Item 2. - Management's Discussion and Analysis of Financial Condition
and
Results of Operations
WARNING CONCERNING FORWARD LOOKING STATEMENTS
The following discussion should be read in conjunction with the financial
statements and notes thereto appearing elsewhere in this report.
This Report on Form 10-Q may contain forward-looking statements within
the meaning of the federal securities laws, principally, but not only, under the caption “Management’s Discussion and
Analysis of Financial Condition and Results of Operations.” We caution investors that any forward-looking statements in this
report, or which management may make orally or in writing from time to time, are based on management’s beliefs and on assumptions
made by, and information currently available to, management. When used, the words “anticipate,” “believe,”
“expect,” “intend,” “may,” “might,” “plan,” “estimate,”
“project,” “should,” “will,” “result” and similar expressions which do not relate
solely to historical matters are intended to identify forward-looking statements. These statements are subject to risks, uncertainties,
and assumptions and are not guarantees of future performance, which may be affected by known and unknown risks, trends, uncertainties,
and factors, that are beyond our control. Should one or more of these risks or uncertainties materialize, or should underlying
assumptions prove incorrect, actual results may vary materially from those anticipated, estimated, or projected. We caution you
that while forward-looking statements reflect our good faith beliefs when we make them, they are not guarantees of future performance
and are impacted by actual events when they occur after we make such statements. We expressly disclaim any responsibility to update
our forward-looking statements, whether as a result of new information, future events or otherwise. Accordingly, investors should
use caution in relying on past forward-looking statements, which are based on results and trends at the time they are made, to
anticipate future results or trends.
Some of the risks and uncertainties that may cause our actual results,
performance or achievements to differ materially from those expressed or implied by forward-looking statements include, among others,
the factors listed and described at Item 1A “Risk Factors” in the Company’s Annual Report on Form 10-K, which
investors should review. There have been changes to the risk factors previously described in the Company’s Form 10-K. for
the fiscal year ended December 31, 2019 (the “Form 10-K”), including significant global economic and pandemic factors
occurring during the first quarter of 2020 and continuing into the third quarter of 2020 which are described in the following two
paragraphs.
At the end of 2019, a novel strain of coronavirus
(“COVID-19”) was reported in China. In the first quarter of 2020 and continuing currently, COVID-19 has spread to
other countries including the U.S. This pandemic has drastically weakened the global demand for oil, putting unprecedented
pressure on the price of oil. In addition, the delay through the end of the first quarter of 2020 of the Organization of
Petroleum Exporting Countries and Russia to agree on production cuts, caused oil prices to drop dramatically in the first
quarter of 2020 to as low as $6.00 per barrel which is approximately one-tenth of the oil price at the beginning of 2020.
Additionally, during the second quarter of 2020, for the first time ever, the price of a barrel of oil plunged below zero
dollars on the West Texas Intermediate Crude Index going as low as negative $37.63 due to concerns about dwindling capacity
to store all the crude oil produced in excess of demand. During the third quarter of 2020, the price of a barrel of oil has somewhat stabilized with an average price
per barrel of $36.48.
During the first nine months of 2020 and continuing subsequent
to the end of the quarter, attempts at containment of COVID-19 have resulted in decreased economic activity which has
adversely affected the broader global economy. As the economy dramatically stalled, the demand for oil and natural gas
substantially weakened. Many countries around the world, as well as the majority of the states in the United States, ordered
their citizens to stay home in order to contain the spread of the virus. As part of the “shelter in place” and
“stay at home” orders in effect during the nine months of the year, fewer businesses than normal are open, less
people are traveling to work, and more people are working from home which has reduced the demand for oil and natural gas.
Airlines have dramatically cut back on flights as the number of passengers has fallen off. Fewer cars on the road and planes
in the sky mean far less demand for oil. At this time, the full extent to which COVID-19 will negatively impact the global
economy and our business is uncertain, but pandemics or other significant public health events will most likely have a
material adverse effect on our business and results of operations.
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The Company has felt the negative effects of these plummeting product
prices and implemented cost cutting measures including temporary company-wide reductions in compensation for Company employees,
including key and technical employees and officers, effective April 1, 2020. To further reduce expenses, the Company temporarily
shut in wells that were not profitable when commodity prices plummeted. The Company is forecasting that oil and natural gas prices
will remain lower than 2019 prices through the end of 2020, which the Company believes may cause an operating loss for all of 2020
in spite of the Company’s cost cutting measures. Operating losses are very likely to continue until oil and natural gas prices
return to substantially higher levels on a continued basis.
