Permian Resources Corp (PR) FY 2023 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the accompanying consolidated financial statements and related notes in “Item 8. Financial Statements and Supplementary Data” in this Annual Report. The following discussion and analysis contains forward-looking statements that reflect our future plans, estimates, beliefs and expected performance. The forward-looking statements are dependent upon events, risks and uncertainties that may be outside our control. Our actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, future market prices for oil, natural gas and NGLs, future production volumes, estimates of proved reserves, capital expenditures, economic and competitive conditions, inflation, regulatory changes, the implementation and actual result of the Earthstone Merger (defined below) and other uncertainties, as well as those factors discussed in “Cautionary Statement Concerning Forward-Looking Statements” and “Item 1A. Risk Factors” in this Annual Report, all of which are difficult to predict. In light of these risks, uncertainties and assumptions, the forward-looking events discussed may or may not occur. We do not undertake any obligation to publicly update any forward-looking statements except as otherwise required by applicable law.
Overview
We are an independent oil and natural gas company focused on the responsible acquisition, optimization and development of high-return oil and natural gas properties. Our assets are mainly located in the core of the Permian Basin. Our principal business objective is to increase shareholder value by efficiently developing our oil and natural gas assets in an environmentally and socially responsible way, with an overall objective of improving our rates of return and generating sustainable free cash flow.
Market Conditions
Our revenue, profitability and ability to return cash to stockholders can depend substantially on factors beyond our control, such as economic, political and regulatory developments. Prices for crude oil, natural gas and NGLs have experienced significant fluctuations in recent years and may continue to fluctuate widely in the future.
Immediately following the COVID-19 pandemic, global oil supply was limited by production curtailment agreements among the Organization of Petroleum Exporting Countries and other oil producing countries (“OPEC+”), in addition to overall reduced drilling and completion activity from U.S. producers. As global economies have reopened, demand for oil and gas has risen steadily post-pandemic and has been positively impacted by a global-wide transition away from coal to natural gas. The aforementioned factors, among others, led to heightened commodity prices during certain time periods of 2022, particularly during the beginning of Russia’s invasion of Ukraine. Specifically, NYMEX WTI spot prices for crude oil reached a high of $123.70 per barrel on March 8, 2022, and the NYMEX Henry Hub index price for natural gas reached a high of $9.85 per MMBtu on August 23, 2022. Subsequently, governments from several countries coordinated a simultaneous release of a portion of their strategic petroleum reserves, which increased global oil inventories to near normalized levels. In response, OPEC+ announced an agreement to curtail production by approximately two million barrels per day. Despite OPEC+’s largest production cut since the pandemic, crude oil prices continued to fall from their peak in mid-2022 due in part to government-coordinated petroleum releases, in addition to global recession concerns, a high interest rate environment, and lower than expected demand from China. Year-to-date, OPEC+ has undertaken a series of actions in an effort to support commodity prices. In April 2023, OPEC+ announced further production cuts, which were later extended. In addition, both Saudi Arabia and Russia announced unilateral production curtailments at separate times during 2023. These actions, coupled with relatively strong global demand and recent tensions in the Middle East, caused crude oil prices to increase during 2023, with NYMEX WTI spot prices reaching a high of $93.68 per barrel on September 27, 2023. However, further concerns of global economic growth and increases in oil and natural gas supply levels have resulted in additional price deterioration at the end of 2023.
