Sabalo Energy, LLC and Sabalo Operating, LLC

 

Reviewed Combined Financial Statements

 

March 31, 2021 and 2020

 

 

Contents

 

Combined Balance Sheets

1

 

Combined Statements of Operations

2

 

Combined Statements of Members’ Equity

3

 

Combined Statements of Cash Flows

4

 

Notes to the Combined Financial Statements

5

 

 

SABALO ENERGY, LLC AND SABALO OPERATING, LLC

 

COMBINED BALANCE SHEETS

 

March 31, 2021 and December 31, 2020

  

		March 31, 2021				December 31, 2020
ASSETS
Current assets
Cash and cash equivalents		$	22,171,586			$	19,818,849
Time deposits			50,528				50,528
Accounts receivable			25,398,157				26,273,725
Other receivable			13,672				14,709
Prepaid expenses			180,710				180,710
Inventory			1,872,989				1,892,024
			49,687,642				48,230,545
Non-current assets
Oil and gas properties – successful efforts method, net			477,176,772				459,287,251
Property, plant, and equipment, net			1,286,551				1,297,062
Total Assets		$	528,150,965			$	508,814,858
LIABILITIES AND MEMBERS' EQUITY
Current liabilities
Accounts payable		$	18,816,444			$	12,140,217
Accrued expenses			588,436				1,780,744
Revenue payables			15,409,471				13,518,466
Prepayments from non-operators			271,310				210,460
Derivative liability, current			11,519,840				33,219
Short term borrowings			137,694				203,040
			46,743,195				27,886,146
Non-current liabilities
Long-term debt, less deferred loan costs			146,746,314				146,549,943
Derivative liability, non-current			8,741,839				2,134,538
Accounts payable - related party			28,228,610				26,106,929
Asset retirement obligation			7,129,085				7,039,313
Total liabilities			237,589,043				209,716,869
Members' equity
Total members' equity			290,561,922				299,097,989
Total Liabilities and Members' Equity		$	528,150,965			$	508,814,858

  

See notes to the combined financial statements.

 

  

SABALO ENERGY, LLC AND SABALO OPERATING, LLC

 

COMBINED STATEMENTS OF OPERATIONS

  

Three Months Ended March 31,		2021				2020
REVENUES
Oil revenue		$	30,671,170			$	42,377,149
Gas revenue			854,790				30,415
Natural gas liquids revenue			984,149				764,685
Total revenues, net			32,510,109				43,172,249
OPERATING EXPENSES
Production taxes			1,495,732				2,014,688
Lease operating expenses			8,442,914				11,793,185
Depreciation, depletion and amortization			8,511,233				23,595,821
Accretion of asset retirement obligation			84,013				82,053
Selling, general and administrative			1,462,295				1,976,298
Total operating expenses			19,996,187				39,462,045
OPERATING INCOME			12,513,922				3,710,204
OTHER INCOME (EXPENSE)
Provision for uncollectible receivables			(22	)			-
Gain (loss) on derivative instruments, net			(19,517,348	)			44,108,179
Interest expense			(1,810,309	)			(2,066,389	)
Interest income			126				9,403
Loss on sale of property and equipment			-				(3,904	)
Other income			277,740				214,451
Total other income (expense)			(21,049,813	)			42,261,740
INCOME (LOSS) BEFORE INCOME TAXES			(8,535,891	)			45,971,944
STATE INCOME TAX EXPENSE			176				5,951
NET INCOME (LOSS)		$	(8,536,067	)		$	45,965,993

 

See notes to the combined financial statements.

 

  

SABALO ENERGY, LLC AND SABALO OPERATING, LLC

 

COMBINED STATEMENTS OF MEMBERS' EQUITY

 

Three Months Ended March 31, 2021 and 2020

  

		Total Members’ Equity
Balance at January 1, 2021		$	299,097,989
Loss from the period			(8,536,067	)
Balance at March 31, 2021		$	290,561,922
Balance at January 1, 2020		$	304,107,040
Income from the period			45,965,993
Balance at March 31, 2020		$	350,073,033

 

See notes to the combined financial statements.

 

  

SABALO ENERGY, LLC AND SABALO OPERATING, LLC

 

COMBINED STATEMENTS OF CASH FLOWS

   

Three Months Ended March 31,		2021				2020
OPERATING ACTIVITIES
Net income (loss)		$	(8,536,067	)		$	45,965,993
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Loss on sale of property and equipment			-				3,904
Depreciation, depletion and amortization			8,511,233				23,595,821
Provision for uncollectible receivables			22				-
Amortization of loan costs			196,371				190,773
Accretion of asset retirement obligation			84,013				82,053
(Gain) loss on derivative instruments			19,517,348				(44,108,179	)
Cash settled on derivative instruments			(1,423,426	)			(542,433	)
Changes in:
Receivables			876,583				23,477,207
Prepaid expenses			-				38,003
Inventory			19,035				378,901
Accounts payable and accrued expenses			8,573,215				(22,410,903	)
Accounts payable - related party			2,121,681				927,335
Prepayment by non-operators			60,850				362,419
Net cash provided by operating activities			30,000,858				27,960,894
INVESTING ACTIVITIES
Capital expenditures on oil and gas properties			(27,578,032	)			(27,628,350	)
Proceeds from sale of property and equipment			-				2,000
Capital expenditures on property and equipment			(4,743	)			(23,462	)
Net cash used in investing activities			(27,582,775	)			(27,649,812	)
FINANCING ACTIVITIES
Payments on short-term borrowings			(65,346	)			(80,564	)
Net cash used in financing activities			(65,346	)			(80,564	)
Net increase in cash and cash equivalents			2,352,737				230,518
Cash and cash equivalents at beginning of year			19,818,849				15,734,982
Cash and cash equivalents at the end of the year		$	22,171,586			$	15,965,500

 

See notes to the combined financial statements.