Other uncertainties regarding the global economic and financial environment
could lead to an extended national or global economic recession. A slowdown in economic activity caused by a recession would likely
reduce national and worldwide demand for oil and natural gas and result in lower commodity prices for long periods of time. Costs
of exploration, development and production have not yet adjusted to current economic conditions, or in proportion to the significant
reduction in product prices. Prolonged, substantial decreases in oil and natural gas prices would likely have a material adverse
effect on the Company’s business, financial condition, and results of operations, and could further limit the Company's access
to liquidity and credit, and could hinder its ability to satisfy its capital requirements.
In the past several years, capital and credit markets have experienced
volatility and disruption. Given the levels of market volatility and disruption, the availability of funds from those markets may
diminish substantially. Further, arising from concerns about the stability of financial markets generally and the solvency of borrowers
specifically, the cost of accessing the credit markets has increased as many lenders have raised interest rates, enacted tighter
lending standards, or altogether ceased to provide funding to borrowers.
Due to these potential capital and credit market conditions, the
Company cannot be certain that funding will be available in amounts or on terms acceptable to the Company. The Company is evaluating
whether current cash balances and cash flow from operations alone would be sufficient to provide working capital to fully fund
the Company's operations. Accordingly, the Company is evaluating alternatives, such as joint ventures with third parties, or
sales of interest in one or more of its properties. Such transactions, if undertaken, could result in a reduction in the Company's
operating interests or require the Company to relinquish the right to operate the property. There can be no assurance that any
such transactions can be completed or that such transactions will satisfy the Company's operating capital requirements. If the
Company is not successful in obtaining sufficient funding or completing an alternative transaction on a timely basis on terms acceptable
to the Company, the Company would be required to curtail its expenditures or restructure its operations, and the Company would
be unable to continue its exploration, drilling, and recompletion program, any of which would have a material adverse effect on
its business, financial condition, and results of operations.
There could be adverse legislation which if passed, would significantly
curtail our ability to attract investors and raise capital. Proposed changes in the Federal income tax laws which would eliminate
or reduce the percentage depletion deduction and the deduction for intangible drilling and development costs for small independent
producers, will significantly reduce the investment capital available to those in the industry as well as our Company. Lengthening
the time to expense seismic costs will also have an adverse effect on our ability to explore and find new reserves.
Other sections of this report may also include suggested factors
that could adversely affect our business and financial performance. Moreover, we operate in a very competitive and rapidly changing
environment. New risks may emerge from time to time and it is not possible for management to predict all such matters; nor can
we assess the impact of all such matters on our business or the extent to which any factor, or combination of factors, may cause
actual results to differ materially from those contained in any forward-looking statements. Given these uncertainties, investors
should not place undue reliance on forward-looking statements as a prediction of actual results. Investors should also refer to
our quarterly reports on Form 10-Q for future periods and current reports on Form 8-K as we file them with the SEC, and to other
materials we may furnish to the public from time to time through Forms 8-K or otherwise.
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Results of Operations
Nine months ended September 30, 2020 compared to nine months
ended September 30, 2019
Oil and gas revenues for the first nine months of 2020 were $2,025,000,
as compared to $3,501,000 for the same period in 2019, a decrease of approximately $1,476,000 or 42.16%, due to low oil and natural
gas prices and the shutting in of wells during 2020.
Oil sales for the first nine months of 2020 were approximately $1,178,000
compared to approximately $2,099,000 for the first nine months of 2019, a decrease of approximately $921,000 or 43.9%. Oil sales
volumes for the first nine months of 2020 were approximately 21,987 bbls, compared to approximately 31,700 bbls during the same
period in 2019, a decrease of approximately 9,713 bbls, or 30.6%.
Average oil prices received were $40.77 per bbl in the first nine
months of 2020 compared to $56.80 per bbl in the first nine months of 2019, a decrease of approximately $13.09 per bbl or 23.1%.
Natural gas revenue for the first nine months of 2020 was $847,000
compared to $1,402,000 for the same period in 2019, a decrease of approximately $555,000 or 39.59%. Natural gas sales volumes for
the first nine months of 2020 were approximately 524,000 mcf compared to approximately 692,000 mcf during the first nine months
of 2019, a decrease of approximately 168,000 mcf or 24.3%.
Average gross natural gas prices received were $1.72 per mcf in the
first nine months of 2020 as compared to $2.03 per mcf in the same time period in 2019, a decrease of approximately $0.41 per mcf
or 20.2%.
Revenues from oil and gas producing operations experienced a significant
decrease for the nine months ended 2020 compared to the same period in 2019. In addition, the third quarter results from operations
also experienced a significant decline over the same period in 2019 as well as a decline from operations during the first nine
months of 2020. The declines result in part from decreased oil and gas prices, as well as production declines. A number of both
operated wells and non-operated wells were shut-in during the first nine months of 2020 due to the low oil and gas prices. Operators
shut in wells, where practicable, waiting for the low oil prices to rebound.
