April 14, 2016 - 9:40 AM EDT
Print Email Article Font Down Font Up
ARABELLA EXPLORATION, INC. - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion may contain forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed here. Factors that could cause or contribute to such differences include, but are not limited to, any factors discussed in this section as well as factors described in "Part II, Item 1A - Risk Factors."


Overview


We are an independent oil and natural gas company focused on the acquisition, development, exploration and exploitation of unconventional, long-life, onshore oil and natural gas reserves in the Delaware Basin in West Texas, which is a part of the Permian Basin. Our activities have historically been directed at the Avalon, Bone Springs, and Wolfcamp formations, which we refer to collectively as the Wolfbone play.

Substantially all of our revenues are generated through the sale of oil, natural gas liquids and natural gas production, though we do on occasion sell parcels of our land when the opportunity to generate profit presents itself. Our production was approximately 83% oil, no natural gas liquids and 17% natural gas for the year ended December 31, 2015, approximately 86% oil, no natural gas liquids and 14% natural gas for the year ended December 31, 2014. On December 31, 2015, our net acreage position in the Delaware Basin was approximately 1,562 net acres. On December 31, 2014, our net acreage position in the Delaware Basin was approximately 4,972 net acres. We are not currently engaged in any drilling activity due to the reduced price of oil.

We were organized on June 17, 2010 as an exempted company under the laws of the Cayman Islands. We were a blank check company formed to acquire through a merger, capital stock exchange, asset acquisition, stock purchase or similar business combination, or control through contractual arrangements, one or more operating businesses. On October 23, 2013, we entered into an Agreement and Plan of Merger and Reorganization to acquire Arabella, LLC, a Texas limited liability company (the "Acquisition"). On December 24, 2013, we consummated the Acquisition with Arabella LLC, as more fully described in our Annual Report on Form 20-F for the year ended December 31, 2013 filed on May 15, 2014. On February 4, 2013, we changed our name from Lone Oak Acquisition Corporation to Arabella Exploration, Inc.

During 2015 the dramatic and continuing decline in oil and gas prices caused significant damage to our assets and business. Among other things, we were forced to write down the value of our oil and gas assets by $21,202,608 reflecting acreage and wells lost to lease expiration and the reduced production economics on our producing wells. Reduced oil pricing has also dramatically reduced our proven reserves through the reduction in the dollar value of our reserve barrels of oil and the number of barrels that we can produce economically over the expected life of ours wells. The adverse pricing conditions have lead to operating losses which were exacerbated by the non-cash earnings charge for the oil and gas asset impairment. Further, the reduced revenue resulting from the prices for oil and gas has left us unable to service and repay our Senior Secured Notes which came due on September 2, 2015.


Future Activity


Any future drilling and completion activity will be highly dependent on the recovery of prices for crude oil. If oil prices do not rebound significantly in a short time, it is highly unlikely that we will drill new wells. We are not currently engaged in any drilling activity due to the reduced price of oil.


Operating Results Overview


During the year ended December 31, 2015, our average daily production was approximately 84 BOE, consisting of 70 Bbls/d of oil, 87 Mcf/d of natural gas and no natural gas liquids, this is a decrease from the year ending December 31, 2014, when our average daily production was approximately 118 BOE, consisting of 102 Bbls/d of oil, 99 Mcf/d of natural gas and no natural gas liquids.

Through the year ended December 31, 2015, we had participated in 8 gross (2.96 net) operated wells in the Delaware Basin.


  36






Reserves and pricing


In the table below, WDVG estimated all of our proved reserves at December 31, 2015 and WPC at December 31, 2014. The prices used to estimate proved reserves for all periods were held constant throughout the life of the properties and have been adjusted for quality, transportation fees, geographical differentials, marketing bonuses or deductions and other factors affecting the price received at the wellhead.



