Notes to Financial Statements
1.
Organization
Nature of Operations
Cross Border Resources,
Inc. (the “Company”) is an independent natural gas and oil company engaged in the exploration, development, exploitation,
and acquisition of natural gas and oil reserves in North America. The Company’s area of focus is the State of
New Mexico, particularly southeastern New Mexico. The Company has two wholly-owned subsidiaries, which are inactive:
Doral West Corporation and Pure Energy Operating, Inc. and accordingly are not consolidated in these financial statements.
The
interim financial statements are condensed and should be read in conjunction with the company’s latest annual financial
statements and interim disclosures generally do not repeat those in the annual statements.
2.
Summary
of Significant Accounting Policies
Reclassification
Certain amounts
have been reclassified to conform with the current period presentation. The amounts reclassified did not have an effect on the
Company’s results of operations or stockholders’ equity.
Cash and cash equivalents
The Company considers
all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. At times,
the amount of cash and cash equivalents on deposit in financial institutions exceeds federally insured limits. The Company monitors
the soundness of the financial institutions and believes the Company’s risk is negligible.
Financial instruments
The carrying amounts
of financial instruments, including cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities and
long-term debt, approximate fair value as of March 31, 2014 and December 31, 2013.
Oil and natural gas properties
The Company follows
the successful efforts method of accounting for its oil and natural gas producing activities. Costs to acquire mineral
interests in oil and natural gas properties and to drill and equip development wells and related asset retirement costs are capitalized.
Costs to drill exploratory wells are capitalized pending determination of whether the wells have proved reserves. If the Company
determines that the wells do not have proved reserves, the costs are charged to expense. There were no exploratory wells capitalized
pending determination of whether the wells have proved reserves at March 31, 2014 or December 31, 2013. Geological and geophysical
costs, including seismic studies and costs of carrying and retaining unproved properties, are charged to expense as incurred. The
Company capitalizes interest on expenditures for significant exploration and development projects that last more than six months
while activities are in progress to bring the assets to their intended use. Through March 31, 2014, the Company had capitalized
no interest costs because its exploration and development projects generally lasted less than six months. Costs incurred to maintain
wells and related equipment are charged to expense as incurred.
On the sale or retirement
of a complete unit of a proved property, the cost and related accumulated depreciation, depletion and amortization are eliminated
from the property accounts, and the resultant gain or loss is recognized. On the retirement or sale of a partial unit of proved
property, the cost is charged to accumulated depreciation, depletion and amortization, with a resulting gain or loss recognized
in income.
Capitalized amounts
attributable to proved oil and natural gas properties are depleted by the unit-of-production method over proved reserves using
the unit conversion ratio of six Mcf of gas to one barrel of oil equivalent (“Boe”). The ratio of six Mcf of natural
gas to one Boe is based upon energy equivalency, rather than price equivalency. Given current price differentials, the price for
a Boe for natural gas differs significantly from the price for a barrel of oil.
It is common for
operators of oil and natural gas properties to request that joint interest owners pay for large expenditures, typically for drilling
new wells, in advance of the work commencing. This right to call for cash advances is typically found in the operating agreement
that joint interest owners in a property adopt. The Company records these advance payments in prepaid and other current assets
and release this account when the actual expenditure is later billed to it by the operator.
On the sale of an
entire interest in an unproved property for cash or cash equivalents, gain or loss on the sale is recognized, taking into consideration
the amount of any recorded impairment if the property had been assessed individually. If a partial interest in an unproved property
is sold, the amount received is treated as a reduction of the cost of the interest retained.
Impairment of long-lived assets
The Company evaluates
its long-lived assets for potential impairment in their carrying values whenever events or changes in circumstances indicate such
impairment may have occurred. Oil and natural gas properties are evaluated for potential impairment by field. Other properties
are evaluated for impairment on a specific asset basis or in groups of similar assets, as applicable. An impairment on proved properties
is recognized when the estimated undiscounted future net cash flows of an asset are less than its carrying value. If an impairment
occurs, the carrying value of the impaired asset is reduced to its estimated fair value, which is generally estimated using a discounted
cash flow approach. If the results of an assessment indicate that the properties are impaired, the amount of the impairment is
added to the capitalized costs to be amortized.