Revenues from lease operations were $168,000 in the first nine months
of 2020 compared to $249,000 in the first nine months of 2019, a decrease of approximately $81,000 or 32.5%. This decrease is due
to a reduction in field supervision charges. Revenues from lease operations are derived from field supervision charged to operated
leases along with operator overhead charged to operated leases.
Revenues from gas gathering, compression and equipment rental
for the first nine months of 2020 were $57,000 compared to $94,000 for the same period in 2019, a decrease of approximately
$37,000 or 39.4%. These revenues are derived from gas volumes produced and transported through the Company owned gas
gathering systems.
Real estate revenue was approximately $204,000 during the first nine
months of 2020 compared to $179,000 for the first nine months of 2019, an increase of approximately $25,000, or 13.9%. The increase
is due to new office leases signed during the period.
Interest income was $164,000 during the first nine months of 2020
as compared to $150,000 during the same period in 2019, an increase of approximately $14,000 or 9.3%. Interest income is due to
the Company investing its funds in both long-term and short-term certificates of depository accounts paying higher rates of interest
than those received in money market accounts.
Other revenues for the first nine months of 2020 were $29,000 as
compared to $49,000 for the same time period in 2019, a decrease of approximately $20,000 or 40.8%.
Lease operating expenses in the first nine months of 2020 were $727,000
as compared to $1,239,000 in the first nine months of 2019, a net decrease of $512,000, or 41.3%. Of this net decrease, approximately
$97,000 is due in part to net decreases in operating expenses billed by third-party operators on non-operated properties that were
shut in during the first nine months of 2020. The remaining net decrease of approximately $415,000 represents overall increases
and decreases in well expenditures on various operated properties. A number of both operated wells and non-operated wells were shut-in
during the first nine months of 2020 due to low oil and gas prices.
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Production taxes, gathering and marketing expenses in the first nine
months of 2020 were approximately $468,000 as compared to $592,000 for the first nine months of 2019, a decrease of approximately
$124,000, or 21.0%. This decrease relates directly to the decrease in oil and gas revenues as described in the above paragraphs.
Pipeline and rental expenses for the first nine months of 2020 were
$6,000 compared to $25,000 for the same time period in 2019, a decrease of approximately $19,000. The decrease in 2020
is due to non-recurring repair and maintenance expenses in the first nine months of 2019.
Real estate expenses in the first nine months of 2020 were approximately
$106,000 compared to $104,000 during the same period in 2019, an increase of approximately $2,000 or 1.9%.
Depreciation, depletion, and amortization expenses for first nine
months of 2020 were $261,000 as compared to $407,000 for the same period in 2019, a decrease of $146,000, or 35.9%. $216,000 of
the amount for the first nine months of 2020 was for amortization of the full cost pool of capitalized costs compared to $362,000
for the same period of 2019, a decrease of $146,000 or 40.3%. The Company re-evaluated its proved oil and natural gas reserve quantities
as of December 31, 2019. This re-evaluated reserve base was reduced for oil and gas reserves that were produced or sold during
the first nine months of 2020 and adjusted for newly acquired reserves or for changes in estimated production curves and future
price assumptions. A depletion rate of 4.184% for the first quarter of 2020, a depletion
rate of 0.813% for the second quarter of 2020, and a depletion rate of 5.269% for the third quarter of 2020 was calculated and
applied to the Company’s full cost pool of capitalized oil and natural gas properties compared to rates of 3.191%, 3.554%
and 3.727% for the third quarter of 2019. respectively.
Asset Retirement Obligation (“ARO”) expense for the first
nine months of 2020 was approximately $90,000 as compared to approximately $142,000 for the same time period in 2019, a decrease
of approximately $52,000 or 36.6%. The ARO expense is calculated to be the discounted present value of the estimated future cost
to plug and abandon the Company’s producing wells.
General and administrative expenses for the first nine months of
2020 were approximately $1,723,000 as compared to approximately $2,212,000 for the same time period of 2019, a decrease of approximately
$489,000 or 22.1%. The decrease is from reduced salary, wages, other personnel costs, and reduced office, computer, and other expenses.
Three months ended September 30, 2020 compared to three months
ended September 30, 2019
Oil and natural gas revenues for the three months ended September
30, 2020 were $933,000, compared to $1,126,000 for the same period in 2019, a decrease of $193,000, or 17.1%, due to low oil prices
and the shutting in of wells during the third quarter of 2020.
Oil sales for the third quarter of 2020 were approximately $570,000
compared to approximately $749,000 for the same period of 2019, a decrease of approximately $179,000 or 23.9%. Oil volumes sold
for the third quarter of 2020 were approximately 9,687 bbls compared to approximately 11,300 bbls during the same period of 2019,
a decrease of approximately 7,000 bbl or 68.6%.
Average oil prices received were approximately $36.48 per bbl in
the third quarter of 2020 compared to $54.84 per bbl during the same period of 2019, a decrease of approximately $9.54 per bbl,
or 17.4%.