 

 

SABALO ENERGY, LLC AND SABALO OPERATING, LLC

 

NOTES TO THE COMBINED FINANCIAL STATEMENTS

 

March 31, 2021 and December 31, 2020

 

1.	NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES

 

Nature of Operations

 

Sabalo Energy, LLC and Sabalo Operating, LLC (collectively the “Company”) were formed to focus on leasing, acquiring, drilling, operating, and developing oil and gas properties in the United States. The Company primarily operates in Texas.

 

Basis of Preparation

 

These combined financial statements have been prepared on the accrual basis of accounting in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) as codified by the Financial Accounting Standards Board (“FASB”) in its Accounting Standards Codification (“ASC”). The accounting policies set out below have been applied in preparing the combined financial statements.

 

Principles of Combination

 

Sabalo Operating, LLC (“Operating”) is the operator of record on all properties owned by Sabalo Energy LLC (“Energy”) under the Joint Operating Agreement (“JOA”) between all working interest owners of each property. As operator, Operating is responsible under the JOA to drill wells, maintain production, pay for costs to drill and operate wells, collect revenues and distribute revenues as approved by the owners, including Energy and other third parties. Additionally, Energy has executed a Management Agreement whereby Operating provides services to develop the properties, pay the costs, collect revenues and distribute to owners. Due to this relationship, the combined financial statements include the financial information of Sabalo Energy, LLC, Sabalo Operating, LLC and Sabalo Energy, Inc. Sabalo Energy, Inc. is the .01% general owner of Sabalo Energy, LLC. Energy and Operating are effectively 100% owned by Sabalo Holdings, LLC. All intercompany amounts have been eliminated upon combination.

 

Use of Estimates

 

The preparation of combined financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the combined financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Management believes that these estimates and assumptions provide a reasonable basis for the fair presentation of the combined financial statements. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the estimate of the fair value of the derivative asset/liability.

 

 

SABALO ENERGY, LLC AND SABALO OPERATING, LLC

 

NOTES TO THE COMBINED FINANCIAL STATEMENTS

 

March 31, 2021 and December 31, 2020

 

1.	NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (continued)

 

Additionally, significant estimates include volumes of oil and natural gas reserves used in calculating depreciation and depletion of oil and gas properties, future net revenues, abandonment obligations, impairment of unproved evaluated properties, the collectability of outstanding accounts receivable, and contingencies. Oil and natural gas reserve estimates, which are the basis for unit-of-production depreciation and depletion, have numerous inherent uncertainties. The accuracy of any reserve estimate is a function of the quality of available data and of engineering and geological interpretation and judgement. Subsequent drilling results, testing, and production may justify revision of such estimates. Accordingly, reserve estimates are often different from the quantities of oil and natural gas that are ultimately recovered. In addition, reserve estimates are sensitive to changes in wellhead prices of crude oil and natural gas. Such prices have been volatile in the past and can be expected to be volatile in the future. The Company’s reserve estimates were determined by an independent petroleum engineering firm.

 

The significant estimates are based on current assumptions that may be materially affected by changes to future economic conditions, such as the market prices received for sales of oil and natural gas. Changes in these assumptions may materially affect these significant estimates in the near term.

 

Oil and Gas Properties

 

The carrying value of the Company’s oil and gas properties represents the cost to acquire or develop the asset, including any asset retirement obligations and capitalized interest, net of accumulated depreciation, depletion and amortization (“DD&A”) and any impairment charges. For assets acquired, the cost of oil and gas properties are based on fair values at the acquisition date. Asset retirement obligations and interest costs incurred in connection with qualifying capital expenditures are capitalized and amortized over the lives of the related assets.

 

The Company uses the successful efforts method to account for its oil and gas properties. Under this method, the Company capitalizes costs of acquiring properties, costs of drilling successful exploration wells and development costs. The costs of exploratory wells are initially capitalized pending a determination of whether proved reserves have been found. If proved reserves have been found, the costs of exploratory wells remain capitalized. Otherwise, the Company charges the costs of the related wells to expense. In some cases, a determination of proved reserves cannot be made at the completion of drilling, requiring additional testing and evaluation of the wells. The Company generally expenses the costs of such exploratory wells if a determination of proved reserves has not been made within a 12-month period after drilling is complete.

 

The Company determines depreciation and depletion of oil and gas properties by the unit-of-production method. It amortizes acquisition costs over total proved reserves, and capitalized development and successful exploration costs over proved developed reserves.

 

 

SABALO ENERGY, LLC AND SABALO OPERATING, LLC

 

NOTES TO THE COMBINED FINANCIAL STATEMENTS

 

March 31, 2021 and December 31, 2020

 

1.	NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (continued)

 

Proved oil and gas reserves are those quantities of oil and gas which, by analysis of geoscience and engineering data, can be estimated with reasonable certainty to be economically producible – from a given date forward, for known reservoirs, and under existing economic conditions, operating methods, and government regulations – prior to the time at which contracts providing the right to operate expire, unless evidence indicates that renewal is reasonably certain, regardless of whether deterministic or probabilistic methods are used for the estimation. The Company has proved oil and gas reserves for which the determination of economic productivity is subject to the completion of major additional capital expenditure as of March 31, 2021 which totaled $787 million.

 

The Company performs impairment tests with respect to its proved properties whenever events or circumstances indicate that the carry value of property may not be recoverable. If there is an indication the carrying amount of the asset may not be recovered due to declines in current and forward prices, significant changes in reserve estimates, changes in management’s plans, or other significant events, management will evaluate the property for impairment. Under the successful efforts method, if the sum of the undiscounted cash flows is less than the carrying value of the proved property, the carrying value is reduced to estimated fair value and reported as an impairment charge in the period. Individually proved properties are grouped for impairment purposes at the lowest level for which there are identifiable cash flows, which is generally on a field by field basis. The impairment test incorporates a number of assumptions involving expectations of future cash flows which can change significantly over time. These assumptions include estimates of future product prices, contractual prices, estimates of risk-adjusted proved oil and gas reserves and estimates of future operating and development costs.

