SANDRIDGE ENERGY INC (SD) FY 2023 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis is intended to help the reader understand our business, financial condition, results of operations, liquidity and capital resources. This discussion and analysis should be read in conjunction with other sections of this report, including: “Business” in Item 1 and “Financial Statements and Supplementary Data” in Item 8. Our discussion and analysis includes the following subjects:
•Overview;
•Consolidated Results of Operations;
•Liquidity and Capital Resources;
•Valuation Allowance; and
•Critical Accounting Policies and Estimates.
We have applied the Securities and Exchange Commission’s adopted FAST Act Modernization and Simplification of Regulation S-K, which limits the discussion to the two most recent calendar years. This discussion and analysis deals with comparisons of material changes in the consolidated financial statements for years ended December 31, 2023 and 2022. For the comparison of the years ended December 31, 2022 and 2021, see “Management's Discussion and Analysis of Consolidated Results of Operations” in Part II, Item 7 of our 2022 Annual Report on Form 10-K, filed with the Securities and Exchange Commission on March 15, 2023.
Overview
We are an independent oil and natural gas company with a principal focus on acquisition, development and production activities in the U.S. Mid-Continent region ("Mid-Con").
Operational Activities
For the year ended December 31, 2023, there were two operated wells drilled and four wells completed. For the year ended December 31, 2022 there were eight operated wells drilled, six wells completed, and 50 wells reactivated.
The charts below show production and percent revenues by product for the years ended December 31, 2023 and 2022:
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Total production for the years ended December 31, 2023 and 2022 was composed of the following:
| Year Ended December 31, | |||||
|---|---|---|---|---|---|
| 2023 | 2022 | ||||
| Oil | 17.0 | % | 14.7 | % | |
| Natural gas | 55.3 | % | 54.4 | % | |
| NGL | 27.7 | % | 30.9 | % | |
| Total | 100.0 | % | 100.0 | % |
The increase in oil production was primarily driven by the newly drilled wells as part of our capital development program. The decrease in total MBoe was primarily driven by a reduction of NGL production, as one of our purchasers elected to retain more ethane in the natural gas stream, which had more favorable market pricing at the time of sales, as well as natural decline of its producing assets. These factors were partially offset by production added during the third quarter from an acquisition that closed on July 11, 2023, which increased our ownership interest in twenty-six wells we operate.
Highlighted Events
•In January 2024, the Board approved a one-time cash dividend of $1.50 per share of the Company's common stock, which was paid on February 20, 2024 to shareholders of record as of the close of business on February 5, 2024. The aggregate total payout was approximately $55.6 million. Additionally, in January 2024, the Board announced that it plans to increase its on-going quarterly dividend to $0.11 per share starting with the next quarterly payout, estimated to be first paid in March 2024, continuing every quarter thereafter until noticed, subject to quarterly approval by the Board.
•On July 11, 2023, the Company closed an acquisition that increased its ownership interest in twenty-six producing
wells operated by the Company within the Northwest Stack play for $10.6 million, after customary post-closing
adjustments, with an effective date of April 1, 2023. The Company used its cash on hand to fund the acquisition.
•In May 2023, the Board approved a one-time cash dividend of $2.00 per share of the Company’s common stock, which was paid on June 7, 2023 to shareholders of record as of the close of business on May 24, 2023. Additionally, in May 2023, the Board announced a regular quarterly dividend of $0.10 per share of the Company’s common stock, subject to quarterly approval by the Board. Our dividend payment in May was $73.8 million and the $0.10 dividend payments made in August 2023 and November 2023 totaled $7.4 million.
•In May 2023, the Board approved a stock buyback program authorizing the repurchase of up to $75 million of the
Company’s outstanding common stock in open market transactions.