Unproved oil and
natural gas properties do not have producing properties. As reserves are proved through the successful completion of exploratory
wells, the cost is transferred to proved properties. The cost of the remaining unproved basis is periodically evaluated by management
to assess whether the value of a property has diminished. To do this assessment, management considers estimated potential reserves
and future net revenues from an independent expert, the Company’s history in exploring the area, the Company’s future
drilling plans per its capital drilling program prepared by the Company’s reservoir engineers and operations management and
other factors associated with the area. Impairment is taken on the unproved property cost if it is determined that the costs are
not likely to be recoverable. The valuation is subjective and requires management to make estimates and assumptions which, with
the passage of time, may prove to be materially different from actual results.
Revenue and accounts receivable
The Company recognizes
revenue for its production when the quantities are delivered to, or collected by, the purchaser. Prices for such production are
generally defined in sales contracts and are readily determinable based on certain publicly available indices. All transportation
costs are included in lease operating expense.
Accounts receivable—oil
and natural gas sales consist of uncollateralized accrued revenues due under normal trade terms, generally requiring payment within
30 to 60 days of production. Accounts receivable—other consist of amounts owed from interest owners of the Company’s
operated wells. No interest is charged on past-due balances. Payments made on all accounts receivable are applied to
the earliest unpaid items. The Company reviews accounts receivable periodically and reduces the carrying amount by a valuation
allowance that reflects its best estimate of the amount that may not be collectible. There was no reserve for bad debts
as of March 31, 2014 or December 31, 2013.
Other property
Furniture, fixtures
and equipment are carried at cost. Depreciation of furniture, fixtures and equipment is provided using the straight-line method
over estimated useful lives ranging from three to ten years. Gain or loss on retirement or sale or other disposition of assets
is included in income in the period of disposition.
Income taxes
The Company is subject
to U.S. federal income taxes along with state income taxes in New Mexico. When tax returns are filed, it is highly certain that
some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about
the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position
is recognized in the financial statements in the period during which, based on all available evidence, management believes it is
more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes,
if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not
recognition threshold are measured as the largest amount of tax benefit that is more than 50% likely of being realized upon settlement
with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured
as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated
interest and penalties that would be payable to the taxing authorities upon examination. Interest and penalties associated with
unrecognized tax benefits are classified as additional income taxes in the Company’s Statements of Operations. The Company
accrues interest and penalties, if any, related to unrecognized tax benefits as a component of income tax expense.
Deferred tax assets
and liabilities are recognized for the estimated future tax consequences attributable to the differences between the financial
statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities
are measured using the tax rate in effect for the year in which those temporary differences are expected to be recovered or settled.
The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the year of the enacted tax
rate change. In addition, a valuation allowance is established to reduce any deferred tax asset for which it is determined that
it is more likely than not that some portion of the deferred tax asset will not be realized.
Asset retirement obligations
Asset retirement
obligations (“AROs”) associated with the retirement of tangible long-lived assets are recognized as liabilities with
an increase to the carrying amounts of the related long-lived assets in the period incurred. The cost of the tangible asset, including
the asset retirement cost, is depreciated over the useful life of the asset. AROs are recorded at estimated fair value, measured
by reference to the expected future cash outflows required to satisfy the retirement obligations discounted at the Company’s
credit-adjusted risk-free interest rate. Accretion expense is recognized over time as the discounted liabilities are accreted to
their expected settlement value. If estimated future costs of AROs change, an adjustment is recorded to both the ARO and the long-lived
asset. Revisions to estimated AROs can result from changes in retirement cost estimates, revisions to estimated inflation rates
and changes in the estimated timing of abandonment.
Business combinations
We follow ASC 805,
Business Combinations (“ASC 805”), and ASC 810-10-65, Consolidation (“ASC 810-10-65”). ASC 805 requires
most identifiable assets, liabilities, non-controlling interests, and goodwill acquired in a business combination to be recorded
at “fair value.” The statement applies to all business combinations, including combinations among mutual entities and
combinations by contract alone. Under ASC 805, all business combinations will be accounted for by applying the acquisition method.
Accordingly, transaction costs related to acquisitions are to be recorded as a reduction of earnings in the period they are incurred
and costs related to issuing debt or equity securities that are related to the transaction will continue to be recognized in accordance
with other applicable rules under U.S. GAAP. ASC 810-10-65 requires non-controlling interests to be treated as a separate component
of equity, not as a liability or other item outside of permanent equity. The statement applies to the accounting for non-controlling
interests and transactions with non-controlling interest holders in consolidated financial statements.