 

A portion of the carrying value of the Company’s oil and gas properties is attributable to unproved properties. The unproved amounts are not subject to DD&A until they are classified as proved properties. Capitalized costs attributable to the properties become subject to DD&A when proved reserves are assigned to the property.

 

If the exploration efforts are unsuccessful, or management decides not to pursue development of these properties as a result of lower commodity prices, higher development and operating costs, contractual conditions or other factors, the capitalized costs of the related properties would be expensed. The timing of any write-downs of these unproved properties, if warranted, depends upon management’s plans, the nature, timing and extent of future exploration and development activities and their results. The Company recorded no impairments during the three months ended March 31, 2021 and 2021.

 

Property, Plant and Equipment

 

Property, plant and equipment are stated at cost, less accumulated depreciation. Improvements or betterments of a permanent nature are capitalized. Expenditures for maintenance and repairs are charged to expense when incurred. The cost of assets retired or otherwise disposed of, and the related accumulated depreciation, are eliminated from the accounts in the year of disposal. Gains or losses resulting from property disposals are credited or charged to current operations.

 

 

SABALO ENERGY, LLC AND SABALO OPERATING, LLC

 

NOTES TO THE COMBINED FINANCIAL STATEMENTS

 

March 31, 2021 and December 31, 2020

 

1.	NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (continued)

 

The Company provides for depreciation and amortization using the straight-line method over the estimated useful lives of the assets, which range from 3 to 7 years. Such rates are calculated to reduce the cost of assets to their estimated residual values over their expected useful lives. The expected useful lives of property, plant and equipment are reviewed annually.

 

Cash and Cash Equivalents

 

Cash and cash equivalents include cash on hand, deposits held with banks and other short-term highly liquid investments with original maturities of three months or less.

 

Time Deposits

 

Time deposits are certificates of deposit held for collateral for a letter of credit amounting to $50,528 as of March 31, 2021 and December 31, 2020. No balance is outstanding on the letter of credit as of March 31, 2021 and December 31, 2020.

 

Prepaid Expenses

 

Prepaid expenses represent payments for insurance, software, and deposits on well studies that will benefit future periods. Prepaid expenses totaled $180,710 and $180,710 as of March 31, 2021 and December 31, 2020, respectively.

 

Accounts Receivable

 

Accounts receivable are stated net of a provision for amounts estimated to be uncollectible. Accounts receivable primarily consist of accrued revenues from oil and gas sales and amounts due from other working interest owners. The Company routinely assesses the recoverability of all material receivables to determine their collectability. The Company creates a provision against a receivable when, based on the judgment of management, it is likely that a receivable will not be collected and the amount of such provision may be reasonably estimated. No allowance for doubtful accounts was considered necessary as of March 31, 2021 and December 31, 2020.

 

Inventory

 

Inventories are carried at the lower of cost or market and consisted of following at:

 

		March 31,				December 31,
		2021				2021
Crude oil held-for-sale		$	449,815			$	445,142
Materials used in oil and gas operations			1,130,439				1,154,147
Water used in oil and gas operations			292,735				292,735
		$	1,872,989			$	1,892,024

 

 

SABALO ENERGY, LLC AND SABALO OPERATING, LLC

 

NOTES TO THE COMBINED FINANCIAL STATEMENTS

 

March 31, 2021 and December 31, 2020

 

1.	NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (continued)

 

Derivative Financial Instruments

 

The Company uses derivative contracts to hedge the effects of fluctuations in the prices of oil and natural gas. Such derivative instruments are accounted for in accordance with ASC 815, “Derivatives and Hedging,” which establishes accounting and disclosure requirements for derivative instruments and requires them to be measured at fair value and recorded as assets or liabilities in the combined balance sheets.

 

Under ASC 815, hedge accounting is used to defer recognition of unrealized changes in the fair value of such financial instruments, for those contracts which qualify as cash flow hedges, as defined in the standard. The Company has not designated any of its derivative contracts as fair value or cash flow hedges. Accordingly, the changes in fair value of the contracts, as well as settlements received or paid, are included in the combined statement of operations.

 

Accounts Payable and Accruals

 

Liabilities are recognized for amounts to be paid in the future for goods and services received, whether billed by the supplier or not.

 

Asset Retirement Obligations

 

The initial estimated asset retirement obligation related to property, plant and equipment is recorded as a liability at its fair value, with an offsetting asset retirement cost recorded as an increase to the associated property, plant and equipment. If the fair value of the recorded asset retirement obligation changes, a revision is recorded to both the asset retirement obligation and the asset retirement cost.

 

Revisions in estimated liabilities can result from changes in estimated inflation rates, changes in service and equipment costs and changes in the estimated timing of an asset’s retirement. Asset retirement costs are depreciated using a systematic and rational method similar to that used for the associated property and equipment. Accretion of the liability is recognized over the estimated productive life of the related assets.

 

Revenue Recognition

 

Under Accounting Standards Codification Topic 606, “Revenue from Contracts with Customers,” (“ASC 606”), oil, natural gas and NGL sales revenues are recognized when control of the product is transferred to the customer, the performance obligations under the terms of the contracts with customers are satisfied and collectability is reasonably assured. All of the Company’s oil, natural gas and NGL sales are made under contracts with customers. The performance obligations for the Company’s contracts with customers are satisfied at a point in time through the delivery of oil and natural gas to its customers.

 

 

SABALO ENERGY, LLC AND SABALO OPERATING, LLC

 

NOTES TO THE COMBINED FINANCIAL STATEMENTS

 

March 31, 2021 and December 31, 2020

 

1.	NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (continued)

 

The Company typically receives payment for oil, natural gas and NGL sales within 30 days of the month of delivery. The Company’s contracts for oil, natural gas and NGL sales are standard industry contracts that include variable consideration based on the monthly index price and adjustments that may include counterparty-specific provisions related to volumes, price differentials, discounts and other adjustments and deductions.

 

The Company’s product types are as follows:

 

Oil Revenue – Under the Company’s oil sales contracts, the Company generally sells oil to the purchaser at or near the wellhead, and collects a contractually agreed upon index price, net of pricing and gathering and transportation differentials. The Company transfers control of the product to the purchaser at or near the wellhead and recognizes revenue based on the net price received.

