ITEM
2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking
Information
This
Form 10-Q quarterly report of Houston American Energy Corp. (the “Company”) for the nine months ended September 30,
2016, contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended,
and Section 21E of the Securities Exchange Act of 1934, as amended, which are intended to be covered by the safe harbors created
thereby. To the extent that there are statements that are not recitations of historical fact, such statements constitute forward-looking
statements that, by definition, involve risks and uncertainties. In any forward-looking statement, where we express an expectation
or belief as to future results or events, such expectation or belief is expressed in good faith and believed to have a reasonable
basis, but there can be no assurance that the statement of expectation or belief will be achieved or accomplished.
The
actual results or events may differ materially from those anticipated and as reflected in forward-looking statements included
herein. Factors that may cause actual results or events to differ from those anticipated in the forward-looking statements included
herein include the Risk Factors described in Item 1A herein and in our Form 10-K for the year ended December 31, 2015.
Readers
are cautioned not to place undue reliance on the forward-looking statements contained herein, which speak only as of the date
hereof. We believe the information contained in this Form 10-Q to be accurate as of the date hereof. Changes may occur after that
date, and we will not update that information except as required by law in the normal course of our public disclosure practices.
Additionally,
the following discussion regarding our financial condition and results of operations should be read in conjunction with the financial
statements and related notes contained in Item 1 of Part 1 of this Form 10-Q, as well as the Risk Factors in Item 1A and the financial
statements in Item 7 of Part II of our Form 10-K for the year ended December 31, 2015.
Critical
Accounting Policies
The
discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements,
which have been prepared in accordance with accounting principles generally accepted in the United States of America. We believe
certain critical accounting policies affect the more significant judgments and estimates used in the preparation of our financial
statements. A description of our critical accounting policies is set forth in our Form 10-K for the year ended December 31, 2015.
As of, and for the nine months ended, September 30, 2016, there have been no material changes or updates to our critical accounting
policies.
Unevaluated
Oil and Gas Properties
Unevaluated
oil and gas properties not subject to amortization, include the following at September 30, 2016:
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September 30, 2016
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Acquisition costs
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$
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902,863
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Development and evaluation costs
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2,044,166
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Total
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$
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2,947,029
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Of
the carrying value of unevaluated oil and gas prospects above, $2,181,340 was attributable to properties in the South American
country of Colombia and $765,689 was attributable to properties in the United States. We are maintaining our interest in these
properties and development has or is anticipated to commence within the next twelve months.
Recent
Developments
Drilling
and Related Activity
During
the nine months ended September 30, 2016, we drilled no wells and, at September 30, 2016, no drilling operations were ongoing.
During
the nine months ended September 30, 2016, our capital investment expenditures totaled $92,217 principally relating to the preparation
and evaluation of our three concessions in Colombia.
During
the nine months ended September 30, 2016, Hupecol, the operator of our Colombian concessions, continued to experience opposition,
at the local level, to their efforts to secure necessary permits to commence drilling operations on our Serrania concession. Commencement
of drilling operations remains contingent upon receipt of final permits in Colombia. Notwithstanding the federal government’s
grant of the concession, local opposition to drilling in the vicinity of the Serrania concession has resulted in repeated delays
in issuance of, including the issuance and subsequent rescission of, necessary permits and there is no assurance as to if, and
when, necessary permits will be issued or the concession will be drilled and/or developed. While Hupecol continues to pursue discussions
with the government regarding issuance of permits or compensation should the necessary permits not be forthcoming, given the continuing
permitting issues, we, through Hupecol, are evaluating our rights and options with respect to Serrania and have shelved plans
to drill the concession in 2016 and for the foreseeable future. Hupecol is also expected to defer commencement of work on the
Los Picachos and Macaya concessions until satisfactory resolution of the permitting issues on the Serrania concession.
In
June 2016, a peace accord was announced between the Colombian government and the Revolutionary Armed Forces of Colombia, also
known as FARC. The peace accord was ultimately rejected in a popular referendum although both government and FARC representatives
have indicated a desire to cease all hostilities and seek to arrive at an acceptable final peace accord. While there is no assurance
as to how the peace initiative will, or will not, impact our assets, we are reevaluating our plans regarding our Colombian assets
in light of the peace initiatives and the potential of the same to enhance our prospects of arriving at a favorable resolution
to the impasse that has prevented the commencement of drilling operations on our Colombian properties.
