We are engaged in the exploration, development and acquisition of oil and gas properties, primarily in the Southwestern, Appalachian and Gulf Coast regions of the United States. We seek to increase reserves and production through internally generated drilling projects, coupled with complementary acquisitions.
At year-end 2006, our proved reserves had the following characteristics:
| • | 1.8 Tcfe of proved reserves; | ||
| • | 82% natural gas; | ||
| • | 63% proved developed; | ||
| • | 80% operated; | ||
| • | a reserve life of 16.3 years (based on fourth quarter 2006 production); and | ||
| • | a pre-tax present value of $2.8 billion ($2.0 billion after tax). |
At year-end 2006, we owned 3,215,000 gross (2,500,000 net) acres of leasehold, which includes over 70,000 of acres associated with royalties. We have built a multi-year inventory of drilling projects which is estimated to be over 9,400 identified drilling locations.
Range was incorporated in early 1980 under the name Lomak Petroleum, Inc. and, later that year, we completed an initial public offering and began trading on the NASDAQ. In 1996, our common stock was listed on the New York Stock Exchange. In 1998, we changed our name to Range Resources Corporation. In 1999, we implemented a strategy of internally generated drillbit growth coupled with complementary acquisitions. Our objective is to build stockholder value
through consistent growth in reserves and production on a cost-efficient basis. During the past five years, we have increased our proved reserves 243%, while production has increased 81% during that same period.
Our corporate offices are located at 777 Main Street, Suite 800, Fort Worth, Texas 76102. Our telephone number is (817) 870-2601. Effective May 1 st , 2007, our corporate offices will be located at 100 Throckmorton Street, Suite 1200, Fort Worth, Texas 76102.
Business Strategy
Our objective is to build stockholder value through consistent growth in reserves and production on a cost-efficient basis. Our strategy is to employ internally generated drillbit growth coupled with complementary acquisitions to achieve such growth. Our strategy requires us to make significant investments in technical staff, acreage and seismic data and technology to build drilling inventory. In implementing our strategy, we employ the following principal elements:
| • | Concentrate in Core Operating Areas. We currently operate in three regions; the Southwestern (which includes the Barnett Shale of North Central Texas, the Permian Basin of West Texas and eastern New Mexico, the East Texas Basin, the Texas Panhandle and Anadarko Basin of Western Oklahoma), Appalachian (which includes tight-gas, shale, coal bed methane and conventional oil and gas production in Pennsylvania, Virginia, Ohio, New York and West Virginia) and Gulf Coast. Concentrating our drilling and producing activities in these core areas allows us to develop the regional expertise needed to interpret specific geological and operating trends and develop economies of scale. Operating in multiple core areas allows us to combine the production characteristics of each area to balance our portfolio toward our goal of consistent production and reserve growth. | ||
| • | Maintain Multi-Year Drilling Inventory. We focus on areas where multiple prospective productive horizons and development opportunities exist. We use our technical expertise to build and maintain a multi-year drilling inventory. A large, multi-year inventory of drilling projects increases our ability to consistently grow production and reserves. Currently, we have over 9,400 identified drilling locations in inventory. In 2006, we drilled 1,017 gross (704 net) wells. In 2007, our capital program targets the drilling of 924 gross (691 net) wells. | ||
| • | Make Complementary Acquisitions. We target complementary acquisitions in existing core areas and focus on acquisition candidates where our existing operating and technical knowledge is transferable and drilling results can be forecast with confidence. Over the past three years, we have completed $1.3 billion of complementary acquisitions. These acquisitions have been located in the Southwestern and Appalachian regions. | ||
| • | Manage Our Risk Exposure. Allocating the majority of our capital spending to long-term development projects in areas where multiple productive horizons exist serves to reduce our risk exposure. Where our exploration projects may involve high dry hole costs, we often bring in industry partners in order to reduce financial exposure. We also invest in new seismic data and technology each year. By equipping our geologists and geophysicists with state-of-the-art seismic technology with multiple reprocessing applications, we hope to multiply the number of higher potential exploration prospects we drill without substantially adding to dry hole risk. | ||
| • | Maintain Flexibility. Because of the volatility of commodity prices and the risks involved in drilling, we remain flexible and adjust our capital budget throughout the year. We may defer capital projects in order to seize an attractive acquisition opportunity. If certain areas generate higher than anticipated returns, we may accelerate drilling in those areas and decrease capital expenditures elsewhere. We also believe in maintaining a strong balance sheet and using commodity hedging. This allows us to be more opportunistic in lower price environments as well as providing more consistent financial results. | ||
| • | Equity Ownership and Incentive Compensation. We want our employees to act like owners. To achieve this, we reward and encourage them through equity ownership in Range. As of December 31, 2006, our employees owned equity securities (vested and unvested) which had a market value of over $170.0 million. |
Significant Accomplishments in 2006
• Production and reserve growth – The fourth quarter of 2006 marked the 16th consecutive quarter of sequential production growth. In 2006, our annual production averaged 276.1 Mmcfe per day, an increase of 15% from 2005. This achievement is the result of our continued drilling success and the completion and integration of complementary acquisitions. Our business is inherently volatile, and while consistent growth such as we have experienced over the past sixteen quarters will be challenging to sustain, the quality of our technical teams and our sizable drilling inventory bode well for the future. Proven reserves increased 25% in 2006 to 1.8 Tcfe, marking the fifth consecutive year our proven reserves have increased.
