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HNR > SEC Filings for HNR > Form 10-Q on 12-Nov-2013All Recent SEC Filings

Show all filings for HARVEST NATURAL RESOURCES, INC.

Form 10-Q for HARVEST NATURAL RESOURCES, INC.


12-Nov-2013

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, 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, 2012, 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 Singapore and small field offices in Jakarta, Republic of Indonesia ("Indonesia") 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) Co÷peratie 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. We do not have a business relationship with Vinccler outside of Venezuela. Harvest Holding owns, indirectly through wholly owned subsidiaries, 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. Corporaciˇn Venezolana del Petroleo S.A. ("CVP") owns the remaining 60 percent of Petrodelta. Petroleos de Venezuela S.A. ("PDVSA") owns 100 percent of CVP. Harvest Holding has an indirect 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 PDVSA.


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Through the pursuit of technically-based strategies, we are building a portfolio of exploration prospects to complement the low-risk 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 Colombia and offshore of the People's Republic of China ("China").

From time to time we learn of possible third party interests in acquiring ownership in certain assets within our property portfolio. During the last three 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. As discussed in Note 1 - Organization, we have entered into negotiations with Pluspetrol Venezuela S.A. to sell our interest in Petrodelta for $373 million, before taking into account repayment of our long-term debt, payment of costs and other obligations, and customary working capital adjustments. As discussed further in Note 13 - Gabon, we have entered into exclusive negotiations with Vitol S.A. to sell our interests in Gabon for $137.0 million in cash. There can be no assurances that these transactions will be completed.

Operations

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") (6.30 Bolivars per U.S. Dollar). During the three and nine months ended September 30, 2013, Harvest Vinccler exchanged approximately $0.4 million and $1.3 million, respectively, and received an average exchange rate of 7.08 Bolivars per U.S. Dollar and 6.37 Bolivars per U.S. Dollar, respectively. During the three and nine months ended September 30, 2012, Harvest Vinccler exchanged approximately $0.4 million and $1.0 million, respectively, and received an average exchange rate of 5.23 Bolivars per U.S. Dollar and 5.17 Bolivars per U.S. Dollar, respectively.

The monetary assets that are exposed to exchange rate fluctuations are cash, accounts receivable, prepaid expenses and other current assets. The monetary liabilities that are exposed to exchange rate fluctuations are accounts payable, accruals, current and deferred income tax and other tax obligations 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, 2013, the balances in Harvest Vinccler's Bolivar denominated monetary assets and liabilities accounts that are exposed to exchange rate changes are 8.8 million Bolivars and 7.1 million Bolivars, respectively. At September 30, 2013, the balances in Petrodelta's Bolivar denominated monetary assets and liabilities accounts that are exposed to exchange rate changes are 787.8 million Bolivars and 5,488.9 million Bolivars, respectively.

Petrodelta, S.A.

During the nine months ended September 30, 2013, Petrodelta drilled and completed ten development wells, delivered approximately 10.7 million barrels ("MBls") of oil and 2.0 billion cubic feet ("Bcf") of natural gas, averaging 40,314 barrels of oil equivalent ("BOE") per day. During the nine months ended September 30, 2012, Petrodelta drilled and completed ten development wells, delivered approximately 9.8 MBls of oil and 1.5 Bcf of natural gas, averaging 36,736 BOE per day.

Currently, Petrodelta is operating six drilling rigs and one workover rig. Infrastructure enhancement projects in the El Salto and Temblador fields continue.

Certain operating statistics for the nine months ended September 30, 2013 and 2012 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.


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                                             Three Months Ended          Nine Months Ended
                                                September 30,              September 30,
                                              2013          2012         2013          2012
Thousand barrels of oil sold                    3,839        3,512        10,677        9,810
Million cubic feet of gas sold                    598          412         1,973        1,536
Total thousand barrels of oil equivalent        3,939        3,581        11,006       10,066
Average price per barrel                   $    93.43      $ 92.43     $   92.73     $  98.63
Average price per thousand cubic feet      $     1.54      $  1.54     $    1.54     $   1.54
Cash operating costs ($millions)           $     25.6      $  34.3     $    88.3     $   75.9
Capital expenditures ($millions)           $     57.8      $  49.7     $   168.2     $  120.3

