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HNR > SEC Filings for HNR > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for HARVEST NATURAL RESOURCES, INC.

Form 10-Q for HARVEST NATURAL RESOURCES, INC.


9-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Harvest Natural Resources, Inc. ("Harvest" or the "Company") cautions that any forward-looking statements as such term is defined in Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act") contained in this report or made by management of the Company involve risks and uncertainties and are subject to change based on various important factors. When used in this report, the words "budget", "forecast", "expect", "believes", "goals", "projects", "plans", "anticipates", "estimates", "should", "could", "assume" and similar expressions are intended to identify forward-looking statements. In accordance with the provisions of the Securities Act and the Exchange Act, we caution you that important factors could cause actual results to differ materially from those in the forward-looking statements. Such factors include our concentration of operations in Venezuela, the political and economic risks associated with international operations (particularly those in Venezuela), the anticipated future development costs for undeveloped reserves, drilling risks, the risk that actual results may vary considerably from reserve estimates, the dependence upon the abilities and continued participation of certain of our key employees, the risks normally incident to the exploration, operation and development of oil and natural gas properties, risks incumbent to being a noncontrolling interest shareholder in a corporation, the permitting and the drilling of oil and natural gas wells, the availability of materials and supplies necessary to projects and operations, the price for oil and natural gas and related financial derivatives, changes in interest rates, the Company's ability to acquire oil and natural gas properties that meet its objectives, availability and cost of drilling rigs and seismic crews, overall economic conditions, political stability, civil unrest, acts of terrorism, currency and exchange risks, currency controls, changes in existing or potential tariffs, duties or quotas, changes in taxes, changes in governmental policy, lack of liquidity, availability of sufficient financing, estimates of amounts and timing of sales of securities, closing of the Share Purchase Agreement, changes in weather conditions, and ability to hire, retain and train management and personnel. A discussion of these factors is included in our Annual Report on Form 10-K for the year ended December 31, 2011, and below under the caption "Risk Factors,", which includes certain definitions and a summary of significant accounting policies and should be read in conjunction with this Quarterly Report on Form 10-Q.

Executive Summary

Harvest Natural Resources, Inc. is a petroleum exploration and production company incorporated under Delaware law in 1989. Our focus is on acquiring exploration, development and producing properties in geological basins with proven active hydrocarbon systems. Our experienced technical, business development and operating personnel have identified low entry cost exploration opportunities in areas with large hydrocarbon resource potential. We operate from our Houston, Texas headquarters. We also have regional/technical offices in the United Kingdom and Singapore, and small field offices in Jakarta, Republic of Indonesia ("Indonesia"); Muscat, Sultanate of Oman ("Oman"); and Port Gentil, Republic of Gabon ("Gabon") to support field operations in those areas.

We have acquired and developed significant interests in the Bolivarian Republic of Venezuela ("Venezuela"). Our Venezuelan interests are owned through Harvest-Vinccler Dutch Holding, B.V., a Dutch private company with limited liability ("Harvest Holding"). Our ownership of Harvest Holding is through HNR Energia, B.V. ("HNR Energia") in which we have a direct controlling interest. Through HNR Energia, we indirectly own 80 percent of Harvest Holding and our partner, Oil & Gas Technology Consultants (Netherlands) Coöperatie U.A., a controlled affiliate of Venezolana de Inversiones y Construcciones Clerico, C.A. ("Vinccler"), indirectly owns the remaining 20 percent interest of Harvest Holding. Harvest Holding owns, indirectly through wholly owned subsidiaries, a 40 percent of Petrodelta, S.A. ("Petrodelta"). As we indirectly own 80 percent of Harvest Holding, we indirectly own a net 32 percent interest in Petrodelta, and Vinccler indirectly owns eight percent. Corporación Venezolana del Petroleo S.A. ("CVP") owns the remaining 60 percent of Petrodelta. Harvest Holding has a direct controlling interest in Harvest Vinccler S.C.A. ("Harvest Vinccler"). Harvest Vinccler's main business purposes are to assist us in the management of Petrodelta and in negotiations with Petroleos de Venezuela S.A. ("PDVSA"). We do not have a business relationship with Vinccler outside of Venezuela.