| • | Successful drilling program – In 2006, we drilled 1,017 gross wells. Competition for quality drilling and completion well services was intense in 2006, yet we were able to increase our number of wells drilled by 21% over 2005. As we continue to build our drilling inventory for the future, our ability to drill a large number of wells each year on a cost effective and efficient basis is important. Production was replaced by 377% through drilling in 2006, and our overall success rate was 99%. The increased pace of drilling did not adversely impact the quality of our drilling program as the 99% success ratio in 2006 compares favorably to the 98% success ratio in 2005. | ||
| • | Continued expansion of drilling inventory and emerging plays – To continue to grow, the size of our prospect inventory must also increase. Our drilling inventory currently includes over 9,400 projects, up from 7,700 at year-end 2005. Meaningful expansion of our coal bed methane plays and our shale plays occurred in 2006. We have now leased 276,000 net acres in our coal bed methane plays and 567,000 net acres in our shale plays. In addition to the expansion of our emerging plays, we have hired additional quality experienced technical professionals to assist us in this effort. | ||
| • | Record financial results and balance sheet improvement – Growth in production volumes and higher oil and gas prices drove our record financial performance in 2006. Revenue, net income, and net cash flow provided from operating activities all reached record highs. The balance sheet continued to improve in 2006 as we refinanced $250 million of shorter term bank debt with a like amount of senior subordinated fixed rate 7.5% notes having a 10-year maturity. This helped to align the maturity schedule of our debt with the long-term life of our assets. Financial leverage, as measured by the debt-to-capitalization ratio improved. Future cash flow will be enhanced through lower income tax payments due to a $229.6 million net operating loss carryforward. | ||
| • | Successful acquisition completed – In June 2006 we acquired Stroud Energy, Inc. (“Stroud”) for $171.5 million in cash and 6.5 million shares of our common stock. The transaction was structured as a merger with Stroud shareholders electing to receive either cash, Range stock, or a combination of both cash and stock. Stroud was a private Fort Worth based independent oil and gas company with operations located in the Barnett Shale play in North Texas, the Cotton Valley in East Texas and the Austin Chalk in Central Texas. We estimate the proved reserves attributable to the Stroud properties totaled 171 Bcfe. Over 90% of Stroud’s Barnett Shale acreage is located in the core or expanding core portions of the Barnett Shale play. In the first quarter of 2007, we sold the Austin Chalk properties in Central Texas for proceeds of $80.4 million. |
Plans for 2007
We have announced a $698.0 million capital budget for 2007, excluding acquisitions. The budget includes $600.0 million to drill 924 gross (691 net) wells and to undertake 72 gross (52 net) recompletions. Approximately 57% of the budget is attributable to the Southwest Division, with 37% allocated to the Appalachia Division and 6% to the Gulf Coast Division. Also included is $58.0 million for land, $20.0 million for seismic and $20.0 million for the expansion and enhancement of gathering systems and facilities. We anticipate drilling slightly fewer shallow wells in favor of deeper wells in 2007 as we seek to improve returns. Deeper wells are typically more costly than shallow wells.
Production, Revenues and Price History
The following table sets forth information regarding oil and gas production, revenues and direct operating expenses for the last three years.
| Year Ended December 31, | ||||||||||||
| 2006 | 2005 | 2004 | ||||||||||
Production |
||||||||||||
Gas (Mmcf) |
75,267 | 63,004 | 50,722 | |||||||||
Crude oil (Mbbl) |
3,160 | 3,031 | 2,512 | |||||||||
Natural gas liquids (Mbbl) |
1,092 | 1,012 | 988 | |||||||||
Total (Mmcfe) (a) |
100,775 | 87,263 | 71,726 | |||||||||
Revenues ($000) |
||||||||||||
Gas |
$ | 497,854 | $ | 380,131 | $ | 225,738 | ||||||
Crude oil |
149,370 | 117,354 | 70,439 | |||||||||
Natural gas liquids |
36,704 | 27,589 | 19,526 | |||||||||
Transportation and gathering |
2,507 | 2,461 | 2,202 | |||||||||
Total |
686,435 | 527,535 | 317,905 | |||||||||
Direct
operating expenses
(b) |
92,224 | 67,112 | 46,308 | |||||||||
Production and ad valorem taxes |
36,915 | 31,516 | 20,504 | |||||||||
Gross margin |
$ | 557,296 | $ | 428,907 | $ | 251,093 | ||||||
Average sales price (excluding hedging) |
||||||||||||
Gas (per mcf) |
$ | 6.58 | $ | 7.98 | $ | 5.79 | ||||||
Crude oil (per bbl) |
62.60 | 53.31 | 39.25 | |||||||||
Natural gas liquids (per bbl) |
33.62 | 31.52 | 23.73 | |||||||||
Total (per mcfe) (a) |
7.25 | 7.98 | 5.80 | |||||||||
Average sales price (including hedging) |
||||||||||||
Gas (per mcf) |
$ | 6.61 | $ | 6.03 | $ | 4.45 | ||||||
Crude oil (per bbl) |
47.27 | 38.71 | 28.04 | |||||||||
Natural gas liquids (per bbl) |
33.62 | 27.27 | 19.76 | |||||||||
Total (per mcfe) (a) |
6.79 | 6.02 | 4.40 | |||||||||
Operating costs (per mcfe) |
||||||||||||
Direct (b) |
$ | 0.92 | $ | 0.77 | $ | 0.65 | ||||||
Production and ad valorem taxes |
0.37 | 0.36 | 0.29 | |||||||||
Total operating costs |
$ | 1.29 | $ | 1.13 | $ | 0.94 | ||||||
Gross margin (per mcfe) |
$ | 5.53 | $ | 4.92 | $ | 3.50 | ||||||
| (a) | Oil and NGLs are converted to mcfe at the rate of one barrel equals six mcfe. | |
| (b) | 2006 direct operating expenses include $1.4 million (or $0.01 per mcfe) of non-cash stock-based compensation related to the adoption of SFAS No. 123(R). |
Competition
We encounter substantial competition in developing and acquiring oil and gas properties, securing and retaining personnel, conducting drilling and field operations and marketing production. Competitors in exploration, development, acquisitions and production include the major oil companies as well as numerous independent oil companies, individual proprietors and others. Although our sizable acreage position and core area concentration provide some competitive advantages, many competitors have financial and other resources substantially exceeding ours. Therefore, competitors may be able to pay more for desirable leases and to evaluate, bid for and purchase a greater number of properties or prospects than our financial or personnel resources allow. Our ability to replace and expand our reserve base depends on our ability to attract and retain quality personnel and identify and acquire suitable producing properties and prospects for future drilling.
