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

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Form 10-Q for US ENERGY CORP


9-Nov-2012

Quarterly Report


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

The following is Management's Discussion and Analysis of significant factors that have affected liquidity, capital resources and results of operations during the three and nine months ended September 30, 2012 and 2011. The following also updates information as to our financial condition provided in our 2011 Annual Report on Form 10-K. Statements in the following discussion may be forward-looking and involve risk and uncertainty (see "Forward Looking Statements"). The following discussion should also be read in conjunction with our condensed financial statements and the notes thereto.

General Overview

We are an independent energy company focused on the acquisition and development of oil and gas producing properties in the continental United States. Our business is currently focused in the Rocky Mountain region (specifically the Williston Basin of North Dakota and Montana), Texas and Louisiana, however, we do not intend to limit our focus to these geographic areas. We continue to focus on increasing production, reserves, revenues and cash flow from operations while managing our level of debt.

We currently explore for and produce oil and gas through a non-operator business model; however, we may operate oil and gas properties for our own account and may expand our operations to other areas. As a non-operator, we rely on our operating partners to propose, permit and manage wells. Before a well is drilled, the operator is required to provide all oil and gas interest owners in the designated well the opportunity to participate in the drilling costs and revenues of the well on a pro-rata basis. After the well is completed, our operating partners also transport, market and account for all production.

We are also involved in the exploration for and development of minerals (molybdenum) through our ownership of the Mt. Emmons Molybdenum Project in Colorado. Gross capitalized dollar amounts invested in each of these areas at September 30, 2012 and December 31, 2011 were as follows:

                                                     (In thousands)
                                            September 30,       December 31,
                                                2012                2011
         Unproved oil and gas properties   $        11,015     $       17,098
         Proved oil and gas properties             117,636            102,405
         Undeveloped mining properties              20,739             20,739
                                           $       149,390     $      140,242

Oil and Gas Activities

We have active agreements with several oil and gas exploration and production companies. Our working interest varies by project, but typically ranges from approximately 1% to 62%. These projects may result in numerous wells being drilled over the next three to five years. We are also actively pursuing the potential acquisition of additional exploration, development or production stage oil and gas properties or companies. The following table details our interests in producing wells as of September 30, 2012 and 2011.

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                                                          September 30,
                                                   2012                  2011
                                             Gross      Net(1)     Gross      Net(1)
 Williston Basin:
 Productive wells                              62.00      10.44      19.00       7.15
 Wells being drilled or awaiting completion     4.00       0.17       8.00       1.87

 Gulf Coast/South Texas:
 Productive wells                               3.00       0.56       6.00       1.16
 Wells being drilled or awaiting completion     2.00       0.40       1.00       0.13

 Eagle Ford:
 Productive wells                               3.00       0.90       1.00       0.30
 Wells being drilled or awaiting completion       --         --         --         --

 Austin Chalk:
 Productive wells                              11.00       2.98      11.00       2.98
 Wells being drilled or awaiting completion       --         --         --         --

 Total:
 Productive wells                              79.00      14.88      37.00      11.59
 Wells being drilled or awaiting completion     6.00       0.57       9.00       2.00

(1) Net working interests may vary over time under the terms of the applicable contracts.

Williston Basin, North Dakota

Rough Rider Prospect. We participate in fifteen 1,280 acre drilling units in the Rough Rider prospect with Brigham Oil & Gas, L.P. ("Brigham"), a subsidiary of Statoil. From August 24, 2009 to September 30, 2012, we have drilled and completed 20 gross Bakken formation wells (7.31 net) and one gross Three Forks formation well (0.18 net) under the Drilling Participation Agreement with Brigham. One additional gross well (0.04 net) is expected to be drilled during the balance of 2012. Brigham operates all of the wells.

During the first nine months of 2012, the Company completed three gross wells (0.45 net) in the Rough Rider prospect. Our net investment in the Rough Rider prospect wells was $4.2 million for the nine months ended September 30, 2012.

Yellowstone and SEHR Prospects. We participate in twenty-seven gross 1,280 acre spacing units in the Yellowstone and SEHR prospects with Zavanna, LLC ("Zavanna"). Through September 30, 2012, we have drilled and completed 14 gross Bakken formation wells (2.54 net) in these prospects, including two gross wells (0.13 net) operated by Murex Petroleum and one gross well (0.01 net) operated by Slawson Exploration Company, Inc. Zavanna operates the remaining wells. At September 30, 2012, two additional gross wells (0.11 net) had been drilled and were awaiting completion.

