Item
1. Business.
General
Information
In
this Annual Report on Form 10-K (this “Report”), we may rely on and refer to information regarding the oil and gas industry
in general from market research reports, analyst reports and other publicly available information. Although we believe that this information
is reliable, we cannot guarantee the accuracy and completeness of this information, we have not independently verified any of it and
we have not commissioned any of the market or survey data that is presented in this Report.
Please
see the “Glossary” above for a list of abbreviations and definitions used throughout this Report.
Our
fiscal year ends on December 31st. Interim results are presented on a quarterly basis for the quarters ended March 31, June 30, and September
30th, the first quarter, second quarter and third quarter, respectively, with the quarter ending December 31st being referenced herein
as our fourth quarter. Fiscal 2022 means the year ended December 31, 2022, whereas fiscal 2021 means the year ended December 31, 2021.
Unless
the context requires otherwise, references to the “Company,” “we,” “us,” “our,” “U.S.
Energy,” and “U.S. Energy Corp.” refer specifically to U.S. Energy Corp. and its consolidated subsidiaries.
In
addition, unless the context otherwise requires and for the purposes of this Report only:
|
● |
“Exchange
Act” refers to the Securities Exchange Act of 1934, as amended; |
|
● |
“SEC”
or the “Commission” refers to the United States Securities and Exchange Commission; and |
|
● |
“Securities
Act” refers to the Securities Act of 1933, as amended. |
Overview
U.S.
Energy Corp. was incorporated in the State of Wyoming on January 26, 1966, and reincorporated to Delaware effective on August 3,
2022. We are an independent energy company focused on the acquisition and development of oil and natural gas producing properties in
the continental United States. Our principal properties and operations are in the Rockies region (Montana, Wyoming and North
Dakota), the Mid-Continent (Oklahoma, Kansas and North and East Texas), West Texas, South Texas and Gulf Coast regions.
We
have historically explored for and produced oil and natural gas through a non-operator business model, however, during 2020 we acquired
operated properties in North Dakota, New Mexico, Wyoming and the Texas Gulf Coast, and on January 5, 2022, we closed the acquisitions
of certain oil and gas properties from three separate sellers, representing a diversified portfolio of primarily operated, producing,
oil-weighted assets located across the Rockies, West Texas, Eagle Ford, and Mid-Continent regions.
Our
business strategy going forward is to enhance the value of our acquired operated assets through evaluation of selected properties with
the goal of increasing production and reserves. We plan to deploy our capital in a conservative and strategic manner and pursue value-enhancing
transactions. We also continuously evaluate strategic alternative opportunities that we believe will enhance stockholder value.
Office
Location
Our
principal executive office is located at 1616 S. Voss Road, Suite 725, Houston, Texas 77057. Our telephone number is (346) 509-8734.
Oil
and Natural Gas Operations
We
participate in oil and natural gas projects as both a non-operating working interest owner through exploration and development agreements
with various oil and natural gas exploration and production companies and as an operator. Our working interest varies by project and
may change over time based on the terms of our leases and operating agreements. These projects may result in numerous wells being drilled
over the next three to five years depending on, among other things, commodity prices and the availability of capital resources required
to fund the expenditures. We are also actively pursuing potential acquisitions of exploration, development and production-stage oil and
natural gas properties or companies. Key attributes of our oil and natural gas properties include the following:
|
● |
Estimated
proved reserves of 7,864,801 barrels of oil equivalent (BOE) (65% oil and 35% natural gas) as of December 31, 2022, with a standardized
measure value of $143.8 million. |
|
● |
As
of December 31, 2022, our oil and natural gas leases covered 314,550 gross acres and 170,196 net acres. |
|
● |
767
gross (595 net) producing wells as of December 31, 2022. |
|
● |
1,700
BOE per day average net production for 2022. |
Recent
Events:
Acquisition
of Properties
January
2022 Acquisitions
On
January 5, 2022 (the “Closing Date”), we closed the acquisitions (the “Closing”) contemplated by three separate Purchase and Sale Agreements (as amended to date, the “Purchase Agreements”), previously entered into by the
Company on October 4, 2021, with each of (a) Lubbock Energy Partners LLC (“Lubbock”); (b) Banner Oil & Gas, LLC, Woodford
Petroleum, LLC and Llano Energy LLC (collectively, “Banner”), and (c) Synergy Offshore LLC (“Synergy”, and collectively
with Lubbock and Banner, (the “Sellers”).
Pursuant
to the Purchase Agreements, we acquired certain oil and gas properties from the Sellers, representing a diversified portfolio of primarily
operated, producing, oil-weighted assets located across the Rockies, West Texas, Eagle Ford, and Mid-Continent. The acquisition also
included certain wells, contracts, technical data, records, personal property and hydrocarbons associated with the acquired assets (collectively
with the oil and gas properties acquired, the “Acquired Assets”).
The
purchase price for the Acquired Assets was (a) $125,000 in cash and 6,568,828 shares of our common stock, as to Lubbock; (b) $1,000,000
in cash, the assumption of $3.3 million in liabilities (which were repaid with funds borrowed under the Credit Agreement discussed and
defined below,), and 6,790,524 shares of common stock, as well as the novation of certain hedges which had a mark to market loss of approximately
$3.1 million as of the Closing Date, as to Banner (which were evidenced by the Master Agreement and Schedule, discussed and defined below);
and (c) $125,000 in cash and 6,546,384 shares of common stock, as to Synergy. The aggregate purchase price under all the Purchase Agreements
was $1.25 million in cash, 19,905,736 shares of common stock (the “PSA Shares”), the repayment of $3.3 million in debt, as
well as the novation of the hedges discussed above. The initial purchase price was subject to customary working capital and
other adjustments following the Closing.
Also
on January 4, 2022, we and each of the Sellers entered into a Nominating and Voting Agreement.
On
and effective on September 16, 2022, the Company, each of the Sellers, and King Oil & Gas Company, Inc., which entity is controlled
by Duane H. King, its President and one of our directors (“King Oil”), WDM Family Partnership, LP, which entity is controlled
by Wallis T. Marsh, its President (“WDM”), and Katla Energy Holdings LLC, which entity is controlled by John A. Weinzierl,
its Chief Executive Officer and our Chairman (“Katla Energy”), entered into an Amended and Restated Nominating and Voting
Agreement (the “A&R Agreement”). The entry into the A&R Agreement followed the distribution of certain shares of
common stock originally issued to the Sellers upon the Closing, including the transfer (a) on July 20, 2022, by Synergy of an aggregate
of 6,546,384 shares of common stock of the Company which it held to: King Oil (2,027,399 shares); Katla Energy (1,781,651 shares) and
certain other parties; and (b) on July 19, 2022, by Lubbock of 6,568,828 shares of common stock of the Company which it then held to:
Katla Energy (3,071,914 shares); WDM (3,071,914 shares) and certain other parties (the “Transfers”).
The
A&R Agreement amended and restated the prior Nominating and Voting Agreement to include King Oil, WDM and Katla Energy as voting
parties thereunder (each a “Voting Party”) and clarify the Company’s change in domicile from Wyoming to Delaware. The
A&R Agreement was entered into to better reflect the original intent of the parties to the Nominating and Voting Agreement, that
the voting obligations of the Sellers as set forth therein would also become obligations of any affiliates of the Seller which received
shares of common stock in any distribution of shares by any Sellers.
The
A&R Agreement provides that each of Lubbock, Synergy and Banner (each a “Nominating Party”) has the right to designate
for nomination to the Board two nominees (for so long as such Nominating Party (and its affiliates) beneficially owns at least 15% of
the Company’s outstanding common stock) and one nominee (for so long as such Nominating Party (and its affiliates) beneficially
owns at least 5% of the Company’s common stock), for appointment at any stockholder meeting or via any consent to action without
meeting of the stockholders of the Company. The A&R Agreement also requires the Board to include such nominees in the slate of directors
up for appointment at each meeting of stockholders where directors will be appointed and take other actions to ensure that such persons
are elected to the Board by the stockholders of the Company.
The
A&R Agreement also provides that for the purposes of calculating the percentage ownership of common stock beneficially held by each
Nominating Party, shares of common stock may only be counted once, and may only be deemed beneficially owned by at a maximum, one Nominating
Party and that further, in the event any shares of common stock are beneficially owned (as determined in accordance with Rule 13d-3 of
the Securities Exchange Act of 1934, as amended (“Rule 13d-3”) by more than one Nominating Party, such affected Nominating
Parties shall apportion beneficial ownership for the purposes of the A&R Agreement equitably, in good faith, and promptly advise
the Company and the other Nominating Parties of such agreed allocations.
Additionally,
the A&R Agreement provides that, for purposes of the Transfers, the parties agreed that the 4,853,565 shares of common stock distributed
by Synergy and Lubbock to Katla Energy (collectively, the “Katla Energy Shares”) would be allocated (a) 36.7% to Synergy;
and (b) 63.3% to Lubbock, solely for the purposes of the calculations relating to the A&R Agreement and the determination of Nominating
Party status and that in the event that Katla Energy shall thereafter distribute, sell, or transfer, any of the Katla Energy Shares,
such remaining shares of common stock held by Katla Energy would continue to be allocated, for the purposes of the A&R Agreement
and the determination of Nominating Party status, pursuant to the same allocation; provided that if Katla Energy shall thereafter acquire
any additional shares of common stock, such shares shall be apportioned at the time of acquisition equitably by the control persons of
Katla Energy to the appropriate Nominating Party, in each case notwithstanding the fact that such Katla Energy Shares, shall consistent
with the requirements of Rule 13d-3, be deemed beneficially owned by John A. Weinzierl, its Chief Executive Officer, who has voting and
dispositive control over such shares, for the purposes of Rule 13d-3.
Pursuant
to the A&R Agreement, if any Nominating Party’s Seller Nominated Party ceases for any reason to serve on the Board, such Seller
Nominated Party will be provided the right to appoint another person to the Board, who shall be appointed to the Board pursuant to the
power to fill vacancies given to the Board without a stockholder vote, by the Bylaws of the Company.
Notwithstanding
the above, no person is required to be included as a nominee for election or appointment to the Board in the event such person is a Disqualified
Person. A “Disqualified Person” is a person for whom the Board reasonably determines that the nomination, election or appointment
of, or retention of such person on the Board, as applicable, would (a) violate the listing rules of Nasdaq or the rules and regulations
of the SEC, (b) due to such person’s past, affiliations or otherwise, negatively affect the reputation of the Company, negatively
affect the Company’s ability to complete future transactions, or disqualify the Company from undertaking any offering under applicable
securities laws, or (c) violate the fiduciary duties that the Board owes to the Company or its stockholders; provided, however, that
if the Board reasonably determines that any person is unfit for service on the Board for the reasons set forth above, then the applicable
Nominating Party is entitled to designate an alternative or replacement person.
Further
notwithstanding the above, the non-Nominating Party directors and Nominating Party directors are required to be apportioned between ‘independent’
and non-‘independent’ directors as required by the rules of Nasdaq such that the Company continues in compliance with applicable
Nasdaq rules.
Each
Seller Nominated Person is entitled to the same expense reimbursement and advancement, exculpation, indemnification and insurance in
connection with his or her role as a director as the other members of the Board, as well as reimbursement for documented, reasonable
out-of-pocket expenses incurred in attending meetings of the Board or any committee of the Board of which such Seller Nominated Person
is a member, if any, in each case to the same extent as the other members of the Board. We also agreed to continue to maintain directors’
and officers’ liability insurance coverage with respect to each Seller Nominated Person’s service on the Board for a period
of at least six years after each such Seller Nominated Person’s service on the Board has concluded.
At
all times when Lubbock holds at least 5% of the Company’s outstanding common stock and its appointee is John A. Weinzierl, each
Seller is required to instruct its appointee on the Board to vote in favor of appointing Mr. Weinzierl as Chairman of the Board.
During
the term of the A&R Agreement, each Seller and each Voting Party, agreed to vote all securities of the Company which they hold in
any manner as may be necessary to nominate and elect (and, if applicable, maintain in office) as a member of the Company’s Board,
each of the Seller Nominated Persons and further to not remove any Seller Nominated Persons, unless such person is a Disqualified Person.
The
A&R Agreement continues in effect until the earlier of (a) the date mutually agreed by each of the Sellers; and (b) the date that
no Seller owns at least 5% of the outstanding shares of common stock of the Company; subject to certain rights and obligations which
survive termination. Once a Seller’s ownership drops below 5% of the Company’s outstanding common stock, it no longer has
any right to nominate any person under the A&R Agreement, even if such Seller’s ownership increases above 5% of the Company’s
common stock in the future. Each Voting Party ceases to be bound by the terms of the A&R Agreement at such time as the Voting Party
no longer holds any shares of common stock of the Company.
May
2022 Acquisition
On
May 3, 2022, the Company acquired certain operated oil and gas producing properties in Liberty County, Texas, adjacent to its existing
assets in the area, for $1.0 million in an all-cash transaction. The effective date of the transaction was April 1, 2022. The assets
include approximately 1,022 acres, which are 100% held by production, a gas pipeline and associated infrastructure. In addition, the
Company assumed suspense accounts of $0.2 million and asset retirement obligations of $0.5 million. The Company accounted for the acquisition
as an asset acquisition.
June
2022 Acquisition
On
June 29, 2022, the Company entered into a Purchase and Sale Agreement (the “PSA”) with ETXENERGY, LLC (the “Seller”).
Pursuant
to the PSA, we agreed to acquire all of the Seller’s rights to, and interest in, certain operated producing properties totaling
approximately 16,600 net acres, located in Henderson and Anderson Counties, Texas, adjacent to the Company’s existing assets in
the area. The acquisition will also include certain wells, pipelines, contracts, technical data, records, personal property and hydrocarbons
associated with the Properties, including two pipeline gathering systems and related infrastructure (collectively with the oil and gas
properties to be acquired, the “ETXEnergy Assets”).
The
PSA closed on July 27, 2022, at which time we acquired the ETXEnergy Assets in consideration for the initial base purchase price of $11.875
million in cash. The effective date of the acquisition was June 1, 2022.
On
July 26, 2022, in anticipation of the closing of the PSA, we entered into a letter agreement with Firstbank whereby we increased our
borrowing base under the Credit Agreement from $15 million to $20 million, and paid the administrative agent an upfront fee of $32,500
in connection with such increase (the “Borrowing Base Increase”).
Credit
Agreement; Hedging Agreement and Related Transactions
Credit
Agreement
Separate
from the January 2022 Closing, but also effective on January 5, 2022, the Company entered into a five-year credit agreement (“Credit
Agreement”) with Firstbank Southwest (“Firstbank”) as administrative agent for one or more lenders (the “Lenders”),
which provides for a revolving line of credit with an initial borrowing base of $15 million, subject to adjustment as discussed in the
Credit Agreement, and redetermination on a semi-annual basis on April 1st and October 1st of each year, or in the
interim as provided in the Credit Agreement, and a maximum credit amount of $100,000,000. The borrowing base is subject to semi-annual
redeterminations in April and October of each year until maturity, based on the value of the Company’s proved oil and natural gas
reserves in accordance with the lenders’ customary procedures and practices. The Company and each of its subsidiaries are considered
“Loan Parties” under the Credit Agreement.
Under
the Credit Agreement, revolving loans may be borrowed, repaid and re-borrowed until January 5, 2026, when all outstanding amounts must
be repaid.
Interest
on the outstanding amounts under the Credit Agreement will accrue at an interest rate equal to the greatest of (a) the prime rate
in effect on such day, and (b) the Federal Funds rate in effect on such day (as determined in the Credit Agreement) plus 0.50%, and an
applicable margin that ranges between 0.25% to 1.25% depending on utilization of the amount of the borrowing base (the “Applicable
Margin”). During the first six months of the term, the applicable margin will be 0.75% regardless of utilization. If the Company
fails to deliver a report setting forth its proved oil and natural gas reserves as and when required under the Credit Agreement, the
applicable margin will be 1.25% regardless of utilization.
In
the event that certain event of defaults (as described under the Credit Agreement) occur, the outstanding amounts will bear an additional
2.00% interest per annum. Accrued interest on each revolving loan is payable in arrears on the last day of each March, June, September
and December.
The
Credit Agreement may require us to hedge certain oil and gas volumes, based on our utilization of the borrowing base, which hedging
will be accomplished pursuant to the ISDA Master Agreement, discussed below.
A
total of $3.5 million was borrowed under the Credit Agreement, immediately upon the entry into such Credit Agreement, which was evidenced
by a Note dated January 5, 2022. Such $3.5 million was immediately used to repay $3.3 million of debt owed by Banner which the Company
agreed to assume as part of the Closing. An additional $10.7 million was borrowed under the Credit Agreement to purchase the ETXEnergy
Assets in July 2022. The balance outstanding on the Credit Facility as of December 31, 2022 was $12.0 million.
Separate
from the Closing, but also effective on January 5, 2022, the Company and NextEra entered into an International Swap Dealers Association,
Inc. Master Agreement (“Master Agreement”), facilitating the Company to enter into derivative and/or hedging transactions
(“Transactions”) to manage the risk associated with its business relating to commodity prices. The derivative and hedging
transactions will be governed by the Master Agreement, including the related Schedule to the ISDA Master Agreement (“Schedule”).
The Company’s obligations to NextEra under the Master Agreement are secured by the collateral which secures the loans under the
Credit Agreement on a pari passu and pro rata basis with the principal of such loans. The structure of the Transactions may include swaps,
caps, floors, collars, locks, forwards and options.
Activities
with Operating Partners
We
operate 86% of our reserves as of December 31, 2022. The remaining 14% represents working interests we own as a non-operator in a geographically
and geologically diverse portfolio of oil-weighted prospects in varying stages of exploration and development. Prospect stages range
from prospect origination, including geologic and geophysical mapping, to leasing, exploratory drilling and development. The Company
participates in the prospect stages either for its own account or with prospective partners to enlarge its oil and natural gas lease
ownership base.
Each
of the operators of our principal prospects has a substantial technical staff. We believe that these arrangements currently allow us
to deliver value to our stockholders without having to build the full staff of geologists, engineers and land personnel required to work
on diverse projects that may involve horizontal drilling in North Dakota, New Mexico, South Texas and West Texas. Consistent with industry
practice with smaller independent oil and natural gas companies, we also utilize specialized consultants with local expertise as needed.
Environmental
Laws and Regulations
Environmental
Matters
Our
operations and properties are subject to extensive and changing federal, state and local laws and regulations relating to environmental
protection, including the generation, storage, handling, emission, transportation and discharge of materials into the environment, and
relating to safety and health. The recent trend in environmental legislation and regulation generally is toward stricter standards, and
this trend will likely continue. These laws and regulations may:
|
● |
Require
the acquisition of a permit or other authorization before construction or drilling commences and for certain other activities; |
|
● |
Limit
or prohibit construction, drilling and other activities on certain lands lying within wilderness and other protected areas; and |
|
● |
Impose
substantial liabilities for pollution resulting from operations. |
The
permits required for our operations may be subject to revocation, modification and renewal by issuing authorities. Governmental authorities
have the power to enforce their regulations, and violations are subject to fines or injunctions, or both. In the opinion of management,
we are in substantial compliance with current applicable environmental laws and regulations and have no material commitments for capital
expenditures to comply with existing environmental requirements. Nevertheless, changes in existing environmental laws and regulations
or in interpretations thereof could have a significant impact on our company, as well as the oil and natural gas industry in general.