Through the pursuit of technically-based strategies, we are building a portfolio of exploration prospects to complement the production, development and exploration prospects we hold in Venezuela. In addition to our interests in Venezuela, we hold exploration acreage mainly onshore West Sulawesi in Indonesia; offshore of Gabon; onshore in Oman; and offshore of the People's Republic of China ("China").


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From time to time we learn of possible third party interests in acquiring ownership in certain assets within our property portfolio. We evaluate these potential opportunities taking into consideration our overall property mix, our operational and liquidity requirements, our strategic focus and our commitment to long-term shareholder value.

During the last two years, we have been exploring a broad range of strategic alternatives for enhancing stockholder value. On September 24, 2010, we retained Merrill Lynch, Pierce, Fenner & Smith ("Merrill Lynch") to provide advisory services to assist us in exploring those strategic alternatives, including, among others, a sale of assets. Since that time, we have received several indications of interest from third parties, provided due diligence materials to third parties under confidentiality agreements and had preliminary discussions with third parties regarding a sale of our interest in Venezuela, but until March 6, 2012, we had not determined that any of the transactions discussed were in our best interests.

On March 6, 2012, we announced that we had commenced exclusive negotiations with a third party for the possible sale of our 32 percent interest in Petrodelta.

Share Purchase Agreement ("SPA")

On June 21, 2012, we and our wholly owned subsidiary HNR Energia entered into a share purchase agreement (the "SPA") with PT Pertamina (Persero), a state-owned limited liability company existing under the laws of Indonesia ("Buyer"). HNR Energia is a private company with limited liability under the laws of Curacao. HNR Energia owns 80 percent of the equity interest of Harvest Holding, which owns 40 percent of the equity interest of Petrodelta. Vinccler, who owns the other 20 percent equity interest of Harvest Holding, is not a party to the transaction.

Under the SPA, HNR Energia will sell all of its 80 percent interest in Harvest Holding to Buyer or a newly formed wholly owned subsidiary of Buyer for a cash purchase price of $725.0 million, subject to adjustment as described in the SPA. The sale of Harvest Holding, including its direct and indirect subsidiaries, will constitute the sale of all of our interest in Venezuela, which consists of our indirect 32 percent interest in Petrodelta and our indirect 80 percent interest in Harvest Vinccler. The effective date of the transaction is January 1, 2012. We have also executed a guarantee in Buyer's favor by which we guarantee HNR Energia's obligations under the SPA.

The closing of the transaction is subject to receipt of three approvals, in addition to satisfaction of other conditions standard in transactions of this type: (a) approval by the Ministerio del Poder Popular de Petroleo y Mineria representing the Government of the Bolivarian Republic of Venezuela (which indirectly owns the other 60 percent interest in Petrodelta); (b) approval by the Government of the Republic of Indonesia in its capacity as Buyer's sole shareholder; and (c) approval by the holders of a majority of Harvest's common stock. If the approval of Buyer's shareholder is not obtained within five months after the date of the SPA, we may terminate the SPA. If the approval of Harvest's stockholders is not obtained within 90 days after approval of Buyer's shareholder is obtained, Buyer may terminate the SPA.

Contemporaneously with signing the SPA, Buyer deposited 15 percent of the $725.0 million purchase price, or $108.8 million, in escrow. The deposit constitutes liquidated damages, and if Buyer defaults, our sole remedy is to retain the deposit and any earned interest. The deposit and any earned interest will be returned to Buyer if the SPA is terminated for any other reason, including if the approval by our stockholders, Buyer's shareholder or the Government of Venezuela is not obtained. The purchase deposit was received by the escrow agent on June 22, 2012.