                                  December 31,
Estimated Net Proved Reserves:        2015           December 31, 2014

Oil (MBbls)                               785.5                 2,509.9
Natural gas (MMcf)                      1,571.8                 7,804.8
Total (MBOE)                            1,047.4                 3,810.7




                      December 31,       December 31,
                          2015               2014
                      Unweighted Arithmetic Average
                      First-Day-of-the-Month Prices
Oil (Bbls)          $          50.16     $       85.54
Natural gas (Mcf)               2.64              5.51




Sources of our revenue



Our revenues are derived from the sale of oil and natural gas production, as well as the sale of natural gas liquids that are extracted from our natural gas during processing. For the years ended December 31, 2015 and December 31, 2014 our revenues were derived 91% and 94%, respectively, from oil sales, 0% and 0%, respectively, from natural gas liquids sales and 9% and 6%, respectively, from natural gas sales. Our revenues may vary significantly from period to period as a result of changes in volumes of production sold or changes in commodity prices. Oil, natural gas liquids and natural gas prices have historically been volatile. During 2015, West Texas Intermediate posted prices ranged from $34.55 to $61.36 per Bbl and the Henry Hub spot market price of natural gas ranged from $1.63 to $3.32 per MMBtu. On December 31, 2015, the West Texas Intermediate posted price for crude oil was $37.13 per Bbl and the Henry Hub spot market price of natural gas was $2.28 per MMBtu.

During the year ended December 31, 2014, we had other revenue from the gain on sale of oil and gas properties.

Principal components of our cost structure

Lease operating expenses. These are daily costs incurred to bring oil and natural gas out of the ground and to the market, together with the daily costs incurred to maintain our producing properties. Such costs also include maintenance, repairs and workover expenses related to our oil and natural gas properties.

Ad valorem and production taxes. Production taxes are paid on produced oil and natural gas based on a percentage of revenues from products sold at fixed rates established by federal, state or local taxing authorities. Arabella is also subject to ad valorem taxes in the counties where our production is located. Ad valorem taxes are generally based on the valuation of our oil and gas properties.

Depreciation, depletion and amortization. We follow the successful efforts method for oil and gas properties, whereby costs of productive wells, developmental dry holes and productive leases are capitalized into appropriate groups of properties based on geographical and geological similarities. These capitalized costs are amortized on a field by field basis using the unit-of-production method based on estimated proved reserves. Additionally, gain or loss is generally recognized on all sales of natural gas and oil properties under the successful efforts method.

Exploration expense. Exploration costs, including geological and geophysical expenses and delay rentals, are charged to expense as incurred. Exploratory drilling costs, including the cost of stratigraphic test wells, are initially capitalized but charged to exploration expense if and when the well is determined to be nonproductive. The determination of an exploratory well's ability to produce must be made within one year from the completion of drilling activities. The acquisition costs of unproved acreage are initially capitalized and are carried at cost, net of accumulated impairment provisions, until such leases are transferred to proved properties or charged to exploration expense as impairments of unproved properties.


  37





General and administrative. These are costs incurred for overhead, including payroll and benefits for our corporate staff, costs of maintaining our headquarters, costs of managing our production and development operations, franchise taxes, audit and other fees for professional services and legal compliance. In 2014 we had an expense sharing agreement with APC concerning rent and certain other office expenses.


                                                                             Year Ended
                                                                   December 31,      December 31,
                                                                       2015              2014

Revenues:
Oil and gas revenue                                                $   1,475,856     $   3,408,296
Other revenue - administrative overhead                                   39,600                 -
Other operating revenue - gain on sale of oil and gas properties               -         3,084,917
Total revenues                                                         1,515,456         6,493,213
Costs and expenses:
Lease operating expenses                                               1,100,312         1,633,456
Ad valorem and production taxes                                           73,182           153,231
Depreciation, depletion and amortization                                 767,116         1,444,315
(Reduction) accretion of asset retirement obligation                      (1,353 )           1,770
General and administrative expenses                                    2,876,348         5,154,056
Impairment of oil and gas properties                                  21,202,608                --
Total costs and expenses                                              26,018,213         8,386,827
Loss from operations                                                 (24,502,757 )      (1,893,614 )
Other expense
Interest expense, related party                                                            (40,722 )
Interest expense                                                      (7,153,516 )      (2,882,212 )
Total other expense                                                   (7,153,516 )      (2,922,934 )
Net loss before taxes                                                (31,656,273 )      (4,816,548 )
Provision for income taxes                                                    --                --
Net loss                                                           $ (31,656,273 )   $  (4,816,548 )