Comprehensive
Environmental, Response, Compensation, and Liability Act (“CERCLA”). CERCLA and comparable state statutes impose
strict, joint and several liabilities on owners and operators of sites and on persons who disposed of or arranged for the disposal of
“hazardous substances” found at such sites. These persons include the owner or operator of the site where the release occurred,
persons who disposed or arranged for the disposal of hazardous substances at the site, and any person who accepted hazardous substances
for transportation to the site. CERCLA authorizes the Environmental Protection Agency (“EPA”), state environmental agencies,
and in some cases third parties, to take actions in response to threats to the public health or the environment and to seek to recover
from the responsible classes of persons the costs they incur. It is not uncommon for the neighboring landowners and other third parties
to file claims for personal injury and property damage allegedly caused by the hazardous substances released into the environment. Although
CERCLA currently excludes petroleum from its definition of “hazardous substance,” state laws affecting our operations may
impose clean-up liability relating to petroleum and petroleum related products.
Waste
Handling. The Resource Conservation and Recovery Act (“RCRA”) and comparable state statutes regulate the generation,
transportation, treatment, storage, disposal, and cleanup of hazardous and non-hazardous wastes. Under the auspices of the United States
Environmental Protection Agency (“EPA”), individual states administer some or all of the provisions of RCRA, sometimes in
conjunction with their own, more stringent requirements. Drilling fluids, produced water, and most of the other wastes associated with
the exploration, development, and production of oil or gas are currently regulated under RCRA’s non-hazardous waste provisions.
However, it is possible that certain oil and gas exploration and production wastes now classified as non-hazardous could be classified
as hazardous wastes in the future. Any such change could result in an increase in our costs to manage and dispose of wastes, which could
have a material adverse effect on our results of operations and financial position.
Endangered
Species. The federal Endangered Species Act and analogous state laws regulate activities that could have an adverse effect on
threatened or endangered species. Some of our operations are conducted in areas where protected species are known to exist. In these
areas, we may be obligated to develop and implement plans to avoid potential adverse impacts on protected species, and we may be prohibited
from conducting operations in certain locations or during certain seasons, such as breeding and nesting seasons, when our operations
could have an adverse effect on these species. It is also possible that a federal or state agency could order a complete halt to activities
in certain locations if it is determined that such activities may have a serious adverse effect on a protected species. The presence
of a protected species in areas where we perform drilling, completion, and production activities could impair our ability to timely complete
well drilling and development and could adversely affect our future production from those areas.
Air
Emissions. The federal Clean Air Act (the “CAA”) and state air pollution laws and regulations provide a framework
for national, state and local efforts to protect air quality. Applicable to our business and operations, the CAA regulates emissions,
discharges and controls with respect to oil and natural gas production and natural gas processing operations. The CAA includes New Source
Performance Standards (“NSPS”) for the oil and natural gas source category to address emissions of sulfur dioxide, methane
and volatile organic compounds (“VOCs”) from new and modified oil and natural gas production, processing and transmission
sources as well as a separate set of emission standards to address hazardous air pollutants frequently associated with oil and natural
gas production and processing activities. Further, the CAA regulates the emissions from compressors, dehydrators, storage tanks and other
production equipment as well as leak detection for natural gas processing plants. These rules have required a number of modifications
to the operations of our third-party operating partners, including the installation of new equipment to control emissions from compressors.
In
addition, the EPA has developed, and continues to develop, stringent regulations governing emissions at specified sources. For example,
under the EPA’s NSPS and National Emission Standards for Hazardous Air Pollutants (“NESHAP”) regulations, since January
1, 2015, owners and operators of hydraulically fractured natural gas wells (wells drilled principally for the production of natural gas)
have been required to use so-called “green completion” technology to recover natural gas that formerly would have been flared
or vented. In 2016, the EPA issued additional rules for the oil and natural gas industry to reduce emissions of methane, VOCs and other
compounds. These rules apply to certain sources of air emissions that were constructed, reconstructed, or modified after September 18,
2015. Among other things, the new rules impose green completion requirements on new hydraulically fractured or re-fractured oil wells
and leak detection and repair requirements at well sites. We do not expect that the currently applicable NSPS or NESHAP requirements
will have a material adverse effect on our business, financial condition or results of operations. However, any future laws and their
implementing regulations may require us to obtain pre-approval for the expansion or modification of existing facilities or the construction
of new facilities expected to produce air emissions, impose stringent air permitting requirements or require us to use specific equipment
or technologies to control emissions.
On
December 17, 2014, the EPA proposed to revise and lower the existing 75 pounds per barrel (ppb) National Ambient Air Quality Standard
(“NAAQS”) for ozone under the CAA to a range within 65-70 ppb. On October 1, 2015, the EPA finalized a rule that lowered
the standard to 70 ppb. This lowered ozone NAAQS could result in an expansion of ozone nonattainment areas across the United States,
including areas in which we operate. Oil and natural gas operations in ozone nonattainment areas likely would be subject to more stringent
emission controls, emission offset requirements for new sources, and increased permitting delays and costs. This could require a number
of modifications to our operations, including the installation of new equipment to control emissions from our wells.
Permit
and related compliance obligations under the CAA, each state’s development and promulgation of regulatory programs to comport with
federal requirements, as well as changes to state implementation plans for controlling air emissions in regional non-attainment or near-non-attainment
areas, may require oil and natural gas exploration and production operators to incur future capital and operating expenditures in connection
with the addition or modification of existing air emission control equipment and strategies.
Global
Warming and Climate change. Various state governments and regional organizations have enacted, or are considering enacting,
new legislation and promulgating new regulations governing or restricting the emission of GHG, including from facilities, vehicles and
equipment. Legislative and regulatory proposals for restricting GHG emissions or otherwise addressing climate change could require us
to incur additional operating costs and could adversely affect demand for the oil and natural gas that we sell or the cost of the equipment
and other materials we use. The potential increase in our operating costs could include new or increased costs to obtain permits, operate
and maintain our equipment, install new emission controls on our equipment, pay taxes related to our greenhouse gas emissions and administer
and manage a greenhouse gas emissions program.
Additionally,
the development of a federal renewable energy standard, or the development of additional or more stringent renewable energy standards
at the state level could reduce the demand for the oil and gas we produce, thereby adversely impacting our earnings, cash flows and financial
position. A cap-and-trade program generally would cap overall greenhouse gas emissions on an economy-wide basis and require major sources
of greenhouse gas emissions or major fuel producers to acquire and surrender emission allowances. A federal cap and trade program or
expanded use of cap and trade programs at the state level could impose direct costs on us through the purchase of allowances and could
impose indirect costs by incentivizing consumers to shift away from fossil fuels. In addition, federal or state carbon taxes could directly
increase our costs of operation and similarly incentivize consumers to shift away from fossil fuels.
In
addition, activists concerned about the potential effects of climate change have directed their attention at sources of funding for fossil-fuel
energy companies, which has resulted in an increasing number of financial institutions, funds and other sources of capital restricting
or eliminating their investment in oil and natural gas activities. Ultimately, this may make it more difficult and expensive for us to
secure funding. Members of the investment community have also begun to screen companies such as ours for sustainability performance,
including practices related to greenhouse gases and climate change, before investing in our securities. Any efforts to improve our sustainability
practices in response to these pressures may increase our costs, and we may be forced to implement technologies that are not economically
viable in order to improve our sustainability performance and to meet the specific requirements to perform services for certain customers.
These
various legislative, regulatory and other activities addressing greenhouse gas emissions could adversely affect our business, including
by imposing reporting obligations on, or limiting emissions of greenhouse gases from, our equipment and operations, which could require
us to incur costs to reduce emissions of greenhouse gases associated with our operations. Limitations on greenhouse gas emissions could
also adversely affect demand for oil and gas, which could lower the value of our reserves and have a material adverse effect on our profitability,
financial condition and liquidity.
Compliance
with GHG laws or taxes could significantly increase our costs, reduce demand for fossil energy derived products, impact the cost and
availability of capital and increase our exposure to litigation. Such laws and regulations could also increase demand for less carbon
intensive energy sources.
Water
discharges. The federal Water Pollution Control Act (“Clean Water Act”) and analogous state laws impose restrictions
and strict controls with respect to the discharge of pollutants, including spills and leaks of oil and other substances, into waters
of the United States and states. The discharge of pollutants into regulated waters is prohibited, except in accordance with the terms
of a permit issued by the EPA, or analogous state agencies. This includes the discharge of certain storm water without a permit which
requires periodic monitoring and sampling. In addition, the Clean Water Act regulates wastewater generated by unconventional oil and
gas operations during the hydraulic fracturing process and discharged to publicly-owned wastewater treatment facilities. The Clean Water
Act also prohibits discharge of dredged or fill material into waters of the United States, including wetlands, except in accordance with
the terms of a permit issued by the United States Army Corps of Engineers, or a state, if the state has assumed authority to issue such
permits. Federal and state regulatory agencies can impose administrative, civil, and criminal penalties for non-compliance with discharge
permits or other requirements of the Clean Water Act and analogous state laws and regulations.
Oil
Pollution Act of 1990 (“OPA”). OPA addresses prevention, containment and cleanup, and liability associated with oil
pollution. OPA applies to vessels, offshore platforms, and onshore facilities. OPA subjects owners of such facilities to strict liability
for containment and removal costs, natural resource damages, and certain other consequences of oil spills into jurisdictional waters.
Any unpermitted release of petroleum or other pollutants from our operations could result in governmental penalties and civil liability.
Safe
Drinking Water Act (“SDWA”). The disposal of oil and natural gas wastes into underground injection wells are subject
to the federal Safe Drinking Water Act, as amended, and analogous state laws. The SDWA’s Underground Injection Control (“UIC”)
Program establishes requirements for permitting, testing, monitoring, recordkeeping and reporting of injection well activities as well
as a prohibition against the migration of fluid containing any contaminants into underground sources of drinking water. State programs
may have analogous permitting and operational requirements. In response to concerns related to increased seismic activity in the vicinity
of injection wells, regulators in some states are considering additional requirements related to seismic safety. For example, the Texas
Railroad Commission (“RRC”) adopted new oil and natural gas permit rules in October 2014 for wells used to dispose of saltwater
and other fluids resulting from the production of oil and natural gas in order to address these seismic activity concerns within the
state. Among other things, the rules require companies seeking permits for disposal wells to provide seismic activity data in permit
applications, provide for more frequent monitoring and reporting for certain wells, and allow the RRC to modify, suspend, or terminate
permits on grounds that a disposal well is likely to be, or determined to be, causing seismic activity. If new regulatory initiatives
are implemented that restrict or prohibit the use of underground injection wells in areas where we rely upon the use of such wells in
our operations, our costs to operate may significantly increase and our ability to continue production may be delayed or limited, which
could have a material adverse effect on our results of operations and financial position. In addition, any leakage from the subsurface
portions of the injection wells may cause degradation of freshwater, potentially resulting in cancellation of operations of a well, issuance
of fines and penalties from governmental agencies, incurrence of expenditures for remediation of the affected resource, and imposition
of liability by third parties for property damages and personal injury.
The
Occupational Safety and Health Act (“OSHA”). OSHA and comparable state laws regulate the protection of the health
and safety of employees. The federal Occupational Safety and Health Administration has established workplace safety standards that provide
guidelines for maintaining a safe workplace in light of potential hazards, such as employee exposure to hazardous substances. OSHA also
requires employee training and maintenance of records, and the OSHA hazard communication standard and EPA community right-to-know regulations
under the Emergency Planning and Community Right-to-Know Act of 1986 require that we organize and disclose information about hazardous
materials used or produced in our operations.
Hydraulic
Fracturing. Substantially all of the oil and natural gas production in which we have interests is developed from unconventional
sources that require hydraulic fracturing as part of the completion process. Hydraulic fracturing is an important and common practice
used to stimulate production of hydrocarbons from tight shale formations. We routinely utilize hydraulic fracturing techniques in most
of our drilling and completion programs. The process involves the injection of water, sand, and chemicals under pressure into the formation
to fracture the surrounding rock and stimulate production. The process is typically regulated by state oil and gas commissions. However,
even on private lands, the EPA has asserted federal regulatory authority over hydraulic fracturing involving diesel additives under the
Safe Drinking Water Act’s Underground Injection Control Program. The federal Safe Drinking Water Act protects the quality of the
nation’s public drinking water through the adoption of drinking water standards and controlling the injection of waste fluids,
including saltwater disposal fluids, into below-ground formations that may adversely affect drinking water sources.
Increased
regulation and scrutiny on oil and gas activities involving hydraulic fracturing techniques could potentially lead to a decrease in the
completion of new oil and gas wells, an increase in compliance costs, delays, and changes in federal income tax laws, all of which could
adversely affect our financial position, results of operations, and cash flows. As new laws or regulations that significantly restrict
hydraulic fracturing are adopted at the state and local levels, such laws could make it more difficult or costly for us to perform fracturing
to stimulate production from tight formations. In addition, if hydraulic fracturing becomes regulated at the federal level as a result
of federal legislation or regulatory initiatives by the EPA or other federal agencies, our fracturing activities could become subject
to additional permitting requirements, which could result in additional permitting delays and potential increases in costs. Restrictions
on hydraulic fracturing could also reduce the amount of oil and gas that we are ultimately able to produce from our reserves.
We
believe the trend in local, state, and federal environmental legislation and regulation will continue toward stricter standards, particularly
under President Biden’s administration. While we believe we are in substantial compliance with existing environmental laws and
regulations applicable to our current operations and that our continued compliance with existing requirements will not have a material
adverse impact on our financial condition and results of operations, we cannot give any assurance that we will not be adversely affected
in the future.
National
Environmental Policy Act (“NEPA”). Oil and natural gas exploration, development and production activities on federal
lands, including tribal lands and lands administered by the BLM, are subject to NEPA. NEPA requires federal agencies, including the BLM,
to evaluate major agency actions having the potential to significantly impact the environment. In the course of such evaluations, an
agency will prepare an Environmental Assessment that assesses the potential direct, indirect and cumulative impacts of a proposed project
and, if necessary, will prepare a more detailed Environmental Impact Statement that may be made available for public review and comment.
If we were to conduct any exploration and production activities on federal lands in the future, those activities may need to obtain governmental
permits that are subject to the requirements of NEPA. This process has the potential to delay, limit or increase the cost of developing
oil and natural gas projects. Authorizations under NEPA are also subject to protest, appeal or litigation, any or all of which may delay
or halt projects. Many of our activities and those of our third-party operating partners are covered under categorical exclusions which
results in a shorter NEPA review process, however, the impact of the NEPA review process on our activities and those of our third-party
operating partners is uncertain at this time and could lead to delays and increased costs that could materially adversely affect our
revenues and results of operations.
Governmental
Regulation
Our
operations are subject to various rules, regulations and limitations impacting the oil and natural gas exploration and production industry
as a whole.
Regulation
of Oil and Natural Gas Production
Our
oil and natural gas exploration, production and related operations are subject to extensive rules and regulations promulgated by federal,
state, tribal and local authorities and agencies. For example, North Dakota requires permits for drilling operations, drilling bonds
and reports concerning operations and imposes other requirements relating to the exploration and production of oil and natural gas. Many
states may also have statutes or regulations addressing conservation matters, including provisions for the unitization or pooling of
oil and natural gas properties, the location of wells, the method of drilling and casing wells, the surface use and restoration of properties
upon which wells are drilled, the sourcing and disposal of water used in the process of drilling, the flaring of natural gas, completion
and abandonment, the establishment of maximum rates of production from wells, and the regulation of spacing, plugging and abandonment
of such wells. The effect of these regulations is to limit the amount of oil and natural gas that we can produce from our wells and to
limit the number of wells or the locations at which we can drill. Moreover, many states impose a production or severance tax with respect
to the production and sale of oil, natural gas and natural gas liquids within their jurisdictions. Failure to comply with any such rules
and regulations can result in substantial penalties. The regulatory burden on the oil and natural gas industry will most likely increase
our cost of doing business and may affect our profitability. Because such rules and regulations are frequently amended or reinterpreted,
we are unable to predict the future cost or impact of complying with such laws. Significant expenditures may be required to comply with
governmental laws and regulations and may have a material adverse effect on our financial condition and results of operations. Additionally,
currently unforeseen environmental incidents may occur or past non-compliance with environmental laws or regulations may be discovered.
Therefore, we are unable to predict the future costs or impact of compliance. Additional proposals and proceedings that affect the oil
and natural gas industry are regularly considered by Congress, the states, the Federal Energy Regulatory Commission (“FERC”)
and the courts. We cannot predict when or whether any such proposals may become effective.
Regulation
of Transportation of Oil
Sales
of crude oil, condensate and natural gas liquids are not currently regulated and are made at negotiated prices. Nevertheless, Congress
could re-enact price controls in the future. Our sales of crude oil are affected by the availability, terms and cost of transportation.
The transportation of oil by common carrier pipelines is also subject to rate and access regulation. The FERC regulates interstate oil
pipeline transportation rates under the Interstate Commerce Act. In general, interstate oil pipeline rates must be cost-based, although
settlement rates agreed to by all shippers are permitted and market-based rates may be permitted in certain circumstances. Effective
January 1, 1995, the FERC implemented regulations establishing an indexing system (based on inflation) for transportation rates for oil
pipelines that allows a pipeline to increase its rates annually up to a prescribed ceiling, without making a cost-of-service filing.
Every five years, the FERC reviews the appropriateness of the index level in relation to changes in industry costs.
Intrastate
oil pipeline transportation rates are subject to regulation by state regulatory commissions. The basis for intrastate oil pipeline regulation
and the degree of regulatory oversight and scrutiny given to intrastate oil pipeline rates varies from state to state. Insofar as effective
interstate and intrastate rates are equally applicable to all comparable shippers, we believe that the regulation of oil transportation
rates will not affect our operations in any way that is of material difference from those of our competitors that are similarly situated.
Further,
interstate and intrastate common carrier oil pipelines must provide service on a non-discriminatory basis. Under this open access standard,
common carriers must offer service to all similarly situated shippers requesting service on the same terms and under the same rates.
When oil pipelines operate at full capacity, access is generally governed by pro-rationing provisions set forth in the pipelines’
published tariffs. Accordingly, we believe that access to oil pipeline transportation services generally will be available to us to the
same extent as to our similarly situated competitors.
Regulation
of Transportation and Sales of Natural Gas
Historically,
the transportation and sale for resale of natural gas in interstate commerce has been regulated by the FERC under the Natural Gas Act
of 1938 (“NGA”), the Natural Gas Policy Act of 1978 (“NGPA”) and regulations issued under those statutes. In
the past, the federal government has regulated the prices at which natural gas could be sold. While sales by producers of natural gas
can currently be made at market prices, Congress could reenact price controls in the future.
Onshore
gathering services, which occur upstream of FERC jurisdictional transmission services, are regulated by the states. Although the FERC
has set forth a general test for determining whether facilities perform a non-jurisdictional gathering function or a jurisdictional transmission
function, the FERC’s determinations as to the classification of facilities is done on a case-by-case basis. State regulation of
natural gas gathering facilities generally includes various safety, environmental and, in some circumstances, nondiscriminatory take
requirements. Although such regulation has not generally been affirmatively applied by state agencies, natural gas gathering may receive
greater regulatory scrutiny in the future.