During the first nine months of 2012, we completed nine gross wells (1.50 net) and drilled six gross wells (0.35 net) in the Yellowstone and SEHR prospects. Our net investment in the Yellowstone and SEHR prospect wells was $15.8 million during the nine months ended September 30, 2012.

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On January 24, 2012 (but effective December 1, 2011), we sold an undivided 75% of our undeveloped acreage in the Yellowstone and SEHR prospects to GeoResources, Inc. (56.25%) and Yuma Exploration and Production Company, Inc. (18.75%) for $16.7 million. Under the terms of the agreement, we retained the remaining 25% of our interest in the undeveloped acreage and our original working interest in the initial 10 developed wells in the prospects. Our average working interest in the remaining locations will be approximately 8.75% and net revenue interests in new wells after the sale are expected to be in the range of 6.7375% to 7.0%, proportionately reduced depending on Zavanna's actual working interest percentages.

Bakken/Three Forks Asset Package Acquisition. On September 21, 2012, but effective July 1, 2012, we acquired interests in 27 producing Bakken and Three Forks formation wells and related acreage in McKenzie, Williams and Mountrail Counties of North Dakota for $2.3 million after adjusting for related revenue and operating expenses from the effective date through September 21, 2012. Under the terms of the agreement, we acquired working interests in 23 drilling units ranging from less than 1% to approximately 5%, with an average working interest of 1.45%. All acreage is currently held by production and produces approximately 47 BOE/day net to the Company.

Daniels County, Montana Undeveloped Acreage. On June 8, 2012, we sold an undivided 87.5% of our acreage in Daniels County, Montana to a third party for $3.7 million. Under the terms of the agreement, we retained a 12.5% working interest in the acreage and reserved overriding royalty interests ("ORRI") in leases we owned that had in excess of 81% NRI. The purchaser also committed to drill a vertical test well to depths sufficient to core the Bakken and Three Forks formations on or before December 31, 2015. The Company delivered an 80% NRI to the purchaser and a 1% ORRI to a land broker. The Company also paid the land broker a 10% commission for the cash consideration paid by the purchaser.

U.S. Gulf Coast (Onshore) / South Texas

We participate with several different operators in the U.S. Gulf Coast
(onshore). At September 30, 2012, we had three gross producing wells (0.56 net)
in this region.

In May 2012, we acquired a 26.5% initial working interest in approximately 6,766 gross acres in this area through a cash payment of $1.7 million. The promoted amount covers our portion of the costs for land, geological and geophysical work, as well as the dry hole costs for an initial test well in each of seven different prospects. Upon payout, our working interest will be reduced to 19.8%. During the nine months ended September 30, 2012, we drilled the seven prospects. Two gross wells (0.40 net) are currently being evaluated for production potential and five gross wells (1.33 net) were deemed to be nonproductive.

During the nine months ended September 30, 2012, we drilled one additional gross well (0.10 net) that was determined to be nonproductive. Our net investment in Gulf Coast / South Texas wells and properties was $2.3 million during the nine months ended September 30, 2012.

Eagle Ford Shale

We participate in up to 114 gross (34 net) drilling locations in the Leona River and Booth-Tortuga Eagle Ford prospects with Crimson Exploration Inc. ("Crimson"). During the nine months ended September 30, 2012, we drilled and completed two gross wells (0.60 net). Our net investment in these wells during the first nine months of 2012 was $4.2 million.

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2012 Production Results

The following table provides a regional summary of our production during the
first nine months of 2012:

                              Williston Basin     Gulf Coast /    Eagle Ford   Austin Chalk     Total
                                                  South Texas
First Nine Months of 2012 Production
Oil (Bbl)                            266,633          2,623            7,463          6,014      282,733
Gas (Mcf)                             91,453        149,084           20,975          1,420      262,932
NGLs (BBs)                             9,354            442              366            163       10,325
Equivalent (BOE)                     291,229         27,912           11,325          6,414      336,880
Avg. Daily Equivalent (BOE/d)          1,063            102               41             23        1,229
Relative percentage                      86%             8%               3%             2%         100%

Additional Comparative Data

The following table provides information regarding selected production and
financial information for the quarter ended September 30, 2012 and the
immediately preceding three quarters.