Employees
As of January 1, 2007, we had 644 full-time employees, 358 of whom were field personnel. All full-time employees are eligible to receive equity awards approved by the Compensation Committee of the Board of Directors. No employees are covered by a labor union or other collective bargaining arrangement. We believe that the relationship with our employees is excellent. We regularly utilize independent consultants and contractors to perform various professional services, particularly in the areas of drilling, completion, field and on-site production operation services.
Available Information
We maintain an internet website under the name “www.rangeresources.com.” We make available, free of charge, on our website, the annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports, as soon as reasonably practicable after providing such reports to the SEC. Also, our Corporate Governance Guidelines, the charters of the Audit Committee, the Compensation Committee, the Dividend Committee, and the Governance and Nominating Committee, and the Code of Business Conduct and Ethics are available on our website and in print to any stockholder who provides a written request to the Corporate Secretary at 777 Main Street, Suite 800, Fort Worth, Texas 76102.
We file annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, proxy statements and other documents with the SEC under the Securities Exchange Act of 1934. The public may read and copy any materials that we file with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Also, the SEC maintains an internet website that contains reports, proxy and information statements, and other information regarding issuers, including Range, that file electronically with the SEC. The public can obtain any document we file with the SEC at “www.sec.gov.” Information contained on or connected to our website is not incorporated by reference into this Form 10-K and should not be considered part of this report or any other filing that we make with the SEC.
Marketing and Customers
We market nearly all of our oil and gas production from the properties we operate for both our interest and that of the other working interest owners and royalty owners. Gas sales are made pursuant to a variety of contractual arrangements; generally month-to-month and one to five-year contracts. Less than 10% of our production is subject to contracts longer than five years. Pricing on the month-to-month and short-term contracts is based largely on the New York Mercantile Exchange (“NYMEX”) pricing, with fixed or floating basis. For one to five-year contracts, gas is sold on NYMEX pricing, published regional index pricing or percentage of proceeds sales based on local indices. Less than 500 mcf per day is sold under long-term fixed price contracts. Many contracts contain provisions for periodic price adjustment, termination and other terms customary in the industry. Gas is sold to utilities, marketing companies and industrial users. Oil is sold under contracts ranging in terms from month-to-month, up to as long as one year. The pricing for oil is based upon the posted prices set by major purchasers in the production area or upon NYMEX pricing or fixed pricing. All oil pricing is adjusted for quality and transportation. Oil and gas purchasers are selected on the basis of price, credit quality and service. For a summary of purchasers of our oil and gas production that accounted for 10% or more of consolidated revenue, see Note 15 to our consolidated financial statements. Because alternative purchasers of oil and gas are usually readily available, we believe that the loss of any of these purchasers would not have a material adverse effect on us.
We enter into hedging transactions with unaffiliated third parties for portions of our production to achieve more predictable cash flows and to reduce our exposure to short-term fluctuations in oil and gas prices. For a more detailed discussion, see the information set forth in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Item 7A. Quantitative and Qualitative Disclosures about Market Risk.” Proximity to local markets, availability of competitive fuels and overall supply and demand are factors affecting the prices for which our production can be sold. Market volatility due to international political developments, overall energy supply and demand, fluctuating weather conditions, economic growth rates and other factors in the United States and worldwide has had, and will continue to have, a significant effect on energy prices.
We incur gathering and transportation expenses to move our natural gas and crude oil from the wellhead and tanks to purchaser specified delivery points. These expenses vary based on volume, distance shipped and the fee charged by the third-party transporters. In the Southwestern and Gulf Coast Divisions, our natural gas and oil production are transported primarily through third-party trucks, gathering systems and pipelines. Transportation space on these gathering systems and pipelines is occasionally limited. In Appalachia, we own approximately 4,900 miles of gas gathering pipelines which transport a majority of our Appalachian gas production as well as third-party gas to transmission lines and directly to end- users and interstate pipelines. For additional information, see “Risk Factors – Our business depends on oil and natural gas transportation facilities, many of which are owned by others ,” in Item 1A. of this report.
