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EPL > SEC Filings for EPL > Form 10-K on 28-Feb-2014All Recent SEC Filings

Show all filings for EPL OIL & GAS, INC.

Form 10-K for EPL OIL & GAS, INC.


28-Feb-2014

Annual Report


Item 7.Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

We were incorporated as a Delaware corporation in January 1998 and operate in a single segment as an independent oil and natural gas exploration and production company. Our current operations are concentrated in the U.S. Gulf of Mexico shelf focusing on state and federal waters offshore Louisiana, which we consider our core area. We have focused on acquiring and developing assets in this region, as it offers a balanced and expansive array of existing and prospective exploration, exploitation and development opportunities in both established productive horizons and deeper geologic formations. As of December 31, 2013, we had estimated proved reserves of 80.4 Mmboe, of which 64% were oil and 71% were proved developed. Of these proved developed reserves, 69% were oil reserves.


Recent Events

On January 15, 2014, we completed the Nexen Acquisition for $70.4 million, subject to customary adjustments to reflect the September 1, 2013, economic effective date. The assets we acquired include five leases in the Eugene Island 258/259 field-namely blocks 254, 255, 257, 258, and 259 (the "EI Interests"). The EI Interests are currently producing approximately 900 net Boe per day, about 95% of which is oil. Estimated proved reserves as of the September 1, 2013 effective date consisted of approximately 2.6 Mmboe of proved developed producing reserves, about 91% of which were oil. The estimated asset retirement obligation to be assumed and recorded on our balance sheet as a result of the Nexen Acquisition is expected to total approximately $27.1 million.

The Nexen Acquisition was financed with borrowings under our Senior Credit Facility. In January 2014, our lenders approved a $50.0 million increase in our borrowing base under our Senior Credit Facility, increasing our borrowing base from $425.0 million to $475.0 million. See "-Liquidity and Capital Resources-Senior Credit Facility" for more information regarding our Senior Credit Facility.

In September and October 2013, we negotiated agreements totaling approximately $45 million with seismic companies to acquire 3D seismic licenses over our core areas. These agreements include a commitment to acquire area-wide data licenses for seismic acquisitions that will be performed by the seismic company during 2014, 2015 and 2016 covering a minimum of 200 blocks, or approximately one million acres, within the shallow water Gulf of Mexico covering our core asset base.

2013 Acquisitions and Dispositions

On April 2, 2013, we sold certain shallow water Gulf of Mexico shelf oil and natural gas interests located within the non-operated Bay Marchand field (the "BM Interests") to the property operator for $51.5 million in cash and the buyer's assumption of liabilities recorded on our balance sheet of $11.3 million resulting in total consideration of $62.8 million, subject to customary adjustments to reflect the January 1, 2013 economic effective date. Our results for the year ended December 31, 2013 reflect a pre-tax gain of $28.1 million from this sale. See "-Liquidity and Capital Resources-Acquisitions and Dispositions" in this Item 2 for more information regarding the use of proceeds from this sale.

On September 26, 2013, we acquired the WD29 Interests for $21.8 million in cash, subject to customary adjustments to reflect an economic effective date of January 1, 2013 (the "WD29 Acquisition"). We estimate that the proved reserves as of the January 1, 2013 economic effective date totaled approximately 0.7 Mmboe, of which 95% were oil and 58% were proved developed reserves. The WD29 Acquisition was funded with a portion of the proceeds from the sale of the BM Interests described above.

On March 20, 2013, we were the high bidder on five leases at the Central Gulf of Mexico Lease Sale 227. The five high bid lease blocks cover a total of 13,892 acres on a gross and net basis and are all located in the shallow Gulf of Mexico within our core area of operations. Our share of the high bids totaled approximately $2.1 million. We have been awarded all five of the leases.

2012 Acquisitions

On October 31, 2012, we acquired the Hilcorp Properties for $550.0 million in cash, subject to customary adjustments to reflect an economic effective date of July 1, 2012. As of December 31, 2012, the Hilcorp Properties had estimated proved reserves of approximately 37.2 Mmboe, of which 49% were oil and 58% were proved developed reserves. The Hilcorp Properties included the three core producing complexes of the Ship Shoal 208, South Pass 78 and South Marsh Island 239 areas and related gathering lines which are described in Part I, Item 1, "Business - Properties."