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Outlook
We will continue to focus on growing the value and cash generation capability of our asset base in a safe, responsible and efficient manner, while exercising prudent capital allocations to projects we believe provide high rates of returns in the current commodity price environment. These projects include (1) artificial lift conversions to more efficient and cost effective systems, (2) high-graded re-fracturing and recompletion and (3) limited opportunistic leasing in proven areas around or adjacent to our area of operations that could further bolster future development. While commodity price futures are not yet at preferred levels to resume drilling or further well reactivations at this time, we retain the development option over a reasonable tenor, since our assets are 99% held by production. We will continue to monitor forward-looking commodity prices, results, costs and other factors that could influence returns on investments, which will continue to shape our disciplined development decisions in 2024 and beyond. We will also continue to maintain optionality to execute on value accretive merger and acquisition opportunities that could bring synergies, leverage our core competencies, compliment our portfolio of assets, further utilize our NOLs or otherwise yield attractive returns for our shareholders.
Consolidated Results of Operations
The majority of our consolidated revenues and cash flow are generated from the production and sale of oil, natural gas and NGLs. Our revenues, profitability and future growth depend substantially on prevailing prices received for our production, the quantity of oil, natural gas and NGLs we produce, and our ability to find and economically develop and produce our reserves. Prices for oil, natural gas and NGLs fluctuate widely and are difficult to predict. To provide information on the general trend in pricing, the average annual NYMEX prices for oil and natural gas for recent years are presented in the table below:
| Year Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| 2023 | 2022 | |||||
| NYMEX WTI Oil (per Bbl) | $ | 77.58 | $ | 94.90 | ||
| NYMEX Henry Hub Natural gas (per Mcf) | $ | 2.63 | $ | 6.68 |
In order to reduce our exposure to price fluctuations, from time to time we enter into commodity derivative contracts for a portion of our anticipated future oil, natural gas, and NGL production as discussed in Item 7A. “Quantitative and Qualitative Disclosures About Market Risk.” During periods where the strike prices for our commodity derivative contracts are below market prices at the time of settlement, we may not fully benefit from increases in the market price of oil, natural gas and NGLs. Conversely, during periods of declining market prices of oil, natural gas and NGL, our commodity derivative contracts may partially offset declining revenues and cash flow to the extent strike prices for our contracts are above market prices at the time of settlement.
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Oil, Natural Gas and NGL Production and Pricing
The table below presents production and pricing information for the years ended December 31, 2023 and 2022.
| Year Ended December 31, | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | Change | ||||||||
| Production data (in thousands) | ||||||||||
| Oil (MBbls) | 1,047 | 949 | 98 | |||||||
| Natural gas (MMcf) | 20,403 | 21,101 | (698) | |||||||
| NGL (MBbls) | 1,705 | 1,997 | (292) | |||||||
| Total volumes (MBoe) | 6,152 | 6,463 | (311) | |||||||
| Average daily total volumes (MBoe/d) | 16.9 | 17.7 | (0.8) | |||||||
| Average prices—as reported (1) | ||||||||||
| Oil (per Bbl) | $ | 74.69 | $ | 92.21 | $ | (17.52) | ||||
| Natural gas (per Mcf) | $ | 1.71 | $ | 4.88 | $ | (3.17) | ||||
| NGL (per Bbl) | $ | 20.83 | $ | 31.88 | $ | (11.05) | ||||
| Total (per Boe) | $ | 24.16 | $ | 39.34 | $ | (15.18) | ||||
| Average prices—including impact of derivative contract settlements | ||||||||||
| Oil (per Bbl) | $ | 74.69 | $ | 92.21 | $ | (17.52) | ||||
| Natural gas (per Mcf) | $ | 2.00 | $ | 4.97 | $ | (2.97) | ||||
| NGL (per Bbl) | $ | 20.83 | $ | 31.72 | $ | (10.89) | ||||
| Total (per Boe) | $ | 25.11 | $ | 39.58 | $ | (14.47) |
___________________
(1)Prices represent actual average prices for the periods presented and do not include the impact of derivative transactions.