Earnings per common share
The Company reports
basic earnings per common share, which excludes the effect of potentially dilutive securities, and diluted earnings per common
share, which includes the effect of all potentially dilutive securities, unless their impact is anti-dilutive.
Recently issued accounting pronouncements
In May 2011, the
FASB issued an accounting pronouncement related to fair value measurement (FASB ASC Topic 820), which amends current guidance to
achieve common fair value measurement and disclosure requirements in U.S. GAAP and International Financial Reporting Standards.
The amendments generally represent clarification of FASB ASC Topic 820, but also include instances where a particular principle
or requirement for measuring fair value or disclosing information about fair value measurements has changed. This pronouncement
is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. We adopted this pronouncement
for our fiscal year beginning January 1, 2012 and the adoption of this pronouncement did not have a material effect on our financial
statements.
In December 2011,
the Financial Accounting Standards Board (“FASB”) issued new standards that require an entity to disclose information
about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements
on its financial position. The new standards are effective for annual periods beginning on or after January 1, 2013. We are currently
evaluating the provisions of the new standards and assessing the impact, if any, it may have on our financial position and results
of operations.
3 – Asset retirement obligations
The following is a description of the
changes to the Company’s asset retirement obligations for the periods ended March 31, 2014 and December 31, 2013:
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2014
|
|
|
2013
|
|
|
|
|
|
|
|
|
Asset retirement obligations at beginning of year
|
|
$
|
3,515,728
|
|
|
$
|
3,317,358
|
|
Settlement of liabilities
|
|
|
—
|
|
|
|
(1,284
|
)
|
Revision of previous estimates
|
|
|
(978)
|
|
|
|
—
|
|
Accretion expense
|
|
|
36,648
|
|
|
|
148,364
|
|
Additions
|
|
|
—
|
|
|
|
51,290
|
|
Asset retirement obligations at end of period
|
|
$
|
3,551,395
|
|
|
$
|
3,515,728
|
|
Less: current portion
|
|
|
562,000
|
|
|
|
562,000
|
|
Long-term portion
|
|
$
|
2,989,395
|
|
|
$
|
2,952,898
|
|
4 – Property and equipment
Oil and natural gas properties
The following table
sets forth the capitalized costs under the successful efforts method for oil and natural gas properties:
|
|
March 31,
|
|
December 31,
|
|
|
|
2014
|
|
2013
|
|
|
|
|
|
|
|
Oil and natural gas properties
|
|
$
|
57,026,296
|
|
$
|
56,561,040
|
|
Less accumulated depletion and impairment
|
|
|
(22,077,562
|
)
|
|
(20,941,867
|
)
|
Net oil and natural gas properties capitalized costs
|
|
$
|
34,948,734
|
|
$
|
35,619,173
|
|
Capitalized costs
related to proved oil and natural gas properties, including wells and related equipment and facilities, are evaluated for impairment
based on the Company’s analysis of undiscounted future net cash flows. If undiscounted future net cash flows are insufficient
to recover the net capitalized costs related to proved properties, then the Company recognizes an impairment charge in income equal
to the difference between carrying value and the estimated fair value of the properties. Estimated fair values are determined using
discounted cash flow models. The discounted cash flow models include management’s estimates of future oil and natural gas
production, operating and development costs, and discount rates.
Uncertainties affect
the recoverability of these costs as the recovery of the costs outlined above are dependent upon the Company obtaining and maintaining
leases and achieving commercial production or sale.
Other property and equipment
The historical cost
of other property and equipment, presented on a gross basis with accumulated depreciation is summarized as follows:
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March 31,
|
|
December 31,
|
|
|
|
2014
|
|
2013
|
|
|
|
|
|
|
|
Other property and equipment
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|
$
|
130,470
|
|
$
|
130,470
|
|
Less accumulated depreciation
|
|
|
(100,489
|
)
|
|
(95,828
|
)
|
Net property and equipment
|
|
$
|
29,981
|
|
$
|
34,641
|
|
5 – Stockholders’ equity and earnings per
share
2011 Equity Financing
On May 26, 2011,
the Company closed a private offering exempt from registration under the Securities Act of 1933 pursuant to Rule 506 of Regulation
D promulgated thereunder. In the offering, the Company issued an aggregate of 3,600,000 units. Each unit
was sold at $1.50 and was comprised of one share of common stock and one five-year warrant to purchase a share of common stock
at an exercise price of $2.25 per share. The warrants became exercisable on November 26, 2011. The
Company agreed to use the net proceeds from the sale of the units for general business and working capital purposes and not to
use such proceeds for the redemption of any common stock or common stock equivalents.