                                            December 31,       December 31,
                                                2015               2014
Production Data:
Oil (Bbls)                                         25,408             37,191
Natural gas (Mcf)                                  31,746             36,258
Combined volumes (BOE)                             30,699             43,234
Daily combined volumes (BOE/d)                       84.1              118.5
Average Prices(1):
Oil (per Bbl)                              $        39.03     $        85.97
Natural gas (per Mcf)                                3.07               4.23
Combined (per BOE)                                  35.47              77.50
Average Costs (per BOE):
Lease operating expense                    $        35.84     $        37.78
Production Taxes                                     2.38               3.54
Production Taxes as a % of sales                      5.0 %              4.5 %
Depreciation, depletion and amortization            24.99              33.41
General and Administrative                          93.70             116.32




  38





Comparison of Years ended December 31, 2015 and December 31, 2014

Oil and Natural Gas Revenues. Our oil and natural gas revenues decreased by $1,932,440, or 57%, to $1,475,856 for the year ended December 31, 2015, as compared to $3,408,296 for the year ended December 31, 2014. Our revenues are a function of oil and natural gas production volumes sold and average sales prices received for those volumes. The major reason for the decrease in revenues is due to the dramatic decline in oil and gas prices from the prior year as well as decreased production.

Other Revenue. Other revenue relates to administrative overhead fees paid to Arabella Operating by other working interest owners to operate our wells. Arabella Operating was paid $39,600 for the year ended December 31, 2015 and did not operate our wells for the year ended December 31, 2014.

Other Operating Revenue. Other operating revenue in 2014 relates to oil and gas property sales. In 2014, we sold properties for $5,665,121 with a net profit of $3,084,917. We did not have any property sales in 2015. Other operating revenue from the sale of oil and gas properties fluctuates due to market demand and preparation of the land. We buy and sell parcels of land when the opportunity to generate significant profit presents itself.

Lease Operating Expense. Lease operating expenses decreased from $1,633,456 in 2015 to $1,100,3120 in 2014. This decrease is the direct result of reduced activity on our wells in response to the dramatic decline in oil and gas prices from the prior year. Lease operating expenses can vary based upon conditions at the well site and well productivity. We experienced significant difficulties in operating our wells during 2014 that increased our costs including power issues for our artificial lift systems and other logistical challenges. We also incurred over $500,000 of non-recurring professional costs associated with our operations in 2014 in the form of billings from the operator of our wells for legal, accounting and other items incurred by the operator.

Ad Valorem and Production Tax Expense. Ad valorem and production taxes as a percentage of oil and natural gas revenues increased for 2015 as compared to 2014. There was an overall reduction in taxes due to the revenue decrease discussed above. Ad valorem and production taxes are primarily based on the market value of our production at the wellhead and may vary across the different counties in which we operate.

Depreciation, Depletion and Amortization. Depreciation, depletion and amortization expense decreased from $1,444,315 in 2014 to $767,116 in 2015. The decrease is related to reduced production due to the decline in oil and gas prices.

General and Administrative. General and administrative expenses decreased from $5,154,056 in 2014 to $2,876,348 in 2015. These expenses relate primarily to salaries and wages, legal fees and professional fees. The decrease is related to reduction general and administrative costs related to reduced activity and cost cutting measures taken in response to the dramatically lower prices for oil in gas as opposed to the prior year.