Natural gas revenues for the third quarter of 2020 were $363,000
compared to $377,000 for the same period in 201 9, a decrease of approximately $14,000 or 3.7%.
Average gross natural gas prices received were approximately $1.88
per mcf in the third quarter of 2020 as compared to approximately $1.62 per mcf during the same period in 2019.
Revenues from lease operations for the third quarter of 2020 were
approximately $49,000 compared to approximately $62,000 for the same period in 2019, a decrease of approximately $13,000 or 21.0%.
This decrease is due to a reduction in field supervision charges. Revenues from lease operations are derived from field supervision
charged to operated leases along with operator overhead charged to operated leases.
Revenues from gas gathering, compression and equipment rental for
the third quarter of 2020 were approximately $12,000, compared to approximately $28,000 for the same period in 2019, a decrease
of approximately $16,000 or 57.1%. These revenues are derived from gas volumes produced and transported through our gas gathering
systems.
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Real estate revenue was approximately $70,000 during the third quarter
of 2020 compared to $60,000 for the same period in 2019. The increase is due to higher rental rates and new office leases signed
during the period.
Interest income for the third quarter of 2020 was approximately $61,000
as compared with approximately $37,000 for the same period in 2019, an increase of approximately $24,000 or 64.9%. Interest income
is derived from investments in both short-term and long-term certificates of deposit as well as money market accounts at banks.
Other revenues for the third quarter of 2020 were approximately $10,000
as compared with approximately $27,000 for the same period in 2019, a decrease of approximately $17,000 or 63.0%.
Lease operating expenses in the third quarter of 2020 were $265,000
as compared to $418,000 in the third quarter of 2019, a net decrease of approximately $153,000, or 36.6%. Of this decrease, approximately
$41,000 is due in part to net decreases in operating expenses billed by third-party operators on non-operated properties. The remaining
net decrease of approximately $112,000 represents overall increases and decreases in well expenditures on various operated properties.
A significant number of both operated wells and non-operated wells were shut-in during the first nine months of 2020 due to low
oil and gas prices. Operators shut in wells, where practicable, waiting for the low prices to rebound.
Production taxes, gathering, transportation and marketing expenses
for the third quarter of 2020 were approximately $212,000 as compared to $204,000 during the third quarter of 2019, a net increase
of approximately $8,000 or 3.9%.
Pipeline and rental expenses for the third quarter of 2020 were $2,000
compared to $6,000 for the same period in 2019, a decrease of approximately $4,000, or 66.7%. The decrease in 2020 is due to non-recurring
repair and maintenance expenses incurred in the third quarter of 2019.
Real estate expenses during the third quarter 2020 were approximately
$39,000 compared to approximately $32,000 for the same period in 2019, an increase of approximately $7,000 or 21.9%.
Depreciation, depletion, and amortization expenses for the third
quarter of 2020 were $126,000 as compared to $137,000 for the same period in 2019, a decrease of $11,000, or 8.0%. $111,000 of
the amount for the third quarter of 2020 was for amortization of the full cost pool of capitalized costs compared to $123,000 for
the third quarter of 2019, a decrease of $12,000 or 9.8%. The Company re-evaluated its proved oil and natural gas reserve quantities
as of December 31, 2019. This re-evaluated reserve base was reduced for oil and gas reserves that were produced or sold during
the first nine months of 2020 and adjusted for newly acquired reserves or for changes in estimated production curves and future
price assumptions. A depletion rate of 5.269% for the third quarter of 2020 was calculated and applied to the Company’s full
cost pool of capitalized oil and natural gas properties compared to rate of 3.727% for the third quarter of 2019, respectively.
Asset Retirement Obligation (“ARO”) expense for the third
quarter of 2020 was approximately $30,000 as compared to approximately $48,000 for the same period in 2019, a decrease of approximately
$18,000 or 37.5%. The ARO expense is calculated to be the discounted present value of the estimated future cost to plug and abandon
the Company’s producing wells.
General and administrative expenses for the third quarter of 2020
were $332,000 compared to $721,000 for the same period in 2019, a decrease of approximately $389,000 or 54.0%. The decrease comes
from decreased salary, wages, and other personnel costs, as well as decreases in office, computer, and other expenses.
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Financial Condition and Liquidity
The Company's operating capital needs, as well as its capital spending
program are generally funded from cash flow generated by operations. The Company is operating at a loss and projects to continue
to operate at a deficient through the end of the year unless oil and natural gas prices rebound substantially. Because future cash
flow is subject to a number of variables, such as the level of production and the sales price of oil and natural gas, the Company
can provide no assurance that its operations will provide cash sufficient to maintain current levels of capital spending. Accordingly,
the Company may be required to seek additional financing from third parties in order to fund its exploration and development programs.