                                                       For the Three Months Ended
                                    September 30,       June 30,        March 31,        December 31,
                                        2012              2012             2012              2011
                                               (in Thousands, except for production data)
Production (BOE)                           106,060         118,783          112,036            118,663
Oil, gas and NGL production
revenue                            $         7,639     $     8,522     $      8,335     $        8,846
Unrealized and realized
derivative (loss) gain             $          (466 )   $     1,764     $       (202 )   $       (1,738 )
Lease operating expense            $         1,692     $     1,630     $      2,010     $        1,954
Production taxes                   $           822     $       928     $        883     $          921
DD&A                               $        (3,410 )   $     4,030     $      3,641     $        4,230
General and administrative         $         1,659     $     1,760     $      1,894     $        1,883
Mineral holding costs              $           400     $       206     $        110     $          140
Water treatment plant              $           609     $       436     $        509     $          454
Income (loss) from continuing
operations                         $        (1,870 )   $       245     $       (445 )   $          309

Results of Operations

Three Months Ended September 30, 2012 compared to Three Months Ended September 30, 2011

During the three months ended September 30, 2012, we recorded a net loss after taxes of $1.9 million as compared to a net income after taxes of $268,000 during the same period of 2011. Significant components of the change in operating revenues and results of operations for the three months ended September 30, 2012 as compared to the three months ended September 30, 2011 are as follows:

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Oil and Gas Operations. Oil and gas operations produced operating income of $1.7 million during the quarter ended September 30, 2012 as compared to operating income of $1.9 million during the quarter ended September 30, 2011. The following table summarizes production volumes, average sales prices and operating revenues for the three months ended September 30, 2012 and 2011:

                                                Three Months Ended
                                                   September 30,               Increase
                                               2012             2011          (Decrease)
Production volumes
Oil (Bbls)                                       90,321           84,028             6,293
Natural gas (Mcf)                                77,861          191,924          (114,063 )
Natural gas liquids (Bbls)                        2,762            4,183            (1,421 )
Equivalent (BOE)                                106,060          120,198           (14,138 )
Avg. Daily Equivalent (BOE/d)                     1,153            1,306              (153 )
Average sales prices
Oil (per Bbl)                              $      80.55     $      84.38     $       (3.83 )
Natural gas (per Mcf)                              3.28             5.59             (2.31 )
Natural gas liquids (per Bbl)                     39.46            58.58            (19.12 )
Operating revenues (in thousands)
Oil                                        $      7,275     $      7,090     $         185
Natural gas                                         255            1,073              (818 )
Natural gas liquids                                 109              245              (136 )
Total operating revenue                           7,639            8,408              (769 )
Lease operating expense                          (1,692 )         (1,811 )             119
Production taxes                                   (822 )           (832 )              10
Income before depreciation, depletion
and amortization                                  5,125            5,765              (640 )
Depreciation, depletion and amortization         (3,410 )         (3,862 )             452
Income                                     $      1,715     $      1,903     $        (188 )

During the three months ended September 30, 2012, we produced approximately 106,060 barrels of oil equivalent (BOE), or an average of 1,153 BOE/day. Portions of our natural gas production are sent to gas processing plants to extract from the gas various natural gas liquids ("NGLs") that are sold separately from the remaining natural gas. We sell some of our gas before processing and some after processing but in both cases receive revenues based on a share of post-processing proceeds from plant sales of the extracted NGLs and the remaining natural gas. In the table above, our share of processing costs is classified in lease operating expenses.

We recognized $7.6 million in revenues during the three months ended September 30, 2012 as compared to $8.4 million during the same period of the prior year. This $769,000 decrease in revenue is primarily due to lower natural gas sales volumes in 2012 when compared to 2011. Revenue from gas sales was lower in the three months ended September 30, 2012 when compared to the same period in 2011, primarily due to production declines from wells in the Gulf Coast. Oil sales volumes were higher in the three months ended September 30, 2012 when compared to the same period in 2011; however, this was partially offset by lower average oil sales prices in the three months ended September 30, 2012.

