Business context and reporting period
PrimeEnergy Corporation’s Form 10-K covers the fiscal year ended December 31, 2012; it is an annual report, not a standalone fourth-quarter filing. The company is a U.S. independent oil and natural gas producer that also operates wells and provides oilfield services. Its largest reserve concentration is West Texas. Figures below are in U.S. dollars; financial statement amounts are in millions unless noted.
Key financial and operating metrics
| Metric | 2012 | 2011 |
|---|---|---|
| Total revenue | $120.98 | $127.08 |
| Income from operations | $25.12 | $11.22 |
| Net income attributable to PrimeEnergy | $15.06 | $4.81 |
| Basic / diluted earnings per share | $5.74 / $4.48 | $1.75 / $1.38 |
| Cash provided by operating activities | $39.71 | $41.34 |
| Capital expenditures, including exploration | $86.31 | $39.95 |
- Revenue and production: Oil and gas sales were $87.83 million, down 1%. Oil production rose 19% to 745,000 barrels, while gas production fell 6% to 4.715 million Mcf. Average realized prices excluding derivatives were $89.67 per barrel of oil and $4.45 per Mcf of gas.
- Margins and earnings: Operating margin was approximately 20.8% of revenue versus 8.8% in 2011. Earnings attributable to PrimeEnergy rose substantially, mainly as depreciation, depletion, amortization and accretion expense fell $25.13 million. Consolidated net income was $14.77 million; the higher $15.06 million attributable figure reflects a loss allocated to non-controlling interests.
- Liquidity: Year-end cash and cash equivalents were $8.60 million, with another $4.67 million classified as restricted. Current assets of $30.45 million were approximately equal to current liabilities of $30.40 million.
- Debt: Bank debt increased to $122.0 million from $69.8 million. The year-end borrowing base was $145.0 million, leaving $23.0 million available. The facility is secured by oil and gas properties and subject to financial and operating covenants; the company reported compliance.
- Reserves: Proved reserves increased to 25.612 million Boe from 17.752 million Boe; 43% were proved undeveloped. The standardized measure of discounted future net cash flows rose to $213.3 million from $184.5 million. This SEC/GAAP measure is not an estimate of market value.
Material changes versus 2011
- Total revenue declined 4.8%, including a $7.10 million reduction in realized derivative gains and a $2.78 million decline in field-service income. The 2011 comparison included $6.3 million of gains from early derivative settlements and $2.59 million of recovered offshore gas-transportation costs.
- Oil revenue grew 18% as production increased, but gas revenue fell 34%, reflecting lower gas prices and lower volumes. Lease operating expense increased 8% to $39.87 million.
- Net income attributable to PrimeEnergy increased by $10.25 million. The company attributed the improvement primarily to lower DD&A, partly offset by lower operating revenue and higher lease operating and income tax expenses. Offshore properties were plugged and abandoned during 2012, contributing to the DD&A decline.
- Operating cash flow was slightly lower while capital spending more than doubled. Operating cash flow less capital expenditures was approximately negative $46.6 million; financing cash flow, including increased bank borrowing, largely funded the investment.
Outlook, risks and unusual items
- Management planned approximately 30 gross (20 net) wells in 2013, primarily in West Texas, at an estimated net cost of $36 million. The company expected continued stock and limited-partnership interest repurchases; spending on these programs was $5.1 million in 2012.
- The company completed plugging and abandonment work on all operated offshore properties during 2012. Asset retirement obligations were $9.0 million at year-end, after $15.4 million of liabilities were settled and estimates were revised.
- Commodity-price exposure remains significant. The company sells most production at spot prices, uses derivatives, and records commodity derivative fair-value changes in earnings without hedge accounting. 2012 included $3.5 million of unrealized derivative gains and $1.0 million of gains from early settlements. The filing also describes an interest-rate swap covering $75 million of debt, with settlements scheduled to begin in January 2014.
- Key risks include oil and gas price volatility, drilling and reserve-estimation uncertainty, the ability to replace reserves, environmental and regulatory requirements (including potential hydraulic-fracturing rules), and uninsured operational or pollution losses. Major purchasers accounted for 57% of oil sales to Plains All American and 45% of gas sales to Atlas Pipeline Mid-Continent; the filing says there are no long-term purchase agreements with these customers.
- The company reported no legal proceedings and no material expected effect from its ordinary-course legal matters or environmental compliance costs. It reported effective disclosure controls and internal control over financial reporting as of year-end; the auditor did not provide an internal-control attestation.
Important facts for investors to verify
- How much of the earnings improvement resulted from the lower DD&A associated with offshore property depletion and abandonment, and how sustainable are earnings under normalized DD&A?
- Whether planned drilling and development spending can be funded while maintaining covenant compliance and adequate borrowing-base availability.
- The economics and development timing of the increased proved undeveloped reserves, particularly the concentration of reserves in West Texas.
- Exposure to lower commodity prices, derivative settlement and mark-to-market volatility, and the concentration of sales among major purchasers.
- The assumptions underlying reserve estimates, the standardized measure, and remaining asset-retirement obligations.