NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2021 and 2020
Note 1 - Organization and Basis of Presentation
Empire Petroleum Corporation (the “Company”,
collectively with its subsidiaries) is an independent energy company operator engaged in optimizing developed production by employing
field management methods to maximize reserve recovery while minimizing costs. Empire has four wholly-owned subsidiaries in its areas
of operations:
| ● | Empire
North Dakota LLC (“Empire North Dakota”) |
| ● | Empire
New Mexico, LLC (“Empire New Mexico”) |
| ● | Empire
Texas (“Empire Texas”), consisting of the following entities: |
| o | Pardus
Oil & Gas Operating, LP (owned 1% by Empire Texas GP LLC and 99% by Empire Texas LLC) |
| ● | Empire
Louisiana LLC (“Empire Louisiana”) |
Empire was incorporated in the State of Utah in
August 1983 and subsequently in the State of Delaware in 1985. The consolidated financial statements of Empire Petroleum Corporation
and subsidiaries include the accounts of the Company and its wholly-owned subsidiaries.
On August 27, 2021 the Company’s Board of
Directors, in conjunction with the majority of the common stock holders, approved a one for four reverse stock split such that every
holder of the Company’s common stock shall receive one share of Common Stock for every four shares owned. In addition, the
Board authorized the Company to issue ten million shares of no-par value Preferred Stock. As of December 31, 2021, the Company had
not made the reverse stock split effective, nor had it issued any Preferred Stock. The reverse stock split was made effective on
March 7, 2022, simultaneous with the Company’s listing to the NYSE American. All shares amounts have retrospectively been
stated at post-reverse split amounts and pricing.
Note 2 – Summary of Significant Accounting
Policies
Principles of Consolidation
The consolidated financial statements include the
accounts and balances of the Company and have been prepared in accordance with accounting principles generally accepted in the United
States (“GAAP”). All intercompany accounts and transactions, including revenues and expenses, have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity
with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying
notes. Actual results could differ from those estimates.
Estimated quantities of crude oil, natural
gas and natural gas liquids (“NGL”) reserves are the most significant of the Company’s estimates. All reserve data
used in the preparation of the Consolidated Financial Statements, as well as included in Supplemental Information On Oil And Gas Exploration
And Production Activities (Unaudited), are based on estimates. Reservoir engineering is a subjective process of estimating underground
accumulations of crude oil, natural gas and NGL. There are numerous uncertainties inherent in estimating quantities of proved crude oil,
natural gas and NGL reserves. The accuracy of any reserve estimate is a function of the quality of available data and of engineering
and geological interpretation and judgment. As a result, reserve estimates may be different from the quantities of crude oil, natural
gas and natural gas liquids that are ultimately recovered.
Other
items subject to estimates and assumptions include, but are not limited to, the carrying amounts of property, plant and equipment,
asset retirement obligations, valuation allowances for deferred income tax assets, conversion features on debt convertible, and
valuation of derivative instruments. Management evaluates estimates and assumptions on an ongoing basis using historical experience
and other factors, including the current economic and commodity price environment. The volatility of commodity prices results in
increased uncertainty inherent in such estimates and assumptions.
Although management believes
these estimates are reasonable, actual results may differ from estimates and assumptions of future events and these revisions could be
material. Future production may vary materially from estimated oil and natural gas proved reserves. Actual future prices may vary significantly
from price assumptions used for determining proved reserves and for financial reporting.
Accounts Receivable
Accounts receivable include estimated amounts due from crude oil, natural
gas, and NGL purchasers and from non-operating working interest owners. Accrued revenue related to product sales from purchasers and
operators are due under normal trade terms, generally requiring payment withing 60 days of production. For receivables from joint interest
owners, the Company generally has the ability to withhold future revenue disbursements to recover any non-payment of joint interest billings.
Receivables are considered past due if full payment is not received by the contractual due date. Past due accounts are generally written
off against the allowance for doubtful accounts only after all collection attempts have been exhausted. The Company did not have an allowance
for doubtful accounts at either December 31, 2021 or 2020.
Derivative Instruments
The Company enters into hedge agreements to manage
its exposure to oil and natural gas price fluctuations. The fair value of derivative contracts is recognized as an asset or liability
on the Company’s consolidated balance sheets. Realized gain or loss is recognized as a component of revenue when the derivative
contracts mature. For contracts which have not matured, an unrealized gain or loss is recorded based on the value of the outstanding
contracts.
Inventory
Inventory consists of oil in tanks which has not
been delivered and is valued at the lower of cost or net realizable value.
Oil and Natural Gas and Other Properties
The Company uses the successful efforts method of
accounting for its oil and gas activities. Costs incurred are deferred until exploration and completion results are evaluated. At such
time, costs of activities with economically recoverable reserves are capitalized as proven properties, and costs of unsuccessful or uneconomical
activities are expensed.
Capitalized drilling costs are reviewed periodically
for impairment. Costs related to impaired prospects or unsuccessful exploratory drilling is charged to expense. Management's assessment
of the results of exploration activities, commodity price outlooks, planned future sales or expiration of all or a portion of such leaseholds
impact the amount and timing of impairment provisions. An impairment expense could result if oil and gas prices decline in the future
as it may not be economical to develop some of these unproved properties.
Lease options are capitalized as unproved property
acquisition costs and are reviewed for impairment if indicators exist that the carrying value of the lease option may not be recoverable.
If the lease options become impaired, expire or are abandoned, the options will be expensed. If proved reserves are discovered
after the options are exercised, these costs will be reclassified as proved property.
Depreciation, depletion and amortization of producing properties is computed on the
units-of-production method on a property-by-property basis. The units-of-production method is based primarily on estimates of proved
reserve quantities. Due to uncertainties inherent in this estimation process, it is at least reasonably possible that reserve quantities
will be revised in the near term. Changes in estimated reserve quantities are applied to depreciation, depletion and amortization computations
prospectively.
Other property and equipment is depreciated on the straight-line method.
Segment Reporting
Operating segments are components of an enterprise that engage in activities
from which it may earn revenues and incur expenses and for which separate operational financial information is available and is regularly
evaluated by management. Based on the Company’s organization and management, it has only one reportable operating segment, which
is oil and natural gas exploration and production.
Comprehensive Income
The Company has no elements of comprehensive income other than net income.
Asset Retirement Obligations
The Company records the fair value of a liability
for an asset retirement obligation in the period in which it is incurred and a corresponding increase in the carrying amount of the related
oil and natural gas property asset. Subsequently, the asset retirement cost included in the carrying amount of the related asset is allocated
to expense through depletion of the asset. Changes in the liability due to passage of time are recognized as an increase in the carrying
amount of the liability through accretion expense. Based on certain factors, including commodity prices and costs, the Company may revise
its previous estimates of the liability, which would also increase or decrease the related oil and natural gas property asset.
Revenue Recognition
The Company’s
revenues are comprised solely of revenues from customers and include the sale of oil, natural gas and NGL. The Company believes that
the disaggregation of revenue into these three major product types, as presented in the Consolidated Statements of Operations, appropriately
depicts how the nature, amount, timing and uncertainty of revenue and cash flows are affected by economic factors based on its single
geographic region, the continental United States. Revenues are recognized when the recognition criteria of Accounting Standards
Codification 606 “Revenue from Contracts with Customers,” (“ASC 606”) are met, which generally occurs at
a point in time when production is sold to a purchaser at a determinable price, delivery has occurred, control has transferred and collection
of the revenue is probable. The Company fulfills its performance obligations under its customer contracts through delivery of
oil, natural gas and NGL and revenues are recorded on a monthly basis and the Company receives payment from one to three months after
delivery. Generally, each unit of product represents a separate performance obligation. The prices received for oil, natural gas and
NGL sales under the Company’s contracts are generally derived from stated market prices which are then adjusted to reflect deductions
including transportation, fractionation and processing. As a result, revenues from the sale of oil, natural gas and NGL will decrease
if market prices decline. The sales of oil, natural gas and NGL, as presented on the Consolidated Statements of Operations, represent
the Company’s share of revenues net of royalties and excluding revenue interests owned by others. When selling oil, natural gas
and NGL on behalf of royalty or working interest owners, the Company is acting as an agent and thus reports the revenue on a net basis.