Termination
of Planned Tamboran Investment
In
February 2016, we agreed to acquire a 12.5% equity ownership interest in Tamboran Resources Limited for $1,000,000. Closing of
the planned acquisition of the interest in Tamboran was subject to satisfaction of certain conditions by Tamboran, including the
receipt by Tamboran of funding from investors other than Houston American Energy in an amount not less than $705,000. Tamboran
failed to satisfy one of the conditions of closing the investment and, effective June 30, 2016, our agreement to purchase an equity
ownership interest in Tamboran was terminated.
Strategic
Alternatives
In
May 2016, our board approved the exploration of strategic alternatives, including, among other options, seeking merger and acquisition
candidates, asset acquisitions or sales. To facilitate our exploration of strategic alternatives, in June 2016, we engaged an
investment banking firm, to assist in making merger and acquisition introductions, negotiating deals, capital sourcing and other
supporting services. We subsequently terminated our engagement of the investment banking firm but continue our exploration of
strategic alternatives.
Supplemental
Director Option Grants
In
light of the limited cash compensation paid to non-employee directors and the anticipated increased demands on non-employee directors
associated with the search for and consideration of strategic alternatives, in June 2016, in addition to ordinary annual option
grants to non-employee directors, we granted supplemental stock options pursuant to which each of the non-employee directors may
acquire up to 150,000 shares of common stock (or an aggregate of 600,000 shares) for a term of ten years at an exercise price
of $0.2201 per share. The supplement options vest: (i) 50% on the earlier of June 7, 2017 or the day preceding the next annual
shareholders meeting at which directors are elected, (ii) 50% on the earlier of June 7, 2018 or the day preceding the second annual
shareholders meeting (after the grant date) at which directors are to be elected, and (iii) in the event that the Company consummates
a transaction(s) (after the option grant date) in the nature of a sale of shares of equity securities for cash or assets resulting
in a net addition(s) to the Company’s stockholders’ equity of not less than $2 million, all unvested options vest
in full.
Results
of Operations
Oil
and Gas Revenues.
Total oil and gas revenues decreased by 68% to $39,738 in the three months ended September 30, 2016 compared
to $124,448 in the three months ended September 30, 2015. Oil and gas revenues decreased 64% to $121,885 in the nine months ended
September 30, 2016 compared to $340,541 in the nine months ended September 30, 2015. The decrease in revenue was due to a steep
decline in average realized oil prices (down 30% for the 2016 nine-month period from the same period in 2015) and average realized
natural gas prices (down 34% for the 2016 nine-month period from the same period in 2015) and a 53% decline in crude oil production
and a 30% decline in natural gas production.
The
following table sets forth the gross and net producing wells, net oil and gas production volumes and average hydrocarbon sales
prices for the quarter and nine months ended September 30, 2016 and 2015:
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Three Months Ended
September 30,
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Nine Months Ended
September 30,
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2016
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2015
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2016
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2015
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Gross producing wells
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9
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11
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|
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9
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|
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11
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Net producing wells
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0.47
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|
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0.72
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0.47
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|
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0.72
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Net oil production (bbl)
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690
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1,654
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2,218
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4,737
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Net gas production (mcf)
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4,172
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9,939
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16,126
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23,112
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Average sales price – oil (per barrel)
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$
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45.61
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$
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57.76
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$
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38.97
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$
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55.69
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Average sales price – natural gas (per mcf)
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$
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1.98
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$
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2.91
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$
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2.20
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$
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3.32
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The
change in average sales prices realized reflects a steep decline in global commodity prices from 2015 and continuing into 2016.
The decline in crude oil production reflects natural decline rates and termination, during 2015, of production on two wells that
were no longer economical to produce at current commodity prices.
Oil
and gas sales revenues by region were as follows:
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Colombia
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U.S.
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Total
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2016 First Nine Months
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Oil sales
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$
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—
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$
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86,420
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$
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86,420
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Gas sales
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—
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35,465
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35,465
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2015 First Nine Months
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|
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Oil sales
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$
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—
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$
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263,809
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$
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263,809
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Gas sales
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—
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76,732
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76,732
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Lease
Operating Expenses.