The sale of oil and gas by Petrodelta to the Venezuelan government is pursuant to a Contract for Sale and Purchase of Hydrocarbons with PDVSA Petroleo S.A. ("PPSA") signed on January 17, 2008. The form of the agreement is set forth in the Conversion Contract. Crude oil delivered from the Petrodelta Fields to PPSA 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 PPSA is priced at $1.54 per thousand cubic feet. Natural gas deliveries are paid in Bolivars, but the pricing for natural gas is referenced to the U.S. Dollar. PPSA is obligated to make payment to Petrodelta of each invoice within 60 days of the end of the invoiced production month by wire transfer, in U.S. Dollars in the case of payment for crude oil and natural gas liquids delivered, and in Bolivars in the case of payment for natural gas delivered, in immediately available funds to the bank accounts designated by Petrodelta. Major contracts for capital expenditures and lease operating expenditures are denominated in U.S. Dollars. Any dividend paid by Petrodelta will be made in U.S. Dollars.

When the Sales Contract was executed, Petrodelta was producing only one type of crude, Merey 16. Beginning in October 2011, the Ministry of the People's Power for Petroleum and Mining ("MENPET") determined that Petrodelta's production flowing through the COMOR transfer point was a heavier type of crude, Boscan. Since Petrodelta was producing only Merey 16 when the Sales Contract was executed, the Boscan gravity and sulphur correction factors and crude pricing formula are not included in the Sales Contract. However, under the Sales Contract, PPSA is obligated to receive all of Petrodelta's production. All production deliveries for all of Petrodelta's fields have been certified by MENPET and acknowledged by PPSA. All pricing factors to be used in the Merey 16 and Boscan pricing formulas have been provided by and certified by MENPET to Petrodelta.

Since the Sales Contract provides for only one crude pricing formula, the Sales Contract had to be amended to include the Boscan pricing formula to allow Petrodelta to invoice PPSA for El Salto crude oil deliveries. From October 1, 2011 through June 30, 2012, Petrodelta used the Boscan pricing formula as published in the Official Gazette on January 11, 2007 to record revenue from El Salto deliveries. Petrodelta subsequently received from PDVSA Trade and Supply a draft amendment to the Sales Contract. The pricing formula in the draft amendment was used to record revenue for El Salto field deliveries from July 1, 2012 through September 30, 2013, and revenue for El Salto deliveries for October 1, 2011 through June 30, 2012 was revised to reflect the pricing formula in the draft amendment. The only item included in the draft amendment is the Boscan pricing formula to be used in invoicing El Salto crude oil deliveries. All other terms and conditions of the Sales Contract remain in force. On January 31, 2013, Petrodelta's board of directors endorsed the amendment to the Sales Contract. The amendment has been approved by CVP's board of directors. HNR Finance, as shareholder, has agreed to the contract amendment.

CVP's board of directors reviewed the amendment on April 30, 2013. A certificate of CVP's final board resolution approving the amendment dated April 30, 2013 was received by Petrodelta on May 23, 2013. The remaining steps for the contract amendment are to (1) inform MENPET of the approval, (2) receive approval from Petrodelta's shareholders to amend the Sales Contract including the Boscan formula, and (3) sign the contract amendment with PDVSA Trade and Supply. Once the Sales Contract is executed, PPSA will be invoiced for the deliveries.

El Salto deliveries, net of royalties, covering the delivery months of October 2011 through September 2013 totaled approximately 7.4 million barrels (2.4 MBls net to our 32 percent interest). The amendment to the Sales Contract pricing formula for Boscan based upon the deliveries and factors certified by MENPET, results in revenue for these deliveries of $646.7 million ($206.9 million net to our 32 percent interest). As of September 30, 2013, these deliveries for El Salto remain uninvoiced to PPSA.