To the extent actual volumes and prices of oil and natural gas sales are unavailable for a given reporting period because of timing or
information not received from third parties, the expected sales volumes and prices for those properties are estimated and recorded. Variances
between the Company’s estimated revenue and actual payment are recorded in the month the payment is received. Historically, these
differences have been insignificant.
At the end of each month when
the performance obligation is satisfied, the variable consideration can be reasonably estimated and amounts due from customers are recorded
in Accounts Receivable in the Consolidated Balance Sheets. Taxes assessed by governmental authorities on oil, natural gas and NGL sales
are presented separately from such revenues in the Consolidated Statements of Operations.
Oil Sales
Oil production is transported from the wellhead
to tank batteries or delivery points through flow-lines or gathering systems. Purchasers of the oil take delivery at the tank batteries
and transport the oil by truck or at a pipeline delivery point and the Company collects a market price, net of pricing differentials.
Revenue is recognized when control transfers to the purchaser at the net price received by the Company.
Natural Gas and NGL Sales
Under the Company’s natural
gas sales arrangements, the purchaser takes control of wet gas at a delivery point near the wellhead or at the inlet of the purchaser’s
processing facility. The purchaser gathers and processes the wet gas and remits proceeds to the Company for the resulting natural gas
and NGL sales. Based on the nature of these arrangements, the processor is the agent and the purchaser is the Company’s customer,
thus, the Company recognizes natural gas and NGL sales based on the net amount of proceeds received from the purchaser.
Contract Balances
Under the Company’s product
sales contracts, the Company invoices customers once performance obligations have been satisfied, at which point payment is unconditional.
Accordingly, the Company’s product sales contracts do not give rise to contract assets or liabilities under ASC 606.
Transaction Price Allocated to
Remaining Performance Obligations
Substantially
all of the Company’s product sales are short-term in nature with a contract term of one year or less. For these contracts,
the Company has utilized the practical expedient in ASC 606 which exempts the Company from the requirements to disclose the transaction
price allocated to remaining performance obligations if the performance obligation is part of a contract that has an original expected
duration of one year or less.
For the Company’s product sales
that have a contract term greater than one year, the Company has utilized the practical expedient in ASC 606 which states the Company
is not required to disclose the transaction price allocated to remaining performance obligations if the variable consideration is allocated
entirely to a wholly unsatisfied performance obligation. Under these contracts, each unit of product generally represents a separate
performance obligation; therefore, future volumes are wholly unsatisfied, and disclosure of the transaction price allocated to remaining
performance obligations is not required.
Prior-Period Performance Obligations
The Company records revenue in the month that
product is delivered to the purchaser. Settlement statements for certain natural gas and NGLs sales, however, may not be received
for 30 to 90 days after the date the product is delivered, and as a result the Company is required to estimate the amount of product
delivered to the purchaser and the price that will be received for the sale of the product. In these situations, the Company records
the differences between its estimates and the actual amounts received for product sales in the month that payment is received from
the purchaser. Any identified differences between the Company’s revenue estimates and actual revenue received have
historically been insignificant. For the years ended December 31, 2021 and 2020, revenue recognized in the reporting period related
to performance obligations satisfied in prior reporting periods was not material.
Stock-Based Compensation
The Company recognized stock-based
compensation expense associated with granted stock options. The Company accounts for forfeitures of equity-based incentive awards as
they occur. Stock-based compensation expense related to time-based restricted stock units is based on the price of the common stock on
the grant date and recognized as vesting occurs.
Income Taxes
The Company accounts for income taxes in accordance
with the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred tax assets and
liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts
of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred tax
assets and liabilities are measured using enacted tax rates expected to apply to the taxable income in the years in which those temporary
differences are expected to be recovered or settled. A valuation allowance is established if management determines it is more likely
than not that some portion of a deferred tax asset will not be realized.
Per Share Amounts
The Company calculates and discloses basic earnings
per share ("Basic EPS") and diluted earnings per share ("Diluted EPS"). The computation of basic earnings per share
is computed by dividing earnings available to common stockholders by the weighted average number of outstanding common shares during
the period.
Diluted Earnings per Share ("EPS")
gives effect to all dilutive potential common shares outstanding during the period. The computation of Diluted EPS does not assume conversion,
exercise or contingent exercise of securities that would have an anti-dilutive effect on losses. As a result, if there is a loss
from continuing operations, Diluted EPS is computed in the same manner as Basic EPS.
Fair Value Measurements
The Financial Accounting Standards Board ("FASB")
fair value measurement standards define fair value, establish a consistent framework for measuring fair value and establish a fair value
hierarchy based on the observability of inputs used to measure fair value.
The three-level fair value hierarchy for disclosure of
fair value measurements defined by ASC Topic 820 is as follows:
Level 1 – Unadjusted,
quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities. An active
market is defined as a market where transactions for the financial instrument occur with sufficient frequency and volume to provide pricing
information on an ongoing basis.
Level 2 – Inputs,
other than quoted prices within Level 1, that are either directly or indirectly observable for the asset or liability through correlation
with market data at the measurement date and for the duration of the instrument’s anticipated life.
Level 3 – Prices
or valuations that require unobservable inputs that are both significant to the fair value measurement and unobservable. Valuation under
Level 3 generally involves a significant degree of judgment from management.
A financial instrument’s level
within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Where available,
fair value is based on observable market prices or parameters or derived from such prices or parameters. Where observable prices or inputs
are not available, valuation models are applied. These valuation techniques involve some level of management estimation and judgment,
the degree of which is dependent on the price transparency for the instruments or market and the instrument’s complexity. The Company
reflects transfers between the three levels at the beginning of the reporting period in which the availability of observable inputs no
longer justifies classification in the original level. There were no transfers between fair value hierarchy levels for the year ended
December 31, 2021.
Impairment of oil and natural gas properties
- The fair value of proved and unproved oil and natural gas properties was measured using valuation techniques that convert the future
cash flows to a single discounted amount. Significant inputs to the valuation of proved and unproved oil and natural gas properties include
estimates of: (i) recoverable reserves; (ii) production rates; (iii) future operating and development costs; (iv) future commodity prices;
and (v) a market-based weighted average costs of capital. The Company utilized a combination of the New York Mercantile Exchange ("NYMEX")
strip pricing and consensus pricing to value the reserves, then applied various discount rates depending on the classification of reserves
and other risk characteristics. For significant acquisitions, management utilized the assistance of a third-party valuation expert to
estimate the value of the oil and natural gas properties acquired.
The fair value of asset retirement obligations
is included in proved oil and natural gas properties with a corresponding liability. The fair value was determined based on a discounted
cash flow model, which included assumptions of the estimated current abandonment costs, discount rate, inflation rate and timing associated
with the incurrence of these costs.
The inputs used to value oil and natural
gas properties for impairments and asset retirement obligations require significant judgment and estimates made by management and represent
Level 3 inputs.
Financial instruments and other- The
fair values determined for accounts receivable, accrued expenses and other current liabilities were equivalent to the carrying value
due to their short-term nature.
Derivatives – Derivative financial
instruments are carried at fair value and measured on a recurring basis. The Company’s commodity price hedges are valued based
on discounted future cash flow models that are primarily based on published forward commodity price curves and published LIBOR forward
curves; thus, these inputs are designated as Level 2 within the valuation hierarchy.
