Gran Tierra Energy Inc. — Q2 2012 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2012. The company explores, develops and produces oil and natural gas, principally in Colombia, Argentina, Peru and Brazil. Amounts below are in U.S. dollars; financial statement figures are converted from thousands to millions where appropriate.
Financial performance and position
- Q2 revenue and other income: $115.2 million, down 29% from $162.1 million in Q2 2011. Oil and natural gas sales were $114.5 million.
- Q2 net income: $13.1 million, or $0.05 per basic and diluted share, versus $31.6 million, or $0.11 per share, a year earlier. Income before tax was $32.8 million; income tax expense was $19.7 million.
- First-half revenue and other income: $271.1 million, down 5% from $284.6 million. Net income was $12.8 million, or $0.05 per basic and diluted share, down 72% from $45.3 million.
- Production and realized prices: Q2 production averaged 14,127 BOEPD, down 22%; first-half production averaged 15,435 BOEPD, down 6%. Realized price was $89.10 per BOE in Q2, down 9%, and $96.04 per BOE for the first half, essentially unchanged year over year.
- Costs and margins: Q2 operating expense was $27.3 million, or $21.26 per BOE, versus $23.2 million, or $14.03 per BOE. First-half operating expense was $51.8 million, up 31%; general and administrative expense was $33.5 million, up 11%. DD&A was $32.6 million in Q2 and $92.9 million for the first half. The filing does not present a single operating-margin measure; costs per BOE and pre-tax results are reported.
- Cash flow: First-half funds flow from operations, a non-GAAP measure, was $116.6 million, down 25%. GAAP operating cash flow was a use of $25.3 million, compared with cash provided of $33.1 million in the first half of 2011. Investing activities used $201.7 million, including $178.6 million in property additions and a $23.0 million increase in restricted cash. Cash and cash equivalents declined $223.2 million to $128.5 million.
- Liquidity and debt: Working capital, including cash, was $160.6 million, down from $213.1 million at year-end 2011. The company reported no debt drawn at June 30 and stated it had no debt. Its reserve-based credit facility had a $20 million committed borrowing base at quarter-end; it was increased to $50 million on August 2, 2012. The facility is priced at LIBOR plus 3.5%, with a 1.5% standby fee on the unused balance. About 73% of cash was held by foreign subsidiaries and was not available for domestic operations unless repatriated, which could incur taxes.
- Balance sheet: Total assets were $1.534 billion, including $1.100 billion of property, plant and equipment and $102.6 million of goodwill. Shareholders’ equity was $1.198 billion. Current liabilities were $119.9 million; long-term liabilities were $216.2 million, including a $196.2 million deferred tax liability. No financial derivatives were held at quarter-end.
Material changes and unusual items
- Colombian pipeline disruptions and delivery restrictions materially reduced production. The OTA pipeline was shut for over 70 days in the first half; Q2 production reflected approximately 59 days of restrictions. The February 2012 change in the Ecopetrol sales point also increased oil inventory in the pipeline and related facilities.
- Q2 revenue and realized prices included a $10.9 million reduction from an arbitration decision on the third-party net profits interest for Chaza Block production from July 2009 through May 2012. The company said the settlement represented less than 1% of revenue for the disputed periods and was not expected to have a materially different effect on future revenue.
- First-half results included a $20.2 million ceiling-test impairment in Brazil related to Block BM-CAL-10 after the company withdrew from the next exploration period. First-half 2011 included a $33.4 million impairment in Peru and a $21.7 million gain on the Petrolifera acquisition, which did not recur in 2012.
- First-half foreign exchange loss rose to $29.2 million from $19.7 million; $16.2 million was unrealized. The filing attributes significant currency effects to Colombian peso movements and tax liabilities.
- Income tax expense was $50.9 million for the first half, an 80% effective tax rate, versus 55% in the comparable period. The company cites non-deductible currency translation losses and royalties, foreign tax effects and valuation allowances as factors.
- Capital expenditures were $154.2 million in the first half. Management reduced the 2012 capital program to $396 million from $444 million in response to production disruptions and lower commodity prices, while stating that current operations and the revised program were expected to be funded by operating cash flow and cash on hand, with possible periodic facility draws.
Outlook, risks and contingencies
- Management’s 2012 program totals $396 million: $171 million in Colombia, $111 million in Brazil, $44 million in Argentina, $68 million in Peru and $2 million for corporate activities. Plans include drilling, development, facilities and exploration work; budgets may change.
- Management identified oil-price volatility and Colombian transport disruptions as major risks and was evaluating alternatives including additional storage, trucking and use of other pipelines. Further cash-flow weakness could lead to more capital reductions, credit-facility draws, debt or equity financing, or asset sales.
- Concentration is significant: Ecopetrol accounted for 75% of Q2 revenue and 81% of first-half revenue. Colombian production relies heavily on the OTA pipeline. The filing also highlights guerrilla activity, political and regulatory uncertainty, permitting delays, foreign-exchange exposure, customer concentration and the risks of operating in South America.
- The ANH dispute over additional royalties on Moqueta production could result in an estimated $10.3 million payment based on production to date if the agency’s interpretation prevails; no amount was accrued because management did not consider a loss probable. A separate Ecopetrol contract dispute includes a claim of approximately $5.8 million, also with no accrual on that basis.
- The Chaza arbitration decision made $10.9 million payable for past production and increases future net profits interest payments. Contractual purchase obligations, firm agreements and leases totaled $149.9 million, including $96.3 million due within one year. Promissory notes totaling $34.4 million secured letters of credit for exploration work commitments.
- After quarter-end, the company announced Costayaco reserves had increased, net after royalty, to approximately 19.6 million barrels proved, 22.2 million barrels proved plus probable, and 25.6 million barrels proved plus probable plus possible, after production. Management attributed revisions to waterflood success and reservoir management.
Most important facts for investors to verify
- Whether OTA pipeline availability and alternate transport or storage arrangements improve production and cash conversion.
- Whether the reduced $396 million capital program remains financeable given negative first-half GAAP operating cash flow, falling cash balances and working-capital movements.
- How the ANH royalty dispute and other legal matters develop, and whether further payments or accruals become necessary.
- Whether the $10.9 million Chaza royalty adjustment and increased future third-party interest affect subsequent realized prices and costs as management expects.
- Whether Argentina’s new oil planning commission, regulatory changes and short-term sales arrangements affect planned investment, production or pricing.
- Whether the August 2 facility increase to $50 million was available on the disclosed terms and whether any borrowing or covenant changes occur after quarter-end.
- Whether announced Costayaco reserve increases are supported by subsequent operating results and translate into production and cash flow.