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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, through PPSA, 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, 2013, Harvest Vinccler advanced to Petrodelta $0.3 million for continuing operations costs and recorded a $0.4 million loss on revaluation of the accounts receivable with Petrodelta. Petrodelta and Petrodelta's board have neither indicated that the advances are not payable, nor that they will not be paid. As of September 30, 2013, Advance to Equity Affiliate of $2.7 million (December 31, 2012: $2.1 million) had been classified as long-term receivable due to slow payment and age of the advances although we expect the full amount to be collected. During the year ended December 31, 2012, Harvest Vinccler advanced to Petrodelta $0.5 million for continuing operations costs, and Petrodelta repaid $0.1 million of the advance. 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"). In February 2013, the Venezuelan government published in the Official Gazette an amendment to the Windfall Profits Tax. The amended Windfall Profits Tax establishes new levels for contribution of extraordinary and exorbitant prices to the Venezuelan government. Extraordinary prices are considered to be equal to or lower than $80 per barrel, and exorbitant prices are considered to be over $80 per barrel. The amended Windfall Profits tax also sets a new royalty cap per barrel of $80. Contributions for extraordinary prices are 20 percent to be applied to the difference between the price fixed by the Venezuela budget for the relevant fiscal year (set at $55 per barrel for 2013) and $80 per barrel. Contributions for exorbitant prices are (1) 80 percent when the average price of the Venezuela Export Basket ("VEB") exceeds $80 per barrel but is less than $100 per barrel; (2) 90 percent when the average price of the VEB equals or exceeds $100 per barrel but is less than $110 per barrel; and (3) 95 percent when the average price of the VEB equals or exceeds $110 per barrel. Windfall Profits Tax is deductible for Venezuelan income tax purposes. During the three and nine months ended September 30, 2013, Petrodelta recorded $67.8 million and $185.7 million, respectively, for Windfall Profits Tax. During the three and nine months ended September 30, 2012, Petrodelta recorded $72.0 million and $231.4 million, respectively, for Windfall Profits Tax.

The amended Windfall Profits Tax states that royalties paid to Venezuela are capped at $80 per barrel (2012: $70 per barrel), but the cap on royalties has not been defined as being applicable to in-cash, in-kind, or both. Per instructions received from PDVSA, Petrodelta reports royalties, whether paid in-cash or in-kind, at $80 per barrel (royalty barrels x $80). The difference between the $80 royalty cap and the current oil price is to be reflected on the income statement as a reduction in oil sales. For the three and nine months ended September 30, 2013, the reduction to oil sales due to the $80 cap applied to all royalty barrels was $17.2 million and $45.3 million, respectively, ($5.5 million and $14.5 million, respectively, net to our 32 percent interest). For the three and nine months ended September 30, 2012, the reduction to oil sales due to the $70 cap applied to all royalty barrels was $26.2 million and $93.6 million, respectively, ($8.4 million and $30.0 million, respectively, net to our 32 percent interest).

Per our interpretation of the Windfall Profits Tax, the $80 cap on royalty barrels should only be applied to the 3.33 percent royalty which Petrodelta pays in cash. We have applied the $80 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 nine months ended


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September 30, 2013. 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 $80 cap to the 3.33 percent royalty paid in cash for the three and nine months ended September 30, 2013. For the three and nine months ended September 30, 2013, net oil sales (oil sales less royalties) are slightly higher, $1.7 million and $4.5 million, respectively, ($0.5 million and $1.4 million, respectively, net to our 32 percent interest) 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. For the three and nine months ended September 30, 2012, net oil sales are slightly higher, $2.7 million and $9.4 million, respectively, ($0.9 million and $3.0 million, respectively, net to our 32 percent interest) under this method. We have reported revenues and royalties for Petrodelta under this method.

The April 2011 Windfall Profits Tax included a provision wherein it considered that an exemption of the Windfall Profits Tax could be granted for the incremental production of projects and grass root developments until the specific investments are recovered. The projects deemed to qualify for the exemption have to be considered and approved in a case by case basis by MENPET. The subsequent amendment to the Windfall Profits tax in February 2013 did not modify the fundamentals of this section from the April 2011 Windfall Profits Tax law. Since the enactment of the April 2011 Windfall Profits Tax, we have believed that several of the fields operated by Petrodelta should qualify for exemption from the Windfall Profits Tax, and we have been waiting for MENPET to establish, through resolution, the definition of incremental production and grass roots developments, as well as guidance on the process of applying for, and the calculation of, the exemption.