The fair values of derivative instruments
in asset positions include measures of counterparty nonperformance risk, and the fair values of derivative instruments in liability positions
include measures of the Company’s nonperformance risk. These measurements were not material to the Consolidated Financial Statements.
Related Party Transactions
Transactions between related parties
are considered to be related party transactions even though they may not be given accounting recognition. FASB ASC 850, Related
Party Disclosures (“FASB ASC 850”) requires that transactions with related parties that would have influence in
decision making shall be disclosed so that users of the financial statements can evaluate their significance. Related party transactions
typically occur within the context of the following relationships: affiliates of the entity; entities for which investments in their
equity securities is typically accounted for under the equity method by the investing entity; trusts for the benefit of employees; principal
owners of the entity and members of their immediate families; management of the entity and members of their immediate families; and other
parties that can significantly influence the management or operating policies of the transacting parties and can significantly influence
the other to an extent that one or more of the transacting parties might be prevented from fully pursuing its own separate interests.
Recently Issued Accounting Pronouncements
FASB periodically issues new accounting standards
in a continuing effort to improve standards of financial accounting and reporting. The Company has reviewed the recently issued pronouncements
and concluded that the following new accounting standards are applicable:
In August 2020, the FASB issued ASU 2020-06,
Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts in Entity’s
Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity. The amendments
in this ASU affect entities that issue convertible instruments and/or contracts in an entity’s own equity. The amendments in
this ASU primarily affect convertible instruments issued with beneficial conversion features or cash conversion features because the
accounting models for those specific features are removed. However, all entities that issue convertible instruments are affected by
the amendments to the disclosure requirements of this ASU. For contracts in an entity’s own equity, the contracts primarily
affected are freestanding instruments and embedded features that are accounted for as derivatives under the current guidance because
of failure to meet the settlement conditions of the derivatives scope exception related to certain requirements of the settlement
assessment. Also affected is the assessment of whether an embedded conversion feature in a convertible instrument qualifies for the
derivatives scope exception. Additionally, the amendments in this ASU affect the diluted EPS calculation for instruments that may be
settled in cash or shares and for convertible instruments. The amendments in this ASU are effective for public business entities,
excluding entities eligible to be smaller reporting companies, for fiscal years beginning after December 15, 2021, including interim
periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December
15, 2023, including interim periods within those fiscal years. The Board specified that an entity
should adopt the guidance as of the beginning of its annual fiscal year. The Board decided to allow entities to adopt the guidance
through either a modified retrospective method of transition or a fully retrospective method of transition. The Company is analyzing
the effect that adoption will have but does not expect a material impact as a result of adopting these standards.
Note 3 – Property
In May 2021 the Company purchased oil and natural gas properties
in New Mexico (see Note 4).
The aggregate capitalized costs of oil
and natural gas properties as of December 31, 2021 and 2020 are as follows:
| |
2021 | | |
2020 | |
| |
| | |
| |
Proved producing wells | |
$ | 20,689,548 | | |
$ | 4,508,739 | |
Proved undeveloped | |
| 2,724,966 | | |
| 2,715,980 | |
Lease and well equipment | |
| 5,311,779 | | |
| 1,360,596 | |
Asset retirement obligation | |
| 18,188,033 | | |
| 14,126,130 | |
Gross capitalized costs | |
| 46,914,326 | | |
| 22,711,445 | |
Depreciation, depletion, amortization and impairment | |
| (17,525,918 | ) | |
| (15,148,444 | ) |
Net capitalized costs | |
$ | 29,388,408 | | |
$ | 7,563,001 | |
Other property and equipment consists of operating lease assets,
vehicles, office furniture, and equipment with lives ranging from three to five years.
| |
2021 | | |
2020 | |
Other property and equipment, at cost | |
$ | 1,547,325 | | |
| 738,438 | |
Less: accumulated depreciation | |
| (258,714 | ) | |
| (76,421 | ) |
Oher property and equipment, net | |
$ | 1,288,611 | | |
| 662,017 | |
Note 4 – Acquisition of XTO Properties
On March 12, 2021 the Company, through its
wholly owned subsidiary Empire New Mexico, entered into a purchase and sale agreement with XTO Holdings, LLC (a subsidiary of ExxonMobil)
(the “Seller’) to acquire, among other things, certain oil and natural gas properties in New Mexico. The purchase price was
$17,800,000 subject to customary adjustments. The transaction closed on May 14, 2021 with an effective date of January 1, 2021.
The XTO acquisition has been assessed under
the screen test for business combinations under FASB ASC 805, Business Combinations (“ASC 805”). The XTO acquisition met
the screen test and has been accounted for as an asset acquisition using the acquisition method of accounting. Under the accounting for
asset acquisitions, the acquisition is recorded using a cost accumulation and allocation model under which the cost of the acquisition
is allocated on a relative fair value basis to the assets acquired and liabilities assumed. Acquisition-related transaction costs are
capitalized as a component of the cost of the assets acquired.
As a condition of the sale, the Company purchased
a $5,000,000 performance bond for the benefit of the seller for proper plugging, abandonment and restoration of the purchased properties.
The performance bond is collateralized with a letter of credit in the amount of $3,750,000. To effect the letter of credit, the Company
entered into a Promissory Note Agreement with Bank of Oklahoma, NA in the amount of $3,750,000 which is due on demand with an interest
rate established by the Bank, currently at 4%. The Promissory Note, and associated letter of credit, is collateralized with a bank certificate
of deposit in a corresponding amount. In addition, the Company is required to deposit $100,000 per month, up to $1,250,000, into a sinking
fund to be held by the surety. Subsequent amendments increased the monthly payment amounts to $160,000 in response to additional bonding
requested by the State of New Mexico.
The following table sets forth the
Company's preliminary purchase price allocation:
Preliminary Fair Value of Assets Acquired | |
| |
Oil and natural gas properties | |
$ | 17,662,402 | |
Inventory of oil in tanks | |
| 318,546 | |
Vehicles | |
| 179,156 | |
Asset retirement obligations | |
| 6,117,709 | |
Total preliminary assets acquired | |
| 24,277,813 | |
| |
| | |
Preliminary Fair Value of Liabilities Assumed | |
| | |
Royalty suspense | |
| 290,325 | |
Asset retirement obligations | |
| 6,117,709 | |
Total preliminary liabilities assumed | |
| 6,408,034 | |
| |
| | |
Purchase Price | |
| 17,869,779 | |
The value of oil and gas properties
was based on an allocation of the purchase price which included assignment of values to the other identifiable assets acquired and liabilities
assumed. The value of inventory, vehicles, and royalty suspense was based on their relative fair values as described above.
The fair value of asset retirement
obligations are included in proved oil and natural gas properties with a corresponding liability in the table above. The fair value was
determined based on a discounted cash flow model, which included assumptions of the estimated current abandonment costs, discount rate,
inflation rate and timing associated with the incurrence of these costs.
Final settlement on this acquisition
is in process and is expected to occur in 2022.
Note 5 – Joint Development Agreement
On August 6, 2020 the Company, through its
wholly owned subsidiary, Empire Texas, entered into a joint development agreement (the “JDA”) with Petroleum & Independent
Exploration, LLC and related entities (“PIE”), a related party (See Note 12), dated August 1, 2020. Under the terms of the
JDA, PIE will perform recompletion or workover on specified mutually agreed upon wells (“Workover Wells”) owned by Empire
Texas. To fund the work, PIE entered into a term loan agreement with Empire Texas dated August 1, 2020, whereby PIE will loan up to $2,000,000,
at an interest rate of 6% per annum, maturing August 7, 2024 unless terminated earlier by PIE. Proceeds of the loan will be used for
recompletion or workover of the Workover Wells. As of December 31, 2021 approximately $800,000 has been advanced from the loan and is
included in Long Term Notes Payable on the Consolidated Balance Sheet. As part of the JDA, Empire Texas will assign to PIE a combined
85% working and revenue interest in the Workover Wells; an assignment was completed in October 2020 for the initial three Workover Wells.