Revenues
Consolidated revenues for the years ended December 31, 2023 and 2022 are presented in the table below (in
thousands).
| Year Ended December 31, | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | Change | ||||||||
| Revenues | ||||||||||
| Oil | $ | 78,174 | $ | 87,528 | $ | (9,354) | ||||
| Natural gas | 34,941 | 103,067 | (68,126) | |||||||
| NGL | 35,526 | 63,663 | (28,137) | |||||||
| Total revenues | $ | 148,641 | $ | 254,258 | $ | (105,617) |
Variances in oil, natural gas and NGL revenues attributable to changes in the average prices received for our production and total production volumes sold for the years ended December 31, 2023 and 2022 are shown in the table below (in thousands):
| 2022 oil, natural gas and NGL revenues | $ | 254,258 |
|---|---|---|
| Change due to production volumes in 2023 | (7,514) | |
| Change due to average prices in 2023 | (98,103) | |
| 2023 oil, natural gas and NGL revenues | $ | 148,641 |
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Oil, natural gas and NGL revenues decreased primarily due to lower commodity prices. Production volumes for the year ended December 31, 2023 decreased slightly due to the natural declines of our producing wells, which were partially offset from the production from our new wells and increased ownership interest from our July 2023 acquisition.
Operating Expenses
Operating expenses for the years ended December 31, 2023 and 2022 consisted of the following (in thousands):
| Year Ended December 31, | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | Change | |||||||||
| Lease operating expenses | $ | 41,862 | $ | 41,286 | $ | 576 | |||||
| Production, ad valorem, and other taxes | 10,870 | 15,880 | (5,010) | ||||||||
| Depreciation and depletion—oil and natural gas | 15,657 | 11,542 | 4,115 | ||||||||
| Depreciation and amortization—other | 6,518 | 6,342 | 176 | ||||||||
| Total operating expenses | $ | 74,907 | $ | 75,050 | $ | (143) | |||||
| Lease operating expenses ($/Boe) | $ | 6.80 | $ | 6.39 | $ | 0.41 | |||||
| Production, ad valorem, and other taxes ($/Boe) | $ | 1.77 | $ | 2.46 | $ | (0.69) | |||||
| Depreciation and amortization—oil and natural gas ($/Boe) | $ | 2.54 | $ | 1.79 | $ | 0.75 | |||||
| Production, ad valorem, and other taxes (% of oil, natural gas, and NGL revenue) | 7.3 | % | 6.2 | % | 1.1 | % |
The increase in lease operating expenses was primarily due to inflationary pressures and higher production costs associated with more producing wells from our prior well reactivations and development program as well as increased ownership interest from our July 2023 acquisition during the year ended December 31, 2023.
Production, ad valorem, and other taxes decreased primarily due to lower commodity prices and related revenues. However, production, ad valorem, and other taxes increased as a percentage of oil, natural gas and NGL revenue primarily due to higher oil and gas property valuation assessments by local jurisdictions who use historical commodity price averages that included prior periods that were higher than current commodity prices, when determining ad valorem tax assessments.
The increase in depreciation and depletion for oil and natural gas properties was primarily the result of capital expenditures for 2023 and a decrease in proved reserves at December 31, 2023, primarily as a result of lower SEC prices (as defined below), which increased our depletion rate.
Full cost pool impairment. We did not record a full cost ceiling limitation impairment for the years ended December 31, 2023 or 2022.
Calculation of the full cost ceiling test is based on, among other factors, trailing twelve-month SEC prices as adjusted for price differentials and other contractual arrangements. The SEC prices utilized in the calculation of proved reserves included in the full cost ceiling test at December 31, 2023 were $78.22 per barrel of oil and $2.64 per MMBtu of natural gas, before price differential adjustments.
