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EX-31.2 - EXHIBIT 31-2 - APCO OIL & GAS INTERNATIONAL INCex31_2.htm



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM 10-Q

(Mark one)

 
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the quarterly period ended June 30, 2011

OR

 
0 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the transition period from           to          

Commission file number 0-8933

APCO OIL AND GAS INTERNATIONAL INC.
(Exact name of registrant as specified in its charter)

CAYMAN ISLANDS
 
(State or Other Jurisdiction of
EIN 98-0199453
Incorporation or Organization)
(I.R.S. Employer Identification No.)
   
ONE WILLIAMS CENTER, 35th FLOOR
 
TULSA, OKLAHOMA
74172
(Address of Principal Executive Offices)
(Zip Code)
   
(Registrant's Telephone Number, Including Area Code)
(918) 573-2164

NO CHANGE
(Former name, Former Address and Former Fiscal Year, if Changed Since Last Report)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes T     No £

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files).

Yes T No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):
 
 
Large Accelerated Filer £   Accelerated Filer T Non-Accelerated Filer £  Smaller Reporting Company £
(Do not check if a smaller reporting company)

 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes £ No T
 
Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date.

Class
Outstanding at July 29, 2011
Ordinary Shares, $0.01 Par Value
9,139,648 Shares
Class A Shares, $0.01 Par Value
20,301,592 Shares




APCO OIL AND GAS INTERNATIONAL INC.



PART I.     FINANCIAL INFORMATION                                                                          Page No.
       
 
Item 1.
Financial Statements - Unaudited
 
       
     
   
5
       
     
   
6
       
   
 
    7
       
     
   
8
       
   
9
       
 
Item 2.
 
   
17
       
 
Item 3.
 
    27
       
 
Item 4.
28
       
PART II
OTHER INFORMATION

 
Item 1.
29
       
 
Item 1A.
29
       
 
Item 6.
30
       
 
FORWARD-LOOKING STATEMENTS

Certain matters contained in this report include “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  These forward-looking statements relate to anticipated financial performance, management’s plans and business objectives for future operations, business prospects, outcome of regulatory proceedings, market conditions and other matters.  We make these forward-looking statements in reliance on the safe harbor protections provided under the Private Securities Litigation Reform Act of 1995.

All statements, other than statements of historical facts, included in this report that address activities, events or developments that we expect, believe or anticipate will exist or may occur in the future, are forward-looking statements.  Forward-looking statements can be identified by various forms of words such as “anticipates,” “believes,” “could,” “may,” “should,” “continues,” “estimates,” “expects,” “forecasts,” “intends,” “might,” “objectives,” “planned,” “potential,” “projects,” “scheduled,” “will” or other similar expressions.  These forward-looking statements are based on management’s beliefs and assumptions and on information currently available to management and include, among others, statements regarding:




·
  Amounts and nature of future capital expenditures;

·
  Volumes of future oil, gas and liquefied petroleum gas (LPG) production;

·
  Expansion and growth of our business and operations;

·
  Financial condition and liquidity;

·
  Business strategy;

·
  Estimates of proved oil and gas reserves;

·
  Reserve potential;

·
  Development drilling potential;

·
  Cash flow from operations or results of operations;

·
  Seasonality of natural gas demand; and

·
  Oil and natural gas prices and demand for those products.

Forward-looking statements are based on numerous assumptions, uncertainties, and risks that could cause future events or results to be materially different from those stated or implied in this report.  Many of the factors that will determine these results are beyond our ability to control or predict.  Specific factors that could cause actual results to differ from results contemplated by the forward-looking statements include, among others, the following:

·
  Availability of supplies (including the uncertainties inherent in assessing, estimating, acquiring and developing future oil and natural gas reserves), market demand, volatility of prices and the availability and cost of capital;

·
  Inflation, interest rates, fluctuation in foreign exchange rates, and general economic conditions (including future disruptions and volatility in the global credit markets and the impact of these events on our customers and suppliers);

·
  The strength and financial resources of our competitors;

·
  Development of alternative energy sources;

·
  The impact of operational and development hazards;

·
  Costs of, changes in, or the results of laws, government regulations (including climate change regulation and/or potential additional regulation of drilling and completion of wells), environmental liabilities and litigation;

·
  Political conditions in Argentina, Colombia, and other parts of the world;

·
  The failure to renew participation in hydrocarbon concessions granted by the Argentine government on reasonable terms;

·
  Risks related to strategy and financing, including restrictions stemming from our loan agreement and the availability and cost of credit;

·
  Risks associated with future weather conditions and earthquakes;

·
  Acts of terrorism; and

·
  Additional risks described in our filings with the Securities and Exchange Commission (SEC).

Given the uncertainties and risk factors that could cause our actual results to differ materially from those contained in any forward-looking statement, we caution investors not to unduly rely on our forward-looking statements.  We disclaim any obligations to and do not intend to update the above list or to announce publicly the result of any revisions to any of the forward-looking statements to reflect future events or developments.



In addition to causing our actual results to differ, the factors listed above and referred to below may cause our intentions to change from those statements of intention set forth in this report.  Such changes in our intentions may also cause our results to differ.  We may change our intentions at any time and without notice, based upon changes in such factors, our assumptions, or otherwise.

Because forward-looking statements involve risks and uncertainties, we caution that there are important factors, in addition to those listed above, that may cause actual results to differ materially from those contained in the forward-looking statements.  For a detailed discussion of those factors, see Part I, Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2010.


 PART I.  FINANCIAL INFORMATION

Item 1.  Financial Statements
APCO OIL AND GAS INTERNATIONAL INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)

(Amounts in Thousands Except Share Amounts)
 
June 30,
   
December 31,
 
   
2011
   
2010
 
ASSETS
           
Current assets:
           
Cash and cash equivalents
  $ 34,812     $ 35,234  
Accounts receivable
    9,991       11,757  
Advances to partners
    294       419  
Inventory
    2,582       2,300  
Restricted cash
    -       4,000  
Other current assets
    2,760       2,265  
Total current assets
    50,439       55,975  
                 
Property and Equipment:
               
Cost, successful efforts method of accounting
    236,552       216,891  
Accumulated depreciation, depletion and amortization
    (119,730 )     (109,986 )
      116,822       106,905  
                 
Argentine investment, equity method
    85,607       82,652  
Deferred income tax asset
    1,270       1,236  
Restricted cash
    8,375       -  
                 
Other assets (net of allowance of $584 at June 30, 2011 and $600 at December 31, 2010)
    2,444       1,421  
                 
    $ 264,957     $ 248,189  
LIABILITIES AND SHAREHOLDERS' EQUITY
               
Current liabilities:
               
Accounts payable
  $ 8,204     $ 8,479  
Affiliate payables
    490       297  
Accrued liabilities
    3,607       3,409  
Income taxes payable
    2,855       3,248  
Dividends payable
    589       589  
Total current liabilities
    15,745       16,022  
                 
Long-term debt
    2,000       -  
Long-term liabilities
    3,068       2,709  
Contingent liabilites and commitments (Note 7)
               
Equity:
               
Shareholders' equity
               
   Share capital, 60,000,000 shares authorized, par value $0.01 per share;
               
Ordinary shares, 9,139,648 shares issued and outstanding at June 30, 2011;
               
29,441,240 issued and outstanding at December 31, 2010
    92       295  
Class A shares, 20,301,592 shares issued and outstanding at June 30, 2011
    203       -  
Additional paid-in capital
    9,105       9,105  
Accumulated other comprehensive loss
    (1,224 )     (1,224 )
Retained earnings
    235,751       221,068  
  Total shareholders' equity
    243,927       229,244  
    Noncontrolling interests in consolidated subsidiaries
    217       214  
        Total equity
    244,144       229,458  
Total liabilities and equity
  $ 264,957     $ 248,189  

The accompanying notes are an integral part of these consolidated financial statements.