Of the assigned interest, 70% working and revenue interest will be used to repay the obligations under the term loan agreement. Once
the term loan is repaid, PIE will reassign a 35% working and revenue interest to Empire Texas in each of the Workover Wells and retain
a 50% working and revenue interest (See Note 8). To the extent the cash flows from the revenue interest are insufficient to repay the obligations under the term loan, the
Company remains required to repay the obligation and the activity resulting from the JDA is being treated as a carried interest
with a corresponding term loan.
In addition, PIE and Empire entered into a
Securities Purchase Agreement (“Securities Agreement”) whereby PIE purchased for $525,000 (a) 875,000 shares of Empire
common stock, (b) warrants to purchase 656,250 shares of Empire common stock at an exercise price of $0.80 per share, (c) warrants
to purchase 450,000 shares of Empire common stock at an exercise price of $1.00 per share, (d) warrants to purchase 2,034,129 shares
of Empire common stock at an exercise price of $0.40 per share, and (e) warrants to purchase up to 2,766,666 shares of Empire common
stock at an exercise price of $0.564 per share, pursuant to various vesting provisions as detailed in the Securities Agreement. On March
11, 2021 the Company amended the Securities Agreement to remove the vesting provisions for the warrants and PIE exercised all of its
warrants for an aggregate exercise price of $3,349,052.
Note 6 - Asset Retirement Obligations
The Company’s asset retirement obligations represent the estimated
present value of the estimated cash flows the Company will incur to plug, abandon and remediate its producing properties at the end of
their productive lives, in accordance with applicable state laws. Market risk premiums associated with asset retirement obligations are
estimated to represent a component of the Company’s credit-adjusted risk-free rate that is utilized in the calculations of asset
retirement obligations.
The Company’s asset retirement obligation transactions during
the years ended December 31, 2021 and 2020 are summarized in the table below.
| |
|
|
|
|
|
| |
| |
For the Year Ended December 31, | |
| |
2021 | | |
2020 | |
| |
| | |
| |
Asset retirement obligations, beginning of period | |
$ | 15,364,217 | | |
$ | 5,788,280 | |
Liabilities assumed in acquisitions | |
| 6,117,709 | | |
| 9,508,484 | |
Revision to estimates | |
| (2,055,806 | ) | |
| (862,405 | ) |
Accretion expense | |
| 1,214,479 | | |
| 929,858 | |
Asset retirement obligation, end of period | |
$ | 20,640,599 | | |
$ | 15,364,217 | |
Note 7 – Commodity Derivative Financial Instruments
The Company uses derivative financial instruments to manage its
exposure to commodity price fluctuations. Commodity derivative instruments are used to reduce the effect of volatility of price changes
on the oil and natural gas the Company produces and sells. The Company does not enter into derivative financial instruments for speculative
or trading purposes. The Company’s derivative financial instruments consist of put options.
The Company does not designate its derivative instruments to qualify
for hedge accounting. Accordingly, the Company reflects changes in the fair value of its derivative instruments in its consolidated statements
of operations as they occur. Unrealized gains and losses related to the contracts are recognized and recorded as an asset or liability
on the Company’s consolidated balance sheets.
The following table summarizes the net realized and unrealized amounts
reported in earnings related to the commodity derivative instruments for the years ended December 31, 2021 and 2020:
| |
For the Year Ended December 31, | |
| |
2021 | | |
2020 | |
Gain (loss) on derivatives: | |
| | | |
| | |
Oil derivatives | |
$ | (586,181 | ) | |
$ | 1,738,871 | |
The following represents the Company’s net cash receipts from
(payments on) derivatives for the years ended December, 2021 and 2020:
| |
For the Year Ended December 31, | |
| |
2021 | | |
2020 | |
| |
| | |
| |
Oil derivatives | |
$ | (299,481 | ) | |
$ | 1,520,988 | |
Natural gas derivatives | |
| (535,960 | ) | |
| — | |
Total | |
$ | (835,441 | ) | |
$ | 1,520,988 | |
The following table sets forth the Company’s outstanding derivative
contracts at December 31, 2021:
|
1st Quarter |
|
2nd Quarter |
|
3rd Quarter |
|
4th Quarter |
2022 |
|
|
|
|
|
|
|
WTI Index Put Options: |
|
|
|
|
|
|
|
Quarterly volume (MBbl) |
20.56 |
|
20.43 |
|
20.32 |
|
15.72 |
Floor Price (Bbl) |
$40.00 |
|
$40.00 |
|
$40.00 |
|
$40.00 |
|
1st Quarter |
|
2nd Quarter |
|
3rd Quarter |
|
|
2023 |
|
|
|
|
|
|
|
WTI Index Put Options: |
|
|
|
|
|
|
|
Quarterly volume (MBbl) |
13.40 |
|
15.34 |
|
10.86 |
|
|
Floor Price (Bbl) |
$40.00 |
|
$55.00 |
|
$55.00 |
|
|
Note 8 - Debt
The following table represents the Company’s
outstanding debt.
| |
December 31, | |
| |
2021 | | |
2020 | |
| |
| | |
| |
Senior Revolver Loan Agreement | |
$ | 7,069,500 | | |
$ | 8,124,000 | |
| |
| | | |
| | |
Term Loan – PIE | |
| 797,010 | | |
| 315,273 | |
| |
| | | |
| | |
Equipment and vehicle notes, 0% to 6.99% interest rates, due in 2025 to 2027 with monthly payments ranging from $400 to $1,400 per month | |
| 305,739 | | |
| 57,935 | |
| |
| | | |
| | |
Unsecured Note, Pardus Acquisition | |
| — | | |
| 378,000 | |
| |
| | | |
| | |
Note Payable to Insurance Provider, bears 3.63% interest, matures November 2022, monthly payments of principal and interest of $50,083 | |
| 442,515 | | |
| — | |
| |
| | | |
| | |
SBA Payroll Protection Program Note Payable | |
| — | | |
| 160,700 | |
Total Debt | |
| 8,614,764 | | |
| 9,035,908 | |
Unamortized debt issue costs | |
| — | | |
| 14,587 | |
Total debt, net of debt issue costs | |
| 8,614,764 | | |
| 9,021,321 | |
Less Current Maturities | |
| 1,700,663 | | |
| 1,301,618 | |
Total Long-Term Debt | |
$ | 6,914,101 | | |
$ | 7,719,703 | |
On July 7, 2021 the Company entered into the
Fourth Amendment to its Senior Revolver Loan Agreement (“the Amended Agreement”) with CrossFirst Bank (“CrossFirst”).
The maximum amount that can be advanced under the Agreement is $20,000,000 and the existing commitment amount is $7,680,000 which is
reduced by $300,000 per calendar quarter beginning September 30, 2021 and includes interest at Wall Street Journal Prime plus 150 basis
points (% as of December 31, 2021). The Amended Agreement matures on March 27, 2024. Collateral for the loan is a lien on all of
the assets of Empire Louisiana and Empire North Dakota, wholly owned subsidiaries of the Company, and a first priority mortgage lien,
pledge of and security interest in not less than 80% of Empire Louisiana’s and Empire North Dakota’s producing oil, gas and
other leasehold and mineral interests. The Amended Agreement requires the Company maintain commodity derivatives at certain thresholds
based on projected production and, beginning March 31, 2021, to maintain certain covenants including an EBITDAX to interest expense of
at least 3:1 and funded debt to EBITDAX of 6:1 on a trailing twelve-month basis and reducing quarterly to 4:1 as of March 31, 2022 and
thereafter. As of December 31, 2021, the Company has an outstanding loan balance of $7,069,500 under the Amended Agreement. The current
maturities of the Amended Agreement is $1,200,000. The Company was in compliance with the loan covenants at December 31, 2021.