 

Natural Gas and NGL Revenue – Under the Company’s natural gas sales contracts, the Company delivers and transfers control of natural gas to the purchaser at delivery points at or near the wellhead. The purchaser gathers and processes the natural gas and sells the resulting residue gas and NGLs. The Company receives its contractual portion of the proceeds for the sale of the residue gas and NGLs at an agreed upon index price, net of pricing differentials and applicable selling expenses including gathering, processing and fractionation costs. The Company recognizes revenue at the net price when control transfers to the purchaser.

 

The Company does not disclose the value of unsatisfied performance obligations for (i) contracts with an original expected length of one year or less and (ii) contracts for which the variable consideration is allocated entirely to a wholly unsatisfied performance obligation, as allowed under ASC 606. Under the Company’s oil, natural gas and NGL sales contracts, each unit of product delivered to the customer represents a separate performance obligation; therefore, future volumes are wholly unsatisfied and disclosure of the transaction price allocated to remaining performance obligations is not required.

 

Contract Balances – Under the Company’s product sales contracts, it has the right to invoice its customers once the performance obligations have been satisfied, at which point payment is unconditional. Accordingly, the Company’s product sales contracts do not give rise to contract assets or liabilities under ASC 606.

 

Prior-period Performance Obligations – The Company records revenue in the month production is delivered to the purchaser. However, settlement statements for certain natural gas and natural gas liquids sales may not be received for 30 to 90 days after the date production is delivered, and as a result, the Company is required to estimate the amount of production delivered to the purchaser and the price that will be received for the sale of the product. The Company records the differences between its estimates and the actual amounts received for product sales in the month that payment is received from the purchaser. The Company has existing internal controls for its revenue estimation process and related accruals, and any identified differences between its revenue estimates and actual revenue received historically have not been significant.

 

 

SABALO ENERGY, LLC AND SABALO OPERATING, LLC

 

NOTES TO THE COMBINED FINANCIAL STATEMENTS

 

March 31, 2021 and December 31, 2020

 

1.	NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (continued)

 

Income Taxes

 

The Company is not a taxpaying entity for federal income tax purposes; accordingly, a provision for income taxes has not been recorded in the accompanying financial statements. Income or losses from disregarded entities are reflected in the member’s individual or corporate income tax returns. The Company does pay franchise taxes, which are considered income taxes under the authoritative guidance. The Company’s current year and prior three years tax returns remain open for examination by the taxing authorities.

 

The Company has adopted the provisions of FASB Accounting Standards Codification 740, “Income Taxes” (“ASC 740”), effective January 1, 2009. ASC 740 provides guidance regarding the recognition, measurement, presentation and disclosure in the financial statements of tax positions taken or expected to be taken on a tax return, including the decision whether to file or not to file in a particular jurisdiction.

 

Concentration of Credit Risk

 

Financial instruments which potentially subject the Company to concentrations of credit risk include cash, cash equivalents, short term loans and accounts receivable. The Company maintains its cash in bank deposit accounts; which, at times, may exceed the federally insured limits set forth by the Federal Deposit Insurance Corporation (“FDIC”). The Company monitors the financial condition of the institutions whereby these deposits are maintained and has not experienced any losses associated with its accounts. As of March 31, 2021, the Company has uninsured deposits totalling $26,292,376.

 

The Company’s financial condition, results of operations, and capital resources are highly dependent upon the prevailing market prices of, and demand for, oil and natural gas. These commodity prices are subject to wide fluctuations and market uncertainties due to a variety of factors that are beyond its control. These factors include the level of global demand for petroleum products, foreign supply of oil and gas, the establishment of and compliance with production quotas by oil-exporting countries, weather conditions, the price and availability of alternative fuels, and overall economic conditions, both foreign and domestic.

 

The Company cannot predict future oil and gas prices with any degree of certainty. Sustained weakness in oil and gas prices may adversely affect its financial condition and results of operations, and may also reduce the amount of net oil and gas reserves that the Company can produce economically. Similarly, any improvement in oil and gas prices can have a favorable impact on the Company’s financial condition, results of operations and capital resources.

 

The Company’s customer concentration may impact the Company’s overall credit risk, either positively or negatively, in that these entities may be similarly affected by changes in economic or other conditions affecting the oil and gas industry.

 

 

SABALO ENERGY, LLC AND SABALO OPERATING, LLC

 

NOTES TO THE COMBINED FINANCIAL STATEMENTS

 

March 31, 2021 and December 31, 2020

 

1.	NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (continued)

 

The Company manages credit risk related to accounts receivable through credit approvals, credit limits and monitoring procedures. The Company routinely assesses the financial strength of its customers and, based upon factors surrounding the credit risk, establishes an allowance, if required, for uncollectible accounts and, as a consequence, believes that its accounts receivable credit risk exposure beyond such allowance is limited.

 

In the exploration, development and production business, production is normally sold to relatively few customers. Substantially all of the Company’s customers are concentrated in the oil and gas industry and revenue can be materially affected by current economic conditions, the price of certain commodities such as crude oil and natural gas and the availability of alternate purchasers. The Company believes that the loss of any of its major purchasers would not have a long-term material adverse effect on its operations.

 

Compensated Absences

 

Compensated absences for sick pay and personal time have not been accrued since they cannot be reasonably estimated. The Company’s policy is to recognize these costs when actually paid.

 

Advertising

 

The Company expenses all advertising costs as incurred, and such expenses were not significant for the three months ended March 31, 2021 and 2020.

 

Contingent Revenue from Sale

 

The Company is entitled to contingent consideration in relation to the sale detailed at Note 14 if certain conditions are met over a three year period. The Company will recognize the amount earned into gain income upon the condition being met. No revenue will be recognized if the condition is not met.