The Hilcorp Acquisition was financed with cash on hand, the net proceeds from the sale of $300.0 million in aggregate principal amount of our 8.25% senior notes due 2018 (the "2012 Senior Notes") and borrowings under our Senior Credit Facility. The 2012 Senior Notes were offered in a private placement only to qualified institutional buyers under Rule 144A promulgated under the Securities Act of 1933, as amended (the "Securities Act"), or to persons outside of the United States in compliance with Regulation S promulgated under the Securities Act. After deducting the initial purchasers' discount, we realized net proceeds of $289.5 million. Also on October 31, 2012, we obtained an increase in the aggregate commitment under our Senior Credit Facility from $250.0 million to $750.0 million under which we borrowed $205.0 million to fund a portion of the purchase price and related expenses of the Hilcorp Acquisition.

In the June 20, 2012, Central Gulf of Mexico Lease Sale 216/222, we were the high bidder on six leases covering a total of 27,148 acres on a gross and net basis located in the shallow Gulf of Mexico shelf within our core area of operations. Our share of the high bids totaled approximately $7.0 million.

On May 15, 2012, we acquired the ST41 Interests for $32.4 million in cash, subject to customary adjustments to reflect an economic effective date of April 1, 2012 (the "ST41 Acquisition"). Prior to the ST41 Acquisition, we owned a 60% working interest in the properties, and W&T owned a 40% working interest. As a result of the ST41 Acquisition, we have become the sole working interest owner of the South Timbalier 41 field. The ST41 Interests had estimated proved reserves as


of the acquisition date of approximately 1.0 Mmboe, of which 51% were oil and 84% were proved developed reserves. We funded the ST41 Acquisition with cash on hand.

2011 Acquisitions

On February 14, 2011, we acquired the ASOP Properties for $200.7 million in cash, subject to customary adjustments to reflect an economic effective date of January 1, 2011 (the "ASOP Acquisition"). On November 17, 2011, we acquired the Main Pass Interests for $38.6 million in cash, subject to customary adjustments to reflect an economic effective date of November 1, 2011 (the "Main Pass Acquisition"). The Main Pass Interests consist of additional interests in the Main Pass 296/311 complex that was included in the assets we purchased from ASOP, along with other unit interests in the Main Pass complex and an interest in a Main Pass 295 primary term lease. As of their respective acquisition dates, the ASOP Properties had estimated proved reserves of approximately 8.1 Mmboe, of which 84% were oil and 76% were proved developed reserves, and the Main Pass Interests had estimated proved reserves of approximately 1.3 Mmboe, of which 96% were oil and 100% were proved developed producing reserves.

We financed the ASOP Acquisition with the proceeds from the sale of $210.0 million in aggregate principal amount of 8.25% senior notes due 2018 (the "2011 Senior Notes"). After deducting the initial purchasers' discount and estimated offering expenses, we realized net proceeds of approximately $202.0 million from the sale of the 2011 Senior Notes. We funded the Main Pass Acquisition with cash on hand.

These acquisitions significantly increased our reserves, production volumes and drilling portfolio, while maintaining our focus on oil-weighted assets in our core area of expertise in the Gulf of Mexico shelf. They have also provided us with access to infrastructure and extensive acreage, with significant exploitation and development potential. We intend to pursue exploration and exploitation of these properties, including recompletions, well reactivations and development drilling. In conjunction with the Hilcorp Acquisition, we implemented a three-year commodity price hedging program weighted towards oil to help reduce commodity price risks associated with future oil production.

Overview and Outlook

During 2013, we spent approximately $335.9 million on development activities and exploration projects and approximately $12.3 million on seismic purchases within existing core field areas. We also spent approximately $2.1 million on the five leases at the Central Gulf of Mexico Lease Sale 227. Additionally, we spent approximately $53.3 million in 2013 on plugging, abandonment and other decommissioning activities. Our fiscal year 2014 capital budget is $360 million, which is allocated to development activities and exploration projects within existing core fields. Additionally, we plan to spend approximately $50 million in 2014 on plugging, abandonment and other decommissioning activities. We budget our capital spending on exploration and development with the goal of remaining within cash flow from operations.

We continue to generate prospects, strive to maintain an extensive inventory of drillable prospects in-house and maintain exposure to new opportunities through relationships with industry partners. We continually review and monitor opportunities to acquire producing properties, leasehold acreage and drilling prospects so that we can act quickly as acquisition opportunities become available. We intend to focus our acquisition strategy on assets in the Gulf of Mexico and the Gulf Coast region that are characterized by production-weighted reserves, seismic coverage, operated positions and the ability to consolidate interests in existing properties. We intend to use acquisitions of this type as a key method to replace and grow reserves and production because we believe this strategy increases production and cash flow while reducing dry hole and exploration risk. We believe our expertise in the Gulf of Mexico shelf and in plugging and abandonment operations allows us to effectively evaluate acquisitions and to operate any properties we eventually acquire.