APCO OIL AND GAS INTERNATIONAL INC.
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)

 
(Amounts in Thousands Except Per Share Amounts)
 
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
   
2011
   
2010
   
2011
   
2010
 
REVENUES:
                       
Oil revenues
  $ 19,601     $ 17,696     $ 37,659     $ 32,837  
Natural gas revenues
    2,980       2,602       6,510       5,781  
LPG revenues
    842       942       1,786       1,840  
Other
    1,153       570       1,704       1,170  
         Total revenues      24,576       21,810       47,659       41,628  
                                 
COSTS AND OPERATING EXPENSES:
                               
Production and lifting costs
    6,106       4,390       10,524       7,823  
Taxes other than income
    4,490       3,909       9,324       7,278  
Transportation and storage
    184       126       331       285  
Selling and administrative
    2,460       2,337       4,781       4,298  
Depreciation, depletion and amortization
    4,851       4,061       9,525       7,878  
Exploration expense
    980       1,130       1,480       5,323  
Foreign exchange losses (gains)
    (305 )     21       (373 )     47  
Other expense
      260       462       692       969  
Total costs and operating expenses
    19,026       16,436       36,284       33,901  
                                 
TOTAL OPERATING INCOME
    5,550       5,374       11,375       7,727  
                                 
INVESTMENT INCOME:
                               
Interest and other income (expense)
    (3 )     183       96       258  
Equity income from Argentine investment
     4,513       4,309       9,280       8,131  
Total investment income
    4,510       4,492       9,376       8,389  
                                 
Income before income taxes
    10,060       9,866       20,751       16,116  
Income taxes
     2,352       2,740       4,873       4,986  
                                 
NET INCOME
    7,708       7,126       15,878       11,130  
    Less: Net income attributable to noncontrolling interests
    9       9       17       17  
Net income attributable to Apco Oil and Gas International Inc.
  $  7,699     $ 7,117     $ 15,861     $ 11,113  
                                 
Amounts attributable to Apco Oil and Gas International Inc.:
                               
  Earnings per share – basic and diluted:
                               
  NET INCOME PER SHARE
  $  0.26     $ 0.24     $ 0.54     $ 0.38  
                                 
Average ordinary and Class A shares outstanding – basic and diluted
    29,441       29,441       29,441       29,441  
                                 
Cash dividends declared per ordinary share
  $ 0.04     $ 0.02     $ 0.04     $ 0.02  
Cash dividends declared per Class A share
  $ 0.02     $ -     $ 0.02     $ -  
 

The accompanying notes are an integral part of these consolidated financial statements.


APCO OIL AND GAS INTERNATIONAL INC.
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
(UNAUDITED)

 
   
For the six months ended June 30,
 
(Amounts in Thousands)
 
2011
   
2010
 
   
Shareholders'
   
Noncontrolling
         
Shareholders'
   
Noncontrolling
       
     Equity      Interests      Total      Equity       Interests      Total  
                                     
Beginning Balance
  $ 229,244     $ 214     $ 229,458     $ 205,633     $ 204     $ 205,837  
Net Income
    15,861       17       15,878       11,113       17       11,130  
                                                 
Total comprehensive income
    15,861       17       15,878       11,113       17       11,130  
Cash dividends declared
    (1,178 )     -       (1,178 )     (589 )     -       (589 )
Dividends and distributions to
                                               
noncontrolling interests
    -       (14 )     (14 )     -       (12 )     (12 )
Ending Balance
  $ 243,927     $ 217     $ 244,144     $ 216,157     $ 209     $ 216,366  
 

The accompanying notes are an integral part of these consolidated financial statements.




APCO OIL AND GAS INTERNATIONAL INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

 
(Amounts in Thousands Except Per Share Amounts)
 
Six Months Ended
 
   
June 30,
 
   
2011
   
2010
 
             
CASH FLOW FROM OPERATING ACTIVITIES:
           
Net income
  $ 15,878     $ 11,130  
Adjustments to reconcile to net cash provided by operating activities:
               
Equity income from Argentine investment
    (9,280 )     (8,131 )
Dividends received from Argentine investment
    6,325       7,351  
Deferred income tax (benefit)
    (72 )     (74 )
Depreciation, depletion and amortization
    9,525       7,878  
Changes in accounts receivable
    1,766       (1,783 )
Changes in inventory
    (282 )     (41 )
Changes in other current assets
    (365 )     (607 )
Changes in accounts payable
    (2,377 )     1,727  
Changes in advances to partners
    126       64  
Changes in affiliate payables, net
    193       142  
Changes in accrued liabilities
    (152 )     (1,656 )
Changes in income taxes payable
    (393 )     (1,274 )
Other, including changes in noncurrent assets and liabilities
      (538 )      (23 )
Net cash provided by operating activities
    20,354       14,703  
CASH FLOW FROM INVESTING ACTIVITIES:
               
Property plant and equipment:
               
Capital expenditures *
    (17,209 )     (13,159 )
Changes in restricted cash
    (4,375 )     -  
Net cash used in investing activities
    (21,584 )     (13,159 )
CASH FLOW FROM FINANCING ACTIVITIES:
               
Proceeds from long-term debt
    2,000       -  
Dividends paid to noncontrolling interests
    (14 )     (12 )
Dividends paid ($.04 per ordinary share in 2011 and 2010)
    (1,178 )     (1,178 )
Net cash provided by financing activities
    808       (1,190 )
                 
(Decrease) / increase in cash and cash equivalents
    (422 )     354  
                 
Cash and cash equivalents at beginning of period
      35,234       32,404  
                 
Cash and cash equivalents at end of period
  $ 34,812     $ 32,758  
                 
________________________
               
*  Increases to property plant and equipment, net of asset dispositions
  $ (19,661 )   $ (14,222 )
    Changes in related accounts payable and accrued liabilities
     2,452        1,063  
    Capital expenditures
  $ (17,209 )   $  (13,159 )

The accompanying notes are an integral part of these consolidated financial statements.


 
8


 
APCO OIL AND GAS INTERNATIONAL INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
(UNAUDITED)

(1)  
Basis of Presentation and Summary of Accounting Policies

General Information and Principles of Consolidation

Apco Oil and Gas International Inc. (“Apco”) is an international oil and gas exploration and production company with a focus on South America.  Exploration and production will be referred to as “E&P” in this document.

Apco began E&P activities in Argentina in the late 1960s, and as of June 30, 2011, had interests in eight oil and gas producing concessions and two exploration permits in Argentina.  E&P activities in Colombia began in 2009 where we have three exploration and production contracts.  Our producing operations are located in the Neuquén, Austral, and Northwest basins in Argentina.  We also have exploration activities currently ongoing in both Argentina and Colombia.  As of June 30, 2011, all of our operating revenues and equity income, and all but $2.6 million of our long-lived assets for which we have carrying values on our balance sheet, were in Argentina.

The consolidated financial statements include the accounts of Apco Oil and Gas International Inc. (a Cayman Islands company) and its subsidiaries, Apco Properties Ltd. (a Cayman Islands company), Apco Austral S.A. (an Argentine corporation), and Apco Argentina S.A. (an Argentine corporation), which as a group are at times referred to in the first person as “we,” “us,” or “our.” We also sometimes refer to Apco as the “Company.”

The Company proportionately consolidates its direct interest of the accounts of its joint ventures into its consolidated financial statements.

Our core operations are our 23 percent working interests in the Entre Lomas, Bajada del Palo and Charco del Palenque concessions and the Agua Amarga exploration permit in the Neuquén basin, and a 40.803 percent equity interest in Petrolera Entre Lomas S.A. (Petrolera, a privately owned Argentine corporation), which is accounted for using the equity method (see Note 4).  Petrolera is the operator and owns a 73.15 percent working interest in the same properties.  Consequently, Apco’s combined direct consolidated and indirect equity interests in the properties underlying the joint ventures total 52.85 percent. The Charco del Palenque concession is the portion of the Agua Amarga exploration permit which was converted to a 25-year exploitation concession in the fourth quarter of 2009. We sometimes refer to these areas in a group as our “Neuquén basin properties.”

The unaudited, consolidated financial statements of Apco included herein do not include all footnote disclosures normally included in annual financial statements and, therefore, should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.

All intercompany balances and transactions between Apco and its subsidiaries have been eliminated in consolidation.