 

Deferred Financing Costs

 

Deferred financing costs are stated at cost, net of amortization, and as a direct reduction from the carrying value of long term debt on the combined balance sheets. Amortization of deferred financing costs is computed using the straight line method over the life of the loan. Amortization of deferred financing costs of $196,371 and $190,773 was recorded for the three months ended March 31, 2021 and 2020, respectively.

 

 

SABALO ENERGY, LLC AND SABALO OPERATING, LLC

 

NOTES TO THE COMBINED FINANCIAL STATEMENTS

 

March 31, 2021 and December 31, 2020

 

1.	NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (continued)

 

Fair Values

 

As defined in FASB ASC Topic No. 820-10,“Fair Value Measurements,” fair value is the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. FASB ASC Topic No. 820-10 requires disclosure that establishes a framework for measuring fair value and expands disclosure about fair value measurements. The statement requires fair value measurements be classified and disclosed in one of the following categories:

 

Level 1 – Inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that we have the ability to access.

 

Level 2 – Inputs utilize other-than-quoted prices that are observable, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and inputs such as interest rates and yield curves that are observable at commonly quoted intervals.

 

Level 3 – Inputs are unobservable and are typically based on our own assumptions, including situations where there is little, if any, market activity.

 

The carrying amounts of financial assets and liabilities, such as cash and cash equivalents, accounts receivable, borrowings, accounts payable and accrued expenses, approximate their fair values because of the short maturity of these instruments and market rates of interest available to the Company. The valuation assumptions the Company has used to measure the fair value of its commodity derivatives were observable inputs based on market data obtained from independent sources and are considered Level 2 inputs (quoted prices for similar assets, liabilities and market-corroborated inputs).

 

Assets and liabilities measured at fair value on a recurring basis

 

Certain assets and liabilities are reported at fair value on a recurring basis in the combined balance sheets. The following methods and assumptions were used to estimate fair value:

 

Commodity derivative instruments. The fair value of commodity derivative instruments is derived using an income approach valuation model that utilizes market-corroborated inputs that are observable over the term of the derivative contract. The Company’s fair value calculations also incorporate an estimate of the counterparties’ default risk for derivative assets and an estimate of the Company’s default risk for derivative liabilities.

 

The Company believes that the majority of the inputs used to calculate the commodity derivative instruments fall within Level 2 of the fair value hierarchy based on the wide availability of quoted market prices for similar commodity derivative contracts. See Note 6 for additional information regarding the Company’s derivative instruments.

 

 

SABALO ENERGY, LLC AND SABALO OPERATING, LLC

 

NOTES TO THE COMBINED FINANCIAL STATEMENTS

 

March 31, 2021 and December 31, 2020

 

1.	NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (continued)

 

The following table presents the Company’s assets and (liabilities) measured at fair value on a recurring basis:

 

		Level 1				Level 2				Level 3				Total Fair
		Inputs				Inputs				Inputs				Value
March 31, 2021
Derivative instruments, net		$	-			$	(20,261,679	)		$	-			$	(20,261,679	)
December 31, 2020
Derivative instruments, net		$	-			$	(2,167,757	)		$	-			$	(2,167,757	)

 

Statement of Cash Flows

 

Supplemental information on cash flows for the three months ended March 31 were as follows:

 

		2021				2021
Property additions financed (paid) through accounts payable and through accruals		$	1,198,291			$	1,032,695
Interest paid		$	1,613,938			$	1,875,616
Asset retirement obligation net additions		$	5,759			$	-
Interest received		$	126			$	9,403

 

2.	OIL AND GAS PROPERTIES AND PROPERTY, PLANT AND EQUIPMENT

 

Gross balances of oil and gas properties and property, plant and equipment were as follows:

 

										Total Oil				Property,
		Unproved				Proved				and Gas				Plant and
		Properties				Properties				Properties				Equipment
Gross balance at March 31, 2021		$	9,265,432			$	665,085,520			$	674,350,952			$	1,638,012
Gross balance at December 31, 2020		$	9,561,436			$	638,404,016			$	647,965,452			$	1,633,269

 

For three months ended March 31, 2021 and 2020, $26,615,267 and $27,787,678, respectively was added to the proved properties via capital expenditure. For three months ended March 31, 2021 and 2020, $397,034 and $195,022, respectively was added to the unevaluated properties via capital expenditure. For three months ended March 31, 2021 and 2020, $8,495,979 and $23,580,804, respectively of depletion expense was incurred. For three months ended March 31, 2021 and 2020, $15,254 and $15,017, respectively of depreciation expense was incurred.

 

 

SABALO ENERGY, LLC AND SABALO OPERATING, LLC

 

NOTES TO THE COMBINED FINANCIAL STATEMENTS

 

March 31, 2021 and December 31, 2020

 

2.	OIL AND GAS PROPERTIES AND PROPERTY, PLANT AND EQUIPMENT (continued)

 

Changes in accumulated depreciation and depletion for the period ended March 31, 2021 were:

 

										Total Oil				Property,
		Unproved				Proved				and Gas				Plant and
		Properties				Properties				Properties				Equipment
Balance at December 31, 2020		$	424,675			$	188,253,526			$	188,678,201			$	336,207
Depreciation, depletion and amortization			-				8,495,979				8,495,979				15,254
Balance at March 31, 2021			424,675				196,749,505				197,174,180				351,461
Net Assets at March 31, 2021		$	8,840,757			$	468,336,015			$	477,176,772			$	1,286,551

 

Changes in accumulated depreciation and depletion for the year ended December 31, 2020 were:

 

										Total Oil				Property,
		Unproved				Proved				and Gas				Plant and
		Properties				Properties				Properties				Equipment
Balance at January 1, 2020		$	3,870,070			$	104,279,961			$	108,150,031			$	275,882
Impairment			424,675				-				424,675				-
Transfer to proved			(3,870,070	)			3,870,070				-				-
Depreciation, depletion and amortization			-				80,103,495				80,103,495				60,325
Balance at December 31, 2020			424,675				188,253,526				188,678,201				336,207
Net Assets at December 31, 2020		$	9,136,761			$	450,150,490			$	459,287,251			$	1,297,062

 

