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EROC > SEC Filings for EROC > Form 10-Q on 5-Aug-2013All Recent SEC Filings

Show all filings for EAGLE ROCK ENERGY PARTNERS L P

Form 10-Q for EAGLE ROCK ENERGY PARTNERS L P


5-Aug-2013

Quarterly Report


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

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This report includes "forward-looking statements" as defined by the Securities and Exchange Commission (the "SEC"). All statements, other than statements of historical facts, included in this report that address activities, events or developments that we expect, believe or anticipate will or may occur in the future are forward-looking statements. These statements are based on certain assumptions made by us based on our experience and perception of historical trends, current conditions, expected future developments and other factors we believe are appropriate under the circumstances. Such statements are subject to a number of assumptions, risks and uncertainties, many of which are beyond our control, which may cause our actual results to differ materially from those implied or expressed by the forward-looking statements. We do not assume any obligation to update such forward-looking statements following the date of this report. For a complete description of known material risks, please read our risk factors set forth in our Annual Report on Form 10-K for the year ended December 31, 2012 and in "Part II. Item 1A. Risk Factors." These factors include but are not limited to:
Drilling and geological / exploration risks;

Assumptions regarding oil and natural gas reserve levels and costs to exploit and timing of development;

Volatility or declines (including sustained declines) in commodity prices;

Our significant existing indebtedness;

Hedging activities;

Ability to obtain credit and access capital markets;

Ability to remain in compliance with the covenants set forth in our credit facility and the indenture governing our Senior Notes;

Conditions in the securities and/or capital markets;

Future processing volumes and throughput;

Loss of significant customers;

Availability and cost of processing and transporting of natural gas liquids ("NGLs");

Competition in the oil and natural gas industry;

Relevant legislative or regulatory changes, including retroactive royalty or production tax regimes, changes in environmental, health and safety regulation, hydraulic fracturing regulation, environmental risks and liability under federal, state and foreign environmental laws and regulations;

Ability to make favorable acquisitions and integrate operations from such acquisitions, including our recent acquisition of the BP Texas Panhandle midstream assets;

Shortages of personnel and equipment;

Potential losses associated with trading in derivative contracts;

Increases in interest rates;

Creditworthiness of our counterparties;

Weather, including the occurrence of any adverse weather conditions and/or natural disasters affecting our business;

Any other factors that impact or could impact the exploration of oil or natural gas resources, including but not limited to the geology of a resource, the total amount and costs to develop recoverable reserves, legal title, regulatory, natural gas administration, marketing and operations factors relating to the extraction of oil and natural gas; and

Tax risk associated with pass-through investment, including potential reduction in tax shield or creation of phantom income in the event distributions are not enough to support the tax burden.


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OVERVIEW

The following discussion and analysis of financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements, and the notes thereto, appearing elsewhere in this report, as well as our Annual Report on Form 10-K for the year ended December 31, 2012 filed with the Securities and Exchange Commission. For a description of oil and natural gas terms, see our Annual Report on Form 10-K for the year ended December 31, 2012.

We are a domestically-focused, growth-oriented, publicly-traded Delaware limited partnership engaged in the following two businesses:

Midstream Business-gathering, compressing, treating, processing, transporting, marketing and trading natural gas; fractionating, transporting and marketing NGLs; and crude oil and condensate logistics and marketing; and

Upstream Business-developing and producing oil and natural gas property interests.

We conduct, evaluate and report on our Midstream Business within three segments-the Texas Panhandle Segment, the East Texas and Other Midstream Segment and the Marketing and Trading Segment. On October 1, 2012, we completed our acquisition of BP America Production Company's ("BP") Texas Panhandle midstream assets (the "Panhandle Acquisition"), as discussed further below. Our Texas Panhandle Segment consists of gathering and processing assets in the Texas Panhandle. Our East Texas and Other Midstream Segment consists of gathering and processing assets in East Texas/Northern Louisiana, South Texas, Southern Louisiana, the Gulf of Mexico and Galveston Bay. Our Marketing and Trading Segment consists of crude oil and condensate logistics and marketing in the Texas Panhandle and Alabama and natural gas marketing and trading. During the three and six months ended June 30, 2013, our Midstream Business had operating income of $8.4 million and $16.0 million, respectively, compared to operating losses of $12.1 million and $46.2 million during the three and six months ended June 30, 2012, respectively.