In the opinion of the Company, all normal adjustments have been made to present fairly the results of the three and six-month periods ended June 30, 2011 and 2010 (see Note 2).  The results for the periods presented are not necessarily indicative of the results for the respective complete years.


 
9


 
APCO OIL AND GAS INTERNATIONAL INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
(UNAUDITED)


Relationship with The Williams Companies, Inc.

Williams Global Energy (Cayman) Limited, (“Williams Global Energy”), a wholly owned subsidiary of The Williams Companies, Inc. (“Williams”) owns 68.96 percent of the outstanding shares of Apco.  We are managed by employees of Williams, and all of our executive officers and three of our directors are employees of Williams. Pursuant to an administrative services agreement between us and Williams, Williams provides us with management services, office space, insurance, treasury, accounting, tax, legal, corporate communications, information technology, human resources, internal audit and other administrative corporate services.

On February 16, 2011, Williams announced that its Board of Directors approved a reorganization plan to divide its business into two separate, publicly-traded corporations.  The initial phase in Williams’ reorganization plan calls for the separation of its exploration and production business into a new, wholly owned subsidiary, WPX Energy, Inc. (“WPX Energy”), and a public offering of WPX Energy common stock.  The second phase calls for a tax-free spin-off of Williams’ remaining interest in WPX Energy to Williams’ shareholders.  On April 29, 2011, pursuant to the first phase of the reorganization plan, WPX Energy filed a Registration Statement on Form S-1 with the SEC with respect to an initial public offering of its equity securities. Williams retains the discretion to determine whether and when to complete these transactions.

Because we are an oil and gas exploration and production company and utilize the personnel and resources of Williams’ exploration and production business, Williams stated its desire to transfer its entire interest in Apco to WPX Energy along with virtually all of its exploration and production assets and personnel.

In order to facilitate the transfer of Williams’ interest in Apco to WPX Energy in a tax efficient manner, on June 30, 2011 our shareholders authorized our Board of Directors to issue a separate redeemable convertible class of shares, designated Class A Shares, which have, as a class, 85 percent of the voting power with respect to the election and removal of our directors and authorized us to issue one Class A Share to Williams Global Energy in exchange for each ordinary share of the Company owned by Williams Global Energy.  Consistent with this approval, on June 30, 2011, we issued 20,301,592 Class A Shares, par value $.01 per share, to Williams Global Energy, in exchange for an equal number of our ordinary shares.  No other consideration was paid in connection with the exchange.   The Class A Shares and the ordinary shares have identical rights and preferences in all other respects, including with respect to dividend rights.  The Class A Shares will automatically convert into our ordinary shares in the event that neither Williams, nor WPX Energy, beneficially owns, separately or in the aggregate, directly or indirectly, at least 50 percent of the aggregate outstanding Class A Shares and ordinary shares of the Company.

Reclassifications

Prior year provincial production taxes, taxes other than income and certain other expenses have been reclassified to conform to current year presentation of all of our operating taxes as Taxes other than income.

Fair Value Measurements

The carrying amount reported in the balance sheet for cash equivalents, accounts receivable, restricted cash and accounts payable is equivalent to fair value due to the frequency and volume of transactions in and the short-term nature of these accounts.

 
10


 
APCO OIL AND GAS INTERNATIONAL INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
(UNAUDITED)

Revenue Recognition

The Company recognizes revenues from sales of oil, gas, and plant products at the time the product is delivered to the purchaser and title has been transferred.

Taxes Other Than Income

The Company is subject to multiple taxes in Argentina and Colombia, including provincial production taxes, severance taxes, export taxes, shareholder equity taxes and various transaction taxes.

Restricted Cash

At June 30, 2011, we have $8.4 million of restricted cash which is collateral for letters of credit related to exploration blocks in Colombia.  The letters of credit expire in various dates in 2012 and 2013.

Property and Equipment

The Company uses the successful-efforts method of accounting for oil and gas exploration and production operations, whereby costs of acquiring non-producing acreage and costs of drilling successful exploration wells and development costs are capitalized. Geological and geophysical costs, including three dimensional (“3D”) seismic survey costs, and costs of unsuccessful exploratory drilling are expensed as incurred. Oil and gas properties are depreciated over their concession lives using the units of production method based on proved and proved producing reserves. The Company’s proved reserves are limited to the concession life even though a concession’s term may be extended for 10 years based on terms to be agreed with and the consent of the Argentine government.

Non oil and gas property is recorded at cost and is depreciated on a straight-line basis, using estimated useful lives of three to 15 years.

The Company reviews its proved and unproved properties for impairment on a property by property basis and recognizes an impairment whenever events or circumstances, such as declining oil and gas prices, indicate that a property’s carrying value may not be recoverable. The Company records a liability for future asset retirement obligations in accordance with the requirements of FASB ASC 410 (Asset Retirement and Environmental Obligations).

Net Income per Share

Net income per share is calculated by dividing net income (loss) attributable to Apco Oil and Gas International Inc. shareholders by the weighted average number of ordinary and Class A shares outstanding.  Basic and diluted net income per share is the same because the Company has not issued any potentially dilutive securities such as stock options.  The Class A Shares and the ordinary shares have identical rights and preferences with respect to dividends.

 
11


 
APCO OIL AND GAS INTERNATIONAL INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
(UNAUDITED)

Nonmonetary Transactions

The Company accounts for nonmonetary transactions based on the fair values of the assets involved, which is the same basis as that used in monetary transactions.  During the first six months of 2011, we delivered a volume of our oil production to a third-party refinery to satisfy a portion of our provincial production tax obligation.  The crude oil inventory that was transferred to satisfy this obligation was recognized at fair value.  We recorded approximately $1.3 million in operating revenues and taxes other than income as a result of this transaction.


(2)  
Taxes Other Than Income
 
During the second quarter 2011, we determined that a special Colombian equity tax assessed effective January 1, 2011 was not recorded in the first quarter of 2011, thereby understating taxes other than income by $572 thousand.  Amounts for the second quarter of 2011 have been properly reported (excluding this assessment).  Amounts for the six months ended June 30, 2011, include this assessment of $572 thousand.  The effect of correcting this assessment in the three months ended March 31, 2011, is to reduce previously reported net income of $8.7 million by $572 thousand to $8.2 million (reflect net income per share of $0.28).
 
(3)  
Income Taxes

As described in Note 8 of the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010, the Company’s earnings are currently not subject to U.S. income taxes, nor Cayman Islands income or corporation taxes.  Income derived by the Company from its Argentine operations is subject to Argentine income tax at a rate of 35 percent and is included in the Consolidated Statements of Income as Income taxes.

The effective income tax rate reflected in the Consolidated Statements of Income differs from Argentina’s statutory rate of 35 percent.  This is because the Company currently incurs income taxes only in Argentina where all of its oil and gas income generating activities are presently located. Additionally, equity income from Argentine investment is recorded by the Company on an after tax basis.  The Company also generates income and incurs expenses outside of Argentina that are not subject to income taxes in Argentina or in any other jurisdiction.  Therefore these amounts do not affect the amount of income taxes paid by the Company.  Such items include interest income resulting from the Company’s cash and cash equivalents deposited in its Cayman Island and Bahamas bank accounts, general and administrative expenses incurred by the Company in its headquarters office in Tulsa, Oklahoma, and foreign exchange gains and losses resulting from changes in the value of the peso which do not affect taxable income in Argentina.  The Company also incurs costs and expenses in Colombia that currently provide no benefit to income tax expense until these activities generate sufficient taxable income in Colombia.


 
12


 
APCO OIL AND GAS INTERNATIONAL INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
(UNAUDITED)


Provision is made for deferred Argentine income taxes applicable to temporary differences between the financial statement and tax basis of the assets and liabilities. The table below summarizes the income tax expense for the periods shown. Amounts are stated in thousands:

   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
   
2011
   
2010
   
2011
   
2010
 
Income taxes:
                       
Current
  $ 2,412     $ 2,776     $ 4,945     $ 5,060  
Deferred
    (60 )      (36 )     (72 )     (74 )
Income tax expense
  $  2,352     $ 2,740     $ 4,873     $ 4,986  
 
The effective income tax rate is lower for the three and six-months ended June 30, 2011, compared with the same periods of 2010 due to the significant amounts of exploration expense incurred in Colombia during 2010 which provided no benefit to income tax expense during those periods.