Governmental Regulation
Our operations are substantially affected by federal, state and local laws and regulations. In particular, oil and gas production and related operations are, or have been, subject to price controls, taxes and numerous other laws and regulations. All of the jurisdictions in which we own or operate producing crude oil and natural gas properties have statutory provisions regulating the exploration for and production of crude oil and natural gas, including provisions related to permits for the drilling of wells, bonding requirements in order to drill or operate wells, the location of wells, the method of drilling and casing wells, the surface use and restoration of properties upon which wells are drilled, and the abandonment of wells. Our operations are also subject to various conservation laws and regulations. These include the regulation of the size of drilling and spacing units or proration units, the number of wells which may be drilled in an area, and the unitization or pooling of crude oil and natural gas wells, generally prohibit the venting or flaring of natural gas, and impose certain requirements regarding the ratability or fair apportionment of production from fields and individuals wells.
Certain operations that we conduct are on federal oil and gas leases which are administered by the Minerals Management Service (“MMS”). These leases contain relatively standardized terms and require compliance with detailed MMS regulations pursuant to the Outer Continental Shelf Lands Act, (“OCSLA”) (which are subject to change by the MMS). Lessees must obtain a permit from the MMS prior to the commencement of drilling, and comply with regulation governing, among other things, engineering, and construction specifications for production facilities, safety procedures, plugging and abandonment of Outer Continental Shelf, (“OCS”), wells, the valuation of production, and the removal of facilities. Under certain circumstances, the MMS may require our operations on federal leases to be suspended or terminated. Any such suspension or termination could materially and adversely affect our financial condition and operation. To cover the various obligations of lessees on the OCS, the MMS generally requires that lessees post substantial bonds or other acceptable assurances that such obligations will be met, unless the MMS exempts the lessee from such obligations. The cost of such bonds or other surety can be substantial and we can provide no assurance that we can continue to obtain bonds or other surety in all cases.
In August 2005, Congress enacted the Energy Policy Act of 2005 (“EPAct 2005”). Among other matters, the EPAct 2005 amends the Natural Gas Act (“NGA”), to make it unlawful for “any entity”, including otherwise non-jurisdictional producers such as Range, to use any deceptive or manipulative device or contrivance in connection with the purchase or sale of natural gas or the purchase or sale of transportation services subject to regulation by the Federal Energy Regulatory Commission (“FERC”), in contravention of rules prescribed by the FERC. On January 20, 2006, the FERC issued rules implementing this provision. The rules make it unlawful in connection with the purchase or sale of natural gas subject to the jurisdiction of FERC, or the purchase or sale of transportation services subject to the jurisdiction of FERC, for any entity, directly or indirectly, to use or employ any device, scheme or artifice to defraud; to make any untrue statement of material fact or omit to make any such statement necessary to make the statements made not misleading; or to engage in any act or practice that operates as a fraud or deceit upon any person. EPAct 2005 also gives the FERC authority to impose civil penalties for violations of the NGA up to $1,000,000 per day per violation. The new anti-manipulation rule does not apply to activities that relate only to intrastate or other non-jurisdictional sale or gathering, but does apply to activities or otherwise non-jurisdictional entities to the extent the activities are conducted “in connection with” gas sales, purchases or transportation subject to FERC jurisdiction. It therefore reflects a significant expansion of FERC’s enforcement authority. Range does not anticipate it will be affected any differently than other producers of natural gas.
Failure to comply with applicable laws and regulations can result in substantial penalties. The regulatory burden on the industry increases the cost of doing business and affects profitability. Although we believe we are in substantial compliance with all applicable laws and regulations, such laws and regulations are frequently amended or reinterpreted. Therefore, we are unable to predict the future costs or impact of compliance.
Additional proposals and proceedings that affect the oil and gas industry are regularly considered by Congress, the states, the FERC, and the courts. We cannot predict when or whether any such proposals may become effective.
Environmental Matters
Our operations are subject to stringent federal, state and local laws governing the discharge of materials into the environment or otherwise relating to environmental protection. Numerous governmental departments such as the Environmental Protection Agency (“EPA”) issue regulations to implement and enforce such laws, which are often difficult and costly to comply with and which carry substantial civil and criminal penalties for failure to comply. These laws and regulations may require the acquisition of a permit before drilling commences, restrict the types, quantities and concentrations of various substances that can be released into the environment in connection with drilling, production and transporting through pipelines, limit or prohibit drilling activities on certain lands lying within wilderness, wetlands, frontier and other protected areas, require some form of remedial action to prevent pollution from former operations such as plugging abandoned wells, and impose substantial liabilities for pollution resulting from operations. In addition, these laws, rules and
regulations may restrict the rate of production. The regulatory burden on the oil and gas industry increases the cost of doing business, affecting growth and profitability. Changes in environmental laws and regulations occur frequently, and changes that result in more stringent and costly waste handling, disposal or clean-up requirements could adversely affect our operations and financial position, as well as the industry in general. We believe we are in substantial compliance with current applicable environmental laws and regulations. Although we have not experienced any material adverse effect from compliance with environmental requirements, there is no assurance that this will continue. We did not have any material capital or other non-recurring expenditures in connection with complying with environmental laws or environmental remediation matters in 2006, nor do we anticipate that such expenditures will be material in 2007.
The Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”), known as the “Superfund” law, imposes liability, without regard to fault or the legality of the original conduct, on certain classes of persons who are considered to be responsible for the release of a “hazardous substance” into the environment. These persons include owners or operators of the disposal site or sites where the release occurred and companies that disposed of or arranged for the disposal of the hazardous substances at the site where the release occurred. Under CERCLA, such persons may be subject to joint and several liability for the costs of cleaning up the hazardous substances that have been released into the environment, for damages to natural resources and for the costs of certain health studies. Furthermore, although petroleum, including crude oil and natural gas, is not a “hazardous substance” under CERCLA, at least two courts have ruled that certain wastes associated with the production of crude oil may be classified as “hazardous substances” under CERCLA and that such wastes may therefore give rise to liability under CERCLA. Beyond CERCLA, state laws regulate the disposal of oil and gas wastes, and periodically new state legislative initiatives are proposed that could have a significant impact on us. In addition, it is not uncommon for neighboring landowners and other third parties to file claims for personal injury and property damages allegedly caused by the release of hazardous substances or other pollutants into the environment pursuant to environmental statutes, common law or both.
