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

Show all filings for PRIMEENERGY CORP

Form 10-Q for PRIMEENERGY CORP


9-Nov-2012

Quarterly Report


Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This report may contain statements relating to the future results of the Company that are considered "forward-looking statements" as defined in the Private Securities Litigation Reform Act of 1995 (the "PSLRA"). In addition, certain statements may be contained in the Company's future filings with the SEC, in press releases, and in oral and written statements made by or with the approval of the Company that are not statements of historical fact and constitute forward-looking statements within the meaning of the PSLRA. Such forward-looking statements, in addition to historical information, which involve risk and uncertainties, are based on the beliefs, assumptions and expectations of management of the Company. Words such as "expects", 'believes", "should", "plans", "anticipates", "will", "potential", "could", "intend", "may", "outlook", "predict", "project", "would", "estimates", "assumes", "likely"' "and variations of such similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve risks and uncertainties and are based on a number of assumptions that could ultimately prove inaccurate and, therefore, there can be no assurance that they will prove to be accurate. Actual results and outcomes may vary materially from what is expressed or forecast in such statements due to various risks and uncertainties. These risks and uncertainties include, among other things, the possibility of drilling cost overruns and technical difficulties, volatility of oil and gas prices, competition, risks inherent in the Company's oil and gas operations, the inexact nature of interpretation of seismic and other geological and geophysical data, imprecision of reserve estimates, and the Company's ability to replace and expand oil and gas reserves. Accordingly, stockholders and potential investors are cautioned that certain events or circumstances could cause actual results to differ materially from those projected. The forward looking statements are made as of the date of this report and other than as required by the federal securities laws, the Company assumes no obligation to update the forward-looking statement or to update the reasons why actual results could differ from those projected in the forward-looking statements.

The following discussion is intended to assist you in understanding our results of operations and our present financial condition. Our Condensed Consolidated Financial Statements and the accompanying Notes to the Condensed Consolidated Financial Statements included elsewhere in this Report contains additional information that should be referred to when reviewing this material.

OVERVIEW

We are an independent oil and natural gas company engaged in acquiring, developing and producing oil and natural gas. We presently own producing and non-producing properties located primarily in Texas, Oklahoma, West Virginia, the Gulf of Mexico, New Mexico, Colorado and Louisiana. In addition, we own a substantial amount of well servicing equipment. All of our oil and gas properties and interests are located in the United States. Assets in our principal focus areas include mature properties with long-lived reserves and significant development opportunities as well as newer properties with development and exploration potential. We believe our balanced portfolio of assets and our ongoing hedging program position us well for both the current commodity price environment and future potential upside as we develop our attractive resource opportunities. Our primary sources of liquidity are cash generated from our operations and our credit facility.

We attempt to assume the position of operator in all acquisitions of producing properties and will continue to evaluate prospects for leasehold acquisitions and for exploration and development operations in areas in which we own interests. We continue to actively pursue the acquisition of producing properties. In order to diversify and broaden our asset base, we will consider acquiring the assets or stock in other entities and companies in the oil and gas business. Our main objective in making any such acquisitions will be to acquire income producing assets so as to build stockholder value through consistent growth in our oil and gas reserve base on a cost-efficient basis.

Our cash flows depend on many factors, including the price of oil and gas, the success of our acquisition and drilling activities and the operational performance of our producing properties. We use derivative instruments to manage our commodity price risk. This practice may prevent us from receiving the full advantage of any increases in oil and gas prices above the maximum fixed amount specified in the derivative agreements and subjects us to the credit risk of the counterparties to such agreements. Since all of our derivative contracts are accounted for under mark-to-market accounting, we expect continued volatility in gains and losses on mark-to-market derivative contracts in our consolidated income statement as changes occur in the NYMEX price indices.

RECENT ACTIVITIES

During 2012, we continued our drilling program in our West Texas and Mid-Continent regions. Thru October 31, 2012, we have drilled a total of 36 gross (27.25 net) wells, with 33 gross (26.00 net) wells having successful completions, and 2 gross (1.22 net) wells under evaluation. In addition we have 2 gross (0.61 net) wells currently drilling. We intend to drill a total of approximately 40 gross (29 net) wells this year, primarily in the West Texas area.

In February 2012, we closed the acquisition of additional working interest in producing properties which we operate. These properties are located in our Gulf Coast region and were acquired at a net cost of $6.32 million.

During 2012, we began plugging and abandoning the majority of our offshore oil and gas properties. This work was completed by September 30, 2012.