As of June 30, 2011 and December 31, 2010, the Company had no unrecognized tax benefits or reserve for uncertain tax positions.

The Company’s policy is to recognize tax related interest and penalties as a component of income tax expense.  The statute of limitations for income tax audits in Argentina is six years, and begins on December 31 in the year in which the tax return is filed, therefore the tax years 2004 through 2010 remain open to examination.

(4)  
Investment in Petrolera Entre Lomas S.A.

The Company uses the equity method to account for its 40.803 percent investment in Petrolera Entre Lomas S.A., “Petrolera” a non-public Argentine corporation. Petrolera’s principal business is its operatorship and 73.15 percent interest in the Entre Lomas, Bajada del Palo and Charco del Palenque concessions and the Agua Amarga exploration permit.

Under the equity method of accounting, the Company's share of net income (loss) from Petrolera is reflected as an increase (decrease) in its investment account and is also recorded as equity income (loss) from Argentine investment. Dividends received from Petrolera are recorded as reductions of the Company’s investment.

The Company’s carrying amount of its investment in Petrolera is greater than its proportionate share of Petrolera’s net equity by $576 thousand.  The reasons for this basis difference are: (i) goodwill recognized on its acquisition of additional Petrolera shares in 2002 and 2003; (ii) certain costs expensed by Petrolera but capitalized by the Company; (iii) recognition of a provision for doubtful account associated with a receivable held by Petrolera; and (iv) a difference from periods prior to 1991 when the Company accounted for its interest in Petrolera under the cost recovery method, which will be recognized upon full recovery of the Company’s investment.

Summarized unaudited financial position and results of operations of Petrolera are presented in the following tables.


 
13


 
APCO OIL AND GAS INTERNATIONAL INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
(UNAUDITED)


Petrolera’s financial position at June 30, 2011 and December 31, 2010 is as follows.  Amounts are stated in thousands:

   
June 30,
   
December 31,
 
   
2011
   
2010
 
             
Current assets
  $ 61,228     $ 65,621  
Non current assets
    226,941       228,875  
Current liabilities
    47,334       52,158  
Non current liabilities
    44,983       41,047  

Petrolera’s results of operations for the three and six months ended June 30, 2011 and 2010 are as follows.  Amounts are stated in thousands:

 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
 2011
 
 2010
 
 2011
 
 2010
               
Revenues
 $        60,013
 
 $        55,647
 
 $      117,015
 
 $      105,188
Expenses other than income taxes
           46,115
 
           37,461
 
           83,237
 
           71,661
Net income
           10,502
 
           10,561
 
           22,598
 
           19,948


(5)  
Accrued Liabilities

The balance of accrued liabilities consisted of the following:
 
   
June 30,
   
December 31,
 
(Amounts in thousands)
 
2011
   
2010
 
             
Taxes other than income payable
  $ 864     $ 593  
Accrued provincial production taxes
    907       687  
Accrued payroll and other general and adminstrative expenses
    1,380       1,365  
Accrued oil and gas expenditures
    237       55  
Other
    219       709  
    $ 3,607     $ 3,409  

 
14


 
APCO OIL AND GAS INTERNATIONAL INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
(UNAUDITED)


(6)  
Debt and Banking Arrangements

Due to increased exploration and development activities in our core areas for the year and in anticipation of obtaining the ten-year concession extensions for certain of our properties in Argentina, we executed a loan agreement with a financial institution for a $10 million bank line of credit.  Borrowings under this facility are unsecured and bear interest at six-month Libor plus three percent per annum plus a one percent arrangement fee per borrowing and a commitment fee for the unused portion of the loan amount. The funds can be borrowed during a one-year period ending in March 2012, and principal amounts will be repaid in four equal installments over four years from each borrowing date after a two and a half year grace period.  This debt agreement contains covenants that restrict or limit, among other things, our ability to create liens supporting indebtedness, purchase or sell assets outside the ordinary course of business, and incur additional debt.  As of June 30, 2011, we have borrowed $2 million under this banking agreement.  The carrying amount of our long-term debt approximates its fair value.

(7)  
Contingencies

In November 2004, the Company received a formal notice from the Banco Central de la Republica Argentina (the Central Bank of Argentina or the “BCRA”), of certain proceedings based upon alleged violation of foreign currency regulations. Specifically, the BCRA claimed that between December of 2001 and November of 2002 the Company failed to bring into the country 100 percent of the foreign currency proceeds from its Argentine oil exports. In 1989, the government established guidelines that required most oil companies to bring into Argentina 30 percent of foreign currency proceeds from exports instead of 100 percent of such proceeds as was generally required of exporters in other industries. In 1991, all foreign exchange controls were lifted by the government.

In response to Argentina’s economic crisis of 2001 and 2002, the government reintroduced foreign exchange controls in 2002, and as a result the Company repatriated 30 percent of its proceeds from oil exports during 2002 following the 1989 guidelines. An opinion from Argentina’s Attorney General, however, declared that the benefits granted to the oil and gas industry in 1989 were no longer effective and, therefore, 100 percent of such funds had to be repatriated. This opinion supported the position taken by the Argentine government during 2002. The government then revised its position in 2003 and expressly clarified that oil companies are required to only repatriate 30 percent of such proceeds. The government’s departure from its 2002 position was effective January 1, 2003, leaving some uncertainty in the law with regard to 2002.

The BCRA audited the Company in 2004 and took the position that 100 percent of its foreign currency proceeds from its 2002 exports were required to be returned to the country rather than only 30 percent, as had been returned to the country by the Company in 2002. The difference for the Company totals $6.2 million. In December 2004, the Company filed a formal response disagreeing with the position taken by the BCRA. In addition, without admitting any wrongdoing, the Company brought into the country $6.2 million and exchanged this amount for Argentine pesos using the applicable exchange rates required by the regulation.


 
15


 
APCO OIL AND GAS INTERNATIONAL INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
(UNAUDITED)


In May 2011, the BCRA sent the case file to the National Justice for Economic Crimes.  The Company anticipates that this matter will remain open for some time. Under the pertinent foreign exchange regulations, the BCRA may impose significant fines on the Company; however, historically few fines have been made effective in those cases where the foreign currency proceeds were brought into the country and traded in the exchange market at the adequate exchange rate and the exporters had reasonable grounds to support their behavior. As a result, a conclusion as to the probability of an outcome or the amount of any loss to the Company that might result from this proceeding cannot be made at this time.

(8)  
Subsequent Events

In July 2011, we earned our full 45 percent interest in the Coirón Amargo exploration permit in the Neuquén basin by completing our drilling commitments.




Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis explains the significant factors that have affected our results of operations for the three and six-month periods ended June 30, 2011, compared with the three and six-month periods ended June 30, 2010, and our financial condition since December 31, 2010. This discussion and analysis should be read in conjunction with the Consolidated Financial Statements and notes thereto included in Item 1 of this document and our 2010 Annual Report on Form 10-K.

Overview of Three and Six Months Ended June 30, 2011

During the second quarter and first six months of 2011, net income attributable to Apco Oil and Gas International Inc. was $7.7 million and $15.9 million compared with $7.1 million and $11.1 million for the same periods in 2010.  Net income was slightly higher quarter-to-quarter as the combination of higher operating revenues, greater equity income and lower income taxes was offset by higher costs and operating expenses.  The increase in net income for the first six months of 2011 is primarily the result of higher average oil sales prices, greater equity income from Argentine investment and lower exploration expense.  These benefits were partially offset by higher production and lifting costs and depreciation expense compared with the first six months of 2010.

Net cash provided by operating activities during the six months of 2011 was $20.4 million, an increase of $5.7 million primarily due to higher operating income compared with the first six months of 2010.  We ended the second quarter with a cash and cash equivalents balance of $34.8 million, or 13 percent of total assets.  Additionally, we have $8 million available credit from our banking agreement. We believe we have sufficient liquidity and capital resources to fund our ongoing operations, planned capital expenditures and dividend payments during 2011.