Based on the SEC prices over the eleven months ended February 1, 2024 and NYMEX strip pricing for March 2024 as of March 1, 2024, we anticipate the SEC prices utilized in the March 31, 2024 full cost ceiling test may be $77.48 per barrel of oil and $2.44 per MMBtu of natural gas, (the "estimated first quarter prices"). Applying these estimated first quarter prices, and holding all other inputs constant to those used in the calculation of our December 31, 2023 ceiling test, no full cost ceiling limitation impairment is indicated for the first quarter of 2024.
However, a full cost ceiling limitation impairment may still be realized in the future based on the outcome of numerous other factors such as additional declines in the actual trailing twelve-month SEC prices, production, lower commodity prices, changes in estimated future development costs and operating expenses, and other revisions to our proved reserves. Any such ceiling test impairments in 2024 could be material to our net earnings.
Full cost pool impairments have no impact to our cash flow or liquidity.
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Other Operating Expenses
Other operating expenses for the years ended December 31, 2023 and 2022 consisted of the following (in thousands):
| Year Ended December 31, | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | Change | |||||||||
| General and administrative | $ | 10,735 | $ | 9,449 | $ | 1,286 | |||||
| Restructuring expenses | 406 | 382 | 24 | ||||||||
| Employee termination benefits | 19 | — | 19 | ||||||||
| (Gain) loss on derivative contracts | (1,447) | (5,975) | 4,528 | ||||||||
| Other operating expense (income) | (157) | (99) | (58) | ||||||||
| Total other operating expenses | $ | 9,556 | $ | 3,757 | $ | 5,799 |
General and administrative expenses increased for the year ended December 31, 2023 primarily due to higher technology, service and personnel costs.
Restructuring expenses represent fees and costs associated with our predecessor company's 2016 bankruptcy filing and our exit from NPB in Colorado.
The following table summarizes derivative activity for the years ended December 31, 2023 and 2022 (in thousands):
| Year Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| 2023 | 2022 | |||||
| (Gain) loss on derivative contracts | $ | (1,447) | $ | (5,975) | ||
| Realized settlement gains (losses) on derivative contracts | $ | 5,876 | $ | 1,525 |
Our derivative contracts are not designated as accounting hedges and, as a result, changes in the fair value of our commodity derivative contracts are recorded quarterly as a component of operating expenses. Internally, management views the settlement of commodity derivative contracts at contractual maturity as adjustments to the price received for oil and natural gas production to determine “effective prices.” In general, cash is received on settlement of contracts due to lower oil and natural gas prices at the time of settlement compared to the contract price for our commodity derivative contracts, and cash is paid on settlement of contracts due to higher oil and natural gas prices at the time of settlement compared to the contract price for our commodity derivative contracts. See Item 7A. “Quantitative and Qualitative Disclosures about Market Risk” of this report for additional discussion of our commodity derivatives.
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Interest (income) expense, net for the years ended December 31, 2023 and 2022 consisted of the following (in thousands):
| Year Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| 2023 | 2022 | |||||
| Interest income (expense), net | ||||||
| Interest income | $ | 10,656 | $ | 2,026 | ||
| Interest expense | ||||||
| Interest expense on letters of credit | $ | (37) | $ | (37) | ||
| Interest expense on right of use assets | (64) | (36) | ||||
| Interest expense - other | (3) | (143) | ||||
| Total interest expense | (104) | (216) | ||||
| Total interest income (expense), net | $ | 10,552 | $ | 1,810 |
Interest (income) expense, net during the year ended December 31, 2023 is primarily comprised of interest income received from cash deposits. Interest (income) expense, net during the year ended December 31, 2022 is primarily comprised of interest income received from cash deposits partially offset by interest paid on royalty obligations of $0.1 million, interest on vehicle leases and letters of credit.
Other income (expense), net
The Other income (expense), net line item was not significant for the year ended December 31, 2023. For the year ended December 31, 2022, Other income (expense), net of $0.4 million is primarily comprised of gains on the sale of fleet vehicles and the removal of previously accrued liabilities due to a change in estimate.