The oil and natural gas industry is cyclical, and it is likely that commodity prices, as well as commodity price differentials, will continue to be volatile due to fluctuations in global supply and demand, inventory levels, geopolitical events, federal and state government regulations, weather conditions, the global transition to alternative energy sources, supply chain constraints and other factors. The following table highlights the quarterly average price trends for NYMEX WTI spot prices for crude oil and NYMEX Henry Hub index price for natural gas since the first quarter of 2021:
| 2021 | 2022 | 2023 | ||||||||||||||||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Q1 | Q2 | Q3 | Q4 | Q1 | Q2 | Q3 | Q4 | Q1 | Q2 | Q3 | Q4 | |||||||||||||||||||||||||||||||||||
| Crude Oil (per Bbl) | $ | 57.84 | $ | 66.06 | $ | 70.56 | $ | 77.09 | $ | 94.40 | $ | 108.34 | $ | 91.56 | $ | 82.64 | $ | 76.13 | $ | 73.78 | $ | 82.26 | $ | 78.32 | ||||||||||||||||||||||
| Natural Gas (per MMBtu) | $ | 3.44 | $ | 2.88 | $ | 4.28 | $ | 4.74 | $ | 4.60 | $ | 7.39 | $ | 7.96 | $ | 5.55 | $ | 2.67 | $ | 2.12 | $ | 2.58 | $ | 2.74 |
Lower commodity prices and lower futures curves for oil and gas prices can result in impairments of our proved oil and natural gas properties or undeveloped acreage and may materially and adversely affect our operating cash flows, liquidity,
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financial condition, results of operations, future business and operations, and/or our ability to finance planned capital expenditures, which could in turn impact our ability to comply with covenants under our Credit Agreement and senior notes. Lower realized prices may also reduce the borrowing base under our Credit Agreement, which is determined at the discretion of the lenders and is based on the collateral value of our proved reserves that have been mortgaged to the lenders. Upon a redetermination, if any borrowings in excess of the revised borrowing capacity were outstanding, we could be forced to immediately repay a portion of the debt outstanding under the Credit Agreement.
Due to the cyclical nature of the oil and gas industry, fluctuating demand for oilfield goods and services can put pressure on the pricing structure within our industry. As commodity prices rise, costs of oilfield goods and services generally also increase; however, during periods of commodity price declines, oilfield costs typically lag and do not adjust downward as fast as oil prices do. In addition, the U.S. inflation rate has been steadily increasing during 2022 and 2023. Inflationary pressures such as these may also result in increases to the costs of our oilfield goods, services and personnel, which can in turn cause our capital expenditures and operating costs to rise.
2023 Highlights and Future Considerations
Earthstone Merger
On August 21, 2023, we entered into an Agreement and Plan of Merger (“the Merger Agreement”) with Earthstone pursuant to which Permian Resources agreed to acquire Earthstone. On November 1, 2023 the Earthstone Merger was completed, and we issued 161.2 million shares of our Class A Common Stock and 49.5 million shares of our Class C Common Stock to Earthstone stockholders under the terms of the Merger Agreement, and we also assumed Earthstone’s debt upon closing of the Merger, which consisted of $1.05 billion of senior notes and $830 million in borrowings outstanding under its credit facility at closing. Based on the fair value of our common stock on the closing date of the Earthstone Merger, November 1, 2023, the merger consideration was $2.9 billion.
Under the terms of the Merger Agreement (i) each share of Earthstone Class A Common Stock was converted into 1.446 shares (the “Exchange Ratio”) of our Class A Common Stock, (ii) each share of Earthstone Class B Common Stock was converted into 1.446 shares of our Class C Common Stock, (iii) each common unit of Earthstone Energy Holdings, LLC (“Earthstone OpCo”), a subsidiary of Earthstone, representing limited liability company membership interests in Earthstone OpCo were converted into common units of OpCo (“Common Unit”), equal to the Exchange Ratio.
As a result of the Earthstone Merger, we acquired approximately 223,000 net leasehold acres in the Permian Basin and increased our aggregate production to approximately 300,000 Boe per day. We believe that the Earthstone Merger will drive accretion across our key financial and operating metrics over the long term, enhance our shareholder returns, improve capital efficiency, add significant core inventory and provide increased acreage to our position in the Permian Basin. The operational and financial information set forth in this Annual Report on Form 10-K do not include the activity of Earthstone for periods prior to the completion of the Earthstone Merger on November 1, 2023.
2023 Bolt-On Acquisitions
On December 15, 2023 we completed the acquisition of approximately 7,000 net leasehold acres for an unadjusted purchase price of $98 million. The acquired assets consist largely of undeveloped acreage that is contiguous to one of our existing core acreage blocks in Eddy County, New Mexico.
On February 16, 2023, we completed an acquisition of approximately 4,000 net leasehold acres and 3,300 net royalty acres for an unadjusted purchase price of $98 million. The acquired assets consist largely of undeveloped acreage that is contiguous to one of our existing core acreage blocks in Lea County, New Mexico.