We have agreed not to solicit other offers to acquire Harvest as a whole or the Petrodelta assets while the SPA is in effect. If we receive an unsolicited superior proposal before our stockholders have approved the transaction, we may enter into discussions with the potential purchaser. We have the right to terminate the SPA and accept a superior proposal if we first offer Buyer the opportunity to modify the transaction so that the competing offer is no longer superior and pay Buyer a break-up fee equal to three percent of the purchase price, or $21.8 million.

Under the SPA, the parties met during the week of September 5, 2012, to assess progress toward obtaining the required governmental approvals and satisfaction of other conditions to closing. The parties agreed to continue pursuing the various approvals required to close the transaction.


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The SPA includes representations and warranties, tax provisions and indemnification provisions typical in transactions of this type. Reference should be made to the SPA regarding those provisions and all other provisions pertinent to a complete understanding of the transaction.

Venezuela

Harvest Vinccler's and Petrodelta's functional and reporting currency is the U.S. Dollar. They do not have currency exchange risk other than the official prevailing exchange rate that applies to their operating costs denominated in Venezuela Bolivars ("Bolivars") (4.30 Bolivars per U.S. Dollar). However, during the three months ended September 30, 2012, Harvest Vinccler exchanged approximately $0.4 million (three months ended September 30, 2011: $0.3 million) through the Sistema de Transacciones con Títulos en Moneda Extranjera ("SITME") and received an average exchange rate of 5.23 Bolivars (three months ended September 30, 2011: 5.15 Bolivars) per U.S. Dollar. During the nine months ended September 30, 2012, Harvest Vinccler exchanged approximately $1.0 million (nine months ended September 30, 2011: $0.7 million) through SITME and received an average exchange rate of 5.17 Bolivars (nine months ended September 30, 2011:
5.17 Bolivars) per U.S. Dollar. Harvest Vinccler currently does not have any Bolivars pending government approval for settlement for U.S. Dollars at the official exchange rate or the SITME exchange rate. Petrodelta does not have, and has not had, any Bolivars pending government approval for settlement for U.S. Dollars at the official exchange rate or the SITME exchange rate.

The monetary assets that are exposed to exchange rate fluctuations are cash, accounts receivable, and other current assets. The monetary liabilities that are exposed to exchange rate fluctuations are accounts payable, accruals and other current liabilities. All monetary assets and liabilities incurred at the official Bolivar exchange rate are settled at the official Bolivar exchange rate. At September 30, 2012, the balances in Harvest Vinccler's Bolivar denominated monetary assets and liabilities accounts that are exposed to exchange rate changes are 5.6 million Bolivars and 8.6 million Bolivars, respectively. At September 30, 2012, the balances in Petrodelta's Bolivar denominated monetary assets and liabilities accounts that are exposed to exchange rate changes are 236.9 million Bolivars and 3,570.4 million Bolivars, respectively.

On May 7, 2012, the Organic Law on Employment, Male and Female Workers ("Labor Law") was published in the Official Gazette, the official government publication where laws, decrees, resolutions, instructions, and other regulations of general interest issued by the central government of Venezuela are published in order to make those acts valid and official. The Labor Law has 554 Articles divided into ten Titles and heavily favors employees over employers. The Labor Law's purpose is to regulate the relations between workers and employers. In August 2012, the labor contract between PDVSA and the labor union was signed. The new labor contract awarded salary increases to both union and non-union labor retroactive to December 2011. The new labor contract has increased the effect of the Labor Law on Petrodelta. However, until the actuarial study that PDVSA has commissioned is completed, the total effect of the Labor Law on Petrodelta's business is not easily determinable. Based on the information that Petrodelta currently has, Petrodelta estimates the financial impact of the Labor Law could be approximately $0.4 million ($0.1 million net to our 32 percent interest) through September 30, 2012. After much analysis, Harvest Vinccler estimates that there will be little, if any, financial impact on its business from the Labor Law.

