared with 11 percent in 2007 and 10 percent in 2006. Consequently, the fluctuation in natural gas sales between summer and winter is not significant for the Company.
New Accounting Standards and Emerging Issues
Accounting standards that have been issued and are not yet effective may have a material effect on our Consolidated Financial Statements in the future. See . . .
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