2023 SWD Divestiture
On March 13, 2023, we completed the sale of our operated saltwater disposal wells and the associated produced water infrastructure in Reeves County, Texas. The total cash consideration received at closing was $125 million, of which $65 million was directly related to the sale and transfer of control of our water assets, while the remaining $60 million consisted of contingent consideration that is tied to our future drilling, completion and water connection activity in Reeves County, Texas. The proceeds from the divestiture were used to fund the February 2023 bolt-on acquisition discussed above and to pay down incremental borrowings under our credit facility.
Return of Capital Program
During each quarter of the year ended December 31, 2023, we declared and paid a quarterly dividend of $0.05 per share of Class A Common Stock and a quarterly distribution of $0.05 per Class C Common Stock (each of which has an underlying Common Unit of OpCo). Additionally, during the year ended December 31, 2023, our Board of Directors declared and paid
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variable dividends and distributions totaling $0.17 per share of Class A Common Stock and Class C Common Stock. The cash dividends and distributions paid to common unitholders totaled $236.0 million for the year ended December 31, 2023.
Also during the year ended 2023, we paid in aggregate $86.5 million to repurchase 7.2 million Common Units of OpCo resulting in an equal number of associated shares of Class C Common Stock simultaneously being canceled under our stock repurchase program.
Financing Highlights
On September 12, 2023, we issued at par $500 million of 7.00% senior notes due 2032 (the “Existing Notes”) in a 144A private placement. On December 13, 2023, we issued additional notes under this indenture dated September 12, 2023, that totaled an additional $500 million of 7.00% senior notes (together with the Existing Notes, the “2032 Senior Notes”) which resulted in aggregate net proceeds to the Company of $982.5 million from the 2032 Senior Notes, after deducting the issuance discount of $2.5 million and debt issuance costs of $15.0 million. The proceeds from the 2032 Senior Notes were used to repay debt outstanding under our credit facility, including borrowings assumed in connection with the closing of the Earthstone Merger.
On December 20, 2023, we entered into the sixth amendment to the Credit Agreement (the “Sixth Amendment”). The Sixth Amendment, among other things, increased the borrowing base from $2.5 billion to $4.0 billion and maintained the elected commitments at $2.0 billion. On September 1, 2023, we entered into the fourth and fifth amendments to the Credit Agreement (the “Fourth Amendment” and the “Fifth Amendment”). The Fourth Amendment expanded the waiver of the automatic reduction of the borrowing base under the Credit Agreement to, among other things, allow for the assumption (or the issuance, in certain circumstances) of up to $1.05 billion principal amount of Permitted Senior Unsecured Notes (as defined in the Credit Agreement) in order to refinance debt assumed in the Earthstone Merger and otherwise allow for the issuance of Permitted Senior Unsecured Notes up to an aggregate principal amount of $1.0 billion. The Fifth Amendment, among other things, waived compliance with certain restrictive covenants to enable the Earthstone Merger, subject to customary conditions. In addition, the Fifth Amendment increased the aggregate elected commitments from $1.5 billion to $2.0 billion. The Fifth Amendment was effective as of the closing date of the Earthstone Merger on November 1, 2023.
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Results of Operations
For the Year Ended December 31, 2023 Compared to the Year Ended December 31, 2022
During 2023, we completed the Earthstone Merger, and the results of operations of Earthstone were included in our financial and operational data beginning on November 1, 2023. During 2022, we completed the Colgate Merger, and the results of operations of Colgate were included in our financial and operational data beginning on September 1, 2022.