Our longer term operating strategy is to increase our oil and natural gas reserves and production while focusing on exploration and development costs and operating costs to remain competitive with our offshore Gulf of Mexico industry peers.

We believe that our core competency in plugging, abandonment and decommissioning operations will enable us to achieve our objectives of prudently removing idle infrastructure throughout the remaining productive lives of our fields and, over time, to reduce ongoing lease operating expenses ("LOE") associated with maintaining idle infrastructure.

Our revenue, profitability and future growth rate depend substantially on factors beyond our control, such as oil and natural gas prices, tropical weather, economic, political and regulatory developments and availability of other sources of energy. Oil and natural gas prices historically have been volatile and may fluctuate widely in the future. Sustained periods of low prices for oil and natural gas could have a material adverse effect on our financial position, our results of operations, our cash flows, the quantities of oil and natural gas reserves that we can economically produce and our access to capital. See "Risk Factors" in Part I, Item 1A of this Annual Report for a more detailed discussion of these risks.


Results of Operations

The following table represents information about our oil and natural gas operations.

                                                              Year Ended December 31,
                                                           2013         2012         2011
Net production (per day):
Oil (Bbls)                                                 16,938       10,398        8,089
Natural gas (Mcf)                                          32,863       17,852       17,968
Total (Boe)                                                22,415       13,373       11,084
Average sales prices:
Oil (per Bbl)                                           $  104.01    $  106.08    $  108.81
Natural gas (per Mcf)                                        3.81         2.89         4.11
Total (per Boe)                                             84.18        86.33        86.07
Oil and natural gas revenues (in thousands):
Oil                                                     $ 643,033    $ 403,663    $ 321,275
Natural gas                                                45,710       18,866       26,932
Total                                                     688,743      422,529      348,207
Impact of derivatives instruments settled during the
period (1):
Oil (per Bbl)                                           $   (1.78)   $   (0.88)   $   (5.87)
Natural gas (per Mcf)                                       (0.04)       (0.07)            -
Average costs (per Boe):
LOE                                                     $   20.27    $   19.38    $   17.37
Depreciation, depletion and amortization ("DD&A")           24.49        23.21        25.86
Accretion of liability for asset retirement
obligations                                                  3.46         3.18         3.94
Taxes, other than on earnings                                1.40         2.66         3.55
General and administrative ("G&A") expenses                  3.44         4.74         4.63
Increase (decrease) in oil and natural gas revenues
due to:
Changes in prices of oil                                $  (7,879)      (8,055)
Changes in production volumes of oil                      247,249       90,443
Total increase in oil sales                               239,370       82,388
Changes in prices of natural gas                        $   6,017       (7,995)
Changes in production volumes of natural gas               20,827          (71)
Total increase (decrease) in natural gas sales             26,844       (8,066)

(1) See "-Other Income and Expense" section for further discussion of the impact of derivative instruments

Year Ended December 31, 2013 Compared to Year Ended December 31, 2012

Overview

During the year ended December 31, 2013, we completed 16 development drilling operations, 13 of which were successful, and 21 recompletion operations, 17 of which were successful. In addition, we were 100% successful in five well operations that re-established production at existing wells, primarily within our Main Pass area. Additionally, we drilled one successful exploratory oil well in a recently-acquired primary term lease in our Main Pass 244 field that reached its target depth in September 2013 and is waiting on production facilities to commence production. One additional exploratory well that we drilled in our East Bay area during the year ended December 31, 2013 was not successful. We are currently in the process of drilling five gross (5.0 net) development wells, three in our Ship Shoal 208 field, one in our West Delta area and one in our South Timbalier area. In addition, we are currently in the process of drilling one exploratory well (0.5 net) in our Ship Shoal 208 field, which we are completing and for which we anticipate first production in April 2014.

One operating results for the year ended December 31, 2013, compared to the year ended December 31, 2012, reflect a 63% increase in oil production and an 84% increase in natural gas production. Our product mix for the year ended December 31, 2013 was 76% oil (including natural gas liquids) compared to 78% for the year ended December 31, 2012, resulting in a 68% increase in our overall production volumes for the year ended December 31, 2013 when compared to the year ended December 31, 2012.