Intrastate
natural gas transportation and facilities are also subject to regulation by state regulatory agencies, and certain transportation services
provided by intrastate pipelines are also regulated by FERC. The basis for intrastate regulation of natural gas transportation and the
degree of regulatory oversight and scrutiny given to intrastate natural gas pipeline rates and services varies from state to state. Insofar
as such regulation within a particular state will generally affect all intrastate natural gas shippers within the state on a comparable
basis, we believe that the regulation of similarly situated intrastate natural gas transportation in any states in which we operate and
ship natural gas on an intrastate basis will not affect our operations in any way that is of material difference from those of our competitors.
Like the regulation of interstate transportation rates, the regulation of intrastate transportation rates affects the marketing of natural
gas that we produce, as well as the revenues we receive for sales of our natural gas.
Research
and Development
No
research and development expenditures have been incurred during the past three fiscal years.
Insurance
We
have general liability and property insurance coverage in amounts we deem sufficient for our business operations, consisting of property
loss insurance on major assets for the approximate value of the assets and additional liability and operator’s and control of well
insurance for our oil and natural gas operations and drilling programs. We do not have insurance coverage for the lost revenues associated
with a business interruption, nor do we have coverage for the loss of our oil and natural gas reserves. There is no guarantee that any
insurance coverage would be sufficient to protect the value of our assets or to fully cover any losses sustained. Payment of substantial
liabilities in excess of coverage could require diversion of internal capital away from regular business, which could result in curtailment
of projected future operations.
Human
Capital
As
of April 12, 2023, we had 39 full-time employees and 4 part-time employees, none of whom were subject to a collective bargaining agreement.
In addition, we utilize several consultants on an as-needed basis. As a result of the acquisition completed on January 5, 2022, we added
13 employees. In addition, in 2022, we increased our corporate accounting, engineering and administrative staff. We recognize that our
employees are our most valuable assets and drive the way we pursue our short-term and long-term goals. To attract and retain talent we
promote:
|
● |
integrity
and ethical behavior in the conduct of our business; |
|
● |
environmental,
health and safety priorities: |
|
● |
prioritizing
the success of others and the team; |
|
● |
communicating
why we do what we do and how every employee contributes to achieving success; and |
|
● |
support
for team members’ professional and personal development. |
The
core values of integrity and ethical behavior are the pillars of our culture, and as a result, the health and safety of our employees
and contractors is our highest priority. All employees are responsible for upholding Company-wide standards and values. We have policies
designed to promote ethical conduct and integrity that employees are required to read and acknowledge.
We
strive to provide competitive, performance-based compensation and benefits to our employees, including market-competitive pay, and various
healthcare, retirement, and other benefit packages The Compensation Committee of our Board of Directors oversees our compensation programs
and designs programs to incentivize achievement of our corporate strategy and the matters of importance to our stakeholders.
Forward
Plan
In
2023 and beyond, we intend to seek additional opportunities in the oil and natural gas sector, including but not limited to further acquisition
of assets, participation with current and new industry partners in their exploration and development projects, acquisition of existing
companies, and the purchase of oil producing assets. In addition, we plan to grow production by performing workovers on operated idle
wells acquired in 2022, returning them back to production.
Business
Strategy
Key
elements of our business strategy include:
|
● |
Deploy
our Capital in a Conservative and Strategic Manner and Review Opportunities to Bolster our Liquidity. In the current industry
environment, maintaining liquidity is critical. Therefore, we plan to be highly selective in the projects we evaluate and to review
opportunities to bolster our liquidity and financial position through various means. |
|
|
|
|
● |
Evaluate
and Pursue Value-Enhancing Transactions. We plan to continuously evaluate strategic alternative opportunities with the goal of
enhancing stockholder value. |
Industry
Operating Environment
The
oil and natural gas industry is affected by many factors that we generally cannot control. Government regulations, particularly in the
areas of taxation, energy, climate change and the environment, can have a significant impact on operations and profitability. Significant
factors that may impact oil prices in the current fiscal year and future periods include the ongoing war between Russia and Ukraine,
the level of inflation and interest rates, political and social developments in the Middle East, demand in Asian and European markets,
and the extent to which members of the Organization of the Petroleum Exporting Countries (“OPEC”) and other oil exporting
nations manage oil supply through export quotas. Natural gas prices are generally determined by North American supply and demand and
are also affected by imports and exports of liquefied natural gas. Weather also has a significant impact on demand for natural gas since
natural gas is a primary heating source.
These
factors may adversely impact the supply and demand for oil and gas and our ability to produce and transport oil and gas and perform operations
at and on our properties. This uncertainty also affects management’s accounting estimates and assumptions, which could result in
greater variability in a variety of areas that depend on these estimates and assumptions, including investments, receivables, and forward-looking
guidance.
Development
During
2023, our development activities will be focused on returning idle wells acquired in 2022 to production and participating in drilling
projects with our joint interest operators.
Until
acquiring operated properties during 2020, we primarily engaged in oil and natural gas exploration and production by participating, on
a proportionate basis, alongside third-party interests in wells drilled and completed in spacing units that include our acreage. We typically
depend on drilling partners to propose, permit and initiate the drilling of wells. Prior to commencing drilling, our partners are required
to provide all owners of oil, natural gas and mineral interests within the designated spacing unit the opportunity to participate in
the drilling costs and revenues of the well to the extent of their pro-rata share of such interest within the spacing unit. We assess
each drilling opportunity on a case-by-case basis and participate in wells that we expect to meet our return thresholds based upon our
estimates of ultimate recoverable oil and natural gas, expected oil and natural gas prices, expertise of the operator, and completed
well cost from each project, as well as other factors. Historically, we have participated pursuant to our working interest in a vast
majority of the wells proposed to us.
Seasonality
Winter
weather conditions and lease stipulations can limit or temporarily halt our drilling and producing activities and other oil and natural
gas operations and those of our operating partners. These constraints and the resulting shortages or high costs could delay or temporarily
halt the operations of our operating partners and materially increase our operating and capital costs. Such seasonal anomalies can also
pose challenges for meeting well drilling objectives and may increase competition for equipment, supplies and personnel during the spring
and summer months, which could lead to shortages and increase costs or delay or temporarily halt our operations and those of our operating
partners.
Title
to Properties
Title
to properties is subject to royalty, overriding royalty, carried working, net profits, working and other similar interests and contractual
arrangements customary in the gas and oil industry, liens for current taxes not yet due and other encumbrances. As is customary in the
industry in the case of undeveloped properties, little investigation of record title is made at the time of acquisition (other than preliminary
review of local records).
Investigation,
including a title opinion of local counsel, generally is made before commencement of drilling operations.
Marketing,
Major Customers and Delivery Commitments
Markets
for oil and natural gas are volatile and are subject to wide fluctuations depending on numerous factors beyond our control, including
seasonality, economic conditions, foreign imports, political conditions in other energy producing countries, OPEC market actions, and
domestic government regulations and policies. All of our production is marketed by our industry partners for our benefit and is sold
to competing buyers, including large oil refining companies and independent marketers. Substantially all of our production is sold pursuant
to agreements with pricing based on prevailing commodity prices, subject to adjustment for regional differentials and similar factors.
We had no material delivery commitments as of December 31, 2022.
Competition
The
oil and natural gas business is highly competitive in the search for and acquisition of additional reserves and in the sale of oil and
natural gas. Our competitors principally consist of major and intermediate-sized integrated oil and natural gas companies, independent
oil and natural gas companies and individual producers and operators. Specifically, we compete for property acquisitions and our operating
partners compete for the equipment and labor required to operate and develop our properties. Our competitors may be able to pay more
for properties and may be able to define, evaluate, bid for and purchase a greater number of properties than we can. Ultimately, our
future success will depend on our ability to develop or acquire additional reserves at costs that allow us to remain competitive.
Available
Information
The
Company’s Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed
pursuant to Sections 13(a) and 15(d) of the Exchange Act, are filed with the U.S. Securities and Exchange Commission. Such reports and
other information filed by the Company with the SEC are available free of charge at https://investors.usnrg.com/investors/sec-filings
when such reports are available on the SEC’s website. The Company periodically provides other information for investors on its
corporate website, https://usnrg.com. The information contained on the websites referenced in this Form 10-K is not incorporated by reference
into this filing. Further, the Company’s references to website URLs are intended to be inactive textual references only. Copies
of documents filed by us with the SEC are also available from us without charge, upon oral or written request to our Secretary, who can
be contacted at the address and telephone number set forth on the cover page of this Report. You may also find information related to
our corporate governance, board committees and code of ethics on our website.
Item
1A. Risk Factors.
An
investment in our common stock involves a high degree of risk. You should carefully consider the risks described below as well as the
other information in this filing before deciding to invest in our company. Any of the risk factors described below could significantly
and adversely affect our business, prospects, financial condition and results of operations. Additional risks and uncertainties not currently
known or that are currently considered to be immaterial may also materially and adversely affect our business, prospects, financial condition
and results of operations. As a result, the trading price or value of our common stock could be materially adversely affected, and you
may lose all or part of your investment.
Summary
Risk Factors
An
investment in our securities involves a high degree of risk. You should carefully consider the risks summarized below. These risks include,
but are not limited to, the following:
|
● |
our
ability to obtain sufficient cash flow from operations, borrowing, and/or other sources to fully develop our undeveloped acreage
positions; |
|
|
|
|
● |
volatility
in oil and natural gas prices, including further declines in oil prices and/or natural gas prices, which would have a negative impact
on operating cash flow and could require further ceiling test write-downs on our oil and natural gas assets; |
|
|
|
|
● |
the
possibility that the oil and natural gas industry may be subject to new adverse regulatory or legislative actions (including changes
to existing tax rules and regulations and changes in environmental regulation); |
|
|
|
|
● |
the
general risks of exploration and development activities, including the failure to find oil and natural gas in sufficient commercial
quantities to provide a reasonable return on investment; |
|
|
|
|
● |
future
oil and natural gas production rates, and/or the ultimate recoverability of reserves, falling below estimates; |
|
|
|
|
● |
the
ability to replace oil and natural gas reserves as they deplete from production; |
|
|
|
|
● |
environmental
risks; |
|
|
|
|
● |
risks
associated with our plan to develop additional operating capabilities, including the potential inability to recruit and retain personnel
with the requisite skills and experience and liabilities we could assume or incur as an operator or to acquire operated properties
or obtain operatorship of existing properties; |
|
● |
availability
of pipeline capacity and other means of transporting crude oil and natural gas production, and related midstream infrastructure and
services; |
|
|
|
|
● |
competition
in leasing new acreage and for drilling programs with operating companies, resulting in less favorable terms or fewer opportunities
being available; |
|
|
|
|
● |
higher
drilling and completion costs related to competition for drilling and completion services and shortages of labor and materials; |
|
|
|
|
● |
disruptions
resulting from unanticipated weather events, natural disasters, and public health crises and pandemics, such as the coronavirus,
resulting in possible delays of drilling and completions and the interruption of anticipated production streams of hydrocarbons,
which could impact expenses and revenues; |
|
|
|
|
● |
our
lack of effective disclosure controls and procedures and internal control over financial reporting; |
|
|
|
|
● |
our
ability to maintain the listing of our common stock on The Nasdaq Capital Market; |
|
|
|
|
● |
dilution
caused by new equity or debt offerings; |
|
|
|
|
● |
our
need for additional capital to complete future acquisitions, conduct our operations and fund our business, and our ability to obtain
such necessary funding on favorable terms, if at all; |
|
|
|
|
● |
the
speculative nature of our oil and gas operations, and general risks associated with the exploration for, and production of oil and
gas; including accidents, equipment failures or mechanical problems which may occur while drilling or completing wells or in production
activities; operational hazards and unforeseen interruptions for which we may not be adequately insured; the threat and impact of
terrorist attacks, cyber-attacks or similar hostilities; declining reserves and production; and losses or costs we may incur as a
result of title deficiencies or environmental issues in the properties in which we invest, any one of which may adversely impact
our operations; |
|
|
|
|
● |
changes
in the legal and regulatory environment governing the oil and natural gas industry, including new or amended environmental legislation
or regulatory initiatives which could result in increased costs, additional operating restrictions, or delays, or have other adverse
effects on us; |
|
|
|
|
● |
improvements
in or new discoveries of alternative energy technologies that could have a material adverse effect on our financial condition and
results of operations; |
|
|
|
|
● |
the
fact that our officers and directors beneficially own a majority of our common stock and that their interests may be different from
other stockholders; |
|
|
|
|
● |
our
dependence on the continued involvement of our present management; |
|
● |
economic
downturns and possible recessions caused thereby (including as a result of COVID-19, increases in inflation, interest rates or global
conflicts, such as the current conflict in Ukraine); |
|
|
|
|
● |
the
effects of global pandemics, such as COVID-19 on our operations, properties, the market for oil and gas, and the demand for oil and
gas; |
|
|
|
|
● |
the
need to write-down assets and/or shut-in wells, or our non-operated wells being shut-in by their operators; |
|
|
|
|
●
|
future
litigation or governmental proceedings which could result in material adverse consequences,
including judgments or settlements;
|
|
●
|
anti-takeover
effects of our governing documents and Delaware law; |
|
|
|
|
● |
unanticipated
down-hole mechanical problems, which could result in higher-than-expected drilling and completion expenses and/or the loss of the
wellbore or a portion thereof; and |
|
|
|
|
● |
Other
risks disclosed below under “Risk Factors”. |
Risk
Factors
The
following risk factors should be carefully considered in evaluating the information in this annual report on Form 10-K.
Risks
Related to the Oil and Natural Gas Industry and Our Business
We
may need additional capital to complete future acquisitions, conduct our operations, and fund our business, and our ability to obtain
the necessary funding is uncertain.
We
may need to raise additional funding to complete future potential acquisitions and will be required to raise additional funds through
public or private debt or equity financing or other various means to fund our operations and complete workovers and acquire assets. In
such a case, adequate funds may not be available when needed or may not be available on favorable terms. If we need to raise additional
funds in the future by issuing equity securities, dilution to existing stockholders will result, and such securities may have rights,
preferences, and privileges senior to those of our common stock. If funding is insufficient at any time in the future and we are unable
to generate sufficient revenue from new business arrangements, to complete future acquisitions or operations, our results of operations
and the value of our securities could be adversely affected.
Additionally,
due to the nature of oil and gas interests, i.e., that rates of production generally decline over time as oil and gas reserves are depleted,
if we are unable to acquire additional properties and/or develop our reserves, either because we are unable to raise sufficient funding
for such development activities, or otherwise, or in the event we are unable to acquire additional operated or non-operated properties,
we believe that our revenues will continue to decline over time. Furthermore, in the event we are unable to raise additional required
funding in the future, we will not be able to participate in the drilling of additional wells, will not be able to complete other drilling
and/or workover activities.
If
this were to happen, we may be forced to scale back our business plan which could result in the value of our outstanding securities declining
in value.
Oil,
natural gas liquids (NGL) and natural gas prices, are volatile and declines in the prices of such commodities have in the past, and will
continue in the future to, adversely affect our business, financial condition or results of operations, and our ability to meet our capital
expenditure obligations or targets and financial commitments.
The
price of oil and, to a lesser extent, natural gas and NGLs, heavily influences our revenue, profitability, cash flows, liquidity, access
to capital, present value and quality of our reserves, the nature and scale of our operations, and our future rate of growth. Oil, NGL,
and natural gas are commodities and, therefore, their prices are subject to wide fluctuations in response to relatively minor changes
in supply and demand. In recent years, the markets for oil and natural gas have been volatile. These markets will likely continue to
be volatile in the future. Further, oil prices and natural gas prices do not necessarily fluctuate in direct relation to each other.
The price of crude oil has experienced significant volatility over the last five years, with the price of a barrel of oil dropping below
$20 during the early part of 2020, due in part to reduced global demand stemming from the global COVID-19 outbreak, and most recently
surging over $125 a barrel in early March 2022 following Russia’s invasion of Ukraine, before more recently trading around $70-$80
a barrel. A prolonged period of low market prices for oil and natural gas, or further declines in the market prices for oil and natural
gas, will likely result in capital expenditures being further curtailed and will adversely affect our business, financial condition and
liquidity. Additionally, lower oil and natural gas prices have, and may in the future, cause, a decline in our stock price. The below
table highlights the recent volatility in oil and gas prices by summarizing the high and low daily NYMEX WTI oil spot price and daily
NYMEX natural gas Henry Hub spot price for the periods presented:
| |
Daily NYMEX WTI oil spot price (per Bbl) | | |
Daily NYMEX natural gas Henry Hub spot price (per MMBtu) | |
| |
High | | |
Low | | |
High | | |
Low | |
Year ended December 31, 2019 | |
$ | 66.24 | | |
$ | 46.31 | | |
$ | 4.25 | | |
$ | 1.75 | |
Year ended December 31, 2020 | |
$ | 63.27 | | |
$ | (36.98 | ) | |
$ | 3.14 | | |
$ | 1.33 | |
Year ended December 31, 2021 | |
$ | 85.64 | | |
$ | 47.47 | | |
$ | 23.86 | | |
$ | 2.43 | |
Year ended December 31, 2022 | |
$ | 123.64 | | |
$ | 71.05 | | |
$ | 9.85 | | |
$ | 3.46 | |
Quarter ended March 31, 2023 (through February 28, 2023) | |
$ | 81.62 | | |
$ | 72.82 | | |
$ | 3.78 | | |
$ | 2.07 | |
Declines
in the prices we receive for our oil and natural gas can also adversely affect our ability to finance capital expenditures, make acquisitions,
raise capital and satisfy our financial obligations. In addition, declines in prices can reduce the amount of oil and natural gas that
we can produce economically and the estimated future cash flow from that production and, as a result, adversely affect the quantity and
present value of our proved reserves. Among other things, a reduction in the amount or present value of our reserves can limit the capital
available to us, and the availability of other sources of capital likely will be based to a significant degree on the estimated quantity
and value of the reserves.
As
described above, oil, NGLs, and natural gas are commodities and, therefore, their prices are subject to wide fluctuations in response
to relatively minor changes in supply and demand. Historically, the commodities market has been volatile. An extended period of continued
lower oil prices, or additional price declines, will have further adverse effects on us. The prices we receive for any future production
and the prices received from operators of our non-operated production, and the levels of such production, will continue to depend on
numerous factors, including the following:
|
● |
the
domestic and foreign supply of oil, NGLs, and natural gas; |
|
|
|
|
● |
the
domestic and foreign demand for oil, NGLs, and natural gas; |
|
|
|
|
● |
the
prices and availability of competitors’ supplies of oil, NGLs, and natural gas; |
|
|
|
|
● |
the
actions of the Organization of Petroleum Exporting Countries, or OPEC, and state-controlled oil companies relating to oil price and
production controls; |
|
|
|
|
● |
the
price and quantity of foreign imports of oil, NGLs, and natural gas; |
|
|
|
|
● |
the
impact of U.S. dollar exchange rates on oil, NGLs, and natural gas prices and inflation; |
|
|
|
|
● |
domestic
and foreign governmental regulations and taxes; |
|
|
|
|
● |
speculative
trading of oil, NGLs, and natural gas futures contracts; |
|
|
|
|
● |
localized
supply and demand fundamentals, including the availability, proximity, and capacity of gathering and transportation systems for natural
gas; |
|
|
|
|
● |
the
availability of refining capacity; |
|
|
|
|
● |
the
prices and availability of alternative fuel sources; |
|
|
|
|
● |
the
threat, or perceived threat, or results, of viral pandemics, for example, as previously experienced with the COVID-19 pandemic; |
|
● |
weather
conditions and natural disasters; |
|
|
|
|
● |
political
conditions in or affecting oil, NGLs, and natural gas producing regions, including the Middle East and South America and the recent
conflict in Ukraine; |
|
|
|
|
● |
the
continued threat of terrorism and the impact of military action and civil unrest; |
|
|
|
|
● |
public
pressure on, and legislative and regulatory interest within, federal, state, and local governments to stop, significantly limit,
or regulate hydraulic fracturing activities; |
|
|
|
|
● |
the
level of global oil, NGL, and natural gas inventories and exploration and production activity; |
|
|
|
|
● |
authorization
of exports from the United States of liquefied natural gas; |
|
|
|
|
● |
the
impact of energy conservation efforts; |
|
|
|
|
● |
technological
advances affecting energy consumption; and |
|
|
|
|
● |
overall
worldwide economic conditions. |
Declines
in oil, NGL, or natural gas prices will reduce not only our revenue but also the amount of oil, NGL, and natural gas that we, and the
operators of our properties, can produce economically. Should natural gas, NGL or oil prices decline in the future, our non-operated
wells and/or any of our own wells, may be forced to be shut-in, and exploration and development plans for prospects and exploration or
development activities may need to be postponed or abandoned. As a result, we may have to make substantial downward adjustments to our
estimated proved reserves, each of which would have a material adverse effect on our business, financial condition, and results of operations.