Petrodelta

Petrodelta's shareholders intend that the company be self-funding and rely on internally-generated cash flow to fund operations. Petrodelta's 2012 capital budget, which has yet to be endorsed by Petrodelta's board, is expected to be approximately $300 million with a significant portion of that total related to infrastructure costs to support the further development of the Temblador and El Salto fields.

Petrodelta began 2012 with three drilling rigs, but PDVSA relocated one rig to another operation. Currently, Petrodelta is operating two drilling rigs and one workover rig and is continuing with infrastructure enhancement projects in the El Salto and Temblador fields. Plans are underway to build a pipeline connection between the Isleño field and the main production facility at Uracoa as Isleño production is currently being trucked to Uracoa. Petrodelta has a new drilling rig to replace the rig that was relocated. The rig is currently rigging up in the Isleño field. The drilling rig is expected to be operational in November 2012. Petrodelta has been notified that it will receive three additional new rigs. The rigs are expected to arrive during the first and second quarters of 2013. These rigs will result in an expected five working rigs in 2013.


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During the nine months ended September 30, 2012, Petrodelta drilled and completed ten development wells, delivered approximately 9.8 million barrels ("MBls") of oil and 1.5 billion cubic feet ("Bcf") of natural gas, averaging 36,736 barrels of oil equivalent ("BOE") per day. During the nine months ended September 30, 2011, Petrodelta drilled and completed nine development wells, one successful appraisal well and two water injector wells, delivered approximately
8.4 MBls of oil and 1.5 Bcf of natural gas, averaging 31,671 BOE per day.

Certain operating statistics for the three and nine months ended September 30, 2012 and 2011 for the Petrodelta fields operated by Petrodelta are set forth below. This information is provided at 100 percent. This information may not be representative of future results.

                                             Three Months Ended          Nine Months Ended
                                                September 30,              September 30,
                                             2012           2011          2012         2011
Thousand barrels of oil sold                   3,512         3,031          9,810       8,396
Million cubic feet of gas sold                   412           594          1,536       1,504
Total thousand barrels of oil equivalent       3,581         3,130         10,066       8,647
Average price per barrel                   $   92.43      $ 100.62     $    98.63     $ 97.02
Average price per thousand cubic feet      $    1.54      $   1.54     $     1.54     $  1.54
Cash operating costs ($millions)           $    34.3      $   20.0     $     75.9     $  52.9
Capital expenditures ($millions)           $    49.7      $   31.4     $    120.3     $  97.9

Under Petrodelta's Contract for Sale and Purchase of Hydrocarbons with PDVSA Petroleo S.A. ("PPSA"), a wholly owned subsidiary of PDVSA, (the "Sales Contract"), crude oil delivered from the Petrodelta fields to PDVSA is priced with reference to Merey 16 published prices, weighted for different markets and adjusted for variations in gravity and sulphur content, commercialization costs and distortions that may occur given the reference price and prevailing market conditions. Merey 16 published prices are quoted and sold in U.S. Dollars. Natural gas delivered from the Petrodelta Fields to PDVSA is priced at $1.54 per thousand cubic feet. PPSA is obligated to make payment to Petrodelta in U.S. Dollars in the case of payment for crude oil and natural gas liquids delivered. Natural gas deliveries are paid in Bolivars, but the pricing for natural gas is referenced to the U.S. Dollar.

The official price formula applied to the Merey 16 by the Ministry of the People's Power for Petroleum and Mining ("MENPET") is used for the sales of Petrodelta crude oil with quality close to 16 degrees API to represent actual quality delivered.

As disclosed in our Annual Report on Form 10-K for the year ended December 31, 2011, production from the Petrodelta fields, except the El Salto field, flows through Petrodelta's pipelines into PDVSA's EPT-1 storage facility. Prior to October 2011, El Salto production was trucked to the EPT-1 storage facility and combined with the other Petrodelta fields' production. Beginning October 2011, production from the El Salto field flows through PDVSA's EPM-1 transfer point at PDVSA Morichal. Currently, the El Salto production flows through COMOR transfer point, a new transfer point for Petrodelta, at PDVSA Morichal.