See additional discussion in Results of Operations and Financial Condition.

Neuquén Basin Properties

During the second quarter of 2011, we continued to have success with development drilling and exploration activities in our Neuquén basin properties.  During the first six months of the year, we completed and put on production five oil wells that commenced drilling in 2010.  For our 2011 drilling program, 12 wells were drilled, completed, and put on production, and five additional wells were in various stages of drilling or completion at the end of the quarter.  Additional activities included exploration efforts to stimulate production from the Vaca Muerta shale in three existing wells in the Bajada del Palo and Entre Lomas concessions.  The Vaca Muerta formation was not productive in two of these wells.  In the third well, results were inconclusive and additional studies are being conducted to more fully understand the actual results of this well.  All of the costs associated with these three well re-entries have been expensed as exploration costs.  During the remainder of 2011 we plan to continue investigating the Vaca Muerta shale through additional well re-entries or drilling.

In our Agua Amarga exploration permit, we completed and put on production the Meseta Filosa exploration well that was in progress at year end.  In April 2011, the first exploration period was formally extended for one year until May 2012.  Since acquiring the Agua Amarga exploration permit in 2007, we have drilled exploration wells on six separate geologic structures all of which have resulted in hydrocarbon discoveries.

The western most portion of our Bajada del Palo concession is known as “Aguada del Poncho.”  Like the southern portion of our Coirón Amargo permit, Aguada del Poncho is situated in the deepest portion of the Neuquén basin near the Repsol YPF S.A. (“YPF”) Loma de la Lata concession. The recently completed interpretation of 3D seismic which was acquired over this portion of the block in 2010 has resulted in the identification of multiple drillable structures targeting both the Quintuco and Tordillo formations. During 2011, an existing well, the Aguada del Poncho 1,  was reentered and successfully put on production from the Quintuco formation at a better than expected rate of oil production. Apco and its partners intend to drill two exploration wells on this acreage prior to the end of 2011.



Coirón Amargo

Pursuant to the farm-in agreement in the Coirón Amargo exploration permit in the Neuquén basin, Apco had previously earned a 22.5 percent non operated interest for funding the drilling of two exploration wells during 2010. Both wells resulted in oil discoveries. Apco elected to proceed to a second phase and drill two additional exploration wells to increase our interest to 45 percent. The second phase wells, the CAS x-1 and CAN x-4, were drilled prior to the end of the second quarter. Both wells were subsequently completed and tested, resulting in oil discoveries in the Tordillo formation. We have completed our commitments to earn a 45 percent interest in the exploration permit.

The CAN x-4 well has been put on production from the Tordillo formation. The CAS x-1 well in the southern part of the permit also tested oil from the Vaca Muerta formation. Initially, this well will remain on test from the Vaca Muerta formation to determine its ability to sustain any flow of oil without stimulation. Our plan is to evaluate its performance during the short term and then, depending on the results of this evaluation, return to the well to either perform a fracture stimulation of the Vaca Muerta or put the well on production from the Tordillo formation. We anticipate conducting further exploration activities targeting both the Tordillo and Vaca Muerta formations that will include drilling and possibly well re-entries throughout the remainder of 2011.  These investments will occur prior to November 2011, the current exploration period expiration date.  By November, we will determine how much of the area will be converted to an exploitation concession and how much acreage, if any, will have to be relinquished.

Since entering our farm-in agreement in early 2010, we have drilled four wells resulting in hydrocarbon discoveries on four geological structures. This achievement is a continuation of our success during recent years where we have utilized an established geologic model to drill exploration wells in our core properties in the Neuquén basin.

Colombia Exploration

Our seismic programs in both the Turpial and Llanos 32 blocks in Colombia were completed in 2010.  Apco and its partners have agreed on the location of the first exploration wells to be drilled in each of these blocks.  Drilling and environmental permit applications were submitted some time ago, but because of the large number of wells scheduled to be drilled in Colombia, there is a significant backlog of unapproved permits and the permitting authority has been slow to grant approvals.  Assuming the permits are obtained in time, we expect to commence drilling our first wells in Colombia during the fourth quarter of 2011.  Because the current exploration period in the Turpial block expires in September, we have requested and expect to receive a contract extension as a result of the permitting delays.  During the second half of 2011, we expect to acquire 305 square kilometers of 3D seismic over our Llanos 40 block estimated to cost $5.7 million net to our 50 percent interest.

Oil Prices

Oil prices have a significant impact on our ability to generate earnings, fund capital projects, and pay shareholder dividends.  In general, oil prices are affected by many factors, including changes in market demands, global economic activity, political events, weather, and OPEC production quotas.  More importantly to Apco, oil sales price realizations for oil produced and sold in Argentina are significantly influenced by Argentine governmental actions.

In Argentina, politically driven mechanisms significantly influence the sale price of oil produced and sold in the country. To alleviate the impact of higher crude oil prices on Argentina’s economy and reduce inflation, the Argentine government created an oil export tax and enacted price controls over gasoline prices to force producers and refiners to negotiate oil sales prices significantly below international market levels.




Gradual increases in gasoline prices in Argentina have enabled producers to negotiate higher oil sales prices with refiners.  The trend of increasing gasoline prices combined with tighter demand for our high-quality crude oil has resulted in higher oil price realizations.  For the second quarter of 2011, our average realized price for our direct working interests consolidated in our operating revenues was $59.54 per barrel, compared with $51.09 in the second quarter of 2010.  The average oil sales price for our equity interests was $59.75 per barrel for the second quarter of 2011 compared with $51.36 for the same period in 2010.  Our oil price netbacks have been increasing since 2009 when we received approximately $43 per barrel.  Nevertheless, as our oil price realizations continue to be negotiated on a short-term basis, and because of any potential change in government policy, we cannot accurately predict if the gradual trend of increasing prices we have experienced will continue throughout 2011 or beyond.

 

Results of Operations

 
The following table and discussion is a summary of our consolidated results of operations for the three and six-months ended June 30, 2011, compared with the three and six-months ended June 30, 2010.  Please read this information in conjunction with the Consolidated Statements of Income.

 
   
For the Three Months Ended June 30,
 
               
$ Change
   
% Change
 
   
2011
   
2010
   
from 2010*
   
from 2010*
 
   
                ($ Amounts in Thousands)
       
                         
Total revenues
  $ 24,576     $ 21,810     $ 2,766       13 %
Total costs and operating expenses
     19,026       16,436       (2,590 )     -16 %
 Operating income
    5,550       5,374       176       3 %
Investment income
    4,510       4,492       18       0 %
Income taxes
    2,352       2,740       388       14 %
  Less: Net income attributable to noncontrolling interests
    9       9       -       0 %
Net income attributable to Apco
  $ 7,699     $ 7,117     $ 582       8 %

 
   
For the Six Months Ended June 30,
 
               
$ Change
   
% Change
 
   
2011
   
2010
   
from 2010*
   
from 2010*
 
   
($ Amounts in Thousands)
       
                         
Total revenues
  $ 47,659     $ 41,628     $ 6,031       14 %
Total costs and operating expenses
    36,284       33,901       (2,383 )     -7 %
 Operating income
    11,375       7,727       3,648       47 %
Investment income
    9,376       8,389       987       12 %
Income taxes
    4,873       4,986       113       2 %
  Less: Net income attributable to noncontrolling interests
     17       17       -       0 %
Net income attributable to Apco
  $ 15,861     $ 11,113     $ 4,748       43 %
 
*           + = Favorable change to net income; — = Unfavorable change.
 

 


Total Revenues
 
Total revenues for the second quarter of 2011 increased by $2.8 million, or 13 percent compared with second quarter 2010.  For the first six months of 2011, Total revenues were greater by $6.0 million, or 14 percent compared with 2010.  The following tables and discussion explain the components and variances in operating revenues.

The three and six-month comparisons of our oil, natural gas, and LPG sales volumes and average sales prices for our consolidated interests accounted for as operating revenues are shown in the following tables.
 