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RESULTS OF OPERATIONS

2012 and 2011 Compared

We reported net income for the three and nine months ended September 30, 2012 of $1.34 million, or $0.51 per share and $10.09 million, or $3.79 per share, respectively as compared to $4.27 million, or $1.56 per share and $5.09 million, or $1.85 per share for the three and nine months ended September 30, 2011, respectively. Net income decreased by $2.93 million for the three months ended September 30, 2012 as compared to the same period during 2011 primarily due to a decrease in unrealized and realized gains on derivative instruments partially offset by decreased depreciation and depletion expenses and income tax provisions. Net income increased by $5.00 million for the nine months ended September 30, 2012 as compared to the same period during 2011 primarily due to decreased depreciation and depletion expenses partially offset by a decrease in unrealized and realized gains on derivative instruments and increased lease operating expenses and income tax provisions. Unrealized gain (loss) on derivative instruments decreased by $15.16 million and $6.57 million for the three and nine months ended September 30, 2012, respectively as compared to the same periods in 2011 largely due to an increase in future crude oil commodity prices during the 2012 periods as compared to crude oil commodity contracts held at the end of the reported periods. Depreciation and depletion decreased by $17.02 million and $21.08 million for the three and nine months ended September 30, 2012, respectively as compared to the same periods in 2011 largely due to decreased depletion rates associated with our offshore properties as several of our offshore properties entered into the last phase of their productive lives.

The significant components of net income are discussed below.

Oil and gas sales increased slightly from $21.76 million for the three months ended September 30, 2011 to $21.81 million for the three months ended September 30, 2012 and increased $0.44 million, or 1% from $65.24 million for the nine months ended September 30, 2011 to $65.68 million for the nine months ended September 30, 2012. Crude oil and natural gas sales vary due to changes in volumes of production sold and realized commodity prices. Our realized prices at the well head increased an average of $4.40 per barrel, or 5% and $1.65 per barrel, or 2% on crude oil during the three and nine months ended September 30, 2012, respectively from the same periods in 2011 while our average well head price for natural gas decreased $2.13 per mcf, or 31% and $1.90 per mcf, or 29% during the three and nine months ended September 30, 2012, respectively from the same periods in 2011.

Our crude oil production increased by 30,000 barrels, or 19% from 155,000 barrels for the third quarter 2011 to 185,000 barrels for the third quarter 2012 and increased by 83,000 barrels, or 18% from 458,000 barrels for the nine months ended September 30, 2011 to 541,000 barrels for the nine months ended September 30, 2012. Our natural gas production decreased by 103,000 mcf, or 8% from 1,294,000 mcf for the third quarter 2011 to 1,191,000 mcf for the third quarter 2012 and decreased by 210,000 mcf, or 6% from 3,703,000 mcf for the nine months ended September 30, 2011 to 3,493,000 mcf for the nine months ended September 30, 2012. The crude oil production variances are a result of our recent drilling success in West Texas and drilling and acquisition activities in the Gulf Coast regions as we place new wells into production, partially offset by the natural decline of existing properties. The natural gas volume decreases are primarily due to the natural decline of the primary natural gas producing offshore properties, partially offset by production from wells in the West Texas region recently placed into production.

The following table summarizes the primary components of production volumes and average sales prices realized for the three and nine months ended September 30, 2012 and 2011 (excluding realized gains and losses from derivatives).

                                   Three Months Ended September 30,                  Nine Months Ended September 30,
                                                              Increase /                                       Increase /
                                 2012            2011         (Decrease)          2012            2011         (Decrease)
Barrels of Oil Produced           185,000         155,000          30,000          541,000         458,000          83,000
Average Price Received        $     88.26     $     83.86     $      4.40      $     91.84     $     90.19     $      1.65

Oil Revenue (In 000's)        $    16,288     $    13,001     $     3,287      $    49,717     $    41,283     $     8,434

Mcf of Gas Produced             1,191,000       1,294,000        (103,000 )      3,493,000       3,703,000        (210,000 )
Average Price Received        $      4.64     $      6.77     $     (2.13 )    $      4.57     $      6.47     $     (1.90 )

Gas Revenue (In 000's)        $     5,525     $     8,756     $    (3,231 )    $    15,961     $    23,953     $    (7,992 )

Total Oil & Gas Revenue (In
000's)                        $    21,813     $    21,757     $        56      $    65,678     $    65,236     $       442

Realized net gains on derivative instruments include net gains of $0.04 million on the settlements of crude oil derivatives for the third quarter 2012 and net gains of $3.30 million and $1.00 million on the settlements of crude oil and natural gas derivatives, respectively, for the third quarter 2011. Realized net gains on derivative instruments include net gains of $0.38 million on the settlements of crude oil derivatives for the nine months ended September 30, 2012 and net gains of $1.46 million and $2.97 million on the settlements of crude oil and natural gas derivatives, respectively, for the nine months ended September 30, 2011. In August 2011, we unwound and monetized crude oil swaps and collars with original settlement dates from September 2011 thru December 2014 for net proceeds of $3.40 million. The $3.40 million gain associated with these early settlement transactions is included in realized gain on derivative instruments for the three and nine months ended September 30, 2011. In the nine months ended September 30, 2012, we unwound and monetized crude oil swaps with original settlement dates from January 2012 through December 2013 for net proceeds of $1.03 million. The gains associated with these early settlement transactions is included in realized gain on derivative instruments for the nine months ended September 30, 2012.