We
have limited control over activities on properties we do not operate.
We
operate 86% of our reserves as of December 31, 2022. The remaining 14% represents working interests we own as a non-operator in a geographically
and geologically diverse portfolio of oil-weighted prospects in varying stages of exploration and development. As a result, our ability
to exercise influence over the operations of our non-operated properties or their associated costs is limited. Our dependence on the
operators and other working interest owners of these projects and our limited ability to influence operations and associated costs or
control the risks could materially and adversely affect the realization of our targeted returns on capital in drilling or acquisition
activities. The success and timing of our drilling and development activities on properties operated by others therefore depends upon
a number of factors, including:
|
● |
the
operator’s expertise and financial resources; |
|
|
|
|
● |
the
rate of production of reserves, if any; |
|
|
|
|
● |
approval
of other participants in drilling wells; and |
|
|
|
|
● |
selection
of technology. |
Certain
of our non-operated wells have previously been temporarily shut-in to preserve oil and gas reserves for production during a more favorable
oil price environment, and our wells may again be shut-in, should market conditions significantly deteriorate.
In
early March 2020, there was a global outbreak of COVID-19 that resulted in a drastic decline in global demand of certain mineral and
energy products including crude oil. As a result of the lower demand caused by the COVID-19 pandemic and the oversupply of crude oil,
spot and future prices of crude oil fell to historic lows during the second quarter of 2020. Operators in North Dakota’s Williston
Basin (including the operators of our Williston Basin wells) responded by significantly decreasing drilling and completion activity and
shutting in or curtailing production from a significant number of producing wells. Operators’ decisions on these matters are changing
rapidly and it is difficult to predict the future effects on the Company’s business. Lower oil and natural gas prices not only
decrease our revenues, but an extended decline in oil or gas prices may materially and adversely affect our future business, financial
position, cash flows, results of operations, liquidity, and ability to finance planned capital expenditures. While our producing wells
are shut-in, we do not generate revenues from such wells, and would need to use our cash on hand and funds we receive from borrowings
and the sale of equity in order to pay our operating expenses. A continued period of low-priced oil may make it non-economical for our
wells to operate, which would have a material adverse effect on our operating results and the value of our assets. We cannot estimate
the future price of oil, and as such cannot estimate, when our wells may again be shut-in by us or their third party operators.
Our
business and operations have been adversely affected by the COVID-19 pandemic, and may be adversely affected by other similar outbreaks.
As
a result of the COVID-19 pandemic or other adverse public health developments, including voluntary and mandatory quarantines, travel
restrictions, and other restrictions, our operations, and those of our subcontractors, customers, and suppliers, have and experienced
delays or disruptions and temporary suspensions of operations. In addition, our financial condition and results of operations have been
adversely affected by the COVID-19 pandemic. Other contagious diseases in the human population could have similar adverse effects.
Declining
general economic, business or industry conditions have, and will continue to have, a material adverse effect on our results of operations,
liquidity, and financial condition, and are expected to continue having a material adverse effect for the foreseeable future.
Concerns
over global economic conditions, the threat of pandemic diseases and the results thereof, energy costs, geopolitical issues, increasing
inflation and interest rates, the availability and cost of credit have contributed to increased economic uncertainty and diminished expectations
for the global economy. These factors, combined with volatile prices of oil and natural gas, declining business and consumer confidence,
and increased unemployment, may result in an economic slowdown and/or a recession, which could expand to a global depression. Concerns
about global economic growth have had a significant adverse impact on global financial markets and commodity prices and are expected
to continue having a material adverse effect for the foreseeable future. If the economic climate in the United States or abroad continues
to deteriorate, demand for petroleum products could diminish, which could further impact the price at which our operators can sell oil,
natural gas, and natural gas liquids, affect the ability of our vendors, suppliers and customers to continue operations, and ultimately
adversely impact our results of operations, liquidity and financial condition to a greater extent than it has already. In addition, a
decline in consumer confidence or changing patterns in the availability and use of disposable income by consumers can negatively affect
the demand for oil and gas and as a result our results of operations.
The
Company’s operations could be disrupted by natural or human causes beyond its control.
The
Company’s operations are subject to disruption from natural or human causes beyond its control, including risks from hurricanes,
severe storms, floods, heat waves, other forms of severe weather, wildfires, ambient temperature increases, sea level rise, war, accidents,
civil unrest, political events, fires, earthquakes, system failures, cyber threats, terrorist acts and epidemic or pandemic diseases
such as the COVID-19 pandemic, some of which may be impacted by climate change and any of which could result in suspension of operations
or harm to people or the natural environment, any of which could have a material adverse effect on the Company’s results of operations
or financial condition.
Economic
uncertainty may affect our access to capital and/or increase the costs of such capital.
Global
economic conditions continue to be volatile and uncertain due to, among other things, consumer confidence in future economic conditions,
fears of recession and trade wars, the price of energy, fluctuating interest rates, the availability and cost of consumer credit, the
availability and timing of government stimulus programs, levels of unemployment, increased inflation, and tax rates. These conditions
remain unpredictable and create uncertainties about our ability to raise capital in the future. In the event required capital becomes
unavailable in the future, or more costly, it could have a material adverse effect on our business, results of operations, and financial
condition.
The
development of oil and natural gas properties involves substantial risks that may result in a total loss of investment.
The
business of exploring for, working over and developing natural gas and oil properties involves a high degree of business and financial
risk, and thus a significant risk of loss of initial investment that even a combination of experience, knowledge and careful evaluation
may not be able to overcome. The cost and timing of drilling, workover completing and operating wells is often uncertain. Factors which
can delay or prevent drilling or production, or otherwise impact expected results, include but are not limited to:
|
● |
unexpected
drilling conditions; |
|
● |
inability
to obtain required permits from governmental authorities; |
|
● |
inability
to obtain, or limitations on, easements from landowners; |
|
● |
uncertainty
regarding our operating partners’ drilling schedules; |
|
● |
high
pressure or irregularities in geologic formations; |
|
● |
equipment
failures; |
|
● |
title
problems; |
|
● |
fires,
explosions, blowouts, cratering, pollution, spills and other environmental risks or accidents; |
|
● |
changes
in government regulations and issuance of local drilling restrictions or moratoria; |
|
● |
adverse
weather; |
|
● |
reductions
in commodity prices; |
|
● |
pipeline
ruptures; and |
|
● |
unavailability
or high cost of equipment, field services and labor. |
A
productive well may become uneconomic in the event unusual quantities of water or other non-commercial substances are encountered in
the well bore that impair or prevent production. We may participate in wells that are or become unproductive or, though productive, do
not produce in economic quantities. In addition, even commercial wells can produce less, or have higher costs, than we projected.
In
addition, initial 24-hour or other limited-duration production rates announced regarding our oil and natural gas properties are not necessarily
indicative of future production rates.
Dry
holes and other unsuccessful or uneconomic exploration, exploitation and development activities can adversely affect our cash flow, profitability
and financial condition, and can adversely affect our reserves.
The
Williston Basin (Bakken and Three Forks shales) oil price differential and oil price differentials in other properties
in Wyoming and Montana could have adverse impacts on our revenue.
Generally,
crude oil produced from the Bakken formation in North Dakota is high quality (36 to 44 degrees API (a measure of how heavy or light a
petroleum liquid is compared to water), which is comparable to West Texas Intermediate Crude (“WTI”). During 2022, our weighted
average realized oil price in our Rockies region, which includes North Dakota, Montana and Wyoming was $88.54, which due to transportation
costs was approximately $6.36 per barrel less than the average WTI spot price for crude oil. This discount, or differential, may widen
in the future, which would reduce the price we receive for our production. We may also be adversely affected by widening differentials
in other areas of operation.
Drilling
and completion costs for the wells we drill in the Williston Basin are typically comparable to or higher than other areas where there
is no price differential. This makes it more likely that a downturn in oil prices will result in a ceiling limitation write-down of our
oil and natural gas properties. A widening of the differential would reduce the cash flow from our Williston Basin properties and adversely
impact our ability to participate fully in drilling. Our production in other areas could also be affected by adverse changes in differentials.
In addition, changes in differentials could make it more difficult for us to effectively hedge our exposure to changes in commodity prices.
Non-consent
provisions could result in penalties and loss of revenues from wells.
Our
industry partners may elect to engage in drilling activities that we are unwilling or unable to participate in during 2023 and thereafter.
Our exploration and development agreements contain customary industry non-consent provisions. Pursuant to these provisions, if a well
is proposed to be drilled or completed but if a working interest owner elects not to participate, the resulting revenues (which otherwise
would go to the non-participant) flow to the participants until the participating parties receive from 150% to 300% of the capital they
provided to cover the non-participant’s share. In order to be in position to avoid non-consent penalties and to make opportunistic
investments in new assets, we will continue to evaluate various options to obtain additional capital, including debt financing, sales
of one or more producing or non-producing oil and natural gas assets and the issuance of shares of our common stock.
Unanticipated
costs could require new capital that may not be available.
The
oil and natural gas business holds the potential opportunity for significant returns on investment, but achievement of such returns is
subject to high risk. For example, initial results from one or more oil and natural gas programs could be marginal but warrant investing
in more wells. Dry holes, over-budget exploration costs, low commodity prices, or any combination of these or other adverse factors,
could result in production revenues falling below projections, thus adversely impacting cash expected to be available for a continued
work program, and a reduction in cash available for investment in other programs. These types of events could require a reassessment
of priorities and therefore potential re-allocations of existing capital and could also mandate obtaining new capital. There can be no
assurance that we will be able to complete any financing transaction on acceptable terms.
Competition
may limit our opportunities in the oil and natural gas business.
The
oil and natural gas business is very competitive. We compete with many public and private exploration and development companies in finding
investment opportunities. We also compete with oil and natural gas operators in acquiring acreage positions. Our principal competitors
are small to mid-size companies with in-house petroleum exploration and drilling expertise. Many of our competitors possess and employ
financial, technical and personnel resources substantially greater than ours. They also may be willing and able to pay more for oil and
natural gas properties than our financial resources permit, and may be able to define, evaluate, bid for and purchase a greater number
of properties. In addition, there is substantial competition in the oil and natural gas industry for investment capital, and we may not
be able to compete successfully in raising additional capital if needed.
Successful
exploitation of shale formations is subject to risks related to horizontal drilling and completion techniques.
Operations
in shale formations in many cases involve utilizing the latest drilling and completion techniques in an effort to generate the highest
possible cumulative recoveries and therefore generate the highest possible returns. Risks that are encountered while drilling include,
but are not limited to, landing the well bore in the desired drilling zone, staying in the zone while drilling horizontally through the
shale formation, running casing the entire length of the well bore (as applicable to the formation) and being able to run tools and other
equipment consistently through the horizontal well bore.
For
wells that are hydraulically fractured, completion risks include, but are not limited to, being able to fracture stimulate the planned
number of fracture stimulation stages, and successfully cleaning out the well bore after completion of the final fracture stimulation
stage. Ultimately, the success of these latest drilling and completion techniques can only be evaluated over time as more wells are drilled
and production profiles are established over a sufficient period of time.
Costs
for any individual well will vary due to a variety of factors. These wells are significantly more expensive than a typical onshore shallow
conventional well. Accordingly, unsuccessful exploration or development activity affecting even a small number of wells could have a
significant impact on our results of operations. Costs other than drilling and completion costs can also be significant for shale wells.
If
our access to oil and natural gas markets is restricted, it could negatively impact our production and revenues. Securing access to takeaway
capacity may be particularly difficult in less developed areas of the Williston Basin and Montana and Wyoming.
Market
conditions or limited availability of satisfactory oil and natural gas transportation arrangements may hinder our access to oil and natural
gas markets or delay our production. The availability of a ready market for our oil and natural gas production depends on a number of
factors, including the demand for and supply of oil and natural gas and the proximity of reserves to pipelines and other midstream facilities.
The ability to market our production depends in substantial part on the availability and capacity of gathering systems, pipelines, rail
transportation and processing facilities owned and operated by third parties. In particular, access to adequate gathering systems or
pipeline or rail takeaway capacity is limited in the Williston Basin and in Montana and Wyoming. In order to secure takeaway capacity
and related services, we or our operating partners may be forced to enter into arrangements that are not as favorable to operators as
those in other areas.
If
we are unable to replace reserves, we will not be able to sustain production.
Our
future operations depend on our ability to find, develop, and acquire crude oil, natural gas, and NGL reserves that are economically
producible. Our properties produce crude oil, natural gas, and NGLs at a declining rate over time. In order to maintain current production
rates, we must locate and develop or acquire new crude oil, natural gas, and NGL reserves to replace those being depleted by production.
Without successful drilling or acquisition activities, our reserves and production will decline over time. In addition, competition for
crude oil and natural gas properties is intense, and many of our competitors have financial, technical, human, and other resources necessary
to evaluate and integrate acquisitions that are substantially greater than those available to us.
As
part of our growth strategy, we intend to make acquisitions. However, suitable acquisition candidates may not be available on terms and
conditions we find acceptable, and acquisitions pose substantial risks to our business, financial condition and results of operations.
In pursuing acquisitions, we compete with other companies, many of which have greater financial and other resources than we do. In the
event we do complete an acquisition, its successful impact on our business will depend on a number of factors, many of which are beyond
our control. These factors include the purchase price for the acquisition, future crude oil, natural gas, and NGL prices, the ability
to reasonably estimate or assess the recoverable volumes of reserves, rates of future production and future net revenues attainable from
reserves, future operating and capital costs, results of future exploration, exploitation, and development activities on the acquired
properties, and future abandonment and possible future environmental or other liabilities. There are numerous uncertainties inherent
in estimating quantities of proved oil and natural gas reserves, actual future production rates, and associated costs and potential liabilities
with respect to prospective acquisition targets. Actual results may vary substantially from those assumed in the estimates. A customary
review of subject properties will not necessarily reveal all existing or potential problems.
Additionally,
significant acquisitions can change the nature of our operations and business depending upon the character of the acquired properties
if they have substantially different operating and geological characteristics or are in different geographic locations than our existing
properties. To the extent that acquired properties are substantially different than our existing properties, our ability to efficiently
realize the expected economic benefits of such transactions may be limited. If we are unable to integrate acquisitions successfully and
realize anticipated economic, operational and other benefits in a timely manner, substantial costs and delays or other operational, technical
or financial problems could result.
Integrating
acquired businesses and properties involves a number of special risks. These risks include the possibility that management may be distracted
from regular business concerns by the need to integrate operations and systems and that unforeseen difficulties can arise in integrating
operations and systems and in retaining and assimilating employees. Any of these or other similar risks could lead to potential adverse
short-term or long-term effects on our operating results and may cause us to not be able to realize any or all of the anticipated benefits
of the acquisitions.
Many
of our joint operating agreements contain provisions that may be subject to legal interpretation, including allocation of non-consent
interests, complex payout calculations that impact the timing of reversionary interests, and the impact of joint interest audits.
Substantially
all of our oil and natural gas interests are subject to joint operating and similar agreements. Some of these agreements include payment
provisions that are complex and subject to different interpretations and/or can be erroneously applied in particular situations.
Joint
interest audits are a normal process in our business to ensure that operators adhere to standard industry practices in the billing of
costs and expenses related to our oil and natural gas properties. However, the ultimate resolution of joint interest audits can extend
over a long period of time in which we attempt to recover excessive amounts charged by the operator. Joint interest audits result in
incremental costs for the audit services and we can incur substantial amounts of legal fees to resolve disputes with the operators of
our properties.
We
have many non-operated drilling locations. Therefore, we will not be able to control the timing of exploration or development efforts,
associated costs, or the rate of production of these non-operated assets.
We
do not currently operate the drilling prospects in South Texas we hold with industry partners. As a non-operator, our ability to exercise
influence over the operations of the drilling programs is limited. In the usual case in the oil and natural gas industry, new work is
proposed by the operator and often is approved by most of the non-operating parties. If the work is approved by the holders of a majority
of the working interests, but we disagree with the proposal and do not (or are unable to) participate, we will forfeit our share of revenues
from the well until the participants receive 150% to 300% of their investment. In some cases, we could lose all of our interest in the
well. We would avoid a penalty of this kind only if a majority of the working interest owners agree with us and the proposal does not
proceed.
The
success and timing of our drilling and development activities on properties operated by others depend upon a number of factors outside
of our control, including:
|
● |
the
nature and timing of the operator’s drilling and other activities; |
|
● |
the
timing and amount of required capital expenditures; |
|
● |
the
operator’s geological and engineering expertise and financial resources; |
|
● |
the
approval of other participants in drilling wells; and |
|
● |
the
operator’s selection of suitable technology. |
The
fact that our industry partners serve as operator makes it more difficult for us to predict future production, cash flows and liquidity
needs. Our ability to grow our production and reserves depends on decisions by our partners to drill wells in which we have an interest,
and they may elect to reduce or suspend the drilling of those wells.
Our
estimated reserves are based on many assumptions that may turn out to be inaccurate. Any material inaccuracies in these reserve estimates
or the relevant underlying assumptions will materially affect the quantity and present value of our reserves.
Oil
and natural gas reserve reports are prepared by independent consultants to provide estimates of the quantities of hydrocarbons that can
be economically recovered from proved properties, utilizing commodity prices for a trailing 12-month period and taking into account expected
capital, operating and other expenditures. These reports also provide estimates of the future net present value of the reserves, which
we use for internal planning purposes and for testing the carrying value of the properties on our balance sheet.
The
reserve data included in this Report represents estimates only. Estimating quantities of, and future cash flows from, proved oil and
natural gas reserves is a complex process and not an exact science. It requires interpretations of available technical data and various
estimates, including estimates based upon assumptions relating to economic factors, such as future production costs; ad valorem, severance
and excise taxes; availability of capital; estimates of required capital expenditures, workover and remedial costs; and the assumed effect
of governmental regulation. The assumptions underlying our estimates of our proved reserves could prove to be inaccurate, and any significant
inaccuracy could materially affect, among other things, future estimates of the reserves, the economically recoverable quantities of
oil and natural gas attributable to the properties, the classifications of reserves based on risk of recovery, and estimates of our future
net cash flows.