When the Sales Contract was executed, Petrodelta was producing only one type of crude, Merey 16. Therefore, the Sales Contract provides for only one crude pricing formula. This formula has been approved by MENPET. The production deliveries and factors to include in the pricing formula are certified and acknowledged by MENPET.

Beginning in October 2011, MENPET determined that Petrodelta's production flowing through the COMOR transfer point was a heavier type of crude, Boscan. The Boscan gravity and sulphur correction factors and crude pricing formula are not included in the Sales Contract. However, under the Sales Contract, PDVSA is obligated to receive all of Petrodelta's production. All production deliveries for all of Petrodelta fields have been certified by MENPET and acknowledged by PDVSA.

The pricing factors for the Boscan crude have been provided and certified by MENPET to Petrodelta. From October 1, 2011 through June 30, 2011, Petrodelta used the Boscan pricing formula as published in the Official Gazette on January 11, 2007 to record the revenue from the El Salto field deliveries. On October 5, 2012, Petrodelta received a draft Sales Contract amendment from PDVSA Trade and Supply. The draft Sales Contract amendment includes a change to Merey 16 pricing formula to allow for indexing of the transportation and commercialization ("ACC") costs and indexing of the ACC costs and additional sales markets to the Boscan pricing formula. Petrodelta has agreed to the changes in the draft Sales Contract. The revised pricing formula for Merey 16 is prospective and does not affect recorded revenues. The revised pricing formula for Boscan resulted in a reduction to net revenue (revenue less royalties) of $8.6 million ($4.3 million net of tax) ($2.8 million revenue reduction and $1.4 million revenue reduction net of tax net to our 32 percent interest). This adjustment to revenue has been recorded in net income from unconsolidated equity affiliates in the consolidated condensed statements of comprehensive income for the three and nine months ended September 30, 2012.


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PDVSA will be invoiced for the El Salto production as soon as the amended Sales Contract is executed. At September 30, 2012, El Salto production, net of royalties, covering the production months of October 2011 through September 2012 totaled approximately 3.0 million barrels of oil ("MBls") (1.0 MBls net to our 32 percent interest). The draft Sales Contract amendment pricing formula for Boscan based upon the production deliveries and factors certified by MENPET, results in estimated revenue for this production of $273.3 million ($87.5 million net to our 32 percent interest).

Due to PDVSA's liquidity constraints, PDVSA has not been providing the necessary monetary and contractual support required by Petrodelta. Continued underinvestment in the development plan may lead to continued under-performance. As discussed in previous filings, PDVSA has failed to pay on a timely basis certain amounts owed to contractors that PDVSA has contracted to do work for Petrodelta. PDVSA purchases all of Petrodelta's oil production. PDVSA and its affiliates have reported shortfalls in meeting their cash requirements for operations and planned capital expenditures, and PDVSA has fallen behind in certain of its payment obligations to its contractors, including contractors engaged by PDVSA to provide services to Petrodelta. In addition, PDVSA has fallen behind in certain of its payment obligations to Petrodelta, which payments Petrodelta would otherwise use to pay its contractors, including Harvest Vinccler. As a result, Petrodelta has experienced, and is continuing to experience, difficulty in retaining contractors who provide services for Petrodelta's operations. We cannot provide any assurance as to whether or when PDVSA will become current on its payment obligations. Inability to retain contractors or to pay them on a timely basis is having an adverse effect on Petrodelta's operations and on Petrodelta's ability to carry out its business plan.