Income tax (benefit)
We recorded income tax expense and benefit of $14.0 million and $64.5 million for the years ended December 31, 2023 and 2022, respectively, which directly relates to our partial valuation allowance release. As the partial valuation allowance release as of December 31, 2023 was lower than the partial valuation allowance release as of December 31, 2022 of $64.5 million, we recognized $14.0 million of deferred federal and state income tax expense for the year ended December 31, 2023.
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Liquidity and Capital Resources
At December 31, 2023, our cash and cash equivalents, including restricted cash, was $253.9 million. We expect our cash on hand and cash from operations to be adequate to meet our short and long-term liquidity needs. As of March 1, 2024, the Company had no outstanding term or revolving debt obligations.
Working Capital and Sources and Uses of Cash
Our principal sources of liquidity for 2024 include cash flow from operations and cash on hand.
Our working capital decreased to $228.5 million at December 31, 2023, compared to $241.6 million at December 31, 2022. Dividend payments to shareholders of $81.5 million, $26.4 million in capital expenditures, and $11.2 million related to an acquisition of proved reserves were the primary drivers in the reduction of working capital. These cash outflows were offset by $115.6 million in cash provided by operating activities.
In May 2023, the Board approved a one-time cash dividend of $2.00 per share of the Company’s common stock, which was paid on June 7, 2023 to shareholders of record as of the close of business on May 24, 2023. The aggregate total payout was $73.8 million. Additionally, in May 2023, the Board announced plans for a regular quarterly dividend of $0.10 per share, subject to quarterly approval by the Board. The Company paid quarterly dividends of $3.7 million each on August 28, 2023 and November 27, 2023, totaling $7.4 million, as well as dividends on vested stock awards of $0.3 million for the year. Total special and regular dividends for the year ended December 31, 2023 were $81.5 million. See Note 13 for further discussion of the Company’s dividends.
Cash Flows
Our cash flows from operations are substantially dependent on current and future prices for oil, natural gas and NGL, which historically have been, and may continue to be, volatile. For example, during the period from January 2019 through December 2023, the NYMEX WTI settled price for oil fluctuated between a high of $123.64 per Bbl and a low of $(36.98) per Bbl, and the NYMEX Henry Hub spot prices for gas fluctuated between a high of $24.77 per Mcf and a low of $1.38 per Mcf.
If oil, natural gas and NGL prices decline from current levels, they could have a material adverse effect on our financial position, results of operations, cash flows and quantities of oil, natural gas and NGL reserves that may be economically produced. Further, if our future capital expenditures are limited or deferred, or we are unsuccessful in developing reserves and adding production through our capital program, the value of our oil and natural gas properties, financial condition and results of operations could be adversely affected. Cash flows from operations are also affected by timing of cash receipts and disbursements and changes in other working capital assets and liabilities.
Cash flows for the years ended December 31, 2023, and 2022 are presented in the following table and discussed below (in thousands):
| Year Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| 2023 | 2022 | |||||
| Cash flows provided by operating activities | $ | 115,578 | $ | 164,696 | ||
| Cash flows used in investing activities | (36,164) | (45,117) | ||||
| Cash flows used in financing activities | (82,938) | (1,635) | ||||
| Net (decrease) increase in cash, cash equivalents and restricted cash | $ | (3,524) | $ | 117,944 |
Cash Flows from Operating Activities
The $49.1 million decrease in operating cash flows for the year ended December 31, 2023 compared to 2022, is primarily due to a decrease in revenues from lower commodity prices. The changes in operating assets and liabilities do not include changes in accounts payable or accrued expenses attributable to capital expenditures noted in the capital expenditure table below.
See “Consolidated Results of Operations” for further analysis of the changes in revenues and operating expenses.