The investors in
the offering (“Selling Stockholders”) received registration rights. The Company agreed to file a registration
statement covering the resale of the common stock issued and the common stock underlying the warrants issued to the Selling Stockholders
within sixty days after the closing date. If the registration statement was not declared effective by the SEC within
the time periods defined within the agreement, then the Company would have made pro rata cash payments to each Selling Stockholder as
liquidated damages in an amount equal to 1.0% of the aggregate amount invested by such Selling Stockholder for each 30-day
period or pro rata for any portion thereof following the date by which such Registration Statement should have been effective. If
at the time of exercise of the warrants there is no effective registration statement covering the resale of the shares underlying
the warrant, then the Selling Stockholders have the right at such time to exercise warrants in full or in part on a cashless basis.
The Company filed an S-1 registration statement registering the shares on July 25, 2011, which was declared effective on August
5, 2011.
In addition to registration
rights, the Selling Stockholders were offered a right of first refusal to participate in future offerings of common stock if the
principal purpose of which was to raise capital. This right of first refusal terminated upon the one-year anniversary
of the closing date.
Warrants
In connection with
the equity offering closed on May 26, 2011, the Company issued warrants to purchase an aggregate of 3,600,000 shares of the Company’s
common stock at a per share price of $2.25 (the "$2.25 Warrants"). The Company also has outstanding warrants
to purchase 3,125 shares of the Company’s common stock at a per share price of $5.00. The $2.25 Warrants became
exercisable in November 2011 and expire in November 2015. On the date of issuance, the warrants were valued at $898,384. Management
determined the fair value of the warrants based upon the Black-Scholes option model with a volatility based on the historical closing
price of common stock of industry peers and the closing price of the Company’s common stock on the OTCBB on the date of issuance.
The volatility and remaining term was 50% and 2.92 years, respectively. The Company does not expect the immediate exercise of these
warrants as the exercise price exceeds the average closing market price for the Company's common stock. Furthermore, no assurances
can be made that any of the warrants will ever be exercised for cash or at all.
Stock Options
In 2011, the Company
issued options to purchase 85,000 shares of its common stock at $4.80 to its directors. For the three months ended March
31, 2014, there was no stock based compensation.
Stock option activity
summary is presented in the table below:
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|
|
|
|
|
|
Weighted-
|
|
|
|
|
|
|
|
|
|
average
|
|
|
|
|
|
|
Weighted-
|
|
|
Remaining
|
|
|
|
|
|
|
average
|
|
|
Contractual
|
|
|
|
Number of
|
|
|
Exercise
|
|
|
Term
|
|
|
|
Shares
|
|
|
Price
|
|
|
(years)
|
|
Outstanding and exercisable December 31, 2012
|
|
87,500
|
|
$
|
4.80
|
|
|
4.08
|
|
Granted
|
|
—
|
|
|
—
|
|
|
—
|
|
Cancelled
|
|
—
|
|
|
—
|
|
|
—
|
|
Exercised
|
|
—
|
|
|
—
|
|
|
—
|
|
Forfeited
|
|
—
|
|
|
—
|
|
|
—
|
|
Expired
|
|
—
|
|
|
—
|
|
|
—
|
|
Outstanding and exercisable at December 31, 2013
|
|
87,500
|
|
|
4.80
|
|
|
3.08
|
|
Granted
|
|
—
|
|
|
—
|
|
|
—
|
|
Cancelled
|
|
—
|
|
|
—
|
|
|
—
|
|
Exercised
|
|
—
|
|
|
—
|
|
|
—
|
|
Forfeited
|
|
—
|
|
|
—
|
|
|
—
|
|
Expired
|
|
—
|
|
|
—
|
|
|
—
|
|
Outstanding and exercisable at March 31, 2014
|
|
87,500
|
|
$
|
4.80
|
|
|
2.83
|
|
There is no intrinsic
value in the outstanding options since the option price is in excess of the market price of the Company's common stock.
The fair value of
the options granted during 2011 was estimated at the date of grant using the Black-Scholes option-pricing model with the following
assumptions:
Closing market price of stock on grant date
|
$3.11
|
Risk-free interest rate
|
2.43%
|
Dividend yield
|
0.00%
|
Volatility factor
|
50%
|
Expected life
|
2.5 years
|
The Company elected to use the “simplified” method
to calculate the estimated life of options granted to employees. The use of the “simplified” method has been extended
until such time when the Company has sufficient information to make more refined estimates on the estimated life of its options.