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Our average net realized price (operating revenue per BOE) for the three months ended September 30, 2012 was $72.03 per BOE compared with $69.95 for the same period in 2011. The increase in our equivalent realized price for production corresponds with a higher percentage of our production coming from oil in 2012 when compared with 2011. Due to takeaway constraints, the discount, or differential, for oil prices in the Williston Basin has ranged from $7 to $25 per barrel during the first nine months of 2012. Until additional takeaway capacity is available, we expect this differential to continue (with the amount of the differential varying over time) and that our oil sales revenue will be affected by lower realized prices.

Lease operating expense of $1.7 million for the three months ended September 30, 2012 was comprised of $1.3 million in lease operating expense and $418,000 in workover expense. The $119,000 decrease in total lease operating expense in 2012 as compared to 2011 is primarily a result of lower workover expense in the three months ended September 30, 2012 as compared to the same period of 2011.

Our depletion, depreciation and amortization (DD&A) rate for the three months ended September 30, 2012 was $32.36 per BOE compared to $32.13 per BOE for the same period in 2011. We have been impacted by higher DD&A rates related to our Williston Basin wells due to increases in drilling and completion costs for wells in this region. Our DD&A rate can also fluctuate as a result of impairments, divestitures, changes in the mix of our production, the underlying proved reserve volumes and estimated costs to drill and complete proved undeveloped reserves.

During the balance of 2012 we anticipate completing wells that were drilled during the third quarter of 2012 as well as drilling and completing new wells. We also anticipate that our production rates will increase as a result of these activities. In particular, we expect that oil volumes will increase as we drill and complete oil wells in the Williston Basin and other areas. The anticipated net increase in production is projected to add additional cash flows from operations. However, natural gas and natural gas liquids volumes are expected to continue to decrease as production declines from the Gulf Coast producing wells. Various factors, including extensive workover costs on existing wells, lower commodity prices, commodity price differentials, cost overruns on projected drilling projects, unsuccessful wells or other development activities and/or faster than expected declines in production from existing wells, would have a negative effect on production, cash flows and earnings from the oil and gas segment and could cause actual results to differ materially from those we expect.

Mt. Emmons and Water Treatment Plant Operations. We recorded $609,000 in costs and expenses for the water treatment plant and $400,000 for holding costs for the Mt. Emmons molybdenum property during the three months ended September 30, 2012. During the three months ended September 30, 2011, we recorded $497,000 in operating costs related to the water treatment plant and $266,000 in holding costs.

General and Administrative. General and administrative expenses decreased by $170,000 during the three months ended September 30, 2012 as compared to general and administrative expenses for the three months ended September 30, 2011. Lower general and administrative costs in 2012 are primarily a result of $237,000 lower stock options expense, $71,000 lower wage and tax expenses and $50,000 lower stock compensation expense. These decreases in costs were partially offset by an increase in professional services of $97,000, contract services of $70,000 and other general and administrative costs of $21,000.

Property impairment. In September 2012, we made the decision to sell our corporate aircraft and its related facilities to cut overhead costs and plan to use the proceeds to further the development of our oil and gas business, reduction of debt or for general corporate purposes. As a result of the anticipated sale amount, at September 30, 2012, the Company recorded a non-cash impairment of $1.8 million to adjust the carrying value to the expected sale value. There were no similar property impairments recorded during the three months ended September 30, 2011.

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Other income and expenses. We recognized an unrealized and realized derivative loss of $466,000 in the third quarter of 2012 compared to a gain of $1.6 million for the same period in 2011. The 2012 amount includes a loss on unrealized changes in the fair value of our commodity derivative contracts of $478,000 and realized cash settlement gains on derivatives of $12,000.

Gain on the sale of marketable securities from the sale of shares of Sutter Gold Mining decreased to $28,000 during the quarter ended September 30, 2012 from $377,000 during the quarter ended September 30, 2011.

There was no gain or loss on the sale of assets during the quarter ended September 30, 2011 as compared to a loss of $21,000 during the quarter ended September 30, 2012 primarily related to the sale of a residential lot.

We recorded equity losses of $17,000 and $63,000 from the investment in SST during the quarters ended September 30, 2012 and 2011, respectively. Equity losses from the investment in SST are expected to continue until such time as SST properties are sold, equity losses reduce our investment to zero or we sell the investment.