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Cash Flows from Investing Activities
During the year ended December 31, 2023, cash flows used in investing activities primarily reflects capital expenditures of $26.4 million made for drilling and completions, capital workovers, and well reactivations and $11.2 million related to an acquisition of proved reserves, which increased ownership interests in properties operated by the Company. Cash outflows were partially offset by $1.5 million of proceeds from the sale of equipment related to our oil and gas assets.
During the year ended December 31, 2022, cash flows used in investing activities primarily reflects capital expenditures of $44.1 million related to drilling and completions, capital workovers, well reactivations, and inventory purchases and $1.4 million related to an acquisition of proved reserves. Cash outflows were partially offset by $0.4 million of proceeds from the sale of assets.
See "Note 3— Acquisitions and Divestitures of Assets and Oil and Gas Properties" to the accompanying consolidated financial statements included in Item 8 of this report for additional information.
Capital Expenditures.
Our capital expenditures for the years ended December 31, 2023 and 2022, are summarized below (in thousands):
| Year Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| 2023 | 2022 | |||||
| Capital Expenditures | ||||||
| Drilling and completions | $ | 18,132 | $ | 38,077 | ||
| Capital workovers | 4,346 | 10,322 | ||||
| Leasehold and geophysical | (46) | 809 | ||||
| Capital expenditures, excluding acquisitions (on an accrual basis) | 22,432 | 49,208 | ||||
| Acquisitions | 11,232 | 1,431 | ||||
| Capital expenditures, including acquisitions | 33,664 | 50,639 | ||||
| Changes in accounts payable and accrued expenses | 5,232 | (5,123) | ||||
| Inventory material transfers to oil and natural gas properties | $ | (1,289) | $ | — | ||
| Total cash paid for capital expenditures, including acquisitions | $ | 37,607 | $ | 45,516 |
Capital expenditures, excluding acquisitions, for development activities decreased for the year ended December 31, 2023 compared to 2022, primarily due to the conclusion of our drilling program in the second quarter of 2023.
Cash Flows from Financing Activities
Our financing activities used $82.9 million of cash for the year ended December 31, 2023, consisting primarily of $81.5 million in cash dividends, $0.9 million of cash used for tax withholdings paid in exchange for shares withheld on employee vested stock awards that were settled by net exercise, and finance lease payments of $0.6 million offset by $0.1 million of proceeds from the exercise of stock options. Net exercises of stock awards allows the holder of a stock award to tender back to us a number of shares at fair value upon the vesting of such stock award, t
hat equals the employee payroll tax obligation due. We then remit a cash payment to the relevant taxing authority on behalf of the employee for their payroll tax obligations resulting from the vesting of their stock award.
Our financing activities used $1.6 million of cash for the year ended December 31, 2022, consisting primarily of $1.2 million of cash used for tax withholdings paid in exchange for shares withheld on employee vested stock awards that were settled by net exercise, and finance lease payments of $0.5 million offset by $0.1 million of proceeds from the exercise of stock options. See discussion in above paragraph for additional information on net exercises of stock awards.
Share Repurchase Program
In May 2023, the Board approved a share repurchase program (the “Program”) authorizing the Company to repurchase up to an aggregate of $75.0 million of the Company’s outstanding common stock with the Company’s cash on hand. The Program replaced the prior share repurchase program previously approved by the Board in August 2021. Purchases under the Program are intended to meet the requirements of Rule 10b5-1 of the Exchange Act. The Program does not require any specific number of shares to be acquired, and can be modified or discontinued by the Board at any time. The Company did not repurchase any common stock under the existing or prior Program during the years ended December 31, 2023 and 2022.
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Contractual Obligations and Off-Balance Sheet Arrangements
At December 31, 2023, our contractual obligations included asset retirement obligations and short and long-term leases. Additionally, we have certain financial instruments representing potential commitments that were incurred in the normal course of business to support our operations, including surety bonds. The underlying liabilities insured by these instruments are reflected in our balance sheets, where applicable. Therefore, no additional liability is reflected for the surety bonds or other instruments.