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Oil and gas prices received including the impact of derivatives but excluding the early settlement transactions were:

                                            Three Months Ended September 30,                    Nine Months Ended September 30,
                                                                         Increase                                            Increase
                                        2012              2011          (Decrease)          2012              2011          (Decrease)
Oil Price                            $     88.46       $     83.22     $       5.24      $     90.63       $     85.96     $       4.67
Gas Price                            $      4.64       $      7.54     $      (2.90 )    $      4.57       $      7.27     $      (2.70 )

We do not apply hedge accounting to any of our commodity based derivatives, thus changes in the fair market value of commodity contracts held at the end of a reported period, referred to as mark-to-market adjustments, are recognized as unrealized gains and losses in the accompanying consolidated statements of operations. As oil and natural gas prices remain volatile, mark-to-market accounting treatment creates volatility in our revenues. During the three months ended September 30, 2012, we recognized unrealized losses of $2.65 million and a net unrealized gain of $2.45 million for the nine months ended September 30, 2012 associated with crude oil fixed swaps and collars due to market fluctuations in crude oil futures market prices between December 31, 2011 and September 30, 2012. During the three months ended September 30, 2011, we recognized $12.51 million in unrealized gains. This unrealized gain consists of $11.40 million associated with crude oil fixed swaps and collars due to a decrease in crude oil futures market prices between June 30, 2011 and September 30, 2011 and $1.11 million associated with natural gas fixed swap contracts due to decreased natural gas futures market prices between June 30, 2011 and September 30, 2011. For the nine months ended September 30, 2011, we recognized $9.01 million in unrealized gains primarily associated with crude oil fixed swaps and collars due to a decrease in crude oil futures market prices between December 31, 2010 and September 30, 2011.

Field service income decreased $0.52 million, or 10% from $5.41 million for the third quarter 2011 to $4.89 million for the third quarter 2012 and increased $0.16 million, or 1% from $15.18 million for the nine months ended September 30, 2011 to $15.34 million for the nine months ended September 30, 2012. This underlying increase is a result of upturns in utilization of equipment and the market allowing us to charge slightly higher rates to customers. Workover rig services represent the bulk of our field service operations, and those rates all increased in our most active districts. Water hauling and disposal services have also increased in our South Texas district, however were slightly down during the third quarter of 2012 due to one of our disposal wells being shut in during the period as a major workover was completed.

Lease operating expense decreased $0.36 million, or 4% from $9.71 million for the third quarter 2011 to $9.35 million for the third quarter 2012 and increased $2.30 million, or 9% from $26.52 million for the nine months ended September 30, 2011 to $28.82 million for the nine months ended September 30, 2012. This underlying increase is primarily due to higher pumper / labor costs, chemical expenses and salt water disposal costs associated with new wells coming on line from the recent drilling success in West Texas and increased expensed workovers across all districts, partially offset by decreased operating expenses on the offshore properties during the first nine months of 2012 as compared to the same period of 2011.

Field service expense decreased $0.12 million, or 3% from $4.39 million for the third quarter 2011 to $4.27 million for the third quarter 2012 and increased $0.48 million, or 4% from $12.54 million for the nine months ended September 30, 2011 to $13.02 million for the nine months ended September 30, 2012. Field service expenses primarily consist of salaries and vehicle operating expenses which have increased during the nine months ended September 30, 2012 over the same period of 2011 as a direct result of increased services and utilization of the equipment.

Depreciation, depletion, amortization and accretion on discounted liabilities decreased $17.02 million, or 74% from $22.90 million for the third quarter 2011 to $5.88 million for the third quarter 2012 and $21.08 million, or 52% from $40.93 million for the nine months ended September 30, 2011 to $19.85 million for the nine months ended September 30, 2012. This decrease is primarily due to decreased depletion rates recognized during the first nine months of 2012 associated with offshore properties as several of our offshore properties entered into the last phase of their productive lives.