Impairment of Oil and Gas Assets. Impairment of oil and gas assets for the year ended December 31, 2015 was $21,202,608. The impairment was due to the prolonged decline in the price of oil and gas which changed the recovery economics and expected future revenue of our producing wells and forced us to incur an impairment charge. In addition, a number of our properties were lost to lease expiration in 2015.

Liquidity and Capital Resources

Our primary sources of liquidity have previously been oil and gas sales revenue and the sales of certain properties as well as equity contributions from the Acquisition and equity and loans from our founder Jason Hoisager as well as loans from Hauser Holdings, LLC and BBS Capital Fund, LP, affiliates of two of our directors and the Senior Secured Note Facility entered into on September 2, 2014 (the "Notes"). Currently, our only source of liquidity is our ongoing sales of oil and gas. Our primary uses of capital have been the acquisition, development and exploration of oil and natural gas properties. As we pursue reserves and production growth, we regularly consider which capital resources, including equity and debt financings, are available to meet our future financial obligations, planned capital expenditure activities and liquidity requirements. Our future ability to grow proved reserves and production will be highly dependent on the capital resources available to us.

The Notes became due on September 2, 2015 and the Company was unable to repay them and is continuing to negotiate with its Senior Lender.


  39





The rapid and substantial decline in oil prices in the later part of 2014 and in 2015 significantly reduced the amount of revenue we receive per barrel of oil. Approximately 91% of our oil and gas revenue comes from oil sales. This decline has reduced our revenue and, as a result, our cash flow, which limits our operations and could limit our future growth. Our current cash position and current level of operating cash flows is not, in aggregate, adequate to support our current working capital requirements, interest costs and, at the same time, support additional drilling activity. The current oil pricing environment and related conditions raise substantial doubt about the Company's ability to continue as a going concern. Management is exploring various opportunities to remedy the Company's liquidity concerns.


Liquidity and cash flow


We commenced oil and gas exploration activities in 2011 and had a working capital deficit of $24,514,819 as of December 31, 2015 largely consisting of our Notes discussed below, accrued liabilities and advances from affiliates. Our net cash flow for the year ended December 31, 2015 was an increase of $70,470, the components of which are described below. Our net cash flow for the year ended December 31, 2014 was a decrease of $2,115,531. We are not currently drilling any new wells; if we were to resume drilling we might need approximately $40 million to fund our operations during the next twelve months, which will include minimum annual property lease payments, well expenditures and operating costs and expenses, however, if oil prices do not rebound significantly in a short time it is highly unlikely that we will resume drilling or drill at such a high pace. In the event that we begin new drilling operations we may require additional funding in 2016.

On September 2, 2014 we sold $16,000,000 of Notes under our $45,000,000 Senior Secured Note Facility, with further sales during the term of the facility to be based upon reserve based performance hurdles. No additional Notes were issued. The Notes became due on September 2, 2015; we were unable to repay them and are continuing to negotiate with our Senior Lender.

Additionally, in the event we are able to redeem our offering warrants, they would likely be exercised resulting in the receipt of proceeds up to $20,532,500. There can be no assurance we will redeem the offering warrants.


Operating Activities


Net cash used in operating activities was $1,368,294 for the year ended December 31, 2015, as compared to net cash used in operating activities of $3,351,574 for the year ended December 31, 2014. The decrease in cash flows used in operating activities is largely a result of the loss from operations in 2015 increasing over that in 2014 and being offset by increase in accounts payable in 2015 and sale of oil and gas properties in 2014.


Investing Activities


The purchase and development of oil and natural gas properties accounted for the majority of our cash outlays for investing activities.

We used net cash for investing activities of $501,841 and $13,776,966 for the years ended December 31, 2015 and 2014, respectively. During the year ended December 31, 2014, we received proceeds of $5,665,121 from sales of oil and gas properties. We used cash for investing in oil and natural gas properties in the amounts of $501,841 and $18,945,118 for the years ended December 31, 2015 and 2014, respectively. We used cash for investing in property and equipment in the amount of $496,969 for the year ended December 31, 2014 and none in 2015. We also invested $25,000 in our affiliate Arabella Operating, LLC to post its operating bond for the Texas Railroad Commission during the year ended December 31, 2014.