3.	ASSET RETIREMENT OBLIGATIONS

 

The change in asset retirement obligations for the three months ended March 31, were as follows:

 

		2021				2021
January 1,		$	7,039,313			$	6,632,125
Additions			5,759				-
Accretion			84,013				82,053
Deletions			-				-
At March 31,		$	7,129,085			$	6,714,178

 

 

 

SABALO ENERGY, LLC AND SABALO OPERATING, LLC

 

NOTES TO THE COMBINED FINANCIAL STATEMENTS

 

March 31, 2021 and December 31, 2020

 

4.	ACCOUNTS RECEIVABLE

 

Accounts receivable consisted of the following as of:

 

		March 31,			December 31,
		2021			2021
Revenue receivable		$	21,678,379		$	18,392,374
Joint interest receivables			1,621,859			5,968,571
Accrued revenue			2,097,919			1,912,780
Total accounts receivable		$	25,398,157		$	26,273,725

 

5.	GENERAL AND ADMINISTRATIVE

 

General and administrative expenses consist of the following for the three months ended March 31:

 

		2021				2021
Staff costs		$	982,520			$	909,134
Professional fees			246,813				467,145
Insurance			1,373				3,792
Communications			9,397				7,734
Occupancy			96,277				97,415
Travel and entertainment			13,894				27,882
Other			112,021				463,196
Total general and administrative		$	1,462,295			$	1,976,298

 

6.	DERIVATIVE FINANCIAL INSTRUMENTS

 

Objectives and Strategies for Using Derivative Instruments

 

The Company is exposed to fluctuations in oil and natural gas prices received for its production. Consequently, the Company believes it is prudent to manage the variability in cash flows on a portion of its oil and natural gas production. The Company utilizes a mix of collars, swaps, put and call options and similar derivative financial instruments to manage fluctuations in cash flows resulting from changes in commodity prices. The Company does not use these instruments for speculative or trading purposes.

 

 

SABALO ENERGY, LLC AND SABALO OPERATING, LLC

 

NOTES TO THE COMBINED FINANCIAL STATEMENTS

 

March 31, 2021 and December 31, 2020

 

6.	DERIVATIVE FINANCIAL INSTRUMENTS (continued)

 

Counterparty Risk and Offsetting

 

The use of derivative instruments exposes the Company to the risk that a counterparty will be unable to meet its commitments. While the Company monitors counterparty creditworthiness on an ongoing basis, it cannot predict sudden changes in counterparties’ creditworthiness. In addition, even if such changes are not sudden, the Company may be limited in its ability to mitigate an increase in counterparty credit risk.

 

Should one of these counterparties not perform, the Company may not realize the benefit of some of its derivative instruments under lower commodity prices while continuing to be obligated under higher commodity price contracts subject to any right of offset under the agreements. Counterparty credit risk is considered when determining the fair value of a derivative instrument; see Note 1 for additional information regarding fair value.

 

The Company executes commodity derivative contracts under master agreements with netting provisions that provide for offsetting assets against liabilities. In general, if a party to a derivative transaction incurs an event of default, as defined in the applicable agreement, the other party will have the right to demand the posting of collateral, demand a cash payment transfer or terminate the arrangement.

 

Financial Statement Presentation and Settlements

 

Settlements of the Company’s derivative instruments are based on the difference between the contract price or prices specified in the derivative instrument and a benchmark price, such as the NYMEX price. To determine the fair value of the Company’s derivative instruments, the Company utilizes present value methods that include assumptions about commodity prices based on those observed in underlying markets. See Note 1 for additional information regarding fair value.

 

Derivatives not Designated as Hedging Instruments

 

The Company records its derivative contracts at fair value in the combined balance sheets and records changes in fair value as a gain or loss on derivative contracts in the combined statements of income. Cash settlements are also recorded as a gain or loss on derivative contracts in the combined statements of income.

 

The Company entered into swaps, basis swaps and collar contracts to reduce its exposure to price risk in the spot market for oil and natural gas. A collar is a combination of two options: a sold call and a purchased put. The sold call establishes the maximum price that the Company will receive for the contracted commodity volumes. The purchased put establishes the minimum price that the Company will receive for the contracted volumes. The contracts settle monthly and are scheduled to coincide with production equivalent to barrels (Bbl) per month. Cash settlement occurs monthly. No derivative contracts have been entered into for trading purpose.

 

 

SABALO ENERGY, LLC AND SABALO OPERATING, LLC

 

NOTES TO THE COMBINED FINANCIAL STATEMENTS

 

March 31, 2021 and December 31, 2020

 

6.	DERIVATIVE FINANCIAL INSTRUMENTS (continued)

 

None of the Company’s derivative contracts have been designated as fair value or cash flow hedges; accordingly mark-to-market accounting is used to recognize changes in the fair value of derivative contracts in the combined statements of income at each reporting date.

 

At March 31, 2021, the Company had the following open derivative assets (liabilities):

 

		Fair Value				Strike				Volume		Expire
Current Asset Fair Value
Natural Gas Collar:		$	11,738							261,169 mmbtu		Mar 2022
Ceiling sold price (call)						$	3.34
Floor purchase price (put)							2.90
Total Current Asset Fair Value		$	11,738
Current Liability Fair Value
Crude Oil Collar:		$	(2,532,692	)						207,439 bbls		Dec 2021
Ceiling sold price (call)						$	45.20
Floor purchase price (put)							40.00
Crude Oil Basis Swap			(217,156	)			0.18			391,305 bbls		Mar 2022
Crude Oil Swap			(2,251,358	)			42.11			130,564 bbls		Sept 2021
Crude Oil Swap			(5,606,148	)			43.60			391,305 bbls		Mar 2022
Crude Oil Basis Swap			(180,111	)			0.05			305,205 bbls		Dec 2021
Natural Gas Swap			(14,819	)			2.58			438,973 mmbtu		Oct 2021
Natural Gas Basis Swap			(11,229	)			(0.28	)		153,490 mmbtu		Mar 2022
Natural Gas Basis Swap			(718,065	)			(1.16	)		763,750 mmbtu		Dec 2021
Total Current Liability Fair Value		$	(11,531,578	)
Net Current Derivative Fair Value		$	(11,519,840	)