   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
                                     
   
2011
   
2010
   
% Change
   
2011
   
2010
   
% Change
 
                                     
Sales Volumes
                                   
Oil (bbls)
    329,189       346,376       -5 %     647,880       654,611       -1 %
Natural Gas (mcf)
    1,659,499       1,529,176       9 %     3,222,228       3,063,194       5 %
LPG (tons)
    2,869       2,491       15 %     5,474       4,889       12 %
Oil, Natural Gas and LPG (boe)
    639,444       630,474       1 %     1,249,150       1,222,514       2 %
                                                 
Average Sales Prices
                                               
Oil (per bbl)
  $ 59.54     $ 51.09       17 %   $ 58.13     $ 50.16       16 %
Natural Gas (per mcf)
    1.80       1.70       6 %     2.02       1.89       7 %
LPG (per ton)
    293.44       378.11       -22 %     326.30       376.37       -13 %
                                                 
Revenues ($ in thousands)
                                               
Oil revenues
  $ 19,601     $ 17,696       11 %   $ 37,659     $ 32,837       15 %
Natural Gas revenues
    2,980       2,602       15 %     6,510       5,781       13 %
LPG revenues
    842       942       -11 %     1,786       1,840       -3 %
    $  23,423     $ 21,240       10 %   $ 45,955     $ 40,458       14 %
 
The volume and price changes in the table above caused the following changes to our oil, natural gas and LPG revenues between the three months ended June 30, 2011 and 2010.
 
   
Three Months Ended June 30,
 
                         
   
Oil
   
Gas
   
LPG
   
Total
 
   
(Amounts in Thousands)
 
                         
2010 Sales
  $ 17,696     $ 2,602     $ 942     $ 21,240  
Changes due to volumes
    (1,024 )     234       111       (679 )
Changes due to prices
     2,929       144       (211 )     2,862  
2011 Sales
  $  19,601     $ 2,980     $ 842     $ 23,423  
 
 
 
The volume and price changes in the table above caused the following changes to our oil, natural gas and LPG revenues between the six months ended June 30, 2011 and 2010.
 
   
Six Months Ended June 30,
 
                         
   
Oil
   
Gas
    LPG    
Total
 
   
(Amounts in Thousands)
 
                         
2010 Sales
  $ 32,837     $ 5,781     $ 1,840     $ 40,458  
Changes due to volumes
    (391 )     321       191       121  
Changes due to prices
    5,213       408       (245 )     5,376  
2011 Sales
  $ 37,659     $ 6,510     $ 1,786     $ 45,955  

Oil Revenues

The increase in Oil revenues during the second quarter and first six months of 2011 is due to higher average oil sales prices.  Our average oil sales prices increased by 17 percent for the quarter and 16 percent for the first six months due to the factors previously discussed on page 18 of this report.  The benefit of higher oil sales prices was partially offset by lower oil sales volumes. Because of greater crude oil inventory accumulation during the period compared with 2010, our oil sales volumes decreased by five percent for the second quarter and one percent for the first six months of 2011 while our total consolidated oil production volumes increased by three percent for the second quarter and two percent for the first six months compared with the same periods of 2010.

Other Operating Revenues

Other operating revenues increased by $583 thousand during the second quarter and $534 thousand for the first six months of 2011 compared with the same periods in 2010.  The increase for both periods is related to benefits realized from the Oil Plus program implemented by the Argentine government in 2008 to provide incentives for successfully increasing oil production volumes.  During 2011, we are requesting additional benefits under the Oil Plus program; however, due to government intervention in the export markets in Argentina, we cannot predict if we will be able to realize any further benefits from this program.
 

Total Costs and Operating Expenses

During the second quarter of 2011, Total costs and operating expenses increased by $2.6 million compared with second quarter 2010 primarily due to greater production costs.  Notable variances for the comparable quarters include the following:
 
·  
Production and lifting costs increased by $1.7 million due to greater operation and maintenance expenses related to our Neuquén basin properties.  These increases were driven primarily by greater well maintenance costs, greater pulling activity and the impact of inflation in Argentina;
 
·  
Taxes other than income increased by $581 thousand primarily due to greater operating revenues from higher sales prices.
 



During the first six months of 2011, Total costs and operating expenses increased by $2.4 million compared with 2010 due to greater production costs which more than offset lower exploration expense in 2011.  Notable variances for the comparable periods include the following:
 
·  
Production and lifting costs increased by $2.7 million due to greater operation and maintenance expenses related to our Neuquén basin properties.  These increases were driven primarily by greater well maintenance costs and the impact of inflation in Argentina;
 
·  
Taxes other than income increased by $2.0 primarily due to greater operating revenues from higher sales prices and a one-time equity tax applicable to our Colombian operations;
 
·  
Depreciation, depletion and amortization expense increased by $1.6 million primarily due to higher depreciation rates (see additional discussion below); and
 
·  
Exploration expense decreased by $3.8 million due to greater exploration activity including seismic acquisition costs in Colombia in the first six months of 2010 compared with 2011.

 Depreciation, Depletion and Amortization Expenses (“DD&A”)

The changes in our total volumes, DD&A average rates per unit and DD&A expense of oil and gas properties between the three and six-months ended June 30, 2011 and 2010 are shown in the following table:

   
Three Months Ended
         
%
   
Six Months Ended
         
%
 
   
June 30,
   
Change
   
Change
   
June 30,
   
Change
   
Change
 
   
2011
   
2010
   
from 2010
   
from 2010
   
2011
   
2010
   
from 2010
   
from 2010
 
                                                 
Consolidated Sales Volumes (boe)
    639,444       630,474       8,970       1 %     1,249,150       1,222,514       26,636       3 %
DD&A Rate per boe
  $ 7.56     $ 6.42     $ 1.14       18 %   $ 7.60     $ 6.42     $ 1.18       18 %
DD&A Expense (In thousands)
  $  4,835     $ 4,047     $ 789       19 %   $ 9,498     $ 7,850     $ 1,648       21 %
 
The following table details the changes in DD&A expense of oil and gas properties due to changes in volumes and average rates between the three and six-months ended June 30, 2011 and 2010.
             
   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
   
(In thousands)
 
             
2010 DD&A
  $ 4,047     $ 7,850  
Changes due to volumes
    68       203  
Changes due to rates
    721       1,445  
2011 DD&A
  $ 4,835     $   9,498  
 
Our DD&A rate increased in the second quarter and first six months of 2011 compared with the same periods in 2010 because we add less proved reserves per well drilled for calculating depreciation with each year that passes without obtaining the remaining ten-year extensions for certain of our concessions because our proved reserves are limited to the current concession life (see discussion below).  Additionally, our weighted average DD&A rate increased in 2011 due to a greater proportion of sales volumes on a barrel of oil equivalent basis from properties with DD&A rates that are higher than the weighted average rate experienced in the second quarter and first six months of 2010.


We are working to obtain the ten-year concession extensions for our properties in Río Negro and Tierra del Fuego which currently have concession terms ending in 2016.  If any extensions are obtained, we expect to experience a favorable effect on future DD&A rates as wells whose productive lives extend beyond 2016 will result in the addition of proved developed reserves.

Investment Income

Total investment income increased by $1.0 million during the first six months of 2011 compared with 2010 due to greater Equity income from Argentine investment.  The increase in our equity income for the period is due to higher net income of our equity investee, Petrolera.  The comparative increase in Petrolera’s net income is primarily a result of greater revenues driven by higher oil sales prices and lower income tax expense.
 
Income Taxes

Income taxes decreased by $388 thousand in the second quarter of 2011 compared with the same period in 2010 as a result of lower pre-tax income in Argentina during second quarter 2011.  The effective income tax rate on the total provision for the second quarter and first six months of 2011 is lower than the effective income tax rate in the prior year periods primarily due to the greater amounts of exploration activity in Colombia in 2010 which provided no benefit to income tax expense during the period.  See Note 3 in the Notes to Consolidated Financial Statements for further discussion of income taxes.