The Federal Water Pollution Control Act (“FWPCA”) imposes restrictions and strict controls regarding the discharge of produced waters and other oil and gas wastes into waters of the United States. Permits must be obtained to discharge pollutants into state and federal waters. The FWPCA and analogous state laws provide for civil, criminal and administrative penalties for any unauthorized discharges of oil and other hazardous substances in reportable quantities and may impose substantial potential liability for the costs of removal, remediation and damages. State water discharge regulations and Federal National Pollutant Discharge Elimination System permits applicable to the oil and gas industry generally prohibit the discharge of produced water, sand and some other substances into coastal waters. The cost to comply with zero discharges mandated under federal and state law has not had a material adverse impact on our financial condition and results of operations. Some oil and gas exploration and production facilities are required to obtain permits for their storm water discharges. Costs may be incurred in connection with treatment of wastewater or developing and implementing storm water pollution prevention plans.
The Resource Conservation and Recovery Act (“RCRA”) as amended, generally does not regulate most wastes generated by the exploration and production of oil and gas. RCRA specifically excludes from the definition of hazardous waste “drilling fluids, produced waters, and other wastes associated with the exploration, development, or production of crude oil, natural gas or geothermal energy.” However, these wastes may be regulated by the EPA or state agencies as non-hazardous solid waste. Moreover, ordinary industrial wastes, such as paint wastes, waste solvents, laboratory wastes and waste compressor oils, can be regulated as hazardous wastes. Although the costs of managing wastes classified as hazardous waste may be significant, we do not expect to experience more burdensome costs than similarly situated companies.
The Oil Pollution Act (“OPA”) requires owners and operators of facilities that could be the source of an oil spill into “waters of the United States” (a term defined to include rivers, creeks, wetlands and coastal waters) to adopt and implement plans and procedures to prevent any spill of oil into any waters of the United States. OPA also requires affected facility owners and operators to demonstrate that they have sufficient financial resources to pay for the costs of cleaning up an oil spill and compensating any parties damaged by an oil spill. Substantial civil and criminal fines and penalties can be imposed for violations of OPA and other environmental statutes.
Stricter standards in environmental legislation may be imposed on the oil and gas industry in the future. For instance, legislation has been proposed in Congress from time-to-time that would alter the RCRA exemption by reclassifying certain oil and gas exploration and production wastes as “hazardous wastes” and make the waste subject to more stringent handling, disposal and clean-up restrictions. If such legislation were enacted, it could have a significant impact on our operating costs, as well as the industry in general. Compliance with environmental requirements generally could have a material adverse effect on our capital expenditures, earnings or competitive position. Although we have not experienced any material adverse effect from compliance with environmental requirements, no assurance may be given that this will continue.
ITEM 1A. RISK FACTORS
We are subject to various risks and uncertainties in the course of our business. The following summarizes some, but not all, of the risks and uncertainties which may adversely affect our business, financial condition or results of operations.
Volatility of oil and natural gas prices significantly affects our cash flow and capital resources and could hamper our ability to produce oil and gas economically
Oil and natural gas prices are volatile, and a decline in prices would adversely affect our profitability and financial condition. The oil and natural gas industry is typically cyclical, and prices for oil and natural gas have been highly volatile. Historically, the industry has experienced severe downturns characterized by oversupply and/or weak demand. Higher oil and natural gas prices have contributed to our positive earnings over the last several years. However, long-term supply and demand for oil and natural gas is uncertain and subject to a myriad of factors such as:
| • | the domestic and foreign supply of oil and gas; | ||
| • | the price and availability of alternative fuels; | ||
| • | weather conditions; | ||
| • | the level of consumer demand; | ||
| • | the price of foreign imports; | ||
| • | world-wide economic conditions; | ||
| • | political conditions in oil and gas producing regions; and | ||
| • | domestic and foreign governmental regulations. |
Decreases in oil and natural gas prices from current levels could adversely affect our revenues, net income, cash flow and proved reserves. Significant price decreases could have a material adverse effect on our operations and limit our ability to fund capital expenditures. Without the ability to fund capital expenditures, we would be unable to replace reserves and production.
Hedging transactions may limit our potential gains and involve other risks
To manage our exposure to price risk, we, from time to time, enter into hedging arrangements, utilizing commodity derivatives with respect to a significant portion of our future production. The goal of these hedges is to lock in prices so as to limit volatility and increase the predictability of cash flow. These transactions limit our potential gains if oil and natural gas prices rise above the price established by the hedge.
In addition, hedging transactions may expose us to the risk of financial loss in certain circumstances, including instances in which:
| • | our production is less than expected; | ||
| • | the counterparties to our futures contracts fail to perform under the contracts; or | ||
| • | a sudden, unexpected event materially impacts oil or natural gas prices or the relationship between the hedged price index and the oil and gas sales price. |
In the fourth quarter of 2005, due to the trading volatility of NYMEX gas contracts, we experienced larger than usual differentials between actual prices paid at delivery points and NYMEX based gas hedges. Due to this event, certain of our gas hedges no longer qualify for hedge accounting and are marked to market. This may result in more volatility in our income in future periods.