In August 2020, concurrent with the Joint Development
Agreement with Petroleum and Independent Exploration, LLC (“PIE”), a related party, the Company entered into a term loan
agreement dated August 1, 2020, whereby PIE will loan up to $2,000,000, at an interest rate of 6% per annum, maturing August 7, 2024
unless terminated earlier by PIE. The loan proceeds will be used for recompletion or workover of certain designated wells. In addition,
the Company assigned 85% working and revenue interest to PIE in the designated wells which will be applied to repayment of the loan.
As of December 31, 2021, $797,010 has been advanced from the PIE loan.
On April 1, 2020, in conjunction with the purchase
of assets from Pardus Oil & Gas, LLC, the Company entered into an unsecured promissory note agreement with the seller in the amount
of $378,000. The note was payable in one installment on April 1, 2021 and bore interest at the one-year LIBOR rate. The note was paid
on April 1, 2021.
On May 5, 2020, the Company received an SBA
Payroll Protection Plan (“PPP”) loan for $160,700. The loan was scheduled to mature on May 5, 2022 and had an interest rate
of 1%. In June 2021 the Company was informed that the SBA had forgiven the entire loan balance. Forgiveness is included in Other Income
on the Consolidated Statements of Operations.
On April 30, 2021 the Company received a Second
Draw SBA “PPP” loan for $106,850. The loan was scheduled to mature on April 30, 2026 and bore interest at 1%. In October
2021 the Company was informed that the SBA had forgiven the entire loan balance. Forgiveness is included in Other Income on the Consolidated
Statements of Operations.
Note 9 – Convertible Notes Payable
Senior Secured Note Agreement
On May 14, 2021, the Company’s wholly
owned subsidiary, Empire New Mexico entered into a Senior Secured Convertible Note Agreement (the “Secured Note”) in the
amount of $16,250,000 with Energy Evolution Master Fund, Ltd., a related party (“Energy Evolution”) (See Note 12). The Secured
Note is collateralized by all assets of Empire New Mexico, matures on December 31, 2021 and bears an interest rate of 3.8%. The Secured
Note provides that up to 40% of the balance, together with accrued interest, can be converted into the Company’s common stock at
the lesser of $1.25 per share or the offering price if the Company has a subsequent capital raise or an aggregate of 1,300,000 shares
of common stock (without giving effect to any interest that may be converted). The conversion terms of the Secured Note were subject
to further adjustments as defined in that agreement. The embedded conversion option has been bifurcated and accounted for separately
as a derivative financial instrument. The separated derivative was initially recorded at fair value at the inception date and revalued
as of September 30, 2021 resulting in a fair value of $5,530,677 and $5,437,746, respectively. On September 30, 2021, the existing bifurcated
derivative liability was removed in connection with the Amended Secured Note as further discussed.
As partial consideration for the issuance of
the Secured Note, Energy Evolution received a closing fee of 375,000 shares of the Company’s common stock and warrants to purchase 750,000
three million shares of common stock for $4.00 per share which expire on May 14, 2022. The Company determined these were equity-classified
financing instruments and the proceeds are allocated on a relative fair value basis between the debt, warrants, and common shares at
issuance. At issuance, the discount associated with the Secured Note was $10,125,177; consisting of $5,530,677 relating to the embedded
derivative liability, $1,500 and $2,773,500 in common stock and paid in capital, respectively, relating to the issuance of shares of
the Company’s common stock, and $1,819,500 in paid in capital relating to the issuance of warrants to purchase common stock. The
fair value of the warrants was determined using a Black-Scholes model. The warrants were exercised in 2021 and the Company received cash
proceeds of $3,000,000. The discount associated with the Secured Note related to the embedded conversion liability and the issuance of
the equity-classified financing instruments is amortized under the interest method and resulted in interest expense. Prior to amending
the Secured Note in September 2021, the Company made principal payments totaling $4,050,000.
On September 29, 2021 the parties entered into
a Loan Modification Agreement (the “Amended Secured Note”) pursuant to which Energy Evolution exchanged $6,500,000 in principal
under the Secured Note in exchange for 1,326,302 shares of common stock, warrants to purchase 500,000 shares of the Company’s
common stock at $1.25 per share and amended certain terms of the remaining $5,700,000 of principal under the Secured Note. As amended,
the remaining principal balance matures and becomes due on June 30, 2023 and upon maturity of the Amended Secured Note, Energy Evolution
has the sole discretion to require cash settlement or to redeem the principal balance, together with accrued interest, in exchange for
the Company’s common stock at $8 per share. Prior to maturity, interest accrues quarterly at 3.8% and Energy Evolution has the
option to receive interest in common stock at $5.00 per share in lieu of cash.
Pursuant to the Amended Secured Note, the Company’s
obligations with respect to a registration statement under the Secured Note were extended, the Company executed and delivered a Pledge
and Security Agreement granting Energy Evolution a first priority perfected security interest in the Company’s membership interest
in Empire New Mexico, d/b/a Green Tree New Mexico, the Company and Green Tree New Mexico agreed to use commercial reasonable best efforts
to separate Green Tree New Mexico from the Company as an independent business on or before December 31, 2022 in a spin-off to stockholders
of the Company. In accordance with ASC 470-20, the Company accounted for this exchange as an induced conversion based on the short period
time of the offer was open and the substantive conversion feature offer. The Company accounted for the conversion of the
debt
instruments as an inducement by expensing the fair value of the instruments that were issued in excess of the original terms of the Secured
Notes. The Company reduced the outstanding debt by $9,141,327, representing the face amount of the Secured Notes converted of $6,500,000,
net of unamortized discount costs of $2,796,419, and the embedded conversion liability of $5,437,746. The Company recorded induced conversion
expense of $2,276,813 representing the difference in fair value of the instruments exchanged, including the fair value of the warrants
to purchase 500,000 shares of common stock at $5.00 per share. The embedded conversion option of the principal balance outstanding
after the conversion and amendment, has been bifurcated and accounted for separately as a derivative financial instrument. The separated
derivative was initially recorded at fair value of $2,017,287, with the amount recorded as a discount against the surviving Amended Secured
Note balance and the derivative liability will be revalued on a quarterly basis. On September 30, 2021, 23,802 shares of common stock
were issued as payment for the outstanding accrued interest on the Secured Note.
On December 30, 2021, the Company amended the
Amended Secured Note to allow full conversion of the remaining principal and accrued interest at that date. $5,715,353 of outstanding
principal and $55,075 of accrued interest were converted into 1,154,085 shares of the Company’s common stock. As a result of this
conversion, the mortgage that Energy Evolution held on the Company’s New Mexico assets was released.
Unsecured Convertible Notes
In May 2021 the Empire New Mexico entered
into $3,243,000 of Unsecured Convertible Notes (the “Unsecured Notes”) with a group of accredited investors, including the
Company’s related party Energy Evolution, constituting $1,500,000 of the total Unsecured Convertible Notes. The Unsecured Notes
had a maturity of May 9, 2022 with a single payment and interest at 5%. The Unsecured Note holders had the ability to convert their notes
to common stock of the Company at the lesser of $5.00 per share or the price per share offered by the Company if the Company has a future
capital raise for an aggregate 648,600 shares of common stock (without giving effect to any interest that may be converted). In September
2021, $325,000 of the notes were repaid and the remaining Unsecured Notes were fully converted.
The Company determined the embedded conversion
features of the Unsecured Notes were equity-classified financing instruments. The fair value of the conversion feature was determined
using a beneficial conversion model based on a 60-day weighted average stock price and the maximum number of shares to be received if
converted. As issuance, the amount recorded to additional paid in capital was $544,824. The discount associated with these transactions
is amortized under the interest method and resulted in interest expense approximately $540,000 for the year ended December 31, 2021.