Harvest Vinccler has advanced certain costs on behalf of Petrodelta. These costs include consultants in engineering, drilling, operations, seismic interpretation, and employee salaries and related benefits for Harvest Vinccler employees seconded into Petrodelta. Currently, we have three employees seconded into Petrodelta. Costs advanced are invoiced on a monthly basis to Petrodelta. Harvest Vinccler is considered a contractor to Petrodelta, and as such, Harvest Vinccler is also experiencing the slow payment of invoices. During the nine months ended September 30, 2012, Harvest Vinccler advanced to Petrodelta $0.4 million for continuing operations costs, and Petrodelta repaid $0.1 million of the advance. Advances to equity affiliate have increased slightly to a balance of $2.7 million as of September 30, 2012. During the year ended December 31, 2011, we advanced Petrodelta $0.8 million for continuing operations costs, and Petrodelta repaid $0.1 million of the advances. Although payment is slow and the balance is increasing, payments continue to be received.

In April 2011, the Venezuelan government published in the Official Gazette the Law Creating a Special Contribution on Extraordinary Prices and Exorbitant Prices in the International Hydrocarbons Market ("Windfall Profits Tax"). Windfall Profits Tax is deductible for Venezuelan income tax purposes. During the three months ended September 30, 2012, Petrodelta recorded $72.0 million for Windfall Profits Tax (three months ended September 30, 2011: $69.4 million). During the nine months ended September 30, 2012, Petrodelta recorded $231.4 million for Windfall Profits Tax (nine months ended September 30, 2011: $161.9 million).

One section of the Windfall Profits Tax states that royalties paid to Venezuela are capped at $70 per barrel, but the cap on royalties has not been defined as being applicable to in-cash, in-kind, or both. In October 2011, Petrodelta received instructions from PDVSA that royalties, whether paid in-cash or in-kind, should be reported at $70 per barrel (royalty barrels x $70). The difference between the $70 royalty cap and the current oil price is to be reflected on the income statement as a reduction in oil sales. For the three months ended September 30, 2012 and 2011, the reduction to oil sales due to the $70 cap applied to all royalty barrels was $26.2 million and $8.0 million ($8.4 million and $2.6 million net to our 32 percent interest), respectively. For the nine months ended September 30, 2012 and 2011, the reduction to oil sales due to the $70 cap applied to all royalty barrels was $93.6 million and $52.7 million ($30.0 million and $16.9 million net to our 32 percent interest), respectively.

Per our interpretation of the Windfall Profits Tax, the $70 cap on royalty barrels should only be applied to the 3.33 percent royalty which Petrodelta pays in cash. We have applied the $70 cap to only the 3.33 percent royalty paid in cash and the current oil sales price to the 30 percent royalty paid in-kind for the three and nine months ended September 30, 2012 and 2011. With assistance from Petrodelta, we have recalculated Petrodelta's oil sales and royalties to apply the current oil price to its total barrels produced and to the 30 percent royalty paid in-kind and applied the $70 cap to the 3.33 percent royalty paid in cash for the three and nine months ended September 30, 2012 and 2011. For the three months ended September 30, 2012 and 2011, net oil sales (oil sales less royalties) are slightly higher, $2.7 million and $0.8 million ($0.9 million and $0.3 million net to our 32 percent interest), respectively, and for the nine months ended September 30, 2012 and 2011, net oil sales (oil sales less royalties) are slightly higher, $9.4 million and $5.3 million ($3.0 million and $1.7 million net to our 32 percent interest), respectively, under this method than the method advised by PDVSA and the method of applying the current oil price to total barrels produced and to total royalty barrels.


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In November 2010, Petrodelta's board of directors declared a dividend of $30.6 million, $12.2 million net to HNR Finance, B.V. ("HNR Finance"), a wholly owned subsidiary of Harvest Holding ($9.8 million net to our 32 percent interest). Petrodelta shareholder approval of the dividend was received on March 14, 2011. Due to Petrodelta's liquidity constraints caused by PDVSA's insufficient monetary and contractual support, as of November 8, 2012, this dividend has not been received, and the timing of the receipt of this dividend is uncertain. To reflect our support of Petrodelta's planned 2013 drilling program which will require all accumulated and available cash flow to support, we reclassified the dividend receivable to long-term at September 30, 2012.

The Organic Law on Sports, Physical Activity and Physical Education ("Sports . . .

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