Lease operating expenses decreased by 56% to $23,054 during the three months ended September 30, 2016
from $52,652 during the three months ended September 30, 2015. During the nine months ended September 30, 2016, lease operating
expenses decreased by 46% to $60,416 from $112,300 during the nine months ended September 30, 2015. The decrease in lease operating
expenses was attributable to operation of fewer wells during the 2016 periods and receipt of a severance tax abatement on one
well during 2016.
Following
is a summary comparison of lease operating expenses, by region, for the periods.
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Colombia
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U.S.
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Total
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Quarter
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-2016
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$
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—
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$
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23,054
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$
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23,054
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-2015
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$
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—
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$
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52,652
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$
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52,652
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Nine Months
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-2016
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$
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—
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$
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60,416
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$
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60,416
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|
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-2015
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$
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—
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$
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112,300
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$
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112,300
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Consistent
with our business model and operating history, we experience steep declines in lease operating expenses following strategic divestitures
and anticipate lease operating expenses to ramp up to levels consistent with regional costs as new wells are brought on line.
Depreciation
and Depletion Expense.
Depreciation and depletion expense was $25,069 and $149,717 for the three months ended September 30,
2016 and 2015, respectively, and $74,333 and $427,792 for the nine months ended September 30, 2016 and 2015, respectively. The
decrease was due to impairment charges during 2015 and lower production rates.
Impairment
of Oil and Gas Properties
. During the three months and nine months ended September 30, 2015, we recorded an impairment expense
of $0 and $677,051, respectively, associated with the decline in energy prices.
General
and Administrative Expenses.
General and administrative expense decreased by 7% to $362,807 during the three months ended
September 30, 2016 from $390,411 during the three months ended September 30, 2015, and increased by 6% to $1,194,223 during the
nine months ended September 30, 2016 from $1,122,987 during the nine months ended September 30, 2015. The increases in general
and administrative expense was primarily attributable to an increase in consulting fees and stock-based compensation expense and
the reversal, during 2015, of an over accrual of legal fees that resulted in lower legal fees in 2015.
Other
Income
. Other income consisted of interest earned on cash balances, net of interest expense. Other income totaled $849 and
$6,887 of net other income during the three and nine-month periods ended September 30, 2016, respectively, as compared to $5,129
and $15,574 of other income during the three and nine-month periods ended September 30, 2015, respectively. The changes were attributable
to lower cash balances.
Income
Tax Expense/Benefit
. We reported no income tax expense during the three months ended September 30, 2016 compared to income
tax expense of $363 during the three months ended September 30, 2015. For the nine months ended September 30, 2016, we reported
no income tax expense compared to income tax expense of $18,423 during the nine months ended September 30, 2015.
Financial
Condition
Liquidity
and Capital Resources.
At September 30, 2016, we had a cash balance of $872,130 and working capital of $1,129,646, compared
to a cash balance of $2,123,520 and working capital of $2,384,283 at December 31, 2015. The change in cash and working capital
during the period was primarily attributable to the operating loss for the first nine months of 2016.
Operating
activities used cash of $1,023,200 during the nine months ended September 30, 2016 as compared to $1,494,704 of cash used during
the nine months ended September 30, 2015. The change in operating cash flow used was primarily attributable to (1) changes in
operating assets and liabilities (reflecting settlement of litigation and insurance claims and associated legal fees, an increase
in prepaid expenses and a decrease in payables and accrued expenses) which accounted for a reduction in cash of $666,734 in 2015
versus changes in operating assets and liabilities which accounted for an increase in cash of $3,246 in 2016, partially offset
by (2) an increase in cash loss, after elimination of non-cash items, of $198,479, attributable to decreased revenues and increased
general and administrative expenses.
Investing
activities used $92,217 during the nine months ended September 30, 2016 compared to $25,029 of cash used during the nine months
ended September 30, 2015. The funds used by investing activities during the 2016 nine-month period reflect the investments in
oil and gas properties, totaling $92,217. The funds used by investing activities during the nine months ended September 30, 2015
reflect the investments in oil and gas properties, totaling $141,146, partially offset by proceeds of $56,705 from the sale of
the Company’s interest in several oil and gas wells and the release of $59,412 of funds held in escrow from the prior sale
of our interests in HDC LLC, HL, LLC and the Tambaqui prospect.
Financing
activities used $135,973 for the acquisition of treasury shares during the nine-months ended September 30, 2016 compared to $0
used during the 2015 period.