Summary of Total Volumes, Sales Prices and Production Costs

The following table reflects our total sales volumes, average sales prices, and our average production costs per unit for the periods presented:

   
Periods Ending June 30,
 
   
Three Months
   
Six Months
 
                         
   
2011
   
2010
   
2011
   
2010
 
                         
Sales Volumes (1):
                       
Consolidated interests
                       
Crude oil and condensate (bbls)
    329,189       346,376       647,880       654,611  
Gas (mcf)
    1,659,499       1,529,176       3,222,228       3,063,194  
LPG (tons)
    2,869       2,491       5,474       4,889  
Barrels of oil equivalent (boe)
    639,444       630,474       1,249,150       1,222,514  
Equity interests (3)
                               
Crude oil and condensate (bbls)
    386,436       408,623       759,037       771,805  
Gas (mcf)
    768,616       510,687       1,460,133       1,054,788  
LPG (tons)
    2,967       2,614       5,803       5,062  
Barrels of oil equivalent (boe)
    549,356       524,413       1,070,492       1,007,000  
Total volumes
                               
Crude oil and condensate (bbls)
    715,625       754,999       1,406,917       1,426,416  
Gas (mcf)
    2,428,115       2,039,863       4,682,361       4,117,982  
LPG (tons)
    5,836       5,105       11,277       9,950  
Barrels of oil equivalent (boe)
    1,188,805       1,154,888       2,319,642       2,229,514  
                                 
Total volumes by basin
                               
Neuquén
    973,959       928,519       1,901,323       1,782,980  
Austral
    161,082       165,541       317,186       325,869  
Others
    53,765       60,827       101,133       120,665  
Barrels of oil equivalent (boe)
    1,188,805       1,154,888       2,319,642       2,229,514  
                                 
Average Sales Prices:
                               
Consolidated interests
                               
Oil (per bbl)
  $ 59.54     $ 51.09     $ 58.13     $ 50.16  
Gas (per mcf)
    1.80       1.70       2.02       1.89  
LPG (per ton)
    293.44       378.11       326.30       376.37  
Equity interests (3)
                               
Oil (per bbl)
  $ 59.75     $ 51.36     $ 58.32     $ 50.47  
Gas (per mcf)
    1.32       1.16       1.93       1.75  
LPG (per ton)
    296.25       379.25       322.45       386.03  
                                 
                                 
Average Production Costs per BOE (2):
                               
Production and lifting cost
  $ 9.55     $ 6.96     $ 8.42     $ 6.40  
Taxes other than income
  $ 7.02     $ 6.20     $ 7.46     $ 5.95  
DD&A
  $ 7.56     $ 6.42     $ 7.60     $ 6.42  
                                 
                                 
 
(1) Volumes presented in the above table have not been reduced by the approximately 12 to 18.5 percent provincial production tax that is accounted for as an expense by Apco.  In calculating provincial production tax payments, Argentine producers are entitled to deduct gathering, storage, treatment, and compression costs.
 
(2) Average production and lifting costs, taxes other than income and depreciation costs are calculated using total costs divided by consolidated interest sales volumes expressed in barrels of oil equivalent (“boe”).  Six mcf of gas are equivalent to one barrel of oil equivalent and one ton of LPG is equivalent to 11.735 barrels of oil equivalent.
 
(3) The equity interest presented above reflects our interest in our equity investee's sales volumes and prices. The revenues resulting from the equity interest sales volumes and prices are not consolidated within the Company’s revenues. See the financial statements and Note 1 and Note 4 of Notes to Consolidated Financial Statements for additional explanation of the equity method of accounting for our investment in Petrolera.


Financial Condition

Outlook

As previously discussed, oil price realizations in Argentina have been on a steady upward trend since first quarter 2009, reaching an average price of $60 per barrel in June 2011.  Higher oil prices also benefit Petrolera’s cash flows from operations and its ability to pay dividends.  Petrolera’s ability to pay dividends is dependent upon numerous factors, including its cash flows provided by operating activities, levels of capital spending, changes in crude oil and natural gas prices, and debt and interest payments.  Oil price realizations in Argentina continue to be negotiated on a short-term basis, and as such, we cannot accurately predict how they will evolve beyond 2011.

Inflation in Argentina has been a persistent problem for some time.  With an annual inflation rate of at least 20 percent in 2010, economists in Argentina are predicting similar levels of inflation during 2011.  In contrast, the devaluation of the Argentine peso during the same period has been modest by comparison causing significant increases in our U.S. dollar cost of operations and capital expenditures.  Consequently, there is no assurance that operating income will increase in line with the upward trend of our oil price realizations.

We will continue to monitor our capital programs and the quarterly shareholder dividend as necessary to provide Apco with the financial resources and liquidity needed to continue development drilling in its core properties over the long-term, fund new investment opportunities, meet future working capital needs and fund any further cash bonus payments that may be negotiated to obtain concession extensions, if any, while maintaining sufficient liquidity to reasonably protect against unforeseen circumstances requiring the use of funds.

We estimate capital expenditures net to our direct working interests will total approximately $40 million in 2011. Due to our funding commitment to pay for 100 percent of the third and fourth wells in Coirón Amargo, increased exploration and development activities in our core areas for the year and in anticipation of obtaining the ten-year concession extensions for our properties in Río Negro and Tierra del Fuego, in the first quarter of 2011 we negotiated a loan agreement with a financial institution for a $10 million bank line of credit.  Borrowings under this facility are unsecured and bear interest at six-month Libor plus three percent per annum plus a one percent arrangement fee per borrowing and a commitment fee for the unused portion of the loan amount. The funds can be borrowed during a one-year period ending in March 2012, and principal amounts will be repaid in four equal installments over four years from each borrowing date after a two and a half year grace period.  We expect to fund our 2011 capital expenditures with cash on hand, cash flows from operations and borrowings under the line of credit.  As of June 30, 2011, we have borrowed $2 million under the line of credit.

Liquidity

Although we have interests in several oil and gas properties in Argentina, our direct participation in those Neuquén basin properties in which we are partners with Petrolera and dividends from our equity interest in Petrolera are the largest contributors to our net cash provided by operating activities.

We have historically funded capital programs and past property acquisitions with internally generated cash flow. We have not relied on debt or equity as sources of capital due to the turmoil that periodically affects Argentina’s economy which made financing difficult to obtain at reasonable terms.  However, as has been the case with financing for Petrolera, we observed an improvement in financing terms for companies doing business in Argentina.  Consequently, we negotiated the previously described $10 million line of credit in the first quarter of 2011.




With a cash and cash equivalents balance at June 30, 2011, of $34.8 million, or 13 percent of total assets, the remaining amount of our bank line of credit, and the ability to adjust capital spending as necessary, we believe we have sufficient liquidity and capital resources to effectively manage our business in 2011.

Our liquidity is affected by restricted cash balances that are pledged as collateral for letters of credit for exploration activities in Colombia.  As of December 31, 2010, a total of $4 million was considered restricted and included in restricted cash.  In first quarter 2011, one of our letters of credit for $4 million was reduced by $1.1 million and extended until September of 2012.  In the second quarter we issued another $5.5 million letter of credit collateralized with cash for another exploration block in Colombia.  Consequently, $8.4 million of cash is considered restricted as of June 30, 2011.  The restricted cash is invested in a short-term money market account with a financial institution.

Cash Flow Analysis
 
The following table summarizes the change in cash and cash equivalents for the periods shown.
   
Six Months Ended June 30,
 
   
2011
   
2010
 
   
(Thousands)
 
Net cash provided (used) by:
           
Operating activities
  $ 20,354     $ 14,703  
Investing activities
    (21,584 )     (13,159 )
Financing activities
    808       (1,190 )
Increase in cash and cash equivalents
  $ (422 )   $ 354  

Operating Activities

Our net cash provided by operating activities totaled $20.4 million for the first six months of 2011, compared with $14.7 million during the same period in 2010.  The change in cash provided by operating activities was a result of greater cash provided by higher operating results.