We conduct, evaluate and report on our Upstream Business as one segment, which includes operated and non-operated wells located in the Mid-Continent (which includes areas in Oklahoma, Arkansas, and the Texas Panhandle); Permian (which includes areas in West Texas); East Texas / South Texas / Mississippi; and Southern Alabama (which also includes two treating facilities and one natural gas processing plant and related gathering systems). During the three and six months ended June 30, 2013, our Upstream Business had operating income of $12.9 million and $25.1 million, respectively, compared to operating income of $9.1 million and $29.3 million during the three and six months ended June 30, 2012, respectively.

Our final reporting segment is our Corporate and Other Segment, which is where we account for our risk management activity (excluding any risk management activity associated with our natural gas marketing and trading activities), intersegment eliminations and our general and administrative expenses. During the three and six months ended June 30, 2013, our Corporate and Other Segment had an operating income of $10.6 million and an operating loss of $26.8 million, respectively, compared to operating income of $76.9 million and $52.2 million during the three and six months ended June 30, 2012, respectively. Results reflected a net gain, realized and unrealized, on our commodity derivatives of $30.5 million and $12.6 million during the three and six months ended June 30, 2013, respectively, compared to a net gain, realized and unrealized, on our commodity derivatives of $96.0 million and $87.4 million during the three and six months ended June 30, 2012, respectively. See "-Results of Operations - Corporate and Other Segment" for a further discussion of the impact of our commodity derivatives.

Acquisitions

On October 1, 2012, we completed the Panhandle acquisition, including the Sunray and Hemphill processing plants and associated 2,500 mile gathering system, for $230.6 million, which included certain closing adjustments.

In addition, on October 1, 2012, we entered into a 20-year, fixed-fee Gas Gathering and Processing Agreement with BP under which we will gather and process BP's natural gas production from the existing wells connected to the newly-acquired Panhandle System. Furthermore, BP has committed itself to us under the same agreement, and committed its farmees to us under substantially the same terms, with respect to all future natural gas production from new wells drilled within an initial two-year period from closing, subject to mutually-agreed extensions, and within a two-mile radius of any portion of our gathering system serving such BP connected wells.


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Impairment

During the three and six months ended June 30, 2013, we recorded an impairment charge of $1.8 million in our Upstream Business related to certain proved properties primarily in the Permian region due to lower commodity prices and continued high operating costs. During the three and six months ended June 30, 2013, we recorded no impairment charges in our Midstream Businesses. During the three and six months ended June 30, 2012, we recorded an impairment charge of $20.6 million and $66.1 million, respectively, in our Midstream Business related to certain plants and pipelines in our East Texas and Other Segment due to (i) reduced throughput volumes as its producer customers curtailed their drilling activity in response to the continued depressed natural gas price environment during the first three months of 2012 and (ii) the loss of significant gathering contracts on the Panola system during the three months ended June 30, 2012. During the three and six months ended June 30, 2012, we recorded an impairment charge of $0.8 million in our Upstream Business related to certain unproved property leaseholds expected to expire in 2013.

Pursuant to accounting principles generally accepted in the United States of America ("GAAP"), our impairment analysis does not take into account the value of our commodity derivative instruments, which generally increase as the estimates of future prices decline. Further declines in commodity prices and other factors could result in additional impairment charges and changes to the fair value of our derivative instruments.

Subsequent Events

Successful Startup of Wheeler Plant

On July 8, 2013, we announced the successful startup of our 60 MMcf/d cryogenic processing facility
in Wheeler County, Texas (the "Wheeler Plant"). We also constructed other intra-system pipeline enhancements in the immediate area to further facilitate product gathering, transportation and marketing to and from the Wheeler Plant. The supporting infrastructure and plant site were designed to accommodate one or more additional expansions. The construction of the facilities, associated gathering and pipelines cost approximately $65 million.

Amended Credit Facility

On July 23, 2013, we announced that we and our lending group amended our existing senior secured credit facility to allow for a temporary step-up in the Total Leverage Ratio and the Senior Secured Leverage Ratio, as defined in the credit facility, through the third quarter of 2014, respectively. The amendment also extends the period of time the Partnership is subject to the Senior Secured Leverage Ratio from September 30, 2013 to September 30, 2014. The amendment is effective as of June 30, 2013. See Note 7 for a description of the amendment to the senior secured credit facility.