Long-Term
Liabilities
. At September 30, 2016, we had long-term liabilities of $25,676 as compared to $25,262 at December 31, 2015. Long-term
liabilities at September 30, 2016 and December 31, 2015 consisted of a reserve for plugging costs.
Capital
and Exploration Expenditures and Commitments.
Our principal capital and exploration expenditures relate to ongoing efforts
to acquire, drill and complete prospects. We expect that future capital and exploration expenditures will be funded principally
through funds on hand and funds provided by capital raising efforts.
During
the nine months ended September 30, 2016, we invested $92,217 for the development of oil and gas properties, consisting of (1)
preparation and evaluation costs in Colombia of $67,966, and (2) costs on U.S. properties of $24,251. Of the amount invested,
we capitalized $24,251 to oil and gas properties subject to amortization, and $67,966 to oil and gas properties not subject to
amortization.
With
the termination of our agreement to purchase an equity interest in Tamboran Resources, we presently have no budgeted capital expenditures
for the balance of 2016 or 2017. Capital expenditure plans for 2016 and 2017 may change should we satisfactorily resolve ongoing
uncertainty regarding operations in Colombia or in connection with a strategic transaction or based on field conditions and other
factors beyond our control or the control of the operators of our prospects and, as such, there can be no assurance as to the
timing or the amount of actual capital expenditures.
Depending
on the timing and ultimate outcome of our strategic alternatives initiative and potential expenditures relating to our Colombian
assets, our cash on hand may not be adequate to fully fund our operations over the upcoming twelve months, including our capital
expenditure budget. Accordingly, absent substantial curtailment of operations and initiatives, we will require additional capital
to fully fund our future drilling budget and operations. If, for any reason, we are unable to fully fund our drilling budget and
fail to satisfy commitments reflected therein, we may be subject to penalties or to the possible loss of some of our rights and
interests in prospects with respect to which we fail to satisfy funding commitments. We have no commitments to provide any additional
financing should we require and seek such financing and there is no guarantee that we will be able to secure additional financing
on acceptable terms, or at all, to fully fund our drilling budget and to support future acquisitions, development activities and
operations.
Outlook;
Strategic Alternatives
Continued
low oil and natural gas prices during 2015 and into 2016 and lagging production in light of recurring delays in drilling of our
Colombian prospects have had a significant adverse impact on our business. Our financial statements include a “going concern”
qualification reflecting substantial doubt as to our ability to continue as a going concern. While we have no debt and have taken
steps to reduce our overhead, we continue to operate at a loss and expect to continue to do so until such time as we can increase
production levels and realize substantial improvement in commodity prices. With the continuing permitting issues in Colombia and
the lack of clarity as to future operations in Colombia, our near term efforts to bolster production and profitability are focused
on opportunistic acquisitions of assets or companies in the current depressed market.
Given
the uncertainty as to timing and ultimate outcome of our current initiatives in Colombia, management has determined that we should
consider strategic alternatives, including seeking a merger partner or acquisition of significant oil and gas assets with a view
to maximizing long-term value to our shareholders. To that end, we have retained a business development advisor to assist in identifying
and financing strategic transactions, have evaluated a substantial number of potential transactions and have submitted letters
of intent with respect to several potential acquisitions but, to date, we have not yet entered into any definitive agreements
to acquire assets. While we believe that there are attractive opportunities that will be available to execute one or more strategic
transactions that will position us to take advantage of an anticipated future recovery in energy markets, such transactions, or
the financing of the same, may be highly dilutive and there can be no assurance that any such strategic transaction can be executed
on acceptable terms or at all.
We
do not presently have adequate financial resources to support operations at current levels for the upcoming twelve months or to
support any meaningful acquisitions or capital calls should development operations resume in Colombia. While we may curtail operations
further or seek to divest certain holdings to preserve liquidity, absent dramatic increases in energy prices or other unforeseen
events, we anticipate that we will be required to seek additional financing to support our ongoing strategic acquisition initiative
and/or a resumption of activities in Colombia. We can provide no assurance that our efforts will be sufficient to reverse the
trend of operating losses, to provide adequate financial resources to sustain operations and retention of our assets pending attainment
of profitable operations or consummate of a strategic transaction.
Off-Balance
Sheet Arrangements
We
had no off-balance sheet arrangements or guarantees of third party obligations at September 30, 2016.
Inflation
We
believe that inflation has not had a significant impact on operations since inception.