 

 

SABALO ENERGY, LLC AND SABALO OPERATING, LLC

 

NOTES TO THE COMBINED FINANCIAL STATEMENTS

 

March 31, 2021 and December 31, 2020

 

6.	DERIVATIVE FINANCIAL INSTRUMENTS (continued)

 

		Fair Value				Strike				Volume		Expire
Non-Current Liability Fair Value
Crude Oil Collar:		$	(154,233.0	)						20,538 bbls		Sept 2022
Ceiling sold price (call)							47.50
Floor purchase price (put)							40.00
Crude Oil Collar:			(82,094	)						19,441 bbls		Dec 2022
Ceiling sold price (call)							50.20
Floor purchase price (put)							45.00
Crude Oil Collar:			(1,558,108	)						143,889 bbls		June 2022
Ceiling sold price (call)							45.50
Floor purchase price (put)							40.00
Crude Oil Basis Swap			(366,988	)			0.40			1,034,124 bbls		Dec 2022
Crude Oil Swap			(6,033,558	)			49.85			780,660 bbls		June 2022
Crude Oil Swap			(546,858	)			41.23			36,798 bbls		June 2022
Total Non-Current Liability Fair Value		$	(8,741,839	)
Net Non-Current Derivative Fair Value		$	(8,741,839	)

 

The fair values of these financial instruments at March 31, 2021 were a loss of $20,261,679 and were included in derivative liabilities on the combined balance sheets.

 

7.	SHORT TERM BORROWINGS

 

In October 2020, the Company entered into a notes payable for $298,754 with a premium finance company to finance its annual insurance premiums. The note matures in August 2021 and is non-interest bearing. The balance as of March 31, 2021 was $137,694. Imputing interest expense on the short-term borrowings is immaterial for the year ended March 31, 2021.

 

In October 2019, the Company entered into a note payable for $351,732 with a premium finance company to finance its annual insurance premiums. The note matured in August 2020 and was non-interest bearing. The balance as of December 31, 2020 was $203,040. Imputing interest expense on the short-term borrowings is immaterial for the year ended December 31, 2020.

 

 

SABALO ENERGY, LLC AND SABALO OPERATING, LLC

 

NOTES TO THE COMBINED FINANCIAL STATEMENTS

 

March 31, 2021 and December 31, 2020

 

8.	LONG-TERM DEBT

 

The Company’s long-term debt consisted of the following as of:

 

		March 31,				December 31,
		2021				2021
Line of credit		$	147,000,000			$	147,000,000
Unamortized deferred financing costs			(253,686	)			(450,057	)
Total carrying value of long-term debt		$	146,746,314			$	146,549,943

 

The Company entered into a reserve based lending facility with certain financial institutions with aggregate commitments from the lenders totalling $150 million; collateralized by oil and gas properties located in the Howard County, Texas area. The interest rate is variable at LIBOR plus the applicable margin in effect, 4.25% at March 31, 2021. Interest is due monthly and principal is due at maturity, February 2022. The Company is subject to certain restrictive covenants, of which these include a current ratio and funded debt ratio. As of March 31, 2021, the Company is in compliance with all such covenants.

 

9.	RELATED PARTY TRANSACTIONS

 

Accounts Payable

 

Sabalo Operating, LLC provides operation services which include recordkeeping, management and accounting services for MB Minerals, LP, a related party due to common control. MB Minerals does not have a bank account so all funds earned are held by Sabalo Operating, LLC. The amounts due to MB Minerals, LP as of March 31, 2021 and December 31, 2020 were $28,228,610 and $26,106,929, respectively.

 

10.	MEMBERS’ EQUITY

 

Sabalo Energy, LLC (“Energy”) and Sabalo Operating, LLC (“Operating”) are effectively owned 100% by Sabalo Holdings, LLC (“Holdings”). Holdings has provided $40 million and $255 million in funding to Operating and Energy, respectively. No contributions or distributions were received by or made to Holdings for the three months ended March 31, 2021 and 2020.

 

 

SABALO ENERGY, LLC AND SABALO OPERATING, LLC

 

NOTES TO THE COMBINED FINANCIAL STATEMENTS

 

March 31, 2021 and December 31, 2020

 

 

11.	COMMITMENTS AND CONTINGENCIES

 

Litigation – From time to time, the Company is subject to various legal proceedings arising in the ordinary course of business, including proceedings for which the Company may not have insurance coverage. While many of these matters involve inherent uncertainty, as of the report date, the Company does not currently have any claims or proceedings.

 

Drilling Rig Contract – The Company enters into drilling rig contracts to ensure availability of desired rigs to facilitate drilling plans. The Company has a short term operating lease for five wells which contains an early termination clause that requires the Company to potentially pay penalties to the third party should the Company cease drilling efforts. These penalties would negatively impact the Company’s financial statements upon early contract termination. The contract runs for approximately three months and can be extended if desired.

 

Firm Sale and Transportation Commitments – The Company has committed to deliver, for sale or transportation, volumes of product under certain contractual arrangements that specify the delivery of substantially 100% of the production under a seven year acreage dedication effective October 5, 2017.

 

Federal and State Regulations – Oil and natural gas exploration, production and related operations are subject to extensive federal and state laws, rules and regulations. Failure to comply with these laws, rules and regulations can result in substantial penalties. The regulatory burden on the oil and natural gas industry increases the cost of doing business and affects profitability. The Company believes that it is in compliance with currently applicable federal and state regulations related to oil and natural gas exploration and production, and that compliance with the current regulations will not have a material adverse impact on the financial position or results of operations of the Company. These rules and regulations are frequently amended or reinterpreted; therefore, the Company is unable to predict the future cost or impact of complying with these regulations.