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RESULTS OF OPERATIONS

Summary of Consolidated Operating Results

Below is a table of a summary of our consolidated operating results for the
three and six months ended June 30, 2013 and 2012.

                                                    Three Months Ended
                                                         June 30,               Six Months Ended June 30,
                                                    2013          2012             2013             2012
                                                                       ($ in thousands)
Revenues:
Natural gas, natural gas liquids, oil,
condensate, sulfur and helium sales              $ 269,392     $ 172,945     $     523,592       $ 395,658
Gathering, compression, processing and treating
fees                                                20,153        10,451            41,095          21,962
Realized commodity derivative gains                  8,177        16,463            18,175          22,626
Unrealized commodity derivative gains (losses)      22,316        79,502            (5,590 )        64,731
Other revenue                                          113         3,043               610           3,182
Total revenue                                      320,151       282,404           577,882         508,159
Cost of natural gas, natural gas liquids,
condensate and helium                              185,760        97,914           365,748         228,368
Costs and expenses:
Operations and maintenance                          35,122        27,562            67,341          54,611
Taxes other than income                              5,060         4,620             8,926           9,770
General and administrative                          19,396        18,736            38,243          35,577
Impairment                                           1,839        21,402             1,839          66,924
Depreciation, depletion and amortization            41,157        38,354            81,394          77,648
Total costs and expenses                           102,574       110,674           197,743         244,530
Operating income                                    31,817        73,816            14,391          35,261
Other income (expense):
Interest expense, net                              (16,609 )     (10,647 )         (33,693 )       (20,888 )
Unrealized interest rate derivatives gains           1,534         2,007             3,029           3,803
Realized interest rate derivative losses            (1,685 )      (3,470 )          (3,336 )        (6,845 )
Other income (expense), net                            113             4               105             (45 )
Total other expense                                (16,647 )     (12,106 )         (33,895 )       (23,975 )
Income (loss) before income taxes                   15,170        61,710           (19,504 )        11,286
Income tax provision (benefit)                        (862 )         (79 )          (2,022 )          (170 )
Net income (loss)                                $  16,032     $  61,789     $     (17,482 )     $  11,456
Adjusted EBITDA(a)                               $  55,853     $  57,668     $     109,470       $ 120,493


________________________


(a) See "-Liquidity and Capital Resources - Non-GAAP Financial Measures" for a definition and reconciliation to GAAP.


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Midstream Business (Three Segments)

Texas Panhandle Segment

                                                      Three Months Ended
                                                           June 30,               Six Months Ended June 30,
                                                      2013            2012           2013            2012
                                                  (Amounts in thousands, except volumes and realized prices)
Revenues:
Natural gas, natural gas liquids, condensate and
helium sales                                     $     108,505     $ 55,937     $     214,899     $ 129,017
Intersegment sales - natural gas and condensate         56,523       19,043           105,658        44,489
Gathering, compression, processing and treating
fees                                                    12,031        3,852            24,552         8,802
Other revenue (d)                                           37        2,864                37         2,864
Total revenue                                          177,096       81,696           345,146       185,172
Cost of natural gas, natural gas liquids,
condensate and helium (b)                              135,296       51,117           267,522       122,605
Intersegment cost of sales - natural gas                    78            -                97             -
Operating costs and expenses:
Operations and maintenance                              22,022       12,399            39,156        24,637
Depreciation and amortization                           14,005        9,873            27,850        19,390
Total operating costs and expenses                      36,027       22,272            67,006        44,027
Operating income                                 $       5,695     $  8,307     $      10,521     $  18,540

Capital expenditures                             $      27,543     $ 44,885     $      45,846     $  78,287

Realized prices (c):
Condensate (per Bbl)                             $       79.83     $  82.29     $       80.08     $   89.28
Natural gas (per MMbtu)                          $        3.76     $   1.93     $        3.53     $    2.19
NGLs (per Bbl)                                   $       33.44     $  38.30     $       34.56     $   42.40
Production volumes:
Gathering volumes (Mcf/d)(a)                           349,681      133,590           346,224       146,749
NGLs (net equity Bbls)                                 265,538      297,688           325,800       626,802
Condensate (net equity Bbls)                           295,204      163,320           570,874       335,414
Natural gas (MMbtu/d)(a)                                 9,676       (5,629 )           6,559        (6,546 )


_______________________


(a) Gathering volumes (Mcf/d) and natural gas positions (MMbtu/d) are calculated by taking the total volume and then dividing by the number of days in the respective period.