At
December 31, 2022, 99% of our estimated proved reserves were developed producing. Estimation of proved undeveloped reserves and proved
developed non-producing reserves is almost always based on analogy to existing wells, volumetric analysis or probabilistic methods, in
contrast to the performance data used to estimate producing reserves. Recovery of proved undeveloped reserves requires significant capital
expenditures and successful drilling operations.
You
should not assume that the present values referred to in this report represent the current market value of our estimated oil and natural
gas reserves. The timing and success of the production and the expenses related to the development of oil and natural gas properties,
each of which is subject to numerous risks and uncertainties, will affect the timing and amount of actual future net cash flows from
our proved reserves and their present value. In addition, our PV-10 and standardized measure estimates are based on costs as of the date
of the estimates and assume fixed commodity prices. Actual future prices and costs may be materially higher or lower than the prices
and costs used in the estimate.
Further,
the use of a 10% discount factor to calculate PV-10 and standardized measure values may not necessarily represent the most appropriate
discount factor given actual interest rates and risks to which our business or the oil and natural gas industry in general are subject.
Our
hedging activities have in the past and may in the future prevent us from benefiting fully from increases in oil and gas prices and may
expose us to other risks, including counterparty risk.
From
time to time, we use derivative instruments, typically fixed-rate swaps and costless collars, to manage price risk underlying our oil
and natural gas production. We have in the past, and to the extent that we continue to engage in hedging activities to protect ourselves
against commodity price declines, we may in the future, be prevented from fully realizing the benefits of increases in oil and/or gas
prices above the prices established by our hedging contracts. For example, in January 2022, the Company entered into NYMEX WTI crude
oil commodity derivative contracts for 2022 and 2023 production. The Company entered into commodity derivative collar contracts for a
total of 210,500 Bbls of crude oil from February 1, 2022 to December 31, 2022 with a floor of $65.00 and a ceiling of $89.40 and 211,500
Bbls of crude oil from January 1, 2023 to December 31, 2023 with a floor of $60.00 and a ceiling of $81.04. For the years ended December
31, 2022 and 2021, we had a total net derivative loss on oil and gas contracts of $5.7 million and $0.3 million, respectively. See
Note 7 Commodity Derivatives to the footnotes to the financial statements included herein under “Item 8. Financial Statements and Supplementary Data”. Our hedging activities may expose us to the risk of financial loss in certain circumstances, including
instances in which the counterparties to our hedging contracts fail to perform under the contracts. Our hedges have in the past and may
in the future result in losses and reduce the amount of revenue we would otherwise obtain upon the sale of oil and gas and may also increase
our margins and decrease our net revenues.
Our
actual future production may be significantly higher or lower than we estimate at the time we enter into derivative contracts for the
relevant period. If the actual amount of production is higher than we estimated, we will have greater commodity price exposure than we
intended. If the actual amount of production is lower than the notional amount that is subject to our derivative instruments, we might
be forced to satisfy all or a portion of our derivative transactions without the benefit of the cash flow from our sale of the underlying
physical commodity, resulting in a substantial diminution of our liquidity. As a result of these factors, our hedging activities may
not be as effective as we intend in reducing the volatility of our cash flows, and in certain circumstances may actually increase the
volatility of our cash flows.
Derivative
instruments also expose us to the risk of financial loss in some circumstances, including when:
|
● |
the
counter-party to the derivative instrument defaults on its contract obligations; |
|
● |
there
is an increase in the differential between the underlying price in the derivative instrument and actual prices received (as existed
in 2021and 2022); or |
|
● |
the
steps we take to monitor our derivative financial instruments do not detect and prevent transactions that are inconsistent with our
risk management strategies. |
In
addition, depending on the type of derivative arrangements we enter into, the agreements could limit the benefit we would receive from
increases in oil prices. It cannot be assumed that the hedging transactions we have entered into, or will enter into, will adequately
protect us from fluctuations in commodity prices.
The
Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) provides for statutory and regulatory requirements
for derivative transactions, including crude oil and natural gas derivative transactions. Among other things, the Dodd-Frank Act provides
for the creation of position limits for certain derivatives transactions, as well as requiring certain transactions to be cleared on
exchanges for which cash collateral will be required. The Dodd-Frank Act requires the Commodities Futures and Trading Commission (the
“CFTC”), the SEC and other regulators to promulgate rules and regulations implementing the Dodd-Frank Act.
The
CFTC has finalized other regulations implementing the Dodd-Frank Act’s provisions regarding trade reporting, margin, clearing and
trade execution; however, some regulations remain to be finalized and it is not possible at this time to predict when the CFTC will adopt
final rules. For example, the CFTC has re-proposed regulations setting position limits for certain futures and option contracts in the
major energy markets and for swaps that are their economic equivalents. Certain bona fide hedging transactions are expected to be made
exempt from these limits. Also, it is possible that under recently adopted margin rules, some registered swap dealers may require us
to post initial and variation margins in connection with certain swaps not subject to central clearing.
The
Dodd-Frank Act and any additional implementing regulations could significantly increase the cost of some commodity derivative contracts
(including through requirements to post collateral, which could adversely affect our available liquidity), materially alter the terms
of some commodity derivative contracts, limit our ability to trade some derivatives to hedge risks, reduce the availability of some derivatives
to protect against risks we encounter and reduce our ability to monetize or restructure our existing commodity derivative contracts.
If we reduce our use of derivatives as a consequence, our results of operations may become more volatile and our cash flows may be less
predictable, which could adversely affect our ability to plan for and fund capital expenditures. Increased volatility may make us less
attractive to certain types of investors. Finally, the Dodd-Frank Act was intended, in part, to reduce the volatility of oil and natural
gas prices, which some legislators attributed to speculative trading in derivatives and commodity instruments related to oil and natural
gas. If the implementing regulations result in lower commodity prices, our revenues could be adversely affected. Any of these consequences
could adversely affect our business, financial condition and results of operations.
Increases
in the differential between the ceiling value for oil and natural gas prices set forth in our commodity derivative contracts and commodity
derivative collar contracts has in the past adversely affected, and is anticipated to continue to adversely affect our business, financial
condition and results of operations.
Our
acreage must be drilled before lease expiration, generally within three to five years, in order to hold the acreage by production. In
the highly competitive market for acreage, failure to drill sufficient wells in order to hold acreage will result in a substantial lease
renewal cost, or if renewal is not feasible, the loss of our lease and prospective drilling opportunities.
Unless
production is established within the spacing units covering the undeveloped acres on which some of our potential drilling locations are
identified, the leases for such acreage will expire. The cost to renew such leases may increase significantly, and we may not be able
to renew such leases on commercially reasonable terms or at all. The risk that our leases may expire will generally increase when commodity
prices fall, as lower prices may cause our operating partners to reduce the number of wells they drill. In addition, on certain portions
of our acreage, third-party leases could become immediately effective if our leases expire. As such, our actual drilling activities may
materially differ from our current expectations, which could adversely affect our business.
Our
producing properties are primarily located in North Dakota, Montana, Wyoming, New Mexico, Texas Oklahoma and Kansas, making us vulnerable
to risks associated with having operations concentrated in these geographic areas.
Because
our operations are geographically concentrated in North Dakota, Montana, Wyoming, New Mexico, Texas, Oklahoma and Kansas the success
and profitability of our operations may be disproportionally exposed to the effect of regional events. These include, among others, regulatory
issues, natural disasters and fluctuations in the prices of crude oil and natural gas produced from wells in the region and other regional
supply and demand factors, including gathering, pipeline and other transportation capacity constraints, available rigs, equipment, oil
field services, supplies, labor and infrastructure capacity. Any of these events has the potential to cause producing wells to be shut-in,
delay operations and growth plans, decrease cash flows, increase operating and capital costs and prevent development of lease inventory
before expiration. In addition, our operations in North Dakota, Montana, Wyoming, New Mexico, Texas, Oklahoma and Kansas, may be adversely
affected by seasonal weather and lease stipulations designed to protect wildlife, which can intensify competition for services, infrastructure
and equipment during months when drilling is possible and may result in periodic shortages. Any of these risks could have a material
adverse effect on our financial condition and results of operations.
Insurance
may be insufficient to cover future liabilities.
Our
business is currently focused on oil and natural gas exploration and development, and we also have potential exposure to general liability
and property damage associated with the ownership of other corporate assets. We have obtained insurance policies for our oil and natural
gas operations covering both operated and non-operated properties, as well as, policies covering corporate liabilities and damage to
corporate assets.
We
would be liable for claims in excess of coverage and for any deductible provided for in the relevant policy. If uncovered liabilities
are substantial, payment could adversely impact the Company’s cash on hand, resulting in possible curtailment of operations. Moreover,
some liabilities are not insurable at a reasonable cost or at all.
We
are dependent upon information technology systems, which are subject to disruption, damage, failure and risks associated with implementation
and integration.
We
are dependent upon information technology systems in the conduct of our operations. Our information technology systems are subject to
disruption, damage or failure from a variety of sources, including, without limitation, computer viruses, security breaches, cyberattacks,
natural disasters and defects in design. Cybersecurity incidents, in particular, are evolving and include, but are not limited to, malicious
software, attempts to gain unauthorized access to data and other electronic security breaches that could lead to disruptions in systems,
unauthorized release of confidential or otherwise protected information and the corruption of data. Various measures have been implemented
to manage our risks related to information technology systems and network disruptions. However, given the unpredictability of the timing,
nature and scope of information technology disruptions, we could potentially be subject to operational delays, the compromising of confidential
or otherwise protected information, destruction or corruption of data, security breaches, other manipulation or improper use of our systems
and networks or financial losses from remedial actions, any of which could have a material adverse effect on our cash flows, competitive
position, financial condition or results of operations.
Improvements
in or new discoveries of alternative energy technologies could have a material adverse effect on our financial condition and results
of operations.
Because
our operations depend on the demand for oil and used oil, any improvement in or new discoveries of alternative energy technologies (such
as wind, solar, geothermal, fuel cells and biofuels) that increase the use of alternative forms of energy and reduce the demand for oil,
gas and oil and gas related products could have a material adverse impact on our business, financial condition and results of operations.
Competition
due to advances in renewable fuels may lessen the demand for our products and negatively impact our profitability.
Alternatives
to petroleum-based products and production methods are continually under development. For example, a number of automotive, industrial
and power generation manufacturers are developing alternative clean power systems using fuel cells or clean-burning gaseous fuels that
may address increasing worldwide energy costs, the long-term availability of petroleum reserves and environmental concerns, which if
successful could lower the demand for oil and gas. If these non-petroleum-based products and oil alternatives continue to expand and
gain broad acceptance such that the overall demand for oil and gas is decreased it could have an adverse effect on our operations and
the value of our assets.
Permitting
requirements could delay our ability to start or continue our operations.
Oil
and natural gas projects are subject to extensive permitting requirements. Failure to timely obtain required permits to start operations
at a project could cause delay and/or the failure of the project resulting in a potential write-off of the investments made.
Negative
public perception regarding us and/or our industry could have an adverse effect on our operations.
Negative
public perception regarding us and/or our industry resulting from, among other things, concerns raised by advocacy groups about hydraulic
fracturing, waste disposal, oil spills, seismic activity, climate change, explosions of natural gas transmission lines and the development
and operation of pipelines and other midstream facilities may lead to increased regulatory scrutiny, which may, in turn, lead to new
state and federal safety and environmental laws, regulations, guidelines and enforcement interpretations. Additionally, environmental
groups, landowners, local groups and other advocates may oppose our operations through organized protests, attempts to block or sabotage
our operations or those of our midstream transportation providers, intervene in regulatory or administrative proceedings involving our
assets or those of our midstream transportation providers, or file lawsuits or other actions designed to prevent, disrupt or delay the
development or operation of our assets and business or those of our midstream transportation providers. These actions may cause operational
delays or restrictions, increased operating costs, additional regulatory burdens and increased risk of litigation. Moreover, governmental
authorities exercise considerable discretion in the timing and scope of permit issuance and the public may engage in the permitting process,
including through intervention in the courts. Negative public perception could cause the permits we require to conduct our operations
to be withheld, delayed or burdened by requirements that restrict our ability to profitably conduct our business.
Recently,
activists concerned about the potential effects of climate change have directed their attention towards sources of funding for fossil-fuel
energy companies, which has resulted in certain financial institutions, funds and other sources of capital restricting or eliminating
their investment in energy-related activities. Ultimately, this could make it more difficult to secure funding for exploration and production
activities.
Seasonal
weather conditions adversely affect our ability to conduct drilling activities in some of the areas where we operate.
Oil
and natural gas operations in the North Dakota, Montana, Wyoming and the Texas Gulf Coast can be adversely affected by seasonal weather
conditions. In North Dakota, Montana and Wyoming, drilling and other oil and natural gas activities sometimes cannot be conducted as
effectively during the winter months, and this can materially increase our operating and capital costs. Texas Gulf Coast operations are
also subject to the risk of adverse weather events, including hurricanes.
Shortages
of equipment, services and qualified personnel could reduce our cash flow and adversely affect results of operations.
The
demand for qualified and experienced field personnel to drill wells and conduct field operations, geologists, geophysicists, engineers
and other professionals in the oil and natural gas industry can fluctuate significantly, often in correlation with oil and natural gas
prices and activity levels in new regions, causing periodic shortages. These problems can be particularly severe in certain regions such
as the Williston Basin and Texas. During periods of high oil and natural gas prices, the demand for drilling rigs and equipment tends
to increase along with increased activity levels, and this may result in shortages of equipment. Higher oil and natural gas prices generally
stimulate increased demand for equipment and services and subsequently often result in increased prices for drilling rigs, crews and
associated supplies, oilfield equipment and services, and personnel in exploration, production and midstream operations. These types
of shortages and subsequent price increases could significantly decrease our profit margin, cash flow and operating results and/or restrict
or delay our ability to drill those wells and conduct those activities that we currently have planned and budgeted, causing us to miss
our forecasts and projections.
Our
oil and natural gas reserves are estimated and may not reflect the actual volumes of oil and natural gas we will receive, and significant
inaccuracies in these reserve estimates or underlying assumptions will materially affect the quantities and present value of our reserves.
The
process of estimating accumulations of oil and natural gas is complex and is not exact, due to numerous inherent uncertainties. The process
relies on interpretations of available geological, geophysical, engineering, and production data. The extent, quality, and reliability
of this technical data can vary. The process also requires certain economic assumptions related to, among other things, oil and natural
gas prices, drilling and operating expenses, capital expenditures, taxes, and availability of funds. The accuracy of a reserves estimate
is a function of:
● |
the
quality and quantity of available data; |
|
|
● |
the
interpretation of that data; |
|
|
● |
the
judgment of the persons preparing the estimate; and |
|
|
● |
the
accuracy of the assumptions. |
The
accuracy of any estimates of proved reserves generally increases with the length of the production history. Due to the limited production
history of our properties, the estimates of future production associated with these properties may be subject to greater variance to
actual production than would be the case with properties having a longer production history. As our wells produce over time and more
data is available, the estimated proved reserves will be re-determined on at least an annual basis and may be adjusted to reflect new
information based upon our actual production history, results of exploration and development, prevailing oil and natural gas prices and
other factors.
Actual
future production, oil, and natural gas prices, revenues, taxes, development expenditures, operating expenses, and quantities of recoverable
oil and natural gas most likely will vary from our estimates. It is possible that future production declines in our wells may be greater
than we have estimated. Any significant variance to our estimates could materially affect the quantities and present value of our reserves.
We
may purchase oil and natural gas properties with liabilities or risks that we did not know about or that we did not assess correctly,
and, as a result, we could be subject to liabilities that could adversely affect our results of operations.
Before
acquiring oil and natural gas properties, we estimate the reserves, future oil and natural gas prices, operating costs, potential environmental
liabilities, and other factors relating to the properties. However, our review involves many assumptions and estimates, and their accuracy
is inherently uncertain. As a result, we may not discover all existing or potential problems associated with the properties we buy. We
may not become sufficiently familiar with the properties to assess fully their deficiencies and capabilities. We generally do not perform
inspections on every well or property, and we may not be able to observe mechanical and environmental problems even when we conduct an
inspection. The seller may not be willing or financially able to give us contractual protection against any identified problems, and
we may decide to assume environmental and other liabilities in connection with the properties we acquire. If we acquire properties with
risks or liabilities we did not know about or that we did not assess correctly, our business, financial condition, and results of operations
could be adversely affected as we settle claims and incur cleanup costs related to these liabilities.
The
properties we acquired in 2022 may be subject to liabilities or risks that we did not know about or that we did not assess correctly,
and, as a result, we could be subject to liabilities that could adversely affect our results of operations as a result of such acquisitions.
We
may fail to realize the anticipated benefits of the acquisitions we completed in 2022 and may assume unanticipated liabilities.
The
success of our 2022 acquisitions will depend on, among other things, our ability to combine our assets and the acquired assets in a manner
that realizes the various benefits, growth opportunities and synergies identified by combining our assets with the acquired assets. Achieving
the anticipated benefits of the acquisition is subject to a number of risks and uncertainties. Completing the integration process may
be more expensive than anticipated, and we cannot assure you that we will be able to affect the integration of these operations smoothly
or efficiently or that the anticipated benefits of the purchase will be achieved.
Risks
Related to Our Financial Statements
We
have written down, and may in the future be forced to further write-down, material portions of our assets due to low oil and natural
gas prices.
The
full cost method of accounting is used for oil and gas acquisition, exploration, development and production activities. Under the full
cost method, all costs associated with the acquisition, exploration and development of oil and natural gas properties are capitalized
and accumulated in a country-wide cost center. This includes any internal costs that are directly related to development and exploration
activities, but does not include any costs related to production, general corporate overhead or similar activities. Proceeds received
from disposals are credited against accumulated cost, except when the sale represents a significant disposal of reserves, in which case
a gain or loss is recognized. The sum of net capitalized costs and estimated future development and dismantlement costs for each cost
center is depleted on the equivalent unit-of-production method, based on proved oil and natural gas reserves. Excluded from amounts subject
to depreciation, depletion and amortization are costs associated with unevaluated properties.
Under
the full cost method, net capitalized costs are limited to the lower of (a) unamortized cost reduced by the related net deferred tax
liability and asset retirement obligations, and (b) the cost center ceiling. The cost center ceiling is defined as the sum of (i) estimated
future net revenue, discounted at 10% per annum, from proved reserves, based on unescalated costs, adjusted for contract provisions,
any financial derivatives qualifying as accounting hedges and asset retirement obligations, and unescalated oil and natural gas prices
during the period, (ii) the cost of properties not being amortized, and (iii) the lower of cost or market value of unproved properties
included in the cost being amortized, less (iv) income tax effects related to tax assets directly attributable to the natural gas and
crude oil properties. If the net book value reduced by the related net deferred income tax liability and asset retirement obligations
exceeds the cost center ceiling limitation, a non-cash impairment charge is required in the period in which the impairment occurs.