As an inducement for investors to enter
into the Unsecured Convertible Notes, the Company’s Chief Executive Officer and President collectively offered to each investor
the right to purchase a number of shares of common stock equal to 40% of such investor’s principal balance under its Unsecured
Convertible Note at $3.00 per share (the “right to buy”). Energy Evolution exercised its right to buy 150,000 shares of the
Company’s common stock. In conjunction with the conversion of the Unsecured Notes, each of the Company’s Chief Executive
Officer and President partially exercised a warrant and options to purchase 160,000 shares at an exercise price of $1.00 and $1.32 respectively.
The Company determined that offering the “right to buy” shares resulted in an expense of $989,155 of the Company based on
the fair value of contributions made by the Company’s Chief Executive Officer and President on its behalf. The fair value of the
“right to buy” shares was determined using a Black-Scholes model. The expense is included in General and Administrative in
the Consolidated Statement of Operations.
Note 10 - Leases
As a lessee, the Company leases its corporate
office headquarters in Tulsa, Oklahoma and three field offices. The leases expire between 2024 and 2027. The corporate office has an
option to renew for an additional five-year term. The option to renew the lease is generally not considered reasonably certain to be
exercised. Therefore, the period covered by such optional period is not included in the determination of the term of the lease and the
lease payments during these periods are similarly excluded from the calculation of right-of-use lease asset and lease liability balances.
The Company recognizes right-of use lease expense
on a straight-line basis, except for certain variable expenses that are recognized when the variability is resolved, typically during
the period in which they are paid. Variable right-of-use lease payments typically include charges for property taxes, insurance, and
variable payments related to non-lease components, including common area maintenance.
Right of use lease expense was approximately $190,000 for the year
ended December 31, 2021. Cash paid for right of use lease was approximately $142,000 for the same period.
Supplemental balance sheet information related to the right of use
leases as of December 31, 2021 is as follows:
| |
| | |
Operating lease asset (included in Other Property and Equipment) | |
$ | 779,183 | |
| |
| | |
Current portion of lease liability | |
$ | 180,105 | |
Long-term lease liability | |
| 646,311 | |
Total right of use lease liabilities | |
$ | 826,416 | |
The weighted average remaining term for the Company’s right
of use leases is 3.7 years.
Maturities of lease liabilities as of December 31, 2021 are as follows:
| | |
| | |
2022 | | |
$ | 235,983 | |
2023 | | |
| 238,931 | |
2024 | | |
| 239,644 | |
2025 | | |
| 193,660 | |
2026 | | |
| 37,200 | |
Thereafter | | |
| 12,400 | |
Total lease payments | | |
| 957,819 | |
Less imputed interest | | |
| (131,403 | ) |
Total lease obligation | | |
$ | 826,416 | |
Note 11 – Equity
Diluted Earnings per Share (“EPS”) gives
effect to all dilutive potential common shares outstanding during the period. The computation of Diluted EPS does not assume conversion,
exercise or contingent exercise of securities that would have an anti-dilutive effect on losses. As a result, if there is a loss from
continuing operations, Diluted EPS is computed in the same manner as Basic EPS. At December 31, 2021 and 2020, the Company had 2,440,700
and 2,500,000 options outstanding that were not included in the calculation of earnings per share for the periods then ended. Such financial
instruments may become dilutive and would then need to be included in future calculations of Diluted EPS.
On August 7, 2020 concurrently with the Joint Development Agreement
with Petroleum & Independent Exploration, LLC and related entities (“PIE”), the companies entered into a Securities Purchase
Agreement (“Securities Agreement”) whereby PIE purchased for $525,000 (a) 875,000 shares of Empire common stock, (b) warrants
to purchase 656,250 shares of Empire common stock at an exercise price of $0.80 per share, (c) warrants to purchase 450,000 shares
of Empire common stock at an exercise price of $1.00 per share, (d) warrants to purchase 2,034,129 shares of Empire common stock at an
exercise price of $0.40 per share, and (c) warrants to purchase up to 2,766,666 shares of Empire common stock at an exercise price of
$0.564 per share pursuant to various vesting provisions as detailed in the Securities Agreement. The value allocated to the warrants
was the fair value determined using the Black-Scholes option valuation with the following assumptions: no dividend yield, expected
annual volatility of 147%, risk free interest rate of .19% and an expected useful life of 4 years. The fair value of the warrants of
$450,848 was allocated to paid in capital. On March 11, 2021 the Company amended the Securities Agreement to remove the vesting
provisions for the warrants and PIE exercised the warrants for an aggregate exercise price of $3,349,052 (See Note 6).
During February and March 2021, the Company issued
to a group of accredited investors 2,248,464 shares of its common stock and warrants to purchase 2,248,464 shares of its common stock
for $2.00 per share which expires on December 31, 2022. Proceeds from the sale were $3,147,850. The value allocated to the warrants
was the fair value determined using the Black-Scholes option valuation with the following assumptions: no dividend yield, expected
annual volatility of 180%, risk free interest rate of .14% and an expected useful life of 21 months. The fair value of the warrants of
$2,350,407 was allocated to Paid in Capital. For the year ended December 31, 2021, warrants for 700,714 shares of common stock have
been exercised.
In connection with the purchase of
XTO assets the Company issued a Senior Secured Convertible Note due December
31, 2021, in the aggregate principal amount $16,250,000
(the “Secured Convertible Note”) to Energy Evolution, a related party. As partial consideration for the
issuance of the Secured Convertible Note, Empire
issued to Energy Evolution Ltd (i) 375,000 shares of common stock along with (ii) a warrant certificate to purchase up
to 750,000 three million shares of common stock at an exercise price of $4.00 per Warrant Share until May 14, 2022. Under
the warrant certificate, the exercise price is subject to customary downward adjustments. The value allocated to
the common stock, conversion feature, and warrants was $10,125,177.
In September, 2021 the Company and the Energy Evolution Master Fund, Ltd. entered into a Loan Modification Agreement
(the “Amended Secured Notes”). Under the Amended Secured Notes, among other terms the Company issued a
warrant certificate to purchase up to 500,000 two million shares of common stock at an exercise price of $5.00 per Warrant
Share until December 31, 2023. The exercise price is subject to customary downward adjustments. An additional 1,154,085
shares of common stock were issued to Energy Evolution on December 30, 2021, in conjunction with its conversion of all
remaining principal and accrued interest on the note.
Additionally, in conjunction with the purchase of
XTO assets, the Company entered into $3,243,000 of Unsecured Convertible Notes (the “Unsecured Notes”) with a group of accredited
investors. The Unsecured Notes had a maturity date of May 9, 2022 with a single payment and interest at 5% (See Note 7). The Unsecured
Note holders had the ability to convert their notes to common stock of the Company at the lesser of $5.00 per share or the price per
share offered by the Company if the Company has a future capital raise. At December 31, 2021 $2,918,000 of the Unsecured Notes have been
converted into 583,600 shares of common stock of the Company. The fair value of the warrants of $589,194 was allocated to Paid in
Capital.
On April 3, 2019, the Board of Directors
of the Company adopted the Empire Petroleum Corporation 2019 Stock Option Plan (the “Stock Option Plan”). The
total number of shares of common stock that may be issued pursuant to stock options under the Stock Option Plan is 2,500,000. Further, on April 3, 2019 the Company granted Mr. Pritchard and Mr. Morrisett each, options to purchase 625,000
shares of common stock of the Company at an exercise price of $1.32
per share. The options vested in three installments with 312,500
vesting immediately and 156,250
vesting each in April 2020 and April 2021. All of the options expire in April 2029. The value allocated to the vested
options was the fair value determined using the Black-Scholes option valuation with the following assumptions: no
dividend yield, expected annual volatility of 213%, risk free interest rate of 2.32%
and an expected useful life of 5.375
years. The fair value of the vested options of $812,500
was recorded as compensation expense and allocated to Paid in Capital in 2019. In 2021 and 2020, the fair value of the
options which vested in April of the respective year of $406,250
was recorded as compensation expense and allocated to Paid in Capital. All of the options were vested as of December 31,
2021.