The expected stock price volatility was calculated by averaging the historical volatility of the Company’s common stock over
a term equal to the expected life of the options.
Issuance of Common Shares to Settle Creditors Payable
As described in Note 8, the Company entered into settlement
agreements with two of the creditors payable arising out of the 2002 bankruptcy. The Company paid the creditors $633,975 in cash
and the Company’s largest shareholder, Red Mountain Resources, Inc. (“RMR”), issued approximately 750,000 shares
of its common stock to the creditors in settlement of the claims. In return for RMR issuing its shares to the creditors payable,
the Company issued RMR 422,650 shares of its common stock.
Conversion of Notes Payable
On February 28, 2013, RMR, the holder of the Green Shoe and
Little Bay notes, elected to convert the outstanding notes and accrued interest into common shares. The board of directors of the
Company had previously resolved to change the conversion feature from $4.00 per common share to $1.50 per common share. As a result,
the Company issued 611,630 common shares to RMR.
6 – Related party transactions
During the year ended December 31, 2013, Red Mountain incurred
approximately $3,000,000 for general and administrative expenses and operating costs, all of which was repaid at December 31, 2013.
During the three months ended March 31, 2014, the Company advanced Red Mountain approximately $1,900,000 to use for its general
and administrative and operating costs. Such funds will be repaid to the Company.
7 – Long term debt
Operating Line of Credit
On February 5, 2013,
the Company entered into a Senior First Lien Secured Credit Agreement with RMR, Black Rock Capital, Inc. and RMR Operating, LLC
and Independent Bank, as Lender. RMR owns approximately 85% of the outstanding common stock of Cross Border and Black Rock and
RMR Operating are wholly owned subsidiaries of RMR. On February 5, 2013, the Company drew $8,900,000 on the line of credit and
used those funds to pay off the line of credit and associated accrued interest. On February 29, 2013, the Company drew $2,000,000
and on May 24, 2013, the Company drew a further $1,300,000 on the line of credit and used those funds to pay accounts payable related
to the drilling program.
The borrowing base
under the Credit Facility is determined at the discretion of the Lender based on, among other things, the Lender’s estimated
value of the proved reserves attributable to the Borrowers’ oil and natural gas properties that have been mortgaged to the
Lender, and is subject to regular redeterminations on September 30 and March 31 of each year, and interim redeterminations described
in the Credit Agreement and potentially monthly commitment reductions, in each case which may reduce the amount of the borrowing
base. As of March 31, 2014, the creditors had borrowed a total of $23,800,000. As of March 31, 2014, the borrowing base was $30,000,000
million, leaving $6,200,000 of availability.
8 – Commitments and contingencies
Litigation
The Company, the
Company’s former Chief Executive Officer, and the Company’s former Chief Operating Officer are party to a lawsuit with
a former employee. On May 4, 2011, Clifton M. (Marty) Bloodworth initially filed a lawsuit in the State District Court of Midland
County, Texas, against Doral West Corp. d/b/a Doral Energy Corp. (the predecessor entity of Cross Border) (“Doral Energy”)
and Everett Willard Gray II, the Company’s former Chief Executive Officer. Mr. Bloodworth later amended his lawsuit to name
Horace Patrick Seale, the Company’s former Chief Operating Officer, as an additional defendant. Mr. Bloodworth generally
alleges that Mr. Gray and Mr. Seale, as agents of the Company, made false representations which induced Mr. Bloodworth to enter
into an employment contract that was subsequently breached by the Company. The claims that Mr. Bloodworth has alleged are: breach
of his employment agreement with Doral Energy, fraud in the inducement and common law fraud, civil conspiracy, breach of fiduciary
duty, and violation of the Texas Deceptive Trade Practices Act. Mr. Bloodworth is seeking damages of approximately $280,000. Mr.
Gray, Mr. Seale and the Company deny that Mr. Bloodworth’s claims have any merit.
The Company was previously
party to an engagement letter, dated February 7, 2012 (the “Engagement Letter”), with KeyBanc Capital Markets Inc.