We
perform a quarterly ceiling test for our only oil and natural gas cost center, which is the United States. During 2022 and 2021, we did
not record ceiling test write-downs, however, during 2020, our capitalized costs for oil and natural gas properties exceeded the ceiling
and, therefore, we recorded an aggregate ceiling test write-down of $2.9 million. The ceiling test incorporates assumptions regarding
pricing and discount rates over which we have no influence in the determination of present value In arriving at the ceiling test for
the year ended December 31, 2022, we used an average price applicable to our properties of $93.67 per barrel for oil and $6.36 per Mcfe
for natural gas, based on average prices per barrel of oil and per Mcfe of natural gas at the first day of each month of the 12-month
period prior to the end of the reporting period, to compute the future cash flows of each of the producing properties at that date.
Capitalized
costs associated with unevaluated properties include exploratory wells in progress, costs for seismic analysis of exploratory drilling
locations, and leasehold costs related to unproved properties. During 2020, the COVID-19 pandemic has led to an economic downturn resulting
in lower oil prices which required us to incur material write-downs. Unevaluated properties not subject to depreciation, depletion and
amortization amounted to an aggregate of approximately $1.6 million as of December 31, 2022. These costs will be transferred to evaluated
properties to the extent that we subsequently determine the properties are impaired or if proved reserves are established. During 2020,
we impaired $2.1 million of unevaluated properties and reclassified these amounts to the full cost pool.
We
have identified material weaknesses in our internal control over financial reporting, and our management has concluded that our
disclosure controls and procedures were not effective for periods since 2017. We cannot
assure you that additional material weaknesses or significant deficiencies do not exist or that they will not occur in the future.
If our internal control over financial reporting or our disclosure controls and procedures are not effective, we may not be able to
accurately report our financial results or prevent fraud, which may cause investors to lose confidence in our reported financial
information and may lead to a decline in our stock price.
Effective
internal controls are necessary for us to provide reliable financial reports and effectively prevent fraud. We maintain a system of internal
control over financial reporting, which is defined as a process designed by, or under the supervision of, our principal executive officer
and principal financial officer, or persons performing similar functions, and effected by our board of directors, management and other
personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements
for external purposes in accordance with GAAP. A “material weakness” is a deficiency, or a combination of deficiencies, in
internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our financial statements
will not be prevented or detected on a timely basis. Based on the results of management’s assessment and evaluation of our internal
controls, our principal executive officer and principal financial officer concluded that our internal control over financial reporting
was not effective as of December 31, 2022 due to the material weaknesses described below.
As
of December 31, 2022, we have identified the following material weaknesses:
|
● |
Third party information technology general controls (“ITGCs”) related to our accounting system were not designed appropriately
and reliance could not be placed on the processing integrity of the accounting system. |
|
● |
Certain control activities with a review component were not implemented
and operating effectively for a sufficient portion of the year and did not include sufficient evidence of review procedures performed
or formal approval by the reviewer. |
|
● |
Certain business process controls were not implemented for a sufficient
portion of the year and did not include sufficient evidence of operation. |
As
a result, our management also concluded that our disclosure controls and procedures were not effective as of December 31, 2022, such
that the information relating to us required to be disclosed in the reports we file with the SEC (a) is recorded, processed, summarized
and reported within the time periods specified in the SEC’s rules and forms and (b) is accumulated and communicated to our management
to allow timely decisions regarding required disclosures and such disclosure controls and procedures have not been deemed effective since
approximately December 31, 2016.
A
material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is
a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented
or detected on a timely basis. A control deficiency exists when the design or operation of a control does not allow management or employees,
in the normal course of performing their assigned functions, to prevent or detect misstatements on a timely basis.
Maintaining
effective disclosure controls and procedures and effective internal control over financial reporting are necessary for us to produce
reliable financial statements and the Company is committed to remediating its material weaknesses in such controls as promptly as possible.
However, there can be no assurance as to when these material weaknesses will be remediated or that additional material weaknesses will
not arise in the future. Any failure to remediate the material weaknesses, or the development of new material weaknesses in our internal
control over financial reporting, could result in material misstatements in our financial statements and cause us to fail to meet our
reporting and financial obligations, which in turn could have a material adverse effect on our financial condition and the trading price
of our common stock, and/or result in litigation against us or our management. In addition, even if we are successful in strengthening
our controls and procedures, those controls and procedures may not be adequate to prevent or identify irregularities or facilitate the
fair presentation of our financial statements or our periodic reports filed with the SEC.
There
are inherent limitations in all control systems and misstatements due to error or fraud that may occur and not be detected.
The
ongoing internal control provisions of Section 404 of the Sarbanes-Oxley Act of 2002 require us to identify material weaknesses in internal
control over financial reporting, which is a process to provide reasonable assurance regarding the reliability of financial reporting
for external purposes in accordance with GAAP. Our management does not expect that our internal controls and disclosure controls, even
assuming all material weaknesses and control deficiencies are remediated, will prevent all errors and all fraud. A control system, no
matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system
are met. In addition, the design of a control system must reflect the fact that there are resource constraints and the benefit of controls
must be relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute
assurance that all control issues and instances of fraud in our company have been detected. These inherent limitations include the realities
that judgments in decision-making can be faulty and that breakdowns can occur because of simple errors or mistakes. Further, controls
can be circumvented by individual acts of some persons, by collusion of two or more persons, or by management override of the controls.
The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there
can be no assurance that any design will succeed in achieving our stated goals under all potential future conditions. Over time, a control
may be inadequate because of changes in conditions, such as growth of the Company or increased transaction volume, or the degree of compliance
with the policies or procedures may deteriorate. Because of inherent limitations in a cost-effective control system, misstatements due
to error or fraud may not be detected.
Our
ability to use net operating loss carryforwards and realize built in losses to offset future taxable income for U.S. federal income tax
purposes is subject to limitation.
In
general, under Section 382 of the Internal Revenue Code of 1986, as amended, a corporation that undergoes an “ownership change”
is subject to limitations on its ability to utilize its pre-change net operating losses (“NOLs”) and realized built in losses
(“RBILS”) to offset future taxable income. In general, an ownership change occurs if the aggregate stock ownership of certain
stockholders (generally 5% stockholders, applying certain look-through rules) increases by more than 50 percentage points over such stockholders’
lowest percentage ownership during the testing period (generally three years).
On
December 27, 2017, we paid down debt under our credit facility with APEG II with shares of our common stock, which represented a 49.3%
ownership change in the Company. In addition, on January 5, 2022, we issued 19,905,736 shares of our common stock for the acquisition
of assets, representing an 81.0% ownership change in the Company. As a result of these transactions, our ability to use these NOLs and
RBILS were significantly reduced.
Risks
Related to Governmental Regulations
Oil
and natural gas operations are subject to environmental, legislative and regulatory initiatives that can materially adversely affect
the timing and cost of operations and the demand for crude oil, natural gas, and NGLs.
Our
operations are subject to stringent and complex federal, state and local laws and regulations relating to the protection of human health
and safety, the environment and natural resources. These laws and regulations can restrict or impact our business activities in many
ways including, but not limited to the following:
|
● |
requiring
the installation of pollution-control equipment or otherwise restricting the handling or disposal of wastes and other substances
associated with operations; |
|
● |
limiting
or prohibiting construction activities in sensitive areas, such as wetlands, coastal regions or areas that contain endangered or
threatened species and/or species of special statewide concern or their habitats; |
|
● |
requiring
investigatory and remedial actions to address pollution caused by our operations or attributable to former operations; |
|
● |
requiring
noise, lighting, visual impact, odor and/or dust mitigation, setbacks, landscaping, fencing, and other measures; |
|
● |
restricting
access to certain equipment or areas to a limited set of employees or contractors who have proper certification or permits to conduct
work (e.g., confined space entry and process safety maintenance requirements); and |
|
● |
restricting
or even prohibiting water use based upon availability, impacts or other factors. |
Failure
to comply with these laws and regulations may trigger a variety of administrative, civil and criminal enforcement measures, including
the assessment of monetary penalties, the imposition of remedial or restoration obligations, and the issuance of orders enjoining future
operations or imposing additional compliance requirements. Certain environmental statutes impose strict, joint and several liability
for costs required to clean up and restore sites where hazardous substances, hydrocarbons or wastes have been disposed or otherwise released.
Moreover, local restrictions, such as state or local moratoria, city ordinances, zoning laws and traffic regulations, may restrict or
prohibit the execution of operational plans. In addition, third parties, such as neighboring landowners, may file claims alleging property
damage, nuisance or personal injury arising from our operations or from the release of hazardous substances, hydrocarbons or other waste
products into the environment.
The
trend in environmental regulation is to place more restrictions and limitations on activities that may affect the environment. We monitor
developments at the federal, state and local levels to keep informed of actions pertaining to future regulatory requirements that might
be imposed in order to mitigate the costs of compliance with any such requirements. We also monitor industry groups that help formulate
recommendations for addressing existing or future regulations and that share best practices and lessons learned in relation to pollution
prevention and incident investigations.
See
“Environmental Laws and Regulations” in Item 1 – Business in this Form 10-K for a discussion of the major environmental,
health and safety laws and regulations that relate to our business. We believe, but cannot be certain, that we are in material compliance
with these laws and regulations. We cannot reasonably predict what applicable laws, regulations or guidance may eventually be adopted
with respect to our operations or the ultimate cost to comply with such requirements.
Proposed
changes to U.S. tax laws, if adopted, could have an adverse effect on our business, financial condition, results of operations, and cash
flows.
From
time to time, legislative proposals are made that would, if enacted, result in the elimination of the immediate deduction for intangible
drilling and development costs, the elimination of the deduction from income for domestic production activities relating to oil and gas
exploration and development, the repeal of the percentage depletion allowance for oil and gas properties, and an extension of the amortization
period for certain geological and geophysical expenditures. Such changes, if adopted, or other similar changes that reduce or eliminate
deductions currently available with respect to oil and gas exploration and development, could adversely affect our business, financial
condition, results of operations, and cash flows.
Our
ability to produce crude oil, natural gas, and associated liquids economically and in commercial quantities could be impaired if we are
unable to acquire adequate supplies of water for our drilling operations and/or completions or are unable to dispose of or recycle the
water we use at a reasonable cost and in accordance with applicable environmental rules.
The
hydraulic fracturing process on which we and others in our industry depend to complete wells that will produce commercial quantities
of crude oil, natural gas, and NGLs requires the use and disposal or recycling of significant quantities of water. Our inability to secure
sufficient amounts of water, or to dispose of, or recycle the water used in our operations, could adversely impact our operations. Moreover,
the imposition of new environmental initiatives and regulations could include restrictions on our ability to conduct certain operations
such as hydraulic fracturing or disposal of wastes, including, but not limited to, produced water, drilling fluids, and other wastes
associated with the exploration, development, or production of crude oil, natural gas, and NGLs.
Compliance
with environmental regulations and permit requirements governing the withdrawal, storage, and use of surface water or groundwater necessary
for hydraulic fracturing of wells may increase our operating costs and cause delays, interruptions, or termination of our operations,
the extent of which cannot be predicted, all of which could have an adverse effect on our operations and financial condition.
Our
industry and the broader US economy have experienced higher than expected inflationary pressures in 2022, related to continued supply
chain disruptions, labor shortages and geopolitical instability. Should these conditions persist, our business, results of operations
and cash flows could be materially and adversely affected.
2022
saw significant increases in the costs of certain materials, including steel, sand and fuel, as a result of availability constraints,
supply chain disruption, increased demand, labor shortages associated with a fully employed US labor force, high inflation, interest
rates and other factors. Supply and demand fundamentals have been further aggravated by disruptions in global energy supply caused by
multiple geopolitical events, including the ongoing conflict between Russia and Ukraine. Recent supply chain constraints and inflationary
pressures may continue to adversely impact our operating costs and may negatively impact our ability to procure materials and equipment
in a timely and cost-effective manner, if at all, which could result in reduced margins and production delays and, as a result, our business,
financial condition, results of operations and cash flows could be materially and adversely affected.
The
conflict in Ukraine and related price volatility and geopolitical instability could negatively impact our business.
In
late February 2022, Russia launched significant military action against Ukraine. The conflict has caused, and could intensify, volatility
in natural gas, oil and NGL prices, and the extent and duration of the military action, sanctions and resulting market disruptions could
be significant and could potentially have a substantial negative impact on the global economy and/or our business for an unknown period
of time. We believe that the increase in crude oil prices during 2022 has partially been due to the impact of the conflict between Russia
and Ukraine on the global commodity and financial markets, and in response to economic and trade sanctions that certain countries have
imposed on Russia. Any such volatility and disruptions may also magnify the impact of other risks described herein.
Risks
Related to Management, Employees and Directors
Potential
conflicts of interest could arise for certain members of our Board of Directors that hold management positions with other entities and
also represent our majority stockholders.
John
A. Weinzierl, Duane H. King and Joshua Batchelor, each a member of the Board of Directors of the Company, hold various other management
positions with privately-held companies, some of which are involved in the oil and gas industry, and together such persons control or
have joint control, over a majority of our common stock. We believe these positions will not conflict with their roles or responsibilities
with our company. Certain of these entities are party to agreements with the Company and if any of these companies enter into any additional
transactions or agreements with our company, or other related party transactions or matters exist, potential conflicts of interests could
arise from the directors performing services for us and these other entities.
Certain
of our directors beneficially own approximately 57.0% of our outstanding common stock, which gives them majority voting control over
stockholder matters, and each are also party to a Nominating and Voting Agreement, which allows them to control who is appointed to the
Board of Directors of the Company and their interests may be different from your interests; and as a result of such ownership, we are
a “controlled company” under applicable Nasdaq Capital Market Rules.
John
A. Weinzierl, Duane H. King and Joshua Batchelor, our Chairman, director and director, respectively, beneficially own an aggregate of
14,107,140 shares of our common stock, representing approximately 53.3% of our outstanding common stock, including approximately 18.4%,
7.7% and 25.7% of our common stock beneficially owned by each of John A. Weinzierl, Duane H. King and Joshua Batchelor. As such, Messrs.
Weinzierl, King and Batchelor can control the outcome of all matters requiring a stockholder vote, including the election of directors,
the adoption of amendments to our Certificate of Incorporation or Bylaws and the approval of mergers and other significant corporate
transactions. Subject to any fiduciary duties owed to the stockholders generally, while Messrs. Weinzierl’s, King’s and Batchelor’s
interests may generally be aligned with the interests of our stockholders, in some instances Messrs. Weinzierl, King and Batchelor may
have interests different than the rest of our stockholders. Messrs. Weinzierl’s, King’s and Batchelor’s influence or
control of our company as stockholders may have the effect of delaying or preventing a change of control of our company and may adversely
affect the voting and other rights of other stockholders. Because Messrs. Weinzierl, King and Batchelor control the stockholder vote,
investors may find it difficult to replace Messrs. Weinzierl, King and Batchelor (and such persons as they may appoint from time to time)
as members of our management and board of directors if they disagree with the way our business is being operated. Additionally, the interests
of Messrs. Weinzierl, King and Batchelor may differ from the interests of the other stockholders and thus result in corporate decisions
that are adverse to other stockholders.
Separately,
each of the entities controlled by Messrs. Weinzierl, King and Batchelor entered into an Amended and Restated Nominating and Voting Agreement
with us and certain of their affiliates and other third parties. The A&R Agreement provides that each of Lubbock, Synergy and Banner
(each a “Nominating Party”) has the right to designate for nomination to the Board two nominees (for so long as such Nominating
Party (and its affiliates) beneficially owns at least 15% of the Company’s outstanding common stock) and one nominee (for so long
as such Nominating Party (and its affiliates) beneficially owns at least 5% of the Company’s common stock), for appointment at
any stockholder meeting or via any consent to action without meeting of the stockholders of the Company. The A&R Agreement also requires
the Board to include such nominees in the slate of directors up for appointment at each meeting of stockholders where directors will
be appointed, and take other actions to ensure that such persons are elected to the Board by the stockholders of the Company. Pursuant
to the A&R Agreement, if any Nominating Party’s Seller Nominated Party ceases for any reason to serve on the Board, such Seller
Nominated Party will be provided the right to appoint another person to the Board, who shall be appointed to the Board pursuant to the
power to fill vacancies given to the Board without a stockholder vote, by the Bylaws of the Company.
Because
of Messrs. Weinzierl’s, King’s and Batchelor’s ownership of the Company, as discussed above, we are a “controlled
company” under the rules of the Nasdaq Capital Market. Under these rules, a company of which more than 50% of the voting power
is held by an individual, a group or another company is a “controlled company” and, as such, can elect to be exempt
from certain corporate governance requirements, including requirements that:
|
● |
a
majority of the Board of Directors consist of independent directors; |
|
|
|
|
● |
the
board maintain a nominations committee with prescribed duties and a written charter; and |
|
|
|
|
● |
the
board maintain a compensation committee with prescribed duties and a written charter and comprised solely of independent directors. |
As
a “controlled company,” we may elect to rely on some or all of these exemptions, provided that we have to date not
taken advantage of any of these exemptions and do not currently intend to take advantage of any of these exemptions moving forward. Notwithstanding
that, should the interests of Messrs. Weinzierl, King and Batchelor differ from those of other stockholders, the other stockholders may
not have the same protections afforded to stockholders of companies that are subject to all of the Nasdaq Capital Market corporate governance
standards. Even if we do not avail ourselves of these exemptions, our status as a controlled company could make our common stock less
attractive to some investors or otherwise harm our stock price.
We
depend significantly upon the continued involvement of our present management.
We
depend to a significant degree upon the involvement of our management, specifically, our Chief Executive Officer and Chief Financial
Officer, Ryan L. Smith. Our performance and success are dependent to a large extent on the efforts and continued employment of Mr. Smith.
We do not believe that Mr. Smith could be quickly replaced with personnel of equal experience and capabilities, and his successor(s)
may not be as effective. If Mr. Smith or any of our other key personnel resign or become unable to continue in their present roles and
if they are not adequately replaced, our business operations could be adversely affected. The Company entered into an agreement with
Mr. Smith on May 5, 2022. The term of Mr. Smith’s Employment Agreement commenced on May 5, 2022, and has an initial term expiring
January 1, 2024, subject to automatic one-year renewals thereafter in the event neither party provides the other at least 60 days prior
written notice of their intention not to renew the terms of the agreement.
We
have an active Board of Directors that meets several times throughout the year and is intimately involved in our business and the determination
of our operational strategies. Members of our Board of Directors work closely with management to identify potential prospects, acquisitions,
and areas for further development. If any of our directors resign or become unable to continue in their present role, it may be difficult
to find replacements with the same knowledge and experience and as a result, our operations may be adversely affected.
Risks
Related to Our Credit Agreement
Our
obligations under the Credit Agreement are secured by a first priority security interest in substantially all of our assets.
Our
obligations under the Credit Agreement are secured by a first priority security interest in substantially all of our assets. Additionally,
substantially all of our subsidiaries agreed to guarantee our obligations under the Credit Agreement. As such, our creditor may enforce
its security interests over our assets and/or our subsidiaries which secure the repayment of such obligations, take control of our assets
and operations, force us to seek bankruptcy protection, or force us to curtail or abandon our current business plans and operations.
If that were to happen, any investment in the Company could become worthless.
Our
failure to comply with the covenants in the documents governing our existing and future indebtedness could materially adversely affect
our financial condition and liquidity.