The following table provides the components of our net revenues and net production (net of all royalties, overriding royalties and production due to others) for the periods indicated, as well as each period’s average prices and average daily production volumes:
| Year Ended December 31, | Increase/(Decrease) | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | $ | % | |||||||||||
| Net revenues (in thousands): | ||||||||||||||
| Oil sales | $ | 2,696,777 | $ | 1,622,035 | $ | 1,074,742 | 66 | % | ||||||
| Natural gas sales(1) | 142,077 | 276,957 | (134,880) | (49) | % | |||||||||
| NGL sales(2) | 282,039 | 232,273 | 49,766 | 21 | % | |||||||||
| Oil and gas sales | $ | 3,120,893 | $ | 2,131,265 | $ | 989,628 | 46 | % | ||||||
| Average sales prices: | ||||||||||||||
| Oil (per Bbl) | $ | 75.84 | $ | 88.95 | $ | (13.11) | (15) | % | ||||||
| Effect of derivative settlements on average price (per Bbl) | 1.81 | (4.85) | 6.66 | 137 | % | |||||||||
| Oil including the effects of hedging (per Bbl) | $ | 77.65 | $ | 84.10 | $ | (6.45) | (8) | % | ||||||
| Average NYMEX WTI price for oil (per Bbl) | $ | 77.62 | $ | 94.24 | $ | (16.62) | (18) | % | ||||||
| Oil differential from NYMEX | (1.78) | (5.29) | 3.51 | 66 | % | |||||||||
| Natural gas price excluding the effects of GP&T (per Mcf)(1) | $ | 1.60 | $ | 4.86 | $ | (3.26) | (67) | % | ||||||
| Effect of derivative settlements on average price (per Mcf) | 0.29 | (0.53) | 0.82 | 155 | % | |||||||||
| Natural gas including the effects of hedging (per Mcf) | $ | 1.89 | $ | 4.33 | $ | (2.44) | (56) | % | ||||||
| Average NYMEX Henry Hub price for natural gas (per MMBtu) | $ | 2.53 | $ | 6.38 | $ | (3.85) | (60) | % | ||||||
| Natural gas differential from NYMEX | (0.93) | (1.52) | 0.59 | 39 | % | |||||||||
| NGL price excluding the effects of GP&T (per Bbl)(2) | $ | 22.83 | $ | 35.97 | $ | (13.14) | (37) | % | ||||||
| Net production: | ||||||||||||||
| Oil (MBbls) | 35,560 | 18,235 | 17,325 | 95 | % | |||||||||
| Natural gas (MMcf) | 119,182 | 59,692 | 59,490 | 100 | % | |||||||||
| NGL (MBbls) | 15,569 | 6,750 | 8,819 | 131 | % | |||||||||
| Total (MBoe)(3) | 70,992 | 34,934 | 36,058 | 103 | % | |||||||||
| Average daily net production: | ||||||||||||||
| Oil (Bbls/d) | 97,424 | 49,958 | 47,466 | 95 | % | |||||||||
| Natural gas (Mcf/d) | 326,525 | 163,539 | 162,986 | 100 | % | |||||||||
| NGL (Bbls/d) | 42,654 | 18,494 | 24,160 | 131 | % | |||||||||
| Total (Boe/d)(3) | 194,499 | 95,708 | 98,791 | 103 | % |
(1) Natural gas sales for the year ended December 31, 2023 include $48.9 million of gathering, processing and transportation costs (“GP&T”) that are reflected as a reduction to natural gas sales and $13.1 million for the year ended December 31, 2022. Natural gas average sales price, however, excludes $0.41 per Mcf of such GP&T charges for the year ended December 31, 2023 and $0.22 for the year ended December 31, 2022.
(2) NGL sales for the year ended December 31, 2023 include $73.3 million of GP&T that are reflected as a reduction to NGL sales and $10.6 million for the year ended December 31, 2022. NGL average sales price, however, excludes $4.71 per Bbl of such GP&T charges for the year ended December 31, 2023 and $1.56 per Bbl for the year ended December 31, 2022.
(3) Calculated by converting natural gas to oil equivalent barrels at a ratio of six Mcf of natural gas to one Boe.
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Oil, Natural Gas and NGL Sales Revenues. Total net revenues for the year ended December 31, 2023 increased by $1.0 billion, or 46%, compared to the year ended December 31, 2022. Revenues are a function of oil, natural gas and NGL volumes sold and average commodity prices realized.