(“KeyBanc”) pursuant to which KeyBanc was to act as exclusive financial advisor to the Company’s Board of Directors
in connection with a possible “Transaction” (as defined in the Engagement Letter). The Engagement Letter was formally
terminated by the Company on August 21, 2012. The Engagement Letter provided that KeyBanc would be entitled to a fee upon consummation
of a Transaction within a certain period of time following termination of the Engagement Letter. On May 16, 2013, KeyBanc delivered
an invoice to the Company in the amount of $751,334, representing amounts purportedly owed by the Company to KeyBanc as a result
of the consummation of a purported Transaction that KeyBanc asserts had been consummated within the required time period and its
out-of-pocket expenses in connection therewith. The Company disputes that any Transaction was consummated and that KeyBanc is entitled
to any out-of-pocket expenses. The matter was originally filed by the Company in the 44th-B Judicial District Court for the State
of Texas, Dallas County but was subsequently removed to the United States District Court for the Northern District of Texas, Dallas
Division, where KeyBanc filed a counterclaim against the Company. The Company and KeyBanc have each filed motions for summary judgment,
requesting the Court to rule in their respective favors. The Company intends to vigorously defend the action.
In addition to the
foregoing, in the ordinary course of business, the Company is periodically a party to various litigation matters that it does not
believe will have a material adverse effect on its results of operations or financial condition.
Environmental Contingencies
The Company is subject to federal and state laws and regulations
relating to the protection of the environment. Environmental risk is inherent in all oil and natural gas operations, and the Company
could be subject to environmental cleanup and enforcement actions. The Company manages this environmental risk through appropriate
environmental policies and practices to minimize the impact to the Company.
As of March 31, 2014 and December 31, 2013, the Company had
approximately $2.1 million in environmental remediation liabilities related to the Company’s operated Tom Tom and Tomahawk
fields located in Chaves and Roosevelt counties in New Mexico. In February 2013, the Bureau of Land Management (“BLM”)
accepted the Company’s remediation plan for the Tom Tom and Tomahawk fields. The Company is working in conjunction with the
BLM to initiate remediation on a site-by-site basis. This is management’s best estimate of the costs of remediation and restoration
with respect to these environmental matters, although the ultimate cost could differ materially. Inherent uncertainties exist in
these estimates due to unknown conditions, changing governmental regulation, and legal standards regarding liability, and emerging
remediation technologies for handling site remediation and restoration. The Company has incurred $11,000 in costs and expects to
incur the remaining expenditures over an eighteen month period beginning in April 2014.
9 – Price risk management activities
ASC 815-25 (formerly
SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities”) requires that all derivative instruments
be recorded on the balance sheet at their fair value. Changes in the fair value of each derivative are recorded each period in
current earnings or other comprehensive income, depending on whether the derivative is designated as part of a hedge transaction
and, if it is, the type of hedge transaction. When choosing to designate a derivative as a hedge, management formally documents
the hedging relationship and its risk-management objective and strategy for undertaking the hedge, the hedging instrument, the
item, the nature of the risk being hedged, how the hedging instrument’s effectiveness in offsetting the hedged risk will
be assessed, and a description of the method of measuring effectiveness. This process includes linking all derivatives that are
designated as cash-flow hedges to specific cash flows associated with assets and liabilities on the balance sheet or to specific
forecasted transactions. Based on the above, management has determined the swaps noted below do not qualify for hedge accounting
treatment.
At March 31, 2014,
the Company had a net derivative liability of $75,148, as compared to a net derivative liability of $38,109 at December 31, 2013. The
change in net derivative asset/liability is recorded as non-cash mark-to-market income or loss. Mark-to-market losses
of $37,039 were recorded in the three months ended March 31, 2014 as compared to mark-to-market income of $283,831 during the twelve
months ended December 31, 2013. Net realized hedge settlement loss for the three months ended March 31, 2014 was $13,614
as compared to net realized hedge settlement loss of $14,062 for the twelve months ended December 31, 2013. The combination
of these two components of derivative expense/income is reflected in "Other Income (Expense)" on the Statements of Operations
as "Gain (loss) on derivatives."