On August 27, 2021, the Board of Directors of the Company adopted
the Empire Petroleum Corporation 2021 Incentive Plan (the “Incentive Plan”). The total number of shares of common stock that
may be issued pursuant to the Incentive Plan is three million. As of December 31, 2021, grants were made amounting to 187,500 options.
A summary of the Company's Incentive Plan as of
December 31, 2021, and changes during the year is presented below:
| |
| | |
Weighted Average | |
| |
Options | | |
Exercise Price | |
Outstanding at December 31, 2019 | |
| 1,251,042 | | |
$ | 1.32 | |
Granted | |
| 1,250,000 | | |
| 1.40 | |
Expired | |
| (1,042 | ) | |
| 12.48 | |
Outstanding at December 31, 2020 | |
| 2,500,000 | | |
$ | 1.36 | |
Granted | |
| 187,500 | | |
| 12.20 | |
Exercised | |
| (246,800 | ) | |
| 1.36 | |
Outstanding at December 31, 2021 | |
| 2,440,700 | | |
$ | 2.19 | |
The following table summarizes information about
stock options outstanding at December 31, 2021:
|
|
Options Outstanding |
|
|
|
Options Exercisable |
|
|
|
|
Weighted |
|
|
|
|
|
|
|
|
|
|
Average |
|
Weighted |
|
|
|
Weighted |
Range of |
|
Number |
|
Remaining |
|
Average |
|
|
|
Average |
Exercise |
|
Outstanding |
|
Contractual |
|
Exercise |
|
|
|
Exercise |
Prices |
|
at 12/31/21 |
|
Life |
|
Price |
|
Exercisable |
|
Price |
|
|
|
|
|
|
|
|
|
|
|
$1.32 to $12.20 |
|
2,440,700 |
|
8.83 years |
|
$2.19 |
|
2,315,700 |
|
$1.65 |
Note 12 – Income Taxes
The current income tax provision and deferred income tax provision for the years ended December 31, 2021 and 2020 were comprised
for the following:
| |
2021 | | |
2020 | |
| |
| | | |
| | |
Expected tax benefit | |
$ | (4,802,660 | ) | |
$ | (4,343,542 | ) |
Nondeductible expenses | |
| 3,503,996 | | |
| 0 | |
Increase in valuation allowance | |
| 1,298,664 | | |
| 4,343,542 | |
Tax provision (benefit) as reported | |
$ | — | | |
$ | — | |
At December 31, 2021, the Company had
net operating loss carryforwards of approximately $20.7 million for federal income tax purposes available to offset future
taxable income, as limited by the applicable provisions, which expire at various dates beginning in 2022 for the federal net
operating loss carryforwards. In accordance with Section 382 of the Internal Revenue Code, the usage of the Company's net
operating loss carryforwards may be limited in the event of a change in ownership. A full Section 382 analysis has not been
prepared and NOLs could be subject to limitation under Section 382.
Deferred tax assets and liabilities are the result of temporary differences between the financial statement carrying values
and the tax basis of assets and liabilities. The Company’s nettax position as of December 31, 2021 and 2020 is as follows
:
| |
2021 | | |
2020 | |
| |
| | |
| |
Deferred tax assets (liabilities): | |
| | | |
| | |
Loss carry-forwards | |
$ | 5,341,256 | | |
$ | 4,071,054 | |
Depreciation, depletion and impairment | |
| 1,239,723 | | |
| 2,696,706 | |
Right of use assets | |
| 8,036 | | |
| — | |
Stock option grants | |
| 796,188 | | |
| — | |
Other property and equipment | |
| (459,745 | ) | |
| — | |
Unrecognized losses on derivatives | |
| 27,210 | | |
| 1,207 | |
Total deferred tax assets | |
| 6,952,668 | | |
| 6,768,967 | |
| |
| | | |
| | |
Valuation allowance | |
| (6,952,668 | ) | |
| (6,768,967 | ) |
Net deferred taxes | |
$ | — | | |
$ | — | |
Reconciliations of the tax expense (benefit) computed
at the statutory federal rate to the Company’s total income tax benefit for the years ended December 31, 2021 and 2020 are as follows:
| |
2021 | | |
2020 | |
| |
| $ | | |
| % | | |
| $ | | |
| % | |
Pretax GAAP Loss | |
| (18,614,962 | ) | |
| — | | |
| (16,835,434 | ) | |
| — | |
Pretax GAAP Loss at Statutory Rate | |
| (3,909,142 | ) | |
| 21.0% | | |
| (3,535,441 | ) | |
| 21.0% | |
State Taxes | |
| (893,518 | ) | |
| 4.8% | | |
| (808,101 | ) | |
| 4.8% | |
Nondeductible Expenses | |
| 3,503,996 | | |
| -18.8% | | |
| — | | |
| 0% | |
Valuation Allowance | |
| 1,298,664 | | |
| -7.0% | | |
| 4,343,542 | | |
| -25.8% | |
Effective | |
| — | | |
| 0% | | |
| — | | |
| 0% | |
Utilization of the Company’s loss carryforwards
is dependent on realizing taxable income. The Company recorded valuation allowances as of December 31, 2021 and 2020 due to the uncertainty
related to its ability to utilize some of its deferred income tax assets, primarily consisting of net operating loss carryforwards prior
to expiration.
The Company has evaluated all tax positions for
which the statute of limitations remains open and believes that the material positions taken would likely than not would be sustained
by examination. Therefore, at December 31, 2021, the Company has not established any reserves for, nor recorded any unrecognized benefits
related to uncertain tax positions.
Note 13 – Related Party Transactions
The Energy Evolution Master Fund, Ltd. (“Energy
Evolution”) is a related party of the Company as it beneficially owns approximately 27% of the Company’s outstanding shares
of common stock as of December 31, 2021. Additionally, a board member of Energy Evolution was appointed to the Company’s board
in October 2021. This board member separately beneficially owns approximately 18% of the Company’s outstanding shares of common
stock as of December 31, 2021. The board member also is a majority owner of Petroleum & Independent
Exploration, LLC and related entities (“PIE”). In October 2021 another Energy Evolution member was appointed to the Company’s
board of directors.
In March 2021, the majority owner of PIE, through
the exercise of warrants, became a significant shareholder of the Company’s outstanding shares of stock (See Note 11). The Company
has a joint development agreement with PIE to perform recompletion or workover on specified mutually agreed upon wells (See Note 5).
As of December 31, 2021, the Company has incurred obligations of approximately $800,000 as a part of the joint development agreement
(See Note 8).
Note 14 – Commitments and Contingencies
From time to time, the Company is subject
to various legal proceedings arising in the ordinary course of business, including proceedings for which the Company may not have insurance
coverage. While many of these matters involve inherent uncertainty, as of the date hereof, the Company does not currently believe that
any such legal proceedings will have a material adverse effect on the Company’s business, financial position, results of operations
or liquidity.
The Company is subject to extensive
federal, state, and local environmental laws and regulations. These laws, among other things, regulate the discharge of materials
into the environment and may require the Company to remove or mitigate the environmental effects of the disposal or release of
petroleum or chemical substances at various sites. Management believes no materially significant liabilities of this
nature existed as of the balance sheet date.
The Company is undergoing a sales tax audit related to its Texas entity. No formal assessment has been
provided to the Company. The maximum exposure of this sales tax assessment is approximately $1.3 million though the Company is
confident that the final assessment will be less than the maximum as previously stated.