Revenue and Net Income






                                 Year Ended December 31,
                                   2013            2012
                                     (in thousands)            $ Change   % Change
Oil and natural gas revenues   $    688,743     $ 422,529    $ 266,214        63%
Net income                           85,274        58,810       26,464        45%

For the year ended December 31, 2013, our oil and natural gas revenues increased 63% as compared to the year ended December 31, 2012, due primarily to the 63% increase in oil production, partially offset by slightly lower average selling prices for our oil. The increase in our oil and natural gas revenues also reflects the 84% increase in natural gas production and a 32% increase in average selling prices for natural gas in the year ended December 31, 2013, as compared to the year ended December 31, 2012.

Our Gulf of Mexico shelf production, excluding the Hilcorp Properties, increased 29% in the year ended December 31, 2013, as compared to the year ended December 31, 2012, due primarily to production increases in our West Delta, South Pass 49 and Main Pass fields partially offset by production declines in our South Timbalier area. Production from the Hilcorp Properties increased our production rate by approximately 5,902 Boe per day in the year ended December 31, 2013, compared to results for the year ended December 31, 2012, which include production from the Hilcorp Properties only for the period from November 1 to December 31, 2012, reflecting a 1,488 Boe per day impact on the production rate in the prior period.

In addition to the items addressed above, our net income for the year ended December 31, 2013 includes a gain on sale of assets of $28.7 million, primarily from the sale of the BM Interests; a loss on abandonment activities of $27.2 million; interest expense of $52.4 million and a net loss on derivative instruments of $32.4 million. Our net income for the year ended December 31, 2012 reflects a loss on abandonment activities of $2.4 million; interest expense of $28.6 million and a net loss on derivative instruments of $13.3 million.

For the years ended December 31, 2013 and 2012, our effective income tax rate was 36.8% and 33.7%, respectively, and the income tax expense that we recorded was all deferred. For the year ended December 31, 2012 the income tax expense that we recorded was reduced due to applying the change in our estimated effective income tax rate to our net deferred tax liabilities. The change in our estimated effective income tax rate from 37.3% in 2011 to 36.4% in 2012 was primarily related to estimated state income taxes.

Operating Expenses

Our operating expenses primarily consisted of the following:




                                                Year Ended December 31,
                                                  2013            2012
                                                    (in thousands)            $ Change     % Change
LOE                                           $    165,841     $  94,850    $  70,991          75%
Exploration expenditures and dry hole costs         26,555        18,799        7,756          41%
Impairments                                          2,937         8,883       (5,946)         -67%
DD&A, including accretion expense                  228,658       129,146       99,512          77%
G&A expenses                                        28,137        23,208        4,929          21%
Taxes, other than on earnings                       11,490        13,007       (1,517)         -12%
Other                                               34,942         4,678       30,264         647%

LOE increased for the year ended December 31, 2013, compared to the year ended December 31, 2012, primarily due to the acquisition of the Hilcorp Properties.
LOE for the year ended December 31, 2013 also included approximately $8.2 million of non-routine workover expenses.

Exploration expenditures and dry hole costs increased for the year ended December 31, 2013, as compared to the year ended December 31, 2012, primarily reflecting costs associated with the increased size of our geological and geophysical staff. We also had increases in seismic expense and dry hole costs. For the year ended December 31, 2013, seismic expense, was $12.3 million compared to $10.6 million for the year ended December 31, 2012. Our seismic expense for the year ended December 31, 2013 relates primarily to the 3-D seismic agreements negotiated during the year. Our seismic expense for the year ended December 31, 2012 related to area-wide 2-D and 3-D seismic purchases. For the year ended December 31, 2013, we recorded approximately $5.5 million of dry hole costs, primarily associated with an exploratory drilling operation during the year which was unsuccessful. For the year ended December 31, 2012, we recorded approximately $4.2 million of dry hole costs, primarily associated with two exploratory wells which reached their target depths in January 2012 and were determined to be unsuccessful and an unsuccessful exploratory portion of a well that was successfully completed in a development zone.


Our exploratory expenditures and dry hole costs will vary significantly depending on the amount of our capital expenditures dedicated to exploration activities and the level of success we achieve in exploratory drilling activities.