As of December 31, 2023, we had future contractual commitments under various agreements, which are summarized below. The short-term leases and operating lease are not recorded in the accompanying consolidated balance sheets.
| Payments Due by Period | ||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Total | Less than1 year | 1-3 years | 3-5 years | More than5 years | ||||||||||||||
| (In thousands) | ||||||||||||||||||
| Asset retirement obligations (1) | $ | 64,404 | $ | 9,851 | $ | — | $ | — | $ | 54,553 | ||||||||
| Operating lease | 167 | 167 | — | — | — | |||||||||||||
| Short-term leases | 1,773 | 1,773 | — | — | — | |||||||||||||
| Finance lease | 1,311 | 616 | 695 | — | — | |||||||||||||
| Total | $ | 67,655 | $ | 12,407 | $ | 695 | $ | — | $ | 54,553 |
____________________
(1)Asset retirement obligations are based on estimates and assumptions that affect the reported amounts as of December 31, 2023. These estimates and assumptions can be inherently unpredictable and may differ from actual results given the uncertainty of when we may be required to plug and abandon a well or retire an asset. As a result, we may not incur all of the estimated costs for the current asset retirement obligation as depicted above. During the year ended December 31, 2023, plugging and abandonment costs incurred were $0.9 million.
Critical Accounting Estimates
The discussion and analysis of the Company’s financial condition and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of the Company’s financial statements requires management to make assumptions and prepare estimates that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. Estimates are based on historical experience and various other assumptions believed to be reasonable; however, actual results may differ significantly. The Company’s critical accounting policies and additional information on significant estimates are discussed below. See “Note 1—Summary of Significant Accounting Policies” to the Company’s accompanying consolidated financial statements in Item 8 of this report for additional discussion of significant accounting policies.
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Proved Reserves. Approximately 95.2% of the Company’s reserves were estimated by independent petroleum engineers as of December 31, 2023. Estimates of proved reserves are based on the quantities of oil, natural gas and NGLs that geological and engineering data demonstrate, with reasonable certainty, to be recoverable in future years from known reservoirs under existing economic and operating conditions. However, there are numerous uncertainties inherent in estimating quantities of proved reserves and in projecting future revenues, rates of production and timing of development expenditures, including many factors beyond the Company’s control. Estimating reserves is a complex process of estimating underground accumulations of oil and natural gas that cannot be measured in an exact manner and relies on assumptions and subjective interpretations of available geologic, geophysical, engineering and production data. The accuracy of reserve estimates is a function of the quality and quantity of available data, engineering and geological interpretation and judgment. In addition, as a result of volatility and changing market conditions, commodity prices and future development costs will change from period to period, causing estimates of proved reserves to change, as well as causing estimates of future net revenues to change. When excluding the effects of pricing, the Company revised its proved reserves an average of approximately 5% over the past five years and the revisions for the year ended December 31, 2023 were less than 3%. In the future, estimates of proved reserves could also be influenced by production performance indicating more (or less) reserves in place, larger (or smaller) reservoir size than initially estimated or additional proved reserve bookings within the original field boundaries among other factors. Estimates of proved reserves are key components of the Company’s financial estimates used to determine depreciation and depletion on oil and natural gas properties and its full cost ceiling limitation. Future revisions to estimates of proved reserves may be material and could materially affect the Company’s future depreciation, depletion and impairment expenses. See Proved Reserves discussion in Part I, Item 1 of this Form 10-K for additional detail.
Depreciation and Depletion of Oil and Natural Gas Properties. In accordance with full cost accounting rules, capitalized costs are amortized using the unit-of-production method. Under this method, depreciation and depletion is computed at the end of each quarter by multiplying total production for the quarter by a depletion rate. The depletion rate is determined by dividing the total unamortized cost base plus future development costs by net equivalent proved reserves at the beginning of the quarter. See above discussion on the uncertainty of proved reserves estimates. If we maintain the same level of production year over year, the depreciation and depletion of oil and natural gas properties may be significantly different if our estimate of remaining reserves or future development costs changes significantly. The average rates used for depreciation and depletion of oil and natural gas properties were $1.82 per Boe in 2023 and $1.18 per Boe in 2022.