Note 15 – Concentrations
The Company’s producing properties and oil and natural gas reserves
are all located in Louisiana, New Mexico, North Dakota, Montana, and Texas. Because of the concentration, the Company is exposed to the
impact of regional supply and demand factors, processing or transportation capacity constraints, severe weather events, water shortages,
and government regulations specific to the geographic area.
For the year ended December 31, 2021, the Company sold 63% of its oil,
natural gas, and NGL to four customers. For the year ended December 31, 2020, the Company sold 96% of its oil and natural gas production
to four customers. The loss of these purchasers could result in a temporary interruption in sales or a lower price for production.
Note 16 – Subsequent Events
The Company uplisted from the OTCQB to the NYSE American effective March 8, 2022. Immediately prior to
the listing, a reverse stock split of 1 for 4 occurred. All pricing and share amounts have been stated at post-reverse split amounts.
On February 28, 2022, the Company granted approximately 249,000
stock options under the 2021 Stock Option and Incentive plan to management and employees of the Company. These options vest in equal
1/3 increments over the course of three years and expire 3.5 years after the grant date and have a grant price of $11.80.
The Company named Eugene J. Sweeney as Chief Operating Officer in
March 2022. Mr. Sweeney previously served as the Company’s Vice President of Operations from May 2021 to the date of his promotion.
EMPIRE PETROLEUM CORPORATION
Supplemental Information “Oil and Natural
Gas Producing Activities (Unaudited)
December 31, 2021 and 2020
The following
reserve estimates present the Company's estimate of the proven natural gas and oil reserves and net cash flow of the Company’s
properties, in accordance with the guidelines established by the Securities and Exchange Commission. The Company emphasizes that
reserve estimates are inherently imprecise and that estimates of new discoveries are more imprecise
than those of producing natural gas and oil properties. Accordingly, the estimates are expected to change as future information
becomes available. All the oil and natural gas reserves are located in Louisiana, New Mexico, North Dakota, Montana and Texas.
Costs Incurred Related to Oil and Gas Activities
Capitalized costs include the cost of properties, equipment,
and facilities for oil and natural gas producing activities. Capitalized costs for proved properties includes costs for oil and natural
gas leaseholds where proved reserves have been identified and non-operated development wells and related equipment and facilities.
| |
Years Ended December 31, | |
| |
2021 | | |
2020 | |
| |
| | |
| |
Proved acquisition costs | |
$ | 23,780,111 | | |
$ | 10,913,393 | |
Revisions to abandonment costs | |
| (1,547,640 | ) | |
| (862,405 | ) |
Development costs | |
| 1,970,410 | | |
| — | |
Total additions | |
$ | 24,202,881 | | |
$ | 10,050,988 | |
Reserve Quantity Information
Proved oil and natural gas reserves are
those quantities of oil and gas, which by analysis of geoscience and engineering data, can be estimated with reasonable certainty to
be economically producible from a given date forward, from known reservoirs, and under existing economic conditions, operating methods,
and government regulations. Proved developed reserves are proved reserves that can be expected to be recovered through existing wells
with existing equipment and operating methods or in which the cost of the required equipment is relatively minor compared to the cost
of a new well. Proved undeveloped reserves are proved reserves that are expected to be recovered from new wells on undrilled acreage,
or from existing wells where a relatively major expenditures is required for recompletion. Below are the net quantities of net proved
developed reserves of the Company’s properties:
|
|
Oil (MMBbls) |
Gas (MMcf) |
MBOE |
Balance, December 31, 2019 |
|
3,643 |
404 |
3,710 |
Acquisition of Reserves |
|
580 |
1,092 |
762 |
Revisions |
|
(397) |
(385) |
(461) |
Production |
|
(165) |
(140) |
(188) |
Balance, December 31, 2020 |
|
3,661 |
971 |
3,823 |
Acquisition of Reserves |
|
5,634 |
10,533 |
7,390 |
Revisions |
|
(617) |
251 |
(576) |
Extensions |
|
150 |
51 |
159 |
Divestiture of Reserves |
|
(47) |
27 |
(42) |
Production |
|
(333) |
(625) |
(437) |
Total Reserves |
|
8,449 |
11,208 |
10,317 |
Standardized Measure of Discounted Future
Net Cash Flows Relating to Oil and Natural Gas Reserves
The standardized measure of discounted future
net cash flows relating to oil and natural gas reserves and associated changes in standard measure amounts were prepared in accordance
with the provision of Financial Accounting Standard Board ASC 932-235-555. Future cash inflows were computed by applying average
prices of oil and natural gas for the last 12 months to estimated future production. Future production and development costs were
computed by estimating the expenditures to be incurred in developing the oil and natural gas reserves at the end of the year, based on
year end costs and assuming continuation of existing economic conditions. Future net cash flows are discounted at the rate of 10%
annually to derive the standardized measure of discounted cash flows. Actual future cash inflows may vary considerably, and the
standardized measure does not necessarily represent the fair value of the acquired properties' oil and natural gas reserves. Standard
measure amounts are:
| |
December 31, | |
Description | |
2021 | | |
2020 | |
Future cash inflows | |
$ | 627,654,125 | | |
$ | 121,959,450 | |
Future production costs | |
| (362,254,813 | ) | |
| (55,350,840 | ) |
Future development costs | |
| (33,021,749 | ) | |
| (1,682,210 | ) |
Future income tax expense | |
| (30,614,383 | ) | |
| — | |
Future net cash flows | |
| 201,763,180 | | |
| 64,926,400 | |
10% annual discount for estimated timing of cash flows | |
| (107,911,087 | ) | |
| (44,156,400 | ) |
Standardized measure | |
$ | 93,852,093 | | |
$ | 20,770,000 | |
The 12-month average prices were adjusted
to reflect applicable transportation and quality differentials on a well-by-well basis to arrive at realized sales prices used to estimate
the properties' reserves. The prices for the properties' reserves were as follows:
| |
2021 | | |
2020 | |
Oil (BBl) | |
$ | 64.31 | | |
$ | 32.94 | |
Natural gas (MMBtu) | |
$ | 7.34 | * | |
$ | 1.41 | |
*Pricing includes revenue received
from NGL sales as well as natural gas.
Changes in the Standardized Measure of
Discounted Future Net Cash Flows at 10% per annum are as follows:
| |
December 31, | |
Description | |
2021 | | |
2020 | |
Beginning of year | |
$ | 20,770,080 | | |
$ | 37,301,920 | |
Net change in prices and production costs | |
| 13,080,689 | | |
| (18,386,232 | ) |
Net change in future development costs | |
| 782,210 | | |
| 16,937,402 | |
Oil & Gas net revenue | |
| (10,587,395 | ) | |
| (2,164,496 | ) |
Extensions | |
| 5,026,479 | | |
| — | |
Acquisition of reserves | |
| 90,104,017 | | |
| 13,694,856 | |
Divestiture of reserves | |
| (318,813 | ) | |
| — | |
Revisions of previous quantity estimates | |
| (3,794,860 | ) | |
| (4,348,703 | ) |
Net change in taxes | |
| (15,544,094 | ) | |
| — | |
Accretion of discount | |
| 2,077,008 | | |
| 5,099,678 | |
Changes in timing and other | |
| (7,743,228 | ) | |
| (27,364,345 | ) |
End of year | |
$ | 93,852,093 | | |
$ | 20,770,080 | |
Estimates of economically recoverable
natural gas and oil reserves and of future net revenues are based upon a number of variable factors and assumptions, all of which are
to some degree subjective and may vary considerably from actual results. Therefore, actual production, revenues, development and
operating expenditures may not occur as estimated. The reserve data are estimates only, are subject to many uncertainties, and
are based on data gained from production histories and on assumptions as to geologic formations and other matters. Actual quantities
of natural gas and oil may differ materially from the amounts estimated.
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