Financing Activities



During the year ended December 31, 2015 we received an aggregate of $1,950,605 in advances from affiliates and shareholders, which are repayable on demand without interest. During the year ended December 31, 2015 we paid $10,000 towards our outstanding term note. During the year ended December 31, 2014 we received $1,300,000 in loans from affiliates of two of our directors. On September 4, 2014 we repaid our loans from BBS Capital Fund, LP and Hauser Holdings, LLC with accrued interest for total repayment of $512,500 and $828,222, respectively.

On June 26, 2014 our Chief Executive Officer Jason Hoisager purchased 190,477 of our ordinary shares for $10.50 a share in a private transaction from us.


  40






Senior Secured Note Facility


On September 2, 2014 we entered into a $45,000,000 Senior Secured Note Facility (the "Notes") with a New York based investor (the "Investor"). The sale of $16,000,000 in Notes occurred on September 2, 2014 with further sales during the term of the facility to be based upon reserve based performance hurdles. No additional Notes were issued. The Notes bear interest at an annual rate of 15%, of which six months was prepaid at close. We paid a 3% origination fee to the Investor and a 5% cash commission to our advisors on the transaction. In conjunction with the sale of the Notes, we issued warrants to purchase 1,300,000 of our ordinary shares at a price of $5.00 per share. The warrants expire on September 2, 2019. The Notes became due on September 2, 2015; we were unable to repay them and are continuing to negotiate with our Senior Lender.

On January 21, 2016 we received notice from our Senior Lender that they were declaring the Notes in default as of June 4, 2015. While we do not necessarily believe that additional interest is due, we have recorded an accrued interest charge in the amount of $591,620 at December 31, 2015 to reflect the maximum possible difference between the original Note interest and the default Note interest provisions.

The Notes are the senior secured obligations of the Company and, with certain exceptions, are secured by first lien positions on all of the Company's assets and property.

Capital Requirements, Sources of Liquidity and Ability to Continue as a Going Concern

We are not currently drilling any new wells; if we were to resume drilling we might need approximately $40 million to fund our operations during the next twelve months, which will include minimum annual property lease payments, well expenditures and operating costs and expenses, however, if oil prices do not rebound significantly in a short time it is highly unlikely that we will resume drilling or drill at such a high pace. In the event that we begin new drilling operations we may require additional funding in 2016.

The amount and timing of any capital expenditures is largely discretionary and within our control. We could choose to defer a portion of any planned capital expenditures depending on a variety of factors, including but not limited to raising of outside capital, the success of our drilling activities, prevailing and anticipated prices for oil and natural gas, the availability of necessary equipment, infrastructure and capital, the receipt and timing of required regulatory permits and approvals, seasonal conditions, drilling and acquisition costs and the level of participation by other interest owners.

Additionally, while some of our capital expenditures will be financed through operations, the majority of these costs will require outside financing.

The current oil pricing environment, the amounts due on the Senior Secured Note Facility and related conditions raise substantial doubt about our ability to continue as a going concern. Our ability to continue as a going concern is dependent on our ability to generate revenue from oil and gas operations or asset sales and achieve profitable operations and to generate sufficient cash flow from financing and operations to meet our obligations, as they become payable. We have plans to explore additional alternatives to our existing oil and gas activities to generate revenue in the current oil pricing environment. Although there are no assurances that our plans will be realized we believe that we will be able to continue operations in the future.


Critical Accounting Policies


Readers of this report and users of the information contained in it should be aware that certain events may impact our financial results based on the accounting policies in place. The policies we consider to be the most significant are discussed below.

The process of preparing financial statements in conformity with accounting principles generally accepted in the United States of America ("GAAP") requires management to make estimates and assumptions that affect reported amounts of certain assets, liabilities, revenues and expenses. We believe our estimates and assumptions are reasonable; however, actual results may differ materially from such estimates.