General and administrative expense increased $0.64 million, or 20% from $3.18 million for the three months ended September 30, 2011 to $3.82 million for the three months ended September 30, 2012 and increased $1.29 million, or 13% from $10.22 million for the nine months ended September 30, 2011 to $11.51 million for the nine months ended September 30, 2012. This increase in 2012 is largely due to increased personnel costs in 2012. The largest component of these personnel costs was salaries, however rent, audit related costs and employee related taxes and insurance also contributed to the increase.

Gain on sale and exchange of assets of $0.72 million for the nine months ended September 30, 2012 consists of sales of non-essential field service equipment. Gain on sale and exchange of assets of $1.61 million for the nine months ended September 30, 2011 consists of $0.50 million related to our Korean Joint Venture combined with $1.11 million related to sales of non-essential field service equipment and sales of non-producing acreage and non-core producing properties.

Interest expense increased $0.26 million, or 38% from $0.69 million for the third quarter 2011 to $0.95 million for the third quarter 2012 and decreased $0.51 million, or 17% from $3.04 million for the nine months ended September 30, 2011 to $2.53 million for the nine months ended September 30, 2012. This decrease includes the reduction of interest expense of $0.79 million for the nine


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months ended September 30, 2012 associated with interest on the subordinated credit facility with a related party private lender which was paid off in June 2011. The remaining increase for the three and nine months ended September 30, 2012 relate to reduced weighted average interest rates substantially offset by an increase in average debt outstanding during the 2012 periods.

A provision for income taxes of $0.46 million, or an effective tax rate of 26% was recorded for the three months ended September 30, 2012 verses a provision of $1.90 million, or an effective tax rate of 31% for the three months ended September 30, 2011. A provision for income taxes of $4.67 million, or an effective tax rate of 32% was recorded for the nine months ended September 30, 2012 verses a provision of $2.36 million, or an effective tax rate of 32% for the nine months ended September 30, 2011. Our provision for income taxes varies from the federal statutory tax rate of 34% primarily due to state taxes and percentage depletion deductions. We are entitled to percentage depletion on certain of our wells, which is calculated without reference to the basis of the property. To the extent that such depletion exceeds a property's basis it creates a permanent difference, which lowers our effective rate. The lower effective tax rate in 2012 is primarily due to larger percentage depletion deductions in excess of basis.

LIQUIDITY AND CAPITAL RESOURCES

Our primary capital resources are cash provided by our operating activities and our credit facility.

Net cash provided by our operating activities for the nine month period ended September 30, 2012 was $33.39 million. Excluding the effects of significant unforeseen expenses or other income, our cash flow from operations fluctuates primarily because of variations in oil and gas production and prices or changes in working capital accounts. Our oil and gas production will vary based on actual well performance but may be curtailed due to factors beyond our control.

Our realized oil and gas prices vary due to world political events, supply and demand of products, product storage levels, and weather patterns. We sell the vast majority of our production at spot market prices. Accordingly, product price volatility will affect our cash flow from operations. To mitigate price volatility we sometimes lock in prices for some portion of our production through the use of financial instruments.

Our activities include development and exploratory drilling. Our strategy is to develop a balanced portfolio of drilling prospects that includes lower risk wells with a high probability of success and higher risk wells with greater economic potential. During 2012, we plan on drilling approximately 40 wells (29 net), mainly in the Permian Basin in West Texas and in the central Oklahoma area.

In February 2012 we invested a net $6.32 million to acquire additional working interest in producing properties that we operate in our Gulf Coast region. It is our goal to increase our oil and gas reserves and production through the acquisition and development of oil and gas properties. We also continue to explore and consider opportunities to further expand our oilfield servicing revenues through additional investment in field service equipment. However, the majority of our capital spending is discretionary, and the ultimate level of expenditures will be dependent on our assessment of the oil and gas business environment, the number and quality of oil and gas prospects available, the market for oilfield services, and oil and gas business opportunities in general.

We have in place both a stock repurchase program and a limited partnership interest repurchase program under which we expect to continue spending during 2012. For the nine month period ended September 30, 2012, we have spent $2.77 million under these programs.

We currently maintain a credit facility totaling $250 million, with a current borrowing base of $125 million and $15.00 million in availability at September 30, 2012. The bank reviews the borrowing base semi-annually and, at their discretion, may decrease or propose an increase to the borrowing base relative to a redetermined estimate of proved oil and gas reserves. Our oil and gas properties are pledged as collateral for the line of credit and we are subject to certain financial and operational covenants defined in the agreement. We are currently in compliance with these covenants. If we do not comply with these covenants on a continuing basis, the lenders have the right to refuse to advance additional funds under the facility and/or declare all principal and interest immediately due and payable.

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