As of March 31,
2014, the Company had crude oil swaps in place relating to a total of 2,000 Bbls per month, as follows:
|
|
|
|
|
|
Price
|
|
Volumes
|
|
Fair Value of Outstanding
Derivative Contracts
(1)
as of
|
|
Transaction
|
|
|
|
|
|
Per
|
|
Per
|
|
|
March 31,
|
|
|
December
|
|
Date
|
|
Type
(2)
|
|
Beginning
|
|
Ending
|
|
Unit
|
|
Month
|
|
|
2014
|
|
|
31, 2013
|
|
November 2011
|
|
Swap
|
|
12/01/2011
|
|
11/30/2014
|
|
$93.50
|
|
2,000
|
|
|
(75,148)
|
|
|
(62,730)
|
|
February 2012
|
|
Swap
|
|
03/01/2012
|
|
02/28/2014
|
|
$106.50
|
|
1,000
|
|
|
—
|
|
|
24,621
|
|
|
|
$
|
(75,148)
|
|
$
|
(38,109)
|
|
(1) The fair value of the Company's outstanding transactions is presented on the balance sheet by counterparty. Currently all of our derivatives are with the same counterparty. The balance is shown as current or long-term based on our estimate of the amounts that will be due in the relevant time periods at currently predicted price levels. Amounts in parentheses indicate liabilities.
|
(2) These crude oil hedges were entered
into on a per barrel delivered price basis, using the NYMEX - West Texas Intermediate Index, with settlement for each calendar
month occurring following the expiration date, as determined by the contracts.
|
10 – Fair Value Measurements
Fair value measurements
are based upon inputs that market participants use in pricing an asset or liability, which are classified into two categories:
observable inputs and unobservable inputs. Observable inputs represent market data obtained from independent sources, whereas unobservable
inputs reflect a company’s own market assumptions, which are used if observable inputs are not reasonably available without
undue cost and effort. These two types of inputs are further prioritized into the following fair value input hierarchy:
|
Level 1 –
|
quoted prices for identical assets or liabilities in active markets.
|
|
|
|
|
Level 2 –
|
quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (e.g. interest rates) and inputs derived principally from or corroborated by observable market data by correlation or other means.
|
|
|
|
|
Level 3 –
|
unobservable inputs for the asset or liability.
|
The fair value input
hierarchy level to which an asset or liability measurement in its entirety falls is determined based on the lowest level input
that is significant to the measurement in its entirety.
The following tables
summarize the valuation of the Company’s financial assets and liabilities at March 31, 2014 and December 31, 2013:
|
|
Fair Value Measurements at Reporting Date Using
|
|
|
Quoted Prices
in Active
Markets for
Identical Assets
or Liabilities
(Level 1)
|
|
Significant or
Other
Observable
Inputs
(Level 2)
|
|
Significant
Unobservable
Inputs
(Level 3)
|
|
Fair Value at
March 31,
2014
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Environmental liability
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
(2,077,306
|
)
|
|
$
|
(2,077,306
|
)
|
Asset retirement obligations (non-recurring)
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
(3,551,395
|
)
|
|
$
|
(3,551,395
|
)
|
Commodities Derivative
|
|
$
|
—
|
|
|
$
|
(75,148
|
)
|
|
$
|
—
|
|
|
$
|
(75,148
|
)
|
Total
|
|
$
|
—
|
|
|
$
|
(75,148
|
)
|
|
$
|
(5,628,701
|
)
|
|
$
|
(5,703,849
|
)
|
|
|
Fair Value Measurements at Reporting Date Using
|
|
|
Quoted Prices
in Active
Markets for
Identical Assets
or Liabilities
(Level 1)
|
|
Significant or
Other
Observable
Inputs
(Level 2)
|
|
Significant
Unobservable
Inputs
(Level 3)
|
|
Fair Value at
December 31,
2013
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Environmental liability
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
(2,087,973
|
)
|
|
$
|
(2,087,973
|
)
|
Commodities derivatives
|
|
$
|
—
|
|
|
$
|
(38,109
|
)
|
|
$
|
—
|
|
|
$
|
(38,109
|
)
|
Asset retirement obligations (non-recurring)
|
|
|
—
|
|
|
|
—
|
|
|
|
(3,514,898
|
)
|
|
|
(3,514,898
|
)
|
Total
|
|
$
|
—
|
|
|
$
|
(38,109
|
)
|
|
$
|
(5,602,871
|
)
|
|
$
|
(5,640,980
|
)
|
The following is a summary
of changes to fair value measurements using Level 3 inputs during the three months ended March 31, 2014:
|
|
Environmental
Liability
|
Balance, December 31, 2013
|
|
$
|
2,086,833
|
|
Acquisitions
|
|
|
—
|
|
Settlement of liabilities
|
|
|
9,527
|
|
Revisions of previous estimates
|
|
|
—
|
|
Balance, March 31, 2014
|
|
$
|
2,077,306
|
|