The selection and application of accounting policies are an important process that changes as our business changes and as accounting rules are developed. Accounting rules generally do not involve a selection among alternatives, but involve an implementation and interpretation of existing rules and the use of judgment to the specific set of circumstances existing in our business.


  41





We review our proved oil and natural gas properties for impairment whenever events and circumstances indicate that a decline in the recoverability of their carrying value may have occurred. We estimate the expected undiscounted future cash flows of its oil and natural gas properties and compare such undiscounted future cash flows to the carrying amount of the oil and natural gas properties to determine if the carrying amount is recoverable. If the carrying amount exceeds the estimated undiscounted future cash flows, we will adjust the carrying amount of the oil and natural gas properties to fair value.

The factors used to determine fair value are subject to management's judgment and expertise and include, but are not limited to, recent sales prices of comparable properties, the present value of future cash flows, net of estimated operating and development costs using estimates of proved reserves, future commodity pricing, future production estimates, anticipated capital expenditures and various discount rates commensurate with the risk and current market conditions associated with realizing the expected cash flows projected. Impairment of oil and gas assets for the year ended December 31, 2015 was $21,202,608. The impairment was due to the prolonged decline in the price of oil and gas which changed the recovery economics and expected future revenue of our producing wells and forced us to incur an impairment charge. In addition, a number of our properties were lost to lease expiration in 2015. No impairment of proved oil and natural gas properties was recorded for year ended December 31, 2014.



Oil and Gas Properties



The accounting for our business is subject to accounting rules that are unique to the oil and natural gas industry. There are two allowable methods of accounting for oil and natural gas business activities: the successful efforts method and the full cost method. We follow the successful efforts method that requires that geological and geophysical costs and costs of carrying and retaining undeveloped properties are charged to expense as incurred. Costs of drilling exploratory wells that do not result in proved reserves are charged to expense. Depreciation, depletion, amortization and impairment of oil and gas properties are generally calculated on a well by well in a field by field basis versus the aggregated "full cost" pool basis under the full cost method. Additionally, gain or loss is generally recognized on all sales of natural gas and oil properties under the successful efforts method. As a result, our financial statements will differ from those of companies that apply the full cost method since we will generally reflect a lower level of capitalized costs as well as a lower oil and gas depreciation, depletion and amortization rate, and we may have exploration expenses that full cost companies do not have.

Under the full cost method, capitalized costs are amortized on a composite unit-of-production method based on proved natural gas and oil reserves. Under the full cost method, a company that maintains the same level of production year over year may report significantly different the depreciation, depletion and amortization expense if estimated remaining reserves or future development costs change significantly. Proceeds from the sale of properties are accounted for as reductions of capitalized costs unless such sales involve a significant change in proved reserves and significantly alter the relationship between costs and proved reserves, in which case a gain or loss is recognized. The costs of unproved properties are excluded from amortization until the properties are evaluated.


Revenue


We utilize the sales method of accounting for oil and natural gas revenues whereby revenues, net of royalties, are recognized as the production is received by purchasers. The amount of gas sold may differ from the amount to which we are entitled based on our revenue interests in the properties. We did not have any significant gas imbalance positions at December 31, 2015 or December 31, 2014.


Income Taxes


We were subject to Federal income taxes for 2015 and 2014 but had taxable losses so we did not pay any federal income tax.

We are subject to federal and state income based taxes and we use the asset and liability method to account for income taxes. Under this method of accounting for income taxes, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in enacted tax rates is recognized in the statements of operations in the period that includes the enactment date. We had no deferred state income taxes for the years 2015 and 2014.

Recent Accounting Pronouncements

Information on recent accounting pronouncements can be found in Note 4 to the consolidated financial statements included in this Annual Report on Form 10-K.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer


Source: Equities.com News (April 14, 2016 - 9:40 AM EDT)

News by QuoteMedia
www.quotemedia.com

Legal Notice