Information concerning our reserves and future net reserve estimates is uncertain
There are numerous uncertainties inherent in estimating quantities of proved oil and natural gas reserves and their values, including many factors beyond our control. Estimates of proved reserves are by their nature uncertain. Although we believe these estimates are reasonable, actual production, revenues and costs to develop will likely vary from estimates, and these variances could be material.
The accuracy of any reserve estimate is a function of the quality of available data, engineering and geological interpretation and judgment, assumptions used regarding quantities of oil and natural gas in place, recovery rates and future
prices for oil and natural gas. Actual prices, production, development expenditures, operating expenses and quantities of recoverable oil and natural gas reserves will vary from those assumed in our estimates, and such variances may be material. Any variance in the assumptions could materially affect the estimated quantity and value of the reserves.
If oil and natural gas prices decrease or exploration efforts are unsuccessful, we may be required to take write-downs of our oil and natural gas properties
In the past, we have been required to write down the carrying value of certain of our oil and natural gas properties, and there is a risk that we will be required to take additional write-downs in the future. This could occur when oil and natural gas prices are low, or if we have downward adjustments to our estimated proved reserves, increases in our estimates of operating or development costs, deterioration in our exploration results or mechanical problems with wells where the cost to redrill or repair does not justify the expense which might occur due to hurricanes.
Accounting rules require that the carrying value of oil and natural gas properties be periodically reviewed for possible impairment. “Impairment” is recognized when the book value of a proven property is greater than the expected undiscounted future net cash flows from that property and on acreage when conditions indicate the carrying value is not recoverable. We may be required to write down the carrying value of a property based on oil and natural gas prices at the time of the impairment review, as well as a continuing evaluation of drilling results, production data, economics and other factors. While an impairment charge reflects our long-term ability to recover an investment, it does not impact cash or cash flow from operating activities, but it does reduce our reported earnings and increases our leverage ratios.
For example, based primarily on the poor performance of certain properties acquired in 1997 and 1998 and significantly lower oil and natural gas prices, we recorded impairments of $215.0 million in 1998 and $29.9 million in 1999. At year-end 2001, we recorded an impairment of $31.1 million due to lower year-end prices. At year-end 2004, we recorded an impairment of $3.6 million on an offshore property due to hurricane damage and related production declines. In the third quarter of 2006, we recorded a $2.4 million impairment on an offshore property due to declining oil and gas prices.
Our business is subject to operating hazards and environmental regulations that could result in substantial losses or liabilities
Oil and natural gas operations are subject to many risks, including well blowouts, craterings, explosions, uncontrollable flows of oil, natural gas or well fluids, fires, formations with abnormal pressures, pipeline ruptures or spills, pollution, releases of toxic natural gas and other environmental hazards and risks. If any of these hazards occur, we could sustain substantial losses as a result of:
| • | injury or loss of life; | ||
| • | severe damage to or destruction of property, natural resources and equipment; | ||
| • | pollution or other environmental damage; | ||
| • | clean-up responsibilities; | ||
| • | regulatory investigations and penalties; or | ||
| • | suspension of operations. |
As we drill to deeper horizons and in more geologically complex areas, we could experience a greater increase in operating and financial risks due to inherent higher reservoir pressures and unknown downhole risk exposures. As we continue to drill deeper, the number of rigs capable of drilling to such depths will be fewer and we may experience greater competition from other operators.
Our operations are subject to numerous and increasingly strict federal, state and local laws, regulations and enforcement policies relating to the environment. We may incur significant costs and liabilities in complying with existing or future environmental laws, regulations and enforcement policies and may incur costs arising out of property damage or injuries to employees and other persons. These costs may result from our current and former operations and even may be caused by previous owners of property we own or lease. Any past, present or future failure by us to completely comply with environmental laws, regulations and enforcement policies could cause us to incur substantial fines, sanctions or liabilities from cleanup costs or other damages. Incurrence of those costs or damages could reduce or eliminate funds available for exploration, development or acquisitions or cause us to incur losses.
We maintain insurance against some, but not all, of these potential risks and losses. We may elect not to obtain insurance if we believe that the cost of available insurance is excessive relative to the risks presented. Recently, we have experienced substantial increases in premiums especially in areas affected by the hurricanes and tropical storms. Insurers have imposed revised limits affecting how much the insurers will pay on actual storm claims plus the cost to re-drill wells where substantial damage has been incurred. Insurers are also requiring us to retain larger deductibles and reducing the scope of what insurable losses will include. Even with the increase in future insurance premiums, coverage will be reduced, requiring us to bear a greater potential risk if our oil and gas properties are damaged. We do not maintain any business interruption insurance. In addition, pollution and environmental risks generally are not fully insurable. If a significant accident or other event occurs that is not fully covered by insurance, it could have a material adverse affect on our financial condition and results of operations.
We are subject to financing and interest rate exposure risks
Our business and operating results can be harmed by factors such as the availability, terms of and cost of capital, increases in interest rates or a reduction in credit rating. These changes could cause our cost of doing business to increase, limit our ability to pursue acquisition opportunities and place us at a competitive disadvantage. For example at December 31, 2006, approximately 57% of our debt is at fixed interest rates with the remaining 43% subject to variable interest rates.