Investing Activities

During the first six months of 2011, capital expenditures totaled $17.2 million, most of which was invested in drilling in our Neuquén basin properties, compared with $13.2 million in 2010.  Additionally, in the first six months of 2011 our cash used as collateral for letters of credit changed by $4.4 million.

Financing Activities

During the first six months of 2011, we paid $1.2 million of dividends to shareholders and non-controlling interests, and we received $2 million in borrowings from our $10 million unsecured bank line of credit to fund capital expenditures.  During the first six months of 2010, $1.2 million of dividends was paid to shareholders and non-controlling interests.


Contractual Obligations

Our contractual obligations have decreased by approximately $6 million from our total obligations as reported in our Annual Report on Form 10-K for the year ended December 31, 2010, as a result of fulfilling certain drilling commitments during the first six months of 2011.  Additionally, our obligations increased due to our borrowing $2 million under our banking agreement.




Off-Balance Sheet Arrangements

We do not currently use any off-balance sheet arrangements to enhance liquidity and capital resources.



Our operations are exposed to market risks as a result of changes in commodity prices and foreign currency exchange rates.

Commodity Price Risk

We have historically not used derivatives to hedge price volatility. As previously mentioned in MD&A, oil sales price realizations for oil produced and sold in Argentina are significantly influenced by Argentine governmental actions. In the current regulatory environment, the combination of hydrocarbon export taxes and strict government controls over Argentine gasoline prices directly impacts net backs for the sale of crude oil in the domestic Argentine market. As a result, our price is impacted more by government controls than changes in world oil prices.  Because our oil prices are negotiated on a short-term basis, we cannot accurately predict our future sales prices, and it is difficult for us to determine what effect increases or decreases in world oil prices may have on our results of operations.

Inflation, Foreign Currency and Operations Risk

The majority of our operations and all of our current production is located in Argentina which has had a history of high levels of inflation and resulting currency devaluation. Therefore, our financial results may be affected by factors such as changes in foreign currency exchange rates, weak economic conditions, or changes in Argentina’s political climate.  During 2002 and 2003, we recorded sizeable foreign currency exchange losses due to the significant devaluation of the Argentine peso that occurred as a consequence of Argentina’s economic problems during 2001 and 2002.  From 2003 to mid-2008, the Argentine government used monetary policies to keep the peso to U.S. dollar exchange rate stable at approximately 3.00:1. Although government policies such as regulated gasoline prices and strict controls over natural gas prices have attempted to reduce inflationary pressures in Argentina, inflation has averaged approximately 20 percent annually for several years.  Since 2009, the peso to US dollar exchange rate has not changed in proportion to these levels of inflation, resulting in significant year-over-year cost increases when measured in US dollars. At December 31, 2010, the peso to US dollar exchange rate was 3.98:1.  At June 30, 2011, the exchange rate was 4.11:1.

Economic and Political Environment

Argentina has a history of economic instability. Because the majority of the Company’s operations are located in Argentina, its operations and financial results have been, and could be in the future, adversely affected by economic, market, currency, and political instability in the country as well as measures taken by the government in response to such instability.

For example, reference is made to the section “Argentine Economic and Political Environment” on page 50 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2010, for a description of Argentina’s economic crisis of 2002 and the government’s reaction to that crisis.  Presidential elections are currently scheduled for the fall of 2011.



Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-(e) of the Securities Exchange Act of 1934) (Disclosure Controls) or our internal controls over financial reporting (Internal Controls) will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. We monitor our Disclosure Controls and Internal Controls and make modifications as necessary; our intent in this regard is that the Disclosure Controls and the Internal Controls will be modified as systems change and conditions warrant.

Evaluation of Disclosure Controls and Procedures

An evaluation of the effectiveness of the design and operation of our Disclosure Controls was performed as of the end of the period covered by this report. This evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that these Disclosure Controls are effective at a reasonable assurance level.

Second Quarter 2011 Changes in Internal Controls

There have been no changes during the second-quarter 2011 that have materially affected, or are reasonably likely to materially affect, our Internal Controls.



PART II.  OTHER INFORMATION

Item 1.   Legal Proceedings

The information called for by this item is provided in Note 7 Contingencies in the Notes to the Consolidated Financial Statements included under Part I, Item 1. Financial Statements of this report, which information is incorporated by reference into this item.

Item 1A.   Risk Factors

Part I, Item 1A. “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2010, includes certain risk factors that could materially affect our business, financial condition or future results. Those risk factors have not materially changed.





Item 6.                      Exhibits

3.1 – Memorandum of Association of Apco Oil and Gas International Inc. (formerly known as Apco Argentina Inc.) as amended (including Certificate of Incorporation on Change of Name issued by the Registry of Companies, Cayman Islands, dated July 13, 2009), (filed on August 7, 2009 as Exhibit 3.1 to Apco Oil and Gas International Inc.’s Form 10-Q (File No. 0-8933)) and incorporated herein by reference.

3.2 – Articles of Association of Apco Oil and Gas International Inc. as amended (formerly known as Apco Argentina Inc.) as amended.*

4.1 – Specimen Share Certificate of Apco Oil and Gas International Inc. (filed on August 7, 2009 as Exhibit 4.1 to Apco Oil and Gas International Inc.’s Form 10-Q (File No. 0-8933)) and incorporated herein by reference.

10.1 – Form of director indemnification agreement. (filed on May 6, 2011, as Exhibit 10.1 to Apco Oil and Gas International Inc.’s Form 10-Q (File No. 0-8933)) and incorporated by herein by reference.*

31.1 – Certification of Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the Securities Exchange Act of 1934, as amended, and Item 601(b)(31) of Regulation S-K, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*

31.2 – Certification of Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the Securities Exchange Act of 1934, as amended, and Item 601(b)(31) of Regulation S-K, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*

32 – Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.**

101 .INS  – XBRL Instance Document**

101 .SCH  – XBRL Schema Document**

101 .CAL  – XBRL Calculation Linkbase Document**

101 .LAB  – XBRL Label Linkbase Document**

101 .PRE  – XBRL Presentation Linkbase Document**

101 .DEF  – XBRL Definition Linkbase Document**
_____________________
* Filed herewith.
**Furnished herewith.




SIGNATURE


Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.



   APCO OIL AND GAS INTERNATIONAL INC.   
(Registrant)




By:         /s/ Landy L. Fullmer         
Chief Financial Officer,
Chief Accounting Officer and Controller
(Duly Authorized Officer
and Principal Accounting Officer)




August 8, 2011


 
INDEX TO EXHIBITS
 


EXHIBIT
NUMBER                                                                DESCRIPTION



3.1
Memorandum of Association of Apco Oil and Gas International Inc. (formerly known as Apco Argentina Inc.) as amended (including Certificate of Incorporation on Change of Name issued by the Registry of Companies, Cayman Islands, dated July 13, 2009), (filed on August 7, 2009 as Exhibit 3.1 to Apco Oil and Gas International Inc.’s Form 10-Q (File No. 0-8933)) and incorporated herein by reference.

Articles of Association of Apco Oil and Gas International Inc. as amended (formerly known as Apco Argentina Inc.) as amended.*

4.1
Specimen Share Certificate of Apco Oil and Gas International Inc. (filed on August 7, 2009 as Exhibit 4.1 to Apco Oil and Gas International Inc.’s Form 10-Q (File No. 0-8933)) and incorporated herein by reference.

10.1
Form of director indemnification agreement. (filed on May 6, 2011, as Exhibit 10.1 to Apco Oil and Gas International Inc.’s Form 10-Q (File No. 0-8933)) and incorporated by herein by reference.*

Certification of Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the Securities Exchange Act of 1934, as amended, and Item 601(b)(31) of Regulation S-K, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*

Certification of Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the Securities Exchange Act of 1934, as amended, and Item 601(b)(31) of Regulation S-K, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*

Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.**

101 .INS
XBRL Instance Document**

101 .SCH
XBRL Schema Document**

101 .CAL
XBRL Calculation Linkbase Document**

101 .LAB
XBRL Label Linkbase Document**

101 .PRE
XBRL Presentation Linkbase Document**

101 .DEF
XBRL Definition Linkbase Document**
_____________________

*      Filed herewith.
**      Furnished herewith.