In
connection with the Credit Agreement, we agreed to comply with certain affirmative and negative covenants and agreed to meet certain
financial covenants. We are required to make certain mandatory repayments under the Credit Agreement, in the event the borrowing base
decreases below the aggregate amount of loans made by the lenders and/or if as of the last business day of any calendar month, certain
required debt ratios required under the Credit Agreement are not met, there are outstanding amounts owed to the lenders, and the Company
has consolidated cash on hand in excess of $5 million, and in some cases we are also required to pay cash to the agent to be held as
collateral. The Credit Agreement contains customary indemnification requirements, representations and warranties and customary affirmative
and negative covenants applicable to the Loan Parties and their subsidiaries, including, among other things, restrictions on indebtedness,
liens, investments, mergers, dispositions, prepayment of other indebtedness, transactions with affiliates, and dividends and other distributions.
In addition, the Credit Agreement contains financial covenants, tested quarterly, that limit the Company’s ratio of total debt
to EBITDAX (as defined in the Credit Agreement) to 3:1 and require its ratio of consolidated current assets to consolidated current liabilities
(as each is described in the Credit Agreement) to remain at 1:1 or higher. The Credit Agreement also requires us to hedge certain oil
and gas volumes, based on our utilization of the borrowing base.
Events
of default under the Credit Agreement include: the failure by the Company to timely make payments due under the Credit Agreement; material
misrepresentations or misstatements in any representation or warranty of any of the Loan Parties; failure by the Company or any of its
subsidiaries to comply with their covenants under the Credit Agreement and other related agreements, subject in certain cases to rights
to cure; certain defaults under other indebtedness of the Loan Parties; insolvency or bankruptcy-related events with respect to the Company
or any of its subsidiaries; certain unsatisfied judgments against the Company or any of its subsidiaries in an amount in excess of $500,000;
if the Credit Agreement or certain related agreements or security interests created by them cease to be in full force and effect; certain
ERISA-related events reasonably expected to have a material adverse effect on the Company and its subsidiaries; and the occurrence of
a change in control, each as discussed in greater detail in the Credit Agreement, and subject to certain cure rights. If any event of
default occurs and is continuing under the Credit Agreement, the lenders may terminate their commitments, and may require the Company
and its subsidiaries to repay outstanding debt and/or to provide a cash deposit as additional security for outstanding letters of credit.
A
breach of any of the covenants of the Credit Agreement or any future agreements, if uncured or unwaived, could lead to an event of default
under any such document, which in some circumstances could give our creditors the right to demand that we accelerate repayment of amounts
due and/or enforce their security interests over substantially all of our assets. This would likely in turn trigger cross-acceleration
or cross-default rights in other documents governing our indebtedness. Therefore, in the event of any such breach, we may need to seek
covenant waivers or amendments from our creditors or seek alternative or additional sources of financing, and we may not be able to obtain
any such waivers or amendments or alternative or additional financing on acceptable terms, if at all. In addition, any covenant breach
or event of default could harm our credit rating and our ability to obtain additional financing on acceptable terms. The occurrence of
any of these events could have a material adverse effect on our financial condition and liquidity and/or cause our lenders to enforce
their security interests which could ultimately result in the foreclosure of our assets, which would have a material adverse effect on
our operations and the value of our securities.
The
covenants in our credit and loan agreements restrict our ability to operate our business and might lead to a default under our Credit
Agreement.
The
Credit Agreement contains customary indemnification requirements, representations and warranties and customary affirmative and negative
covenants applicable to the Loan Parties and their subsidiaries, including, among other things, restrictions on indebtedness, liens,
investments, mergers, dispositions, prepayment of other indebtedness, transactions with affiliates, and dividends and other distributions.
In addition, the Credit Agreement contains financial covenants, tested quarterly, that limit the Company’s ratio of total debt
to EBITDAX (as defined in the Credit Agreement) to 3:1 and require its ratio of consolidated current assets to consolidated current liabilities
(as each is described in the Credit Agreement) to remain at 1:1 or higher.
As
a result of these covenants and limitations, we may not be able to respond to changes in business and economic conditions and to obtain
additional financing, if needed, and we may be prevented from engaging in transactions that might otherwise be beneficial to us. Our
Credit Agreement requires, and our future credit facilities and loan agreements may require, us to maintain certain financial ratios
and satisfy certain other financial condition tests. Our ability to meet these financial ratios and tests can be affected by events beyond
our control, and we may not be able to meet those tests. The breach of any of these covenants could result in a default under our Credit
Agreement or future credit facilities. Upon the occurrence of an event of default, the lenders could elect to declare all amounts outstanding
under such Credit Agreement, including accrued interest or other obligations, to be immediately due and payable. If amounts outstanding
under such Credit Agreement were to be accelerated, our assets might not be sufficient to repay in full that indebtedness and our other
indebtedness.
A
prolonged period of weak, or a significant decrease in, industry activity and overall markets, due to COVID-19 or otherwise, may make
it difficult to comply with our covenants and the other restrictions in the agreements governing our debt and current global and market
conditions have increased the potential for that difficulty.
Risks
Related to Our Common Stock
We
currently have 245,000,000 shares of common stock authorized and there may be future issuances of sales of our common stock, which could
adversely affect the market price of our common stock and dilute a stockholder’s ownership of common stock.
The
exercise of any options granted to executive officers and other employees under our equity compensation plans could have an adverse effect
on the market price of the shares of our common stock. Additionally, we are not restricted from issuing additional shares of common stock,
including any securities that are convertible into or exchangeable for, or that represent the right to receive shares of common stock,
and currently have 245,000,000 authorized shares of common stock, provided that we are subject to the requirements of The NASDAQ Capital
Market (“NASDAQ”)(which generally requires stockholder approval for any transactions which would result in the issuance of
more than 20% of our then outstanding shares of common stock or voting rights representing over 20% of our then outstanding shares of
stock, subject to certain exceptions, including sales in a public offering and/or sales which are undertaken at or above the lower of
the closing price immediately preceding the signing of the binding agreement or the average closing price for the five trading days preceding
the signing of the binding agreement). Issuances of a substantial number of shares of our common stock and/or sales of a substantial
number of shares of our common stock in the public market or the perception that such issuances or sales might occur could materially
adversely affect the market price of the shares of our common stock. Because our decision to issue securities in the future, including
in connection with any future offering, will depend on market conditions and other factors beyond our control, we cannot predict or estimate
the amount, timing, or nature of our future issuances or offerings. Accordingly, our stockholders bear the risk that our future issuances
and/or offerings will reduce the market price of our common stock and dilute their stock holdings in us.
We
have established preferred stock which can be designated by the Board of Directors without stockholder approval.
We
have 5,000,000 shares of preferred stock authorized (none of which are outstanding). Shares of preferred stock may be designated and
issued by our Board of Directors without stockholder approval with voting powers, and such preferences and relative, participating, optional,
or other special rights and powers as determined by our Board of Directors, which may be greater than the shares of common stock currently
outstanding. As a result, shares of preferred stock may be issued by our Board of Directors which cause the holders to have voting power
over our shares or provide the holders of the preferred stock the right to convert the shares of preferred stock they hold into shares
of our common stock, which may cause substantial dilution to our then common stock stockholders and/or have other rights and preferences
(including, but not limited to voting rights) greater than those of our common stock stockholders. Investors should keep in mind that
the Board of Directors has the authority to issue additional shares of preferred stock, which could cause substantial dilution to our
existing stockholders or result in a change of control. Because our Board of Directors is entitled to designate the powers and preferences
of the preferred stock without a vote of our stockholders, subject to NASDAQ rules and regulations, our stockholders will have no control
over what designations and preferences our future preferred stock, if any, will have.
Our
stock price has historically been and is likely to continue to be, volatile.
Our
stock is traded on The NASDAQ Capital Market under the symbol “USEG”. During the last 52 weeks, our common stock has traded
as high as $8.36 per share and as low as $1.37 per share. We expect our common stock will continue to be subject to wide fluctuations
as a result of a variety of factors, including factors beyond our control. These factors include:
|
● |
price
volatility in the oil and natural gas commodities markets; |
|
● |
variations
in our drilling, recompletion and operating activity; |
|
● |
relatively
small amounts of our common stock trading on any given day; |
|
● |
additions
or departures of key personnel; |
|
● |
legislative
and regulatory changes; and |
|
● |
changes
in the national and global economic outlook, including, but not limited to, as a result of inflation and interest rates, and global
conflicts, including the current ongoing conflict between Ukraine and Russia). |
The
stock market has recently experienced significant price and volume fluctuations, and oil and natural gas prices have declined significantly.
These fluctuations have particularly affected the market prices of securities of oil and natural gas companies like ours.
Our
Common Stock may be delisted from The Nasdaq Capital Market if we cannot satisfy Nasdaq’s continued listing requirements.
Among
the conditions required for continued listing on The Nasdaq Capital Market, Nasdaq requires us to maintain at least $2.5 million in stockholders’
equity, at least $35 million in market value of listed securities or $500,000 in net income over the prior two years or two of the prior
three years, to have a majority of independent directors, and to maintain a stock price over $1.00 per share. Our stockholders’
equity may not remain above Nasdaq’s $2.5 million minimum, we may not have at least $35 million in market value of listed securities,
and we may not generate over $500,000 of yearly net income moving forward, we may not be able to maintain independent directors, and
we may not be able to maintain a stock price over $1.00 per share. Delisting from The Nasdaq Capital Market could make trading our common
stock more difficult for investors, potentially leading to declines in our share price and liquidity. Without a Nasdaq Capital Market
listing, stockholders may have a difficult time getting a quote for the sale or purchase of our stock, the sale or purchase of our stock
would likely be made more difficult and the trading volume and liquidity of our stock could decline. Delisting from The Nasdaq Capital
Market could also result in negative publicity and could also make it more difficult for us to raise additional capital. The absence
of such a listing may adversely affect the acceptance of our common stock as currency or the value accorded by other parties. Further,
if we are delisted, we would also incur additional costs under state blue sky laws in connection with any sales of our securities. These
requirements could severely limit the market liquidity of our common stock and the ability of our stockholders to sell our common stock
in the secondary market. If our common stock is delisted by Nasdaq, our common stock may be eligible to trade on an over-the-counter
quotation system, such as the OTCQB market, where an investor may find it more difficult to sell our stock or obtain accurate quotations
as to the market value of our common stock. In the event our common stock is delisted from The Nasdaq Capital Market, we may not be able
to list our common stock on another national securities exchange or obtain quotation on an over-the counter quotation system.
If
we are delisted from The Nasdaq Capital Market, your ability to sell your shares of our common stock could also be limited by the penny
stock restrictions, which could further limit the marketability of your shares.
If
our common stock is delisted, it could come within the definition of “penny stock” as defined in the Exchange Act
and would then be covered by Rule 15g-9 of the Exchange Act. That Rule imposes additional sales practice requirements on broker-dealers
who sell securities to persons other than established customers and accredited investors. For transactions covered by Rule 15g-9, the
broker-dealer must make a special suitability determination for the purchaser and receive the purchaser’s written agreement to
the transaction prior to the sale. Consequently, Rule 15g-9, if it were to become applicable, would affect the ability or willingness
of broker-dealers to sell our securities, and accordingly would affect the ability of stockholders to sell their securities in the public
market. These additional procedures could also limit our ability to raise additional capital in the future.
We
may not be able to continue to pay dividends on our common stock in the future which could impair the value of such stock.
Under
Delaware law, dividends to stockholders may be made only from the surplus of a company, or, in certain situations, from the net profits
for the current fiscal year or the fiscal year before which the dividend is declared. We have initiated and paid a quarterly dividend
on our common stock since March 2022. We may not be able to legally pay a dividend in the future pursuant to Delaware law and/or our
Board of Directors may choose to discontinue our dividend in the future. Our ability to pay dividends in the future will depend on our
financial results, liquidity and financial condition. In the event we cease paying a dividend or reduce our current quarterly dividend,
the value of our common stock may decline in value.
A
sale of a substantial number of registered shares of common could cause the price of our common stock to decline and make it harder for
us to sell equity in the future.
We
have registered the resale of 19,905,736 shares of common stock pursuant to a Form S-3 Registration Statement, which shares of common
stock represent approximately 78.9% of our outstanding shares of common stock. Such shares of common stock may be resold in the public
market immediately without restriction. The registered shares represent a significant number of shares of our common stock, and if sold
in the market all at once or at about the same time, could significantly depress the market price of our common stock during the period
the registration statement remains effective and could also affect our ability to raise equity capital in the future at a time and price
that we deem reasonable or appropriate.
Risks
Relating to Our Governing Documents and Delaware Law
Our
Certificate of Incorporation provides for indemnification of officers and directors at our expense and limits their liability, which
may result in a major cost to us and hurt the interests of our stockholders because corporate resources may be expended for the benefit
of officers or directors.
Article
VI.B. of our Certificate of Incorporation provides for indemnification as follows: “To the fullest extent permitted by
applicable law, as the same exists or may hereafter be amended, the Corporation shall indemnify and hold harmless each person who is
or was made a party or is threatened to be made a party to or is otherwise involved in any threatened, pending or completed action,
suit or proceeding, whether civil, criminal, administrative or investigative (a “proceeding”) by reason of the fact that
he or she is or was a director or officer of the Corporation or, while a director or officer of the Corporation, is or was serving
at the request of the Corporation as a director, officer, employee or agent of another corporation or of a partnership, joint
venture, trust, other enterprise or nonprofit entity, including service with respect to an employee benefit plan (an
“indemnitee”), whether the basis of such proceeding is alleged action in an official capacity as a director, officer,
employee or agent, or in any other capacity while serving as a director, officer, employee or agent, against all liability and loss
suffered and expenses (including, without limitation, attorneys’ fees, judgments, fines, ERISA excise taxes and penalties and
amounts paid in settlement) reasonably incurred by such indemnitee in connection with such proceeding. The Corporation shall to the
fullest extent not prohibited by applicable law pay the expenses (including attorneys’ fees) incurred by an indemnitee in
defending or otherwise participating in any proceeding in advance of its final disposition; provided, however, that, to the extent
required by applicable law, such payment of expenses in advance of the final disposition of the proceeding shall be made only upon
receipt of an undertaking, by or on behalf of the indemnitee, to repay all amounts so advanced if it shall ultimately be determined
that the indemnitee is not entitled to be indemnified under Article VI.B. of the Certificate of Incorporation or
otherwise.”
Our
obligation to indemnify our officers and directors may discourage stockholders from bringing a lawsuit against our officers or directors
for breach of their fiduciary duty. These provisions also may have the effect of reducing the likelihood of derivative litigation against
our officers and directors, even though such an action, if successful, might otherwise benefit us and our stockholders. Furthermore,
a stockholder’s investment may be adversely affected to the extent we pay the costs of settlement and damage awards against our
officers and directors pursuant to these indemnification provisions.
We
have been advised that, in the opinion of the SEC, indemnification for liabilities arising under federal securities laws is against public
policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification for liabilities
arising under federal securities laws, other than the payment by us of expenses incurred or paid by a director, officer or controlling
person in the successful defense of any action, suit or proceeding, is asserted by a director, officer or controlling person in connection
with our activities, we will (unless in the opinion of our counsel, the matter has been settled by controlling precedent) submit to a
court of appropriate jurisdiction, the question whether indemnification by us is against public policy as expressed in the Securities
Act and will be governed by the final adjudication of such issue. The legal process relating to this matter if it were to occur is likely
to be very costly and may result in us receiving negative publicity, either of which factors is likely to materially reduce the market
and price for our shares.
Our
Certificate of Incorporation contains a specific provision that limits the liability of our directors for monetary damages to the Company
and the Company’s stockholders and requires us, under certain circumstances, to indemnify officers, directors and employees.
The
limitation of monetary liability against our directors, officers and employees under Delaware law and the existence of indemnification
rights to them may result in substantial expenditures by us and may discourage lawsuits against our directors, officers and employees.
Our
Certificate of Incorporation contains a specific provision that limits the liability of our directors for monetary damages to the Company
and the Company’s stockholders, including as a result of a breach of their fiduciary duties, except to the extent such exception
from liability is not permitted under Delaware General Corporation Law. We also have contractual indemnification obligations under our
employment and engagement agreements with our executive officers and directors, as well as pursuant to indemnification agreements. The
foregoing indemnification obligations could result in us incurring substantial expenditures to cover the cost of settlement or damage
awards against our directors and officers, which the Company may be unable to recoup. These provisions and resultant costs may also discourage
us from bringing a lawsuit against our directors and officers for breaches of their fiduciary duties and may similarly discourage the
filing of derivative litigation by our stockholders against our directors and officers, even though such actions, if successful, might
otherwise benefit us and our stockholders.
Anti-takeover
provisions may impede the acquisition of the Company.
Certain
provisions of the Delaware General Corporation Law (DGCL) have anti-takeover effects and may inhibit a non-negotiated merger or other
business combination, notwithstanding the fact that our Certificate of Incorporation provides that we are not subject to Section 203
of the DGCL, which relates to certain restrictions on business combinations with interested stockholders. These provisions are intended
to encourage any person interested in acquiring the Company to negotiate with, and to obtain the approval of, our directors, in connection
with such a transaction. As a result, certain of these provisions may discourage a future acquisition of the Company, including an acquisition
in which the stockholders might otherwise receive a premium for their shares. In addition, we can also authorize “blank check”
preferred stock, which could be issued by our Board of Directors without stockholder approval and may contain voting, liquidation, dividend
and other rights superior to our common stock.
Anti-takeover
provisions in our Certificate of Incorporation and our Amended and Restated Bylaws, as well as provisions of Delaware law, might discourage,
delay or prevent a change in control of our company or changes in our management and, therefore, depress the trading price of our common
stock.
Our
Certificate of Incorporation and Amended and Restated Bylaws and Delaware law contain provisions that may discourage, delay or prevent
a merger, acquisition or other change in control that stockholders may consider favorable, including transactions in which you might
otherwise receive a premium for your shares of our common stock. These provisions may also prevent or delay attempts by our stockholders
to replace or remove our management. Our corporate governance documents include provisions:
|
● |
a
classified board of directors, as a result of which our board of directors is divided into three classes, with each class serving
for staggered three-year terms; |
|
|
|
|
● |
the
removal of directors only for cause; |
|
|
|
|
● |
requiring
advance notice of stockholder proposals for business to be conducted at meetings of our stockholders and for nominations of candidates
for election to our Board of Directors; |
|
|
|
|
● |
authorizing
blank check preferred stock, which could be issued with voting, liquidation, dividend and other rights superior to our common stock;
and |
|
|
|
|
● |
limiting
the liability of, and providing indemnification to, our directors and officers. |
Any
provision of our Certificate of Incorporation or Amended and Restated Bylaws or Delaware law that has the effect of delaying or deterring
a change in control could limit the opportunity for our stockholders to receive a premium for their shares of our common stock, and could
also affect the price that some investors are willing to pay for our common stock.
The
existence of the foregoing provisions and anti-takeover measures could limit the price that investors might be willing to pay in the
future for shares of our common stock. They could also deter potential acquirers of our company, thereby reducing the likelihood that
you could receive a premium for your common stock in an acquisition.
Our
Certificate of Incorporation contains exclusive forum provisions that may discourage lawsuits against us and our directors and officers.
Our
Certificate of Incorporation provides that unless the corporation consents in writing to the selection of an alternative forum, the Court
of Chancery of the State of Delaware, will be the sole and exclusive forum for (i) any derivative action or proceeding brought on behalf
of the Company, (ii) any action asserting a claim for breach of a fiduciary duty owed by any current or former director, officer, employee
or stockholder of the Company to the Company or the Company’s stockholders, (iii) any action asserting a claim arising pursuant
to any provision of the Delaware General Corporation Law, our Certificate of Incorporation or Bylaws or (iv) any action asserting a claim
governed by the internal affairs doctrine.