 

Environmental – The Company is subject to extensive federal, state and local environmental laws and regulations. These laws, among other things, regulate the discharge of materials into the environment and may require the Company to remove or mitigate the environmental effects of the disposal or release of petroleum or chemical substances at various sites. Environmental expenditures are expensed in the period incurred. Liabilities for expenditures of a non-capital nature are recorded when environmental assessment or remediation is probable and the costs can be reasonably estimated. Such liabilities are generally undiscounted unless the timing of cash payments is fixed and readily determinable. Management believes no materially significant liabilities of this nature existed as of March 31, 2021.

 

As of March 31, 2021, the Company had no accrued commitments.

 

 

SABALO ENERGY, LLC AND SABALO OPERATING, LLC

 

NOTES TO THE COMBINED FINANCIAL STATEMENTS

 

March 31, 2021 and December 31, 2020

 

12.	OPERATING LEASES

 

The Company had one lease related to its office space in Corpus Christi, Texas, which expires in 2022. During the three months ended March 31, 2021 and 2020, the Company incurred $89,257 and $90,073, respectively of rent expense related to this lease.

 

Minimum future lease payments on non-cancellable operating leases are as follows:

 

Year ending March 31,
2022	$	172,084
2023	$	86,042

 

13.	EMPLOYEE BENEFIT PLAN

 

The Company provides post-retirement benefits to employees in the form of a 401(k) retirement plan. As of March 31, 2021, the Company offered a matching contribution equal to 100% of salary deferrals that do not exceed 3% of a participant’s compensation plus 50% of salary deferrals between 3% and 5%. The Company’s contributions to the plan for the three months ended March 31, 2021 and 2020 were $22,520 and $22,520, respectively.

 

14.	SALE OF OIL AND GAS PROPERTY

 

In August 2019, the Company sold a large portion of their salt water disposal facilities located in Howard County, Texas. Costs associated with the properties sold were $29,549,047. The proceeds from the sale of these properties was $51,829,446. The sale resulted in a gain of $22,280,399. The Company now purchases their salt water disposal services from the new buyer. No revenue was generated by the salt water disposal facilities in the three months ended March 31, 2021 or 2020. As part of the sales contract, the Company will receive contingency payments in the following years if they are able to gather specific amounts of water as follows for the twelve months ending June 30:

 

2021	Cumulative water gathered is greater than 38 million barrels		$	3,500,000
2022	Cumulative water gathered is greater than 65 million barrels		$	3,500,000

 

 

 

SABALO ENERGY, LLC AND SABALO OPERATING, LLC

 

NOTES TO THE COMBINED FINANCIAL STATEMENTS

 

March 31, 2021 and December 31, 2020

 

15.	DRILLING DEVELOPMENT AGREEMENT

 

On November 21, 2017, the Company entered into a Farmout and Development Agreement with Shad Permian, LLC (“Shad”). Based on the agreement, Shad agreed to fund 75% of the required capital expenditures the Company incurred on the participating wells in exchange for 55% of the net revenue for a specific period of time. Shad’s total commitment was approximately $228.8 million from inception to March 31, 2021. Shad participates in 27 wells operated by the Company and 29 wells operated by others owned by the Company in Howard County, Texas. All wells are developed and producing as of December 31, 2018. The Company maintains a drill company statement for Shad’s share of capital expenditures and net revenue on the participating wells.

 

The amount owed to the Company from Shad included in accounts receivable totalled $764,073 and $2,362,860 as of March 31, 2021 and December 31, 2020, respectively. The amount owed by the Company to Shad included in revenues payable totalled $3,182,411 and $2,545,478 as of March 31, 2021 and December 31, 2020, respectively.

  

16.	COVID-19 RISKS AND UNCERTAINTIES

 

On January 31, 2020, the Secretary of Health and Human Services declared a public health emergency in response to the spread of coronavirus disease 2019 (“COVID-19”). The COVID-19 pandemic and subsequent global recession are having significant effects on global markets, supply chains, businesses, and communities. Going forward, there may be additional negative impacts, including but not limited to losses of revenue, costs for emergency preparedness, or potential shortage of personnel. Management believes the Company is taking appropriate actions to mitigate the negative impacts of the COVID-19 pandemic. However, the full impact of COVID-19 is unknown.

 

17.	SUBSEQUENT EVENTS

 

The Company has performed a review of subsequent events through May 24, 2021, which is the date the combined financial statements were available for issuance, and concludes there were no other events or transactions occurring during this period that required recognition or disclosure in the financial statements except as disclosed in the notes. Any events occurring after this date have not been factored into the combined financial statements being presented.

 

 

SABALO ENERGY, LLC AND SABALO OPERATING, LLC

 

NOTES TO THE COMBINED FINANCIAL STATEMENTS

 

March 31, 2021 and December 31, 2020

 

18.	RECENTLY ISSUED AUTHORITATIVE GUIDANCE

 

ASU 2016-02, “Leases (Topic 842).” In February 2016, the FASB amended existing guidance that requires lessees recognize the following for all leases (with the exception of short term leases) at the commencement date (1) A lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) A right-of-use asset, which is an asset that represents the lessee’s right to use or control the use of a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary: lessor accounting with the lessee accounting model and Topic 606, Revenue from Contracts with Customers. The amendments will be effective for financial statements issued for fiscal years beginning after December 15, 2021. The Company is currently evaluating the impact this change will have on the Company’s combined financial statements. Management believes it will have little impact on operating results but will create additional assets and debt obligations, primarily related to leased premises and equipment treated as operating leases under current GAAP.

 

ASU 2017-12, “Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities”. In August 2017, the FASB provided guidance to improve the financial reporting of hedging relationships to better portray the economic results of an entity's risk management activities in its financial statements. The amendments also simplify the application of the hedge accounting guidance. The amendments in this Update better align an entity's risk management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results. The amendments expand and refine hedge accounting for both nonfinancial and financial risk components and align the recognition and presentation of the effects of the hedging instrument and the hedged item in the financial statements. The amendment will be effective for annual periods beginning after December 15, 2020 and is not expected to have a significant impact on the Company’s combined financial statements.