Many of our current and potential competitors have greater resources than we have and we may not be able to successfully compete in acquiring, exploring and developing new properties
We face competition in every aspect of our business, including, but not limited to, acquiring reserves and leases, obtaining goods, services and employees needed to operate and manage our business and marketing oil and natural gas. Competitors include multinational oil companies, independent production companies and individual producers and operators. Many of our competitors have greater financial and other resources than we do.
The demand for field services and their ability to meet that demand may limit our ability to drill and produce our oil and natural gas properties
Due to current industry demands, well service providers and related equipment and personnel are in short supply. This is causing escalating prices, the possibility of poor services coupled with potential damage to downhole reservoirs and personnel injuries. Such pressures will likely increase the actual cost of services, extend the time to secure such services and add costs for damages due to accidents sustained from the over use of equipment and inexperienced personnel.
The oil and natural gas industry is subject to extensive regulation
The oil and natural gas industry is subject to various types of regulations in the United States by local, state and federal agencies. Legislation affecting the industry is under constant review for amendment or expansion, frequently increasing our regulatory burden. Numerous departments and agencies, both state and federal, are authorized by statute to issue rules and regulations binding on participants in the oil and natural gas industry. Compliance with such rules and regulations often increases our cost of doing business and, in turn, decreases our profitability.
Acquisitions are subject to the risks and uncertainties of evaluating reserves and potential liabilities and may be disruptive and difficult to integrate into our business
We could be subject to significant liabilities related to our acquisitions. It generally is not feasible to review in detail every individual property included in an acquisition. Ordinarily, a review is focused on higher valued properties. However, even a detailed review of all properties and records may not reveal existing or potential problems in all of the properties, nor will it permit us to become sufficiently familiar with the properties to assess fully their deficiencies and capabilities. We do not always inspect every well we acquire, and environmental problems, such as groundwater contamination, are not necessarily observable even when an inspection is performed.
For example, in 1997, we consummated a large acquisition that proved extremely disappointing. Production from the acquired properties fell more rapidly than anticipated and further development results were below the results we had originally projected. The poor production performance of these properties resulted in material downward reserve revisions. There is no assurance that our recent and/or future acquisition activity will not result in similarly disappointing results.
In addition, there is intense competition for acquisition opportunities in our industry. Competition for acquisitions may increase the cost of, or cause us to refrain from, completing acquisitions. Our acquisition strategy is dependent upon, among other things, our ability to obtain debt and equity financing and, in some cases, regulatory approvals. Our ability to
pursue our acquisition strategy may be hindered if we are not able to obtain financing on terms acceptable to us or regulatory approvals.
Acquisitions often pose integration risks and difficulties. In connection with recent and future acquisitions, the process of integrating acquired operations into our existing operations may result in unforeseen operating difficulties and may require significant management attention and financial resources that would otherwise be available for the ongoing development or expansion of existing operations. Future acquisitions could result in our incurring additional debt, contingent liabilities, expenses and diversion of resources, all of which could have a material adverse effect on our financial condition and operating results.
Our success depends on key members of our management and our ability to attract and retain experienced technical and other professional personnel
Our success is highly dependent on our management personnel, none of which is currently subject to an employment contract. The loss of one or more of these individuals could have a material adverse effect on our business. Furthermore, competition for experienced technical and other professional personnel is intense. If we cannot retain our current personnel or attract additional experienced personnel, our ability to compete could be adversely affected.
Our future success depends on our ability to replace reserves that we produce
Because the rate of production from oil and natural gas properties generally declines as reserves are depleted, our future success depends upon our ability to economically find or acquire and produce additional oil and natural gas reserves. Except to the extent that we acquire additional properties containing proved reserves, conduct successful exploration and development activities or, through engineering studies, identify additional behind-pipe zones or secondary recovery reserves, our proved reserves will decline as reserves are produced. Future oil and natural gas production, therefore, is highly dependent upon our level of success in acquiring or finding additional reserves that are economically recoverable. We cannot assure you that we will be able to find or acquire and develop additional reserves at an acceptable cost.
A portion of our business is subject to special risks generally related to offshore operations and specifically in the Gulf of Mexico
Offshore operations are subject to a variety of operating risks specific to the marine environment, such as capsizing, collisions and damage or loss from hurricanes or other adverse weather conditions. These conditions can cause substantial damage to facilities and interrupt production. As a result, we could incur substantial expense and liabilities that could materially reduce the funds available for exploration, development or leasehold acquisitions or result in the loss of equipment and properties. As of February 20, 2007, we continued to have approximately 1.0 Mmcfe per day of production shut-in due to the effects of hurricanes Katrina and Rita.
Production of reserves from reservoirs in the Gulf of Mexico generally declines more rapidly than from reservoirs in many other producing regions. This results in recovery of a relatively higher percentage of reserves from properties in the Gulf of Mexico during the initial few years of production. As a result, reserve replacement needs from new prospects are greater and require us to incur significant capital expenditures to replace production.
New technologies may cause our current exploration and drilling methods to become obsolete
The oil and natural gas industry is subject to rapid and significant advancements in technology, including the introduction of new products and services using new technologies. As competitors use or develop new technologies, we may be placed at a competitive disadvantage, and competitive pressures may force us to implement new technologies at a substantial cost. In addition, competitors may have greater financial, technical and personnel resources that allow them to enjoy technological advantages and may in the future allow them to implement new technologies before we can. One or more of the technologies that we currently use or that we may implement in the future may become obsolete. We cannot be certain that we will be able to implement technologies on a timely basis or at a cost that is acceptable to us. If we are not able to maintain technological advancements consistent with industry standards, our operations and financial condition may be adversely affected.