The
choice of forum provision in our Certificate of Incorporation does not waive our compliance with our obligations under the federal securities
laws and the rules and regulations thereunder. Moreover, the provision does not apply to suits brought to enforce a duty or liability
created by the Exchange Act or by the Securities Act. Section 27 of the Exchange Act creates exclusive federal jurisdiction over all
suits brought to enforce any duty or liability created by the Exchange Act or the rules and regulations thereunder, and Section 22 of
the Securities Act creates concurrent jurisdiction for federal and state courts with respect to suits brought to enforce a duty or liability
created by the Securities Act or the rules and regulations thereunder. Accordingly, both state and federal courts have jurisdiction to
entertain claims under the Securities Act.
Notwithstanding
the above, to prevent having to litigate claims in multiple jurisdictions and the threat of inconsistent or contrary rulings by different
courts, among other considerations, our Certificate of Incorporation provides that unless the Company consents, the U.S. federal district
courts will be the exclusive forum for resolving any complaint asserting a cause of action arising under the Securities Act. However,
there is uncertainty as to whether a court would enforce such a provision. While the Delaware courts have determined that choice of forum
provisions of the type included in our Certificate of Incorporation are facially valid, a stockholder may nevertheless seek to bring
a claim in a venue other than those designated in our exclusive forum provision. In such instance, to the extent applicable, we would
expect to vigorously assert the validity and enforceability of our exclusive forum provision. This may require additional costs associated
with resolving such action in other jurisdictions and there can be no assurance that the provisions will be enforced by a court in those
other jurisdictions.
These
exclusive forum provisions may limit the ability of the Company’s stockholders to bring a claim in a judicial forum that such stockholders
find favorable for disputes with the Company or the Company’s directors or officers, which may discourage such lawsuits against
the Company and the Company’s directors and officers. Alternatively, if a court were to find one or more of these exclusive forum
provisions inapplicable to, or unenforceable in respect of, one or more of the specified types of actions or proceedings described above,
we may incur additional costs associated with resolving such matters in other jurisdictions or forums, which could materially and adversely
affect our business, financial condition, or results of operations.
General
Risk Factors
Because
we are a smaller reporting company, the requirements of being a public company, including compliance with the reporting requirements
of the Exchange Act and the requirements of the Sarbanes-Oxley Act and the Dodd-Frank Act, may strain our resources, increase our costs
and distract management, and we may be unable to comply with these requirements in a timely or cost-effective manner.
As
a public company with listed equity securities, we must comply with the federal securities laws, rules and regulations, including certain
corporate governance provisions of the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”) and the Dodd-Frank Act,
related rules and regulations of the SEC and NASDAQ, with which a private company is not required to comply. Complying with these laws,
rules and regulations will occupy a significant amount of time of our board of directors and management and will significantly increase
our costs and expenses, which we cannot estimate accurately at this time. Among other things, we must:
|
● |
establish
and maintain a system of internal control over financial reporting in compliance with the requirements of Section 404 of the Sarbanes-Oxley
Act and the related rules and regulations of the SEC and the Public Company Accounting Oversight Board; |
|
|
|
|
● |
comply
with rules and regulations promulgated by NASDAQ; |
|
|
|
|
● |
prepare
and distribute periodic public reports in compliance with our obligations under the federal securities laws; |
|
|
|
|
● |
maintain
various internal compliance and disclosures policies, such as those relating to disclosure controls and procedures and insider trading
in our common stock; |
|
|
|
|
● |
involve
and retain to a greater degree outside counsel and accountants in the above activities; |
|
|
|
|
● |
maintain
a comprehensive internal audit function; and |
|
|
|
|
● |
maintain
an investor relations function. |
In
addition, being a public company subject to these rules and regulations may require us to accept less director and officer liability
insurance coverage than we desire or to incur substantial costs to obtain coverage. These factors could also make it more difficult for
us to attract and retain qualified members of our board of directors, particularly to serve on our audit committee, and qualified executive
officers.
Our
business could be adversely affected by security threats, including cybersecurity threats.
We
face various security threats, including cybersecurity threats to gain unauthorized access to our sensitive information or to render
our information or systems unusable, and threats to the security of our facilities and infrastructure or third-party facilities and infrastructure,
such as gathering and processing facilities, refineries, rail facilities and pipelines. The potential for such security threats subjects
our operations to increased risks that could have a material adverse effect on our business, financial condition and results of operations.
For example, unauthorized access to our seismic data, reserves information or other proprietary information could lead to data corruption,
communication interruptions, or other disruptions to our operations.
Our
implementation of various procedures and controls to monitor and mitigate such security threats and to increase security for our information,
systems, facilities and infrastructure may result in increased capital and operating costs. Moreover, there can be no assurance that
such procedures and controls will be sufficient to prevent security breaches from occurring. If any of these security breaches were to
occur, they could lead to losses of, or damage to, sensitive information or facilities, infrastructure and systems essential to our business
and operations, as well as data corruption, reputational damage, communication interruptions or other disruptions to our operations,
which, in turn, could have a material adverse effect on our business, financial position and results of operations.
The
threat and impact of terrorist attacks, cyber-attacks or similar hostilities may adversely impact our operations.
We
cannot assess the extent of either the threat or the potential impact of future terrorist attacks on the energy industry in general,
and on us in particular, either in the short-term or in the long-term. Uncertainty surrounding such hostilities may affect our operations
in unpredictable ways, including the possibility that infrastructure facilities, including pipelines and gathering systems, production
facilities, processing plants and refineries, could be targets of, or indirect casualties of, an act of terror, a cyber-attack or electronic
security breach, or an act of war.
The
marketability of our production is dependent upon oil and natural gas gathering and transportation and storage facilities owned and operated
by third parties, and the unavailability of satisfactory oil and natural gas transportation arrangements have had a material adverse
effect on our revenue in the past and may again in the future.
The
unavailability of satisfactory oil and natural gas transportation arrangements has in the past hindered our access to oil and natural
gas markets and has delayed production from our wells. The availability of a ready market for our oil and natural gas production depends
on a number of factors, including the demand for, and supply of, oil and natural gas and the proximity of reserves to pipelines, terminal
facilities and storage facilities. Our ability to market our production depends in substantial part on the availability and capacity
of gathering systems, pipelines and processing facilities owned and operated by third parties. Our failure to obtain these services on
acceptable terms has in the past, and could in the future, materially harm our business. We do not expect to purchase firm transportation
capacity on third-party facilities. Therefore, we expect the transportation of our production to be generally interruptible in nature
and lower in priority to those having firm transportation arrangements.
The
disruption of third-party facilities due to maintenance and/or weather could negatively impact our ability to market and deliver our
products. The third parties’ control when or if such facilities are restored after disruption, and what prices will be charged
for products. Federal and state regulation of oil and natural gas production and transportation, tax and energy policies, changes in
supply and demand, pipeline pressures, damage to or destruction of pipelines and general economic conditions could adversely affect our
ability to produce, gather and transport oil and natural gas.
We
may have difficulty managing growth in our business, which could have a material adverse effect on our business, financial condition
and results of operations and our ability to execute our business plan in a timely fashion.
Because
of our small size, growth in accordance with our business plans, if achieved, will place a significant strain on our financial, technical,
operational and management resources. As we expand our activities, including our planned increase in oil exploration, development and
production, and increase the number of projects we are evaluating or in which we participate, there will be additional demands on our
financial, technical and management resources. The failure to continue to upgrade our technical, administrative, operating and financial
control systems or the occurrence of unexpected expansion difficulties, including the inability to recruit and retain experienced managers,
geoscientists, petroleum engineers and landmen could have a material adverse effect on our business, financial condition and results
of operations and our ability to execute our business plan in a timely fashion.
Failure
to adequately protect critical data and technology systems could materially affect our operations.
Information
technology solution failures, network disruptions and breaches of data security could disrupt our operations by causing delays or cancellation
of customer orders, impeding processing of transactions and reporting financial results, resulting in the unintentional disclosure of
customer, employee or our information, or damage to our reputation. There can be no assurance that a system failure or data security
breach will not have a material adverse effect on our financial condition, results of operations or cash flows.
If
we complete acquisitions or enter into business combinations in the future, they may disrupt or have a negative impact on our business.
If
we complete acquisitions or enter into business combinations in the future, funding permitting, we could have difficulty integrating
the acquired companies’ assets, personnel and operations with our own. Additionally, acquisitions, mergers or business combinations
we may enter into in the future could result in a change of control of the Company, and a change in the board of directors or officers
of the Company. In addition, the key personnel of the acquired business may not be willing to work for us. We cannot predict the effect
expansion may have on our core business. Regardless of whether we are successful in making an acquisition or completing a business combination,
the negotiations could disrupt our ongoing business, distract our management and employees and increase our expenses. In addition to
the risks described above, acquisitions and business combinations are accompanied by a number of inherent risks, including, without limitation,
the following:
|
● |
the
difficulty of integrating acquired companies, concepts and operations; |
|
● |
the
potential disruption of the ongoing businesses and distraction of our management and the management of acquired companies; |
|
● |
change
in our business focus and/or management; |
|
● |
difficulties
in maintaining uniform standards, controls, procedures and policies; |
|
● |
the
potential impairment of relationships with employees and partners as a result of any integration of new management personnel; |
|
● |
the
potential inability to manage an increased number of locations and employees; |
|
● |
our
ability to successfully manage the companies and/or concepts acquired; |
|
● |
the
failure to realize efficiencies, synergies and cost savings; or |
|
● |
the
effect of any government regulations which relate to the business acquired. |
Our
business could be severely impaired if and to the extent that we are unable to succeed in addressing any of these risks or other problems
encountered in connection with an acquisition or business combination, many of which cannot be presently identified. These risks and
problems could disrupt our ongoing business, distract our management and employees, increase our expenses and adversely affect our results
of operations.
Any
acquisition or business combination transaction we enter into in the future could cause substantial dilution to existing stockholders,
result in one party having majority or significant control over the Company or result in a change in business focus of the Company.
If
persons engage in short sales of our common stock, the price of our common stock may decline.
Selling
short is a technique used by a stockholder to take advantage of an anticipated decline in the price of a security. In addition, holders
of options and warrants will sometimes sell short knowing they can, in effect, cover through the exercise of an option or warrant, thus
locking in a profit. A significant number of short sales or a large volume of other sales within a relatively short period of time can
create downward pressure on the market price of a security. Further sales of common stock issued upon exercise of future warrants or
other convertible securities could cause even greater declines in the price of our common stock due to the number of additional shares
available in the market upon such exercise, which could encourage short sales that could further undermine the value of our common stock.
Stockholders could, therefore, experience a decline in the values of their investment as a result of short sales of our common stock.
Stockholders
may be diluted significantly through our efforts to obtain financing and satisfy obligations through the issuance of securities.
Wherever
possible, our Board of Directors will attempt to use non-cash consideration to satisfy obligations. In many instances, we believe that
the non-cash consideration will consist of shares of our common stock, preferred stock, or warrants to purchase shares of our common
stock. Our Board of Directors has authority, without action or vote of the stockholders, subject to the requirements of The NASDAQ Capital
Market (which generally require stockholder approval for any transactions which would result in the issuance of more than 20% of our
then outstanding shares of common stock or voting rights representing over 20% of our then outstanding shares of stock, subject to certain
exceptions, including sales in a public offering and/or sales which are undertaken at or above the lower of the closing price immediately
preceding the signing of the binding agreement or the average closing price for the five trading days preceding the signing of the binding
agreement), to issue all or part of the authorized but unissued shares of common stock, preferred stock or warrants to purchase such
shares of common stock. In addition, we may attempt to raise capital by selling shares of our common stock, possibly at a discount to
market in the future. These actions will result in dilution of the ownership interests of existing stockholders and may further dilute
common stock book value, and that dilution may be material. Such issuances may also serve to enhance existing management’s ability
to maintain control of us, because the shares may be issued to parties or entities committed to supporting existing management.
Future
litigation or governmental proceedings could result in material adverse consequences, including judgments or settlements.
From
time to time, we are involved in lawsuits, regulatory inquiries and may be involved in governmental and other legal proceedings arising
out of the ordinary course of our business. Many of these matters raise difficult and complicated factual and legal issues and are subject
to uncertainties and complexities. The timing of the final resolutions to these types of matters is often uncertain. Additionally, the
possible outcomes or resolutions to these matters could include adverse judgments or settlements, either of which could require substantial
payments, adversely affecting our results of operations and liquidity.
We
may become involved in securities class action litigation that could divert management’s attention and harm the combined company’s
business, and insurance coverage may not be sufficient to cover all costs and damages.
In
the past, securities class action or stockholder derivative litigation often follows certain significant business transactions, such
as a material acquisition such as the one completed in January 2022. The combined company may become involved in this type of litigation
in the future. Litigation often is expensive and diverts management’s attention and resources, which could adversely affect the
combined company’s business.
The
physical effects of climate change could disrupt our production and cause us to incur significant costs in preparing for or responding
to those effects. An economy-wide transition to lower GHG energy sources could have a variety of adverse effects on our operations and
financial results.
Many
scientists have shown that increasing concentrations of carbon dioxide, methane and other GHGs in the Earth’s atmosphere are changing
global climate patterns. One consequence of climate change could be increased severity of extreme weather, such as increased hurricanes
and floods. If such events were to occur, or become more frequent, our operations could be adversely affected in various ways, including
through damage to our facilities or from increased costs for insurance.
Another
possible consequence of climate change is increased volatility in seasonal temperatures. The market for natural gas is generally improved
by periods of colder weather and impaired by periods of warmer weather, so any changes in climate could affect the market for the fuels
that we produce. As a result, if there is an overall trend of warmer temperatures, it would be expected to have an adverse effect on
our business.
Efforts
by governments, international bodies, businesses and consumers to reduce GHGs and otherwise mitigate the effects of climate change are
ongoing. The nature of these efforts and their effects on our business are inherently unpredictable and subject to change. However, actions
taken by private parties in anticipation of, or to facilitate, a transition to a lower-GHG economy will affect us as well. For example,
our cost of capital may increase if lenders or other market participants decline to invest in fossil fuel-related companies for regulatory
or reputational reasons. Similarly, increased demand for low-carbon or renewable energy sources from consumers could reduce the demand
for, and the price of, the products we produce. Technological changes, such as developments in renewable energy and low-carbon transportation,
could also adversely affect demand for our products.
The
Company does not insure against all potential losses, which could result in significant financial exposure.
The
Company does not have commercial insurance or third-party indemnities to fully cover all operational risks or potential liability in
the event of a significant incident or series of incidents causing catastrophic loss. As a result, the Company is, to a substantial extent,
self-insured for such events. The Company relies on existing liquidity, financial resources and borrowing capacity to meet short-term
obligations that would arise from such an event or series of events. The occurrence of a significant incident, series of events, or unforeseen
liability for which the Company is self-insured, not fully insured or for which insurance recovery is significantly delayed could have
a material adverse effect on the Company’s results of operations or financial condition.
Increasing
attention to environmental, social, and governance (ESG) matters may impact our business.
Increasing
attention to ESG matters, including those related to climate change and sustainability, increasing societal, investor and legislative
pressure on companies to address ESG matters, may result in increased costs, reduced profits, increased investigations and litigation
or threats thereof, negative impacts on our stock price and access to capital markets, and damage to our reputation. Increasing attention
to climate change, for example, may result in demand shifts for hydrocarbon and additional governmental investigations and private litigation,
or threats thereof, against the Company. In addition, organizations that provide information to investors on corporate governance and
related matters have developed ratings processes for evaluating companies on their approach to ESG matters, including climate change
and climate-related risks. Such ratings are used by some investors to inform their investment and voting decisions. Also, some stakeholders,
including but not limited to sovereign wealth, pension, and endowment funds, have been divesting and promoting divestment of or screening
out of fossil fuel equities and urging lenders to limit funding to companies engaged in the extraction of fossil fuel reserves. Unfavorable
ESG ratings and investment community divestment initiatives, among other actions, may lead to negative investor sentiment toward the
Company and to the diversion of investment to other industries, which could have a negative impact on our stock price and our access
to and costs of capital. Additionally, evolving expectations on various ESG matters, including biodiversity, waste and water, may increase
costs, require changes in how we operate and lead to negative stakeholder sentiment.
Global
economic conditions could materially adversely affect our business, results of operations, financial condition and growth.
Adverse
macroeconomic conditions, including inflation, slower growth or recession, new or increased tariffs, changes to fiscal and monetary policy,
tighter credit, higher interest rates, high unemployment and currency fluctuations could materially adversely affect our operations,
expenses, access to capital and the market for oil and gas. In addition, uncertainty about, or a decline in, global or regional economic
conditions could have a significant impact on our expected funding sources, suppliers and partners. A downturn in the economic environment
could also lead to limitations on our ability to issue new debt; reduced liquidity; and declines in the fair value of our financial instruments.
These and other economic factors could materially adversely affect our business, results of operations, financial condition and growth.
We
may be adversely affected by climate change or by legal, regulatory or market responses to such change.
The
long-term effects of climate change are difficult to predict; however, such effects may be widespread. Impacts from climate change may
include physical risks (such as rising sea levels or frequency and severity of extreme weather conditions), social and human effects
(such as population dislocations or harm to health and well-being), compliance costs and transition risks (such as regulatory or technology
changes) and other adverse effects. The effects of climate change could increase the cost of certain products, commodities and energy
(including utilities), which in turn may impact our ability to procure goods or services required for the operation of our business.
Climate change could also lead to increased costs as a result of physical damage to or destruction of our facilities, equipment and business
interruption due to weather events that may be attributable to climate change. These events and impacts could materially adversely affect
our business operations, financial position or results of operation.
We
might be adversely impacted by changes in accounting standards.
Our
consolidated financial statements are subject to the application of U.S. GAAP, which periodically is revised or reinterpreted. From time
to time, we are required to adopt new or revised accounting standards issued by recognized authoritative bodies, including the Financial
Accounting Standards Board (“FASB”) and the SEC. It is possible that future accounting standards may require changes to the
accounting treatment in our consolidated financial statements and may require us to make significant changes to our financial systems.
Such changes might have a materially adverse impact on our financial position or results of operations.
SEC
rules could limit our ability to book additional proved undeveloped reserves (“PUDs”) in the future.
SEC
rules require that, subject to limited exceptions, PUDs may only be booked if they relate to wells scheduled to be drilled within five
years after the date of booking. This requirement has limited and may continue to limit our ability to book additional PUDs as we pursue
our drilling program. Moreover, we may be required to write down our PUDs if we do not drill or plan on delaying those wells within the
required five-year timeframe.
Future
changes to U.S. tax laws, if adopted, could have an adverse effect on our business, financial condition, results of operations, and cash
flows.
From
time to time, legislative proposals are made that would, if enacted, result in the elimination of the immediate deduction for intangible
drilling and development costs, the elimination of the deduction from income for domestic production activities relating to oil and gas
exploration and development, the repeal of the percentage depletion allowance for oil and gas properties, and an extension of the amortization
period for certain geological and geophysical expenditures. Such changes, if adopted, or other similar changes that reduce or eliminate
deductions currently available with respect to oil and gas exploration and development, could adversely affect our business, financial
condition, results of operations, and cash flows.