Impairments for the year ended December 31, 2013 were primarily related to reservoir performance at a gas well in one of our smaller producing fields. This field was determined to have future net cash flows less than its carrying value resulting in the write down of this property to its estimated fair value during the year ended December 31, 2013. Impairments for the year ended December 31, 2012 were primarily due to the decline in our estimate of future natural gas prices, which affected three of our natural gas producing fields and reservoir performance at two of those fields. These fields were determined to have future net cash flows less than their carrying values resulting in the write down of these properties to their estimated fair values. We also recorded impairments for undeveloped leases that were expiring in 2013 for which we had no development plans. We periodically assess our oil and natural gas assets for impairment based on factors described in "-Discussion of Critical Accounting Policies." The factors that can result in impairment include declines in the estimated future selling prices of oil and natural gas.

DD&A increased for the year ended December 31, 2013, as compared to the year ended December 31, 2012, primarily due to the increase in production associated with the acquisition of the Hilcorp Properties.

G&A expenses increased for the year ended December 31, 2013, as compared to the year ended December 31, 2012, primarily as a result of higher professional fees related to the expansion of our asset base following the acquisition of the Hilcorp Properties and an increase in non-cash share-based compensation. G&A per Boe for the year ended December 31, 2013, as compared to the year ended December 31, 2012, declined significantly because of the increase in production primarily from the Hilcorp Properties.

Taxes, other than on earnings, were lower in the year ended December 31, 2013, as compared to the year ended December 31, 2012. The decrease is primarily related to severance taxes and a decrease in production from state leases (which is subject to a severance tax regime).

Other operating expenses increased for the year ended December 31, 2013, as compared to the year ended December 31, 2012, primarily as a result of an increase in loss on abandonment activities and amortization of the premium paid for our weather derivative. During the year ended December 31, 2013, we recorded loss on abandonment activities totaling $27.2 million and amortization expense related to our weather derivative of $8.0 million. During the year ended December 31, 2012, we recorded loss on abandonment activities totaling $2.4 million and amortization expense related to our weather derivative of $2.4 million. For the year ended December 31, 2013, our loss on abandonment activities primarily reflects an increase of $20.8 million in our ARO liability related to our non-operated deepwater properties.

Other Income and Expense

Interest expense increased for the year ended December 31, 2013, as compared to the year ended December 31, 2012. The increase in our interest expense is due to the full year of interest on our 2012 Senior Notes and borrowings on our Senior Credit Facility for the year ended December 31, 2013. For the year ended December 31, 2012, our interest expense included interest on our 2012 Senior Notes and interest on borrowings on the Senior Credit Facility beginning in late October 2012 in connection with the Hilcorp Acquisition.

Other income (expense) in the year ended December 31, 2013 includes a net loss on derivative instruments of $32.4 million consisting of a loss of $20.9 million due to the change in fair value of derivative instruments to be settled in the future and a loss of $11.5 million on derivative instruments settled during the period primarily from the impact of higher oil prices on our oil fixed-price swaps. Other income (expense) in the year ended December 31, 2012 includes a net loss on derivative instruments of $13.3 million consisting of a loss of $9.5 million due to the change in fair market value of derivative instruments and a loss of $3.8 million on derivative instruments settled during the period primarily from the impact of higher oil prices during 2012 on our oil fixed-price swaps.

Year Ended December 31, 2012 Compared to Year Ended December 31, 2011

Overview

During the year ended December 31, 2012, we completed 12 development drilling operations, 11 of which were successful, and 18 recompletion operations, 16 of which were successful. We also completed three exploratory drilling operations, one of which was successfully completed in a development zone.

Our operating results for the year ended December 31, 2012, compared to the year ended December 31, 2011, reflect a 29% increase in oil production, partially offset by lower average selling prices for our oil and natural gas. Our product mix for the year ended December 31, 2012 was 78% oil (including natural gas liquids) compared to 73% for the year ended December 31, 2011. Production from the acquired Hilcorp Properties, ST41 Interests, ASOP Properties and Main Pass Interests had an impact of approximately 6,648 Boe per day on the production rate for the year ended December 31, 2012, compared to results for the year ended December 31, 2011, which include production from the ASOP Properties for the


period from February 14, 2011 to December 31, 2011, reflecting only a 3,283 Boe per day impact on the production rate in the prior period.

For the year ended December 31, 2012, our total revenue increased 22% as compared to the year ended December 31, 2011, due primarily to the 29% increase in oil production. Our overall production volumes increased 21% for the year ended December 31, 2012 when compared to the year ended December 31, 2011. Our Gulf of Mexico shelf production, excluding the recently acquired Hilcorp . . .

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