(b) Includes the cost of gathering, compression, processing and treating fees of $0.7 million, $1.0 million, $0.7 million and $0.7 million, respectively, for the three and six months ended June 30, 2013 and 2012.

(c) Excludes the impact of adjustments related to prior periods, including true-ups of estimates.

(d) The three and six months ended June 30, 2012 included the receipt of an insurance payment of $2.9 million for business interruption related to the downtime to our Cargray plant caused by the severe winter weather in 2011.

Revenues and Cost of Natural Gas, NGLs, Condensate and Helium. For the three and six months ended June 30, 2013, revenues minus cost of natural gas, NGLs, condensate and helium for our Texas Panhandle Segment operations totaled $41.7 million and $77.5 million, respectively, compared to $30.6 million and $62.6 million for the three and six months ended June 30, 2012, respectively. The addition of volumes from the Panhandle Acquisition, which closed on October 1, 2012, positively impacted the Texas Panhandle Segment's revenues minus cost of natural gas, NGLs, condensate and helium relative to the corresponding prior year period by $14.2 million and $25.6 million during the three and six months ended June 30, 2013, respectively. This increase resulting from the Panhandle Acquisition was partially offset by the following: (i) lower condensate and NGL prices, (ii) the harsh winter storms in the Texas Panhandle in early January and late February 2013, which resulted in lower volumes and lower-than-normal NGL recovery rates and (iii) adjustments related to amounts recorded during the three months ended December 31, 2012. During the three and six months ended June 30, 2013, we received new information related to the assets acquired in the Panhandle Acquisition, which were operated by BP during the three months ended December 31, 2012. We were informed that the cost of natural gas, NGLs and condensate on the assets was higher than previously


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communicated. Due to these adjustments, our results for the three and six months ended June 30, 2013 were negatively impacted by $0.8 million and $2.0 million, respectively.

Our NGL equity volumes were lower in part due to our decision to reject ethane during the three and six months ended June 30, 2013. Our election to reject ethane is an economic decision based on our contract portfolio and the price spread between ethane and natural gas. This decision also has a positive impact on our natural gas volumes as the ethane remains unprocessed and sold as natural gas.

Our Texas Panhandle Segment lies within 14 counties in Texas and consists of our East Panhandle System and our West Panhandle System. The combination of our contract mix and the high NGL content of the natural gas gathered in the West Panhandle System provides us with a high level of equity NGL and condensate production; however, the limited drilling activity on this system is not sufficient to offset the natural declines of the existing wells. As such, any declines in gathered volumes from the West Panhandle System must be offset with increases in gathered volumes from other systems on a greater than one-to-one basis in order to maintain our total equity NGL and condensate production. We have seen continued drilling activity in the East Panhandle System by our producer customers and expect drilling activity and the resulting volumes to continue during the remainder of 2013.

Operating Expenses. Operating expenses, including taxes other than income, for the three and six months ended June 30, 2013, increased $9.6 million and $14.5 million, respectively, as compared to the three and six months ended June 30, 2012. The increase was primarily driven by $8.9 million and $13.9 million, respectively, of costs related to the operation of the assets acquired in the Panhandle Acquisition for the three and six months ended June 30, 2013. Excluding the acquisition, operating expenses increased primarily due to higher chemical costs and increased labor and related expenses, partially offset by repair costs related to the incident at our Phoenix processing facility in 2012.

Depreciation and Amortization. Depreciation and amortization expenses for the three and six months ended June 30, 2013 increased $4.1 million and $8.5 million, respectively, from the three and six months ended June 30, 2012. The increase was due to increased depreciation expense primarily associated with the new Woodall Plant, the assets acquired in the Panhandle Acquisition and other capital projects placed into service during the period.