Interest income decreased to $2,000 during the quarter ended September 30, 2012 from $6,000 during the quarter ended September 30, 2011. The decrease is a result of lower amounts of cash invested in interest bearing instruments during the quarter, and lower interest rates received on those investments.

Interest expense decreased to $53,000 during the quarter ended September 30, 2012 from $69,000 during the quarter ended September 30, 2011.

Discontinued operations. We recorded a loss of $75,000, net of taxes from Remington Village during the quarter ended September 30, 2012 and income of $138,000, net of taxes for the quarter ended September 30, 2011. The decrease in income when comparing the quarter ended September 30, 2012 to the quarter ended September 30, 2011 is primarily a result of higher interest expense and higher contract services costs for the drainage system. We continue to market the property for sale.

We therefore recorded a net loss after taxes of $1.9 million, or $0.07 per share basic and diluted, during the quarter ended September 30, 2012 as compared to net income after taxes of $268,000, or $0.01 per share basic and diluted, during the quarter ended September 30, 2011.

Nine Months Ended September 30, 2012 compared to Nine Months Ended September 30, 2011

During the nine months ended September 30, 2012, we recorded a net loss after taxes of $3.3 million as compared to a net loss after taxes of $2.0 million during the same period of 2011. Significant components of the change in operating revenues and results of operations for the nine months ended September 30, 2012 as compared to the nine months ended September 30, 2011 are as follows:

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Oil and Gas Operations. Oil and gas operations produced operating income of $4.9 million during the nine months ended September 30, 2012 as compared to operating income of $3.7 million during the nine months ended September 30, 2011. The increase in earnings from oil and gas operations is primarily due to
(a) a $4.9 million increase in oil revenues during 2012 compared to 2011 and (b) $1.1 million lower lease operating expenses in the nine months ending September 30, 2012 as compared to the same period of the prior year. This increase was partially offset by $1.3 million higher depletion expense in 2012 and a $2.5 million decrease in natural gas and natural gas liquids revenues. The following table summarizes production volumes, average sales prices and operating revenues for the nine months ended September 30, 2012 and 2011:

                                             Nine Months Ended
                                               September 30,              Increase
                                           2012            2011          (Decrease)
     Production volumes
     Oil (Bbls)                             282,733         207,487           75,246
     Natural gas (Mcf)                      262,932         604,504         (341,572 )
     Natural gas liquids (Bbls)              10,325          15,464           (5,139 )
     Equivalent (BOE)                       336,880         323,701           13,179
     Avg. Daily Equivalent (BOE/d)            1,229           1,186               44
     Average sales prices
     Oil (per Bbl)                      $     82.06     $     88.18     $      (6.12 )
     Natural gas (per Mcf)                     3.07            4.92            (1.85 )
     Natural gas liquids (per Bbl)            47.46           54.45            (6.99 )
     Operating revenues (in
     thousands)
     Oil                                $    23,200     $    18,296     $      4,904
     Natural gas                                806           2,974           (2,168 )
     Natural gas liquids                        490             842             (352 )
     Total operating revenue                 24,496          22,112            2,384
     Lease operating expense                 (5,332 )        (6,496 )          1,164
     Production taxes                        (2,633 )        (2,181 )           (452 )
     Impairment                                (523 )             -             (523 )
     Income before depreciation,
     depletion and amortization              16,008          13,435            2,573
     Depreciation, depletion and
     amortization                           (11,081 )        (9,767 )         (1,314 )
     Income                             $     4,927     $     3,668     $      1,259

During the nine months ended September 30, 2012, we produced approximately 336,880 barrels of oil equivalent (BOE), or an average of 1,229 BOE/day. Portions of our natural gas production are sent to gas processing plants to extract from the gas various natural gas liquids ("NGLs") that are sold separately from the remaining natural gas. We sell some of our gas before processing and some after processing but in both cases receive revenues based on a share of post-processing proceeds from plant sales of the extracted NGLs and the remaining natural gas. In the table above, our share of processing costs are classified in lease operating expenses.

We recognized $24.5 million in revenues during the nine months ended September 30, 2012 as compared to $22.1 million during the same period of the prior year. This $2.4 million increase in revenue is primarily due to higher oil sales . . .

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