In March 2013, PDVSA requested an exemption from MENPET for the Windfall Profits Tax under the provision in the April 2011 Windfall Profits Tax law. The exemption was applied to several oil development projects, including Petrodelta. The exemption is allowable under the April 2011 Windfall Profits Tax law; however, MENPET has neither defined the projects qualifying for exemption, nor the guidance to be used in calculating the exemption. PDVSA issued to Petrodelta its share of the exemption credit for 2012 of $55.2 million ($36.4 million net of tax) ($17.7 million net to our 32 percent interest, $11.6 million net of tax net to our 32 percent interest) based on PDVSA's calculation and projects PDVSA deemed to qualify for the exemption. Neither Petrodelta nor us have been provided with supporting documentation indicating the properties have been appropriately qualified by MENPET, the specific details for the exemption credit, such as which fields, production period or production, or the supporting calculations. Until MENPET either issues guidance on the exemption provision in the April 2011 Windfall Profits Tax law or issues payment forms including the exemption credit, or written approval from MENPET for this exemption credit is received by Petrodelta or us, we have and will continue to exclude the exemption credit from our equity earnings in Petrodelta.

The Organic Law on Sports, Physical Activity and Physical Education ("Sports Law") was published in the Official Gazette on August 23, 2011 and is effective beginning January 1, 2012. The purpose of the Sports Law is to establish the public service nature of physical education and the promotion, organization and administration of sports and physical activity. Funding of the Sports Law is by contributions made by companies or other public or private organizations that perform economic activities for profit in Venezuela. The contribution is one percent of annual net or accounting profit and is not deductible for income tax purposes. Per the Sports Law, contributions are to be calculated on an after-tax basis. However, CVP has instructed Petrodelta to calculate the contribution on a before-tax basis contrary to the Sports Law resulting in an overstatement of the liability. We have adjusted for the over-accrual of the Sports Law in the three and nine months ended September 30, 2013 and 2012 Net Income from Equity Affiliate. As of September 30, 2013, the cumulative amount of this adjustment is $2.5 million ($0.8 million net to our 32 percent interest).

On November 12, 2010, Petrodelta's board of directors declared a dividend of $30.6 million, $12.2 million net to HNR Finance ($9.8 million net to our 32 percent interest). Petrodelta shareholder approval of the dividend was received on March 14, 2011. Petrodelta had working capital of $407.5 million as of September 30, 2013; however, due to Petrodelta's liquidity constraints caused by PDVSA's insufficient monetary support and contractual adherence, this dividend has not yet been received, although it is due and payable, and dividends for subsequent periods have not been declared and/or paid. Petrodelta's board of directors declared this dividend and has neither indicated that the dividend is not payable, nor that it will not be paid. Petrodelta has consistently earned a profit from 2007 through September 30, 2013; however, dividends of profits since 2010 have not been declared. There is uncertainty with respect to the timing of the receipt of the dividend declared in November 2010 or whether future dividends will be declared and/or paid. The dividend receivable is classified as a long-term receivable at September 30, 2013 due to the uncertainty in the timing of payment. We have and will continue to monitor our investment in Petrodelta. Should the dividend receivable not be collected or facts and circumstances surrounding our investment change, our results of operations and investment in Petrodelta could be adversely impacted.


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Budong-Budong Project, Indonesia

In January 2013, the Budong PSC partners were granted a four year extension of the initial six year exploration term of the Budong PSC to January 15, 2017. The extension of the initial exploration term includes an exploration well, which if not drilled by January 2016, results in the obligation of the Joint Venture to return the entire Budong PSC to the Government of Indonesia. Also, if this exploration well is not drilled within 18 months of the date of approval from the Government of Indonesia of this transaction (October 9, 2014), we will be required to pay our partner in the Budong PSC $3.2 million.

Operational activities during the three months ended September 30, 2013 included continued work on an exploration program targeting the Pliocene and Miocene targets encountered in the previous two wells. Land access and acquisition; environmental studies; construction and upgrades to access roads, bridges, and well site; permitting; and tender prequalification and procurement are on-going.

During the nine months ended September 30, 2013, we had cash capital expenditures of $0.1 million for environment studies and well planning.

Dussafu Project, Gabon

We have met all funding commitments for the third exploration phase of the Dussafu PSC.

Operational activities during the three months ended September 30, 2013 included continuation of planning for a cluster field development. Geoscience, reservoir engineering and economic studies have been progressed, and a field development plan is being prepared. Planning and contracting for a 3D seismic acquisition survey over the outer half of the license took place. Acquisition of a 1,260 . . .

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