Capital Expenditures. Capital expenditures for the three and six months ended June 30, 2013, decreased by $17.3 million and $32.4 million, respectively, compared to the three and six months ended June 30, 2012. The decrease was primarily driven by spending related to the construction of our Woodall Plant in 2012, partially offset by spending related to construction of our Wheeler Plant in 2013.

On July 8, 2013, we announced the successful startup of previously announced 60 MMcf/d high-efficiency cryogenic processing plant in Wheeler County, Texas, in the heart of the Granite Wash play. With the completion of the Wheeler Plant, we now have in excess of 500 MMcf/d of high-efficiency cryogenic processing capacity serving the Granite Wash play. The construction of the Wheeler Plant and associated gathering and compression is expected to cost approximately $65 million, of which $59.1 million had been spent through June 30, 2013.


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East Texas and Other Midstream Segment
                                                        Three Months Ended
                                                             June 30,                  Six Months Ended June 30,
                                                      2013              2012               2013           2012
                                                    (Amounts in thousands, except volumes and realized prices)
Revenues:
Natural gas, natural gas liquids and condensate
sales                                            $    26,597       $     30,998       $     53,985     $  72,268
Intersegment sales - natural gas                      12,705              6,928             21,243        16,451
Gathering, compression, processing and treating
fees (b)                                               8,081              6,599             16,439        13,160
Total revenue                                         47,383             44,525             91,667       101,879
Cost of natural gas, natural gas liquids,
condensate and helium                                 36,340             32,550             69,574        78,058
Operating costs and expenses:
Operations and maintenance                             5,006              5,764              9,835        10,893
Impairment                                                 -             20,617                  -        66,139
Depreciation and amortization                          4,989              6,667              9,991        13,802
Total operating costs and expenses                     9,995             33,048             19,826        90,834
Operating (loss) income                          $     1,048       $    (21,073 )     $      2,267     $ (67,013 )

Capital expenditures                             $     3,071       $      2,967       $      4,847     $   5,652

Realized prices (c):
Condensate (per Bbl)                             $     93.29       $     103.71       $      93.75     $  103.68
Natural gas (per MMbtu)                          $      3.93       $       2.22       $       3.63     $    2.59
NGLs (per Bbl)                                   $     28.10       $      39.72       $      29.01     $   42.53
Production volumes:
Gathering volumes (Mcf/d)(a)                         194,704            265,472            197,164       278,961
NGLs (net equity Bbls)                                74,620             84,981            127,605       176,325
Condensate (net equity Bbls)                           9,100             10,403             14,299        21,727
Natural gas (MMbtu/d)(a)                                (190 )            3,952                 14         2,031


_________________________

(a) Gathering volumes (Mcf/d) and natural gas positions (MMbtu/d) are calculated by taking the total volume and then dividing by the number of days in the respective period.

(b) Includes the cost of gathering, compression, processing and treating fees of $0.7 million, $1.2 million, $1.3 million and $2.8 million, respectively, for the three and six months ended June 30, 2013 and 2012.

(c) Excludes the impact of adjustments related to prior periods, including true-ups of estimates.

Revenues and Cost of Natural Gas, NGLs and Condensate. For the three and six months ended June 30, 2013, revenues minus cost of natural gas and NGLs for our East Texas and Other Midstream Segment totaled $11.0 million and $22.1 million, respectively, compared to $12.0 million and $23.8 million for the three and six months ended June 30, 2012, respectively. During the three and six months ended June 30, 2013 and 2012, we recorded revenues associated with indemnity payments of $1.9 million, $4.0 million, $0.7 million and $0.7 million, respectively. We receive indemnity payments under certain of our gathering contracts when delivered volumes fail to meet certain thresholds. These amounts are included within gathering and treating services revenue. Excluding these indemnity payments, revenues minus cost of natural gas, NGLs and condensate for the three and six months ended June 30, 2013 and 2012, would have been $9.1 million, $18.1 million, $11.3 million and $23.1 million, respectively. The decrease, excluding indemnity payments, for the three and six months ended June 30, 2013 compared to the three and six months ended June 30, 2012, is primarily due to a decrease in gathering and equity volumes and lower condensate and NGL prices.

The gathering, NGL and condensate volumes for the three and six months ended June 30, 2013, decreased as compared to the three and six months ended June 30, . . .

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