Our business depends on oil and natural gas transportation facilities, most of which are owned by others
The marketability of our oil and natural gas production depends in part on the availability, proximity and capacity of pipeline systems owned by third parties. The unavailability of or lack of available capacity on these systems and facilities could result in the shut-in of producing wells or the delay or discontinuance of development plans for properties. Although we have some contractual control over the transportation of our product, material changes in these business relationships could materially affect our operations. We generally do not purchase firm transportation on third party facilities and therefore, our production transportation can be interrupted by those having firm arrangements. 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.
The disruption of third-party facilities due to maintenance and/or weather could negatively impact our ability to market and deliver our products. We have no control over when or if such facilities are restored or what prices will be charged. A total shut-in of production could materially affect us due to a lack of cash flow, and if a substantial portion of the production is hedged at lower than market prices, those financial hedges would have to be paid from borrowings absent sufficient cash flow.
Our indebtedness could limit our ability to successfully operate our business
We are leveraged and our exploration and development program will require substantial capital resources estimated to range from $650.0 million to $825.0 million per year over the next three years, depending on the level of drilling and the expected cost of services. Our existing operations will also require ongoing capital expenditures. In addition, if we decide to pursue additional acquisitions, our capital expenditures will increase both to complete such acquisitions and to explore and develop any newly acquired properties.
The degree to which we are leveraged could have other important consequences, including the following:
| • | we may be required to dedicate a substantial portion of our cash flows from operations to the payment of our indebtedness, reducing the funds available for our operations; | ||
| • | a portion of our borrowings are at variable rates of interest, making us vulnerable to increases in interest rates; | ||
| • | we may be more highly leveraged than some of our competitors, which could place us at a competitive disadvantage; | ||
| • | our degree of leverage may make us more vulnerable to a downturn in our business or the general economy; | ||
| • | the terms of our existing credit arrangements contain numerous financial and other restrictive covenants; | ||
| • | our debt level could limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; and | ||
| • | we may have difficulties borrowing money in the future. |
Despite our current levels of indebtedness we still may be able to incur substantially more debt. This could further increase the risks described above.
Any failure to meet our debt obligations could harm our business, financial condition and results of operations
If our cash flow and capital resources are insufficient to fund our debt obligations, we may be forced to sell assets, seek additional equity or restructure our debt. In addition, any failure to make scheduled payments of interest and principal on our outstanding indebtedness would likely result in a reduction of our credit rating, which could harm our ability to incur additional indebtedness on acceptable terms. Our cash flow and capital resources may be insufficient for payment of interest on and principal of our debt in the future and any such alternative measures may be unsuccessful or may not permit us to meet scheduled debt service obligations, which could cause us to default on our obligations and impair our liquidity.
We exist in a litigious environment
Any constituent could bring suit or allege a violation of an existing contract. This action could delay when operations can actually commence or could cause a halt to production until such alleged violations are resolved by the courts. Not only could we incur significant legal and support expenses in defending our rights, planned operations could be delayed which would impact our future operations and financial condition. Such legal disputes could also distract management and other personnel from their primary responsibilities.
Common stockholders will be diluted if additional shares are issued
Since 1998, we have exchanged 31.9 million shares of common stock for debt and convertible securities. The exchanges were made based on the relative market value of the common stock and the debt and convertible securities at the time of the exchange. Also in 2004 and 2005, we sold 33.8 million shares of common stock to finance acquisitions. In 2006, we issued 6.5 million shares as part of the Stroud acquisition. While the exchanges have reduced interest expense, preferred dividends and future repayment obligations, the larger number of common shares outstanding had a dilutive effect on our existing stockholders. Our ability to repurchase securities for cash is limited by our bank credit facility and our senior subordinated note agreements. In addition, we may issue additional shares of common stock, additional subordinated notes or other securities or debt convertible into common stock, to extend maturities or fund capital expenditures, including acquisitions. If we issue additional shares of our common stock in the future, it may have a dilutive effect on our current outstanding stockholders.
Dividend limitations
Limits on the payment of dividends and other restricted payments, as defined, are imposed under our bank credit facility and under our senior subordinated note agreements. These limitations may, in certain circumstances, limit or prevent the payment of dividends independent of our dividend policy.
Our financial statements are complex
Due to accounting rules, our financial statements continue to be complex, particularly with reference to hedging, asset retirement obligations, equity awards, deferred taxes and the accounting for our deferred compensation plan. We expect such complexity to continue and possibly increase.
Our stock price may be volatile and you may not be able to resell shares of our common stock at or above the price you paid
The price of our common stock fluctuates significantly, which may result in losses for investors. The market price of our common stock has been volatile. From January 1, 2004 to December 31, 2006, the last daily sale price of our common stock reported by the New York Stock Exchange ranged from a low of $6.25 per share to a high of $31.77 per share. We expect our stock to continue to be subject to fluctuations as a result of a variety of factors, including factors beyond our control. These include:
| • | changes in oil and natural gas prices; | ||
| • | variations in quarterly drilling, recompletions, acquisitions and operating results; | ||
| • | changes in financial estimates by securities analysts; | ||
| • | changes in market valuations of comparable companies; | ||
| • | additions or departures of key personnel; or | ||
| • | future sales of our stock. |
We may fail to meet expectations of our stockholders or of securities analysts at some time in the future, and our stock price could decline as a result.
ITEM 1B. UNRESOLVED STAFF COMMENTS
As of the date of this filing, we have no unresolved comments from the staff of the Securities and Exchange Commission.