Impairment of Oil and Natural Gas Properties. In accordance with full cost accounting rules, capitalized costs are subject to a limitation. The capitalized cost of oil and natural gas properties, net of accumulated depreciation, depletion and impairment, less related deferred income taxes and electrical infrastructure costs, may not exceed an amount equal to the ceiling limitation. The Company calculates its full cost ceiling limitation using SEC prices adjusted for basis or location differentials, held constant over the life of the reserves. See above discussion on the uncertainty of proved reserves estimates. If capitalized costs exceed the ceiling limitation, the excess must be charged to expense. Once incurred, a write-down cannot be reversed at a later date. The Company did not record any impairment for the years ended December 31, 2023 or 2022.
Asset Retirement Obligations. Asset retirement obligations represent the estimate of fair value of the cost to plug, abandon and remediate the Company’s wells at the end of their productive lives, in accordance with applicable federal and state laws. The Company estimates the fair value of an asset’s retirement obligation in the period in which the liability is incurred (at the time the wells are drilled or acquired). Estimating future asset retirement obligations requires management to make estimates and judgments regarding timing, existence of a liability and what constitutes adequate restoration. The Company employs a present value technique to estimate the fair value of an asset retirement obligation, which reflects certain assumptions and requires significant judgment, including an inflation rate, its credit-adjusted risk-free interest rate, the estimated settlement date of the liability and the estimated current cost to settle the liability based on current actual costs. Inherent in the present value calculation are the timing of settlement and changes in the legal, regulatory, environmental and political environments, which are subject to change. Changes in timing or to the original estimate of cash flows will result in changes to the carrying amount of the liability. For the years ended December 31, 2023 and 2022, the Company revised its asset retirement obligations by approximately $0.9 million downwards and $2.7 million upwards, respectively, due primarily to changes in working interest and estimated well lives.
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Income Taxes. Deferred income taxes are recorded for temporary differences between the financial statement and income tax basis of assets and liabilities. Deferred tax assets are recognized for temporary differences that will be deductible in future years’ tax returns and for operating loss and tax credit carryforwards. Deferred tax assets are reduced by a valuation allowance if it is deemed more likely than not that some or all of the deferred tax assets will not be realized. Deferred tax liabilities are recognized for temporary differences that will be taxable in future years’ tax returns. In assessing the realizability of the deferred tax assets, we consider whether it is more likely than not that some or all of the deferred tax assets will not be realized. The ultimate realization of the deferred tax assets is dependent upon the generation of future income in periods in which the deferred tax assets can be utilized. Upon emergence from bankruptcy and the application of fresh start accounting in 2016, our tax basis in oil and gas properties and property, plant, and equipment exceeded the book carrying value of our assets. Additionally, we had significant U.S. federal net operating losses remaining after the attribute reduction caused by the restructuring transactions. As such, the successor Company had significant deferred tax assets to consume upon emergence. In prior years, we determined that the deferred tax assets did not meet the more likely than not threshold of being utilized and thus recorded a valuation allowance. Our partial valuation release of $64.5 million as of December 31, 2022 was partially offset by $14.0 million due to changes in expected future income, resulting in net deferred tax assets of $50.6 million as of December 31, 2023. We anticipate being able to utilize these deferred tax assets based on the generation of future income. A change in the estimate of future income could cause the valuation allowance to be adjusted in subsequent periods.
New Accounting Pronouncements. For a discussion of recently adopted accounting standards and recent accounting standards not yet adopted, see “Note 1—Summary of Significant Accounting Policies” to the Company’s accompanying consolidated financial statements in Item 8 of this report.
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