Net production volumes for oil, natural gas, and NGLs increased 95%, 100% and 131%, respectively, between periods. The oil production volume increase resulted from placing 183 wells on production since December 31, 2022 as compared to 95 wells brought online during the year ended December 31, 2022. Oil production also benefited from wells acquired in the mergers with Colgate and Earthstone, which collectively added 9,852 MBbls of net oil production to the year ended December 31, 2023 compared to 3,517 MBbls of net oil production added from the Colgate Merger to the year ended December 31, 2022. These oil volume increases were partially offset by normal production decline across our existing wells. Natural gas and NGLs are produced concurrently with our crude oil volumes, typically resulting in a high correlation between fluctuations in oil quantities sold and natural gas and NGL quantities sold driving the 100% and 131%, respectively, increase in gas and NGL volumes between periods. The higher increase in gas and NGL volumes between periods as compare to the 95% increase in oil volumes was due to the producing wells acquired in the Earthstone Merger, which have a higher gas-to-oil ratio than our existing production base, and this has resulted in more volumes of gas and NGLs being added to our total production stream since the closing of the Earthstone Merger on November 1, 2023. Additionally, certain processors of our raw gas operated in higher ethane-recovery mode during the year ended December 31, 2023 as compared to the year ended December 31, 2022, which resulted in a higher percentage of NGLs being recovered from our wet gas stream during 2023.
These production increases were partially offset by decreases in the average realized sale prices for oil, natural gas and NGLs which decreased 15%, 67% and 37%, respectively, for the year ended December 31, 2023 compared to the same 2022 period. The 15% decrease in the average realized oil price was mainly the result of 18% lower NYMEX crude prices between periods, which was slightly offset by improved oil differentials. The average realized sales price of natural gas decreased 67% due to 60% lower average NYMEX gas prices between periods as well as a larger proportional gas differential during the year ended December 31, 2023 compared to the same 2022 period. The 37% decrease in average realized NGL prices between periods was primarily attributable to lower Mont Belvieu spot prices for plant products in 2023 compared to 2022. The market prices for oil and natural gas have been impacted by global supply and demand factors throughout 2022 and 2023 as discussed in the market conditions section above.
Operating Expenses. The following table sets forth selected operating expense data for the periods indicated:
| Year Ended December 31, | Increase/(Decrease) | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | Change | % | |||||||||||
| Operating costs (in thousands): | ||||||||||||||
| Lease operating expenses | $ | 373,772 | $ | 171,867 | $ | 201,905 | 117 | % | ||||||
| Severance and ad valorem taxes | 240,762 | 155,724 | 85,038 | 55 | % | |||||||||
| Gathering, processing, and transportation expense | 89,282 | 97,915 | (8,633) | (9) | % | |||||||||
| Operating cost metrics: | ||||||||||||||
| Lease operating expenses (per Boe) | $ | 5.26 | $ | 4.92 | $ | 0.35 | 7 | % | ||||||
| Severance and ad valorem taxes (% of revenue) | 7.7 | % | 7.3 | % | 0.4 | % | 6 | % | ||||||
| Gathering, processing, and transportation expense (per Boe) | 1.26 | 2.80 | (1.55) | (55) | % |
Lease Operating Expenses. Lease operating expenses (“LOE”) for the year ended December 31, 2023 increased $201.9 million compared to the year ended December 31, 2022. This increase in LOE was primarily related to higher fixed and semi-variable well costs, such as water disposal, equipment rentals, repair work, wellhead chemicals, labor and electricity, associated with our significantly higher well count from new producing wells drilled or acquired. The higher well count in 2023 was due to (i) 309 gross operated horizontal wells acquired in the Colgate Merger on September 1, 2022 that operated for the entire year of 2023 compared to four months in 2022, (ii) 183 wells placed on production since December 31, 2022, and (iii) 1,190 gross operated horizontal wells acquired in the Earthstone Merger on November 1, 2023.
LOE per Boe was $5.26 for the year ended December 31, 2023, which represents an increase of $0.35 per Boe (or 7%) from the year ended December 31, 2022. This increase was primarily driven by per Boe increases associated with higher water disposal rates between periods, resulting from the sale of our operated saltwater disposal system in March 2023 (see Note 3—Acquisitions and Divestitures for additional information on the divestiture). This increase was partially offset by fewer workovers and lower semi-variable well costs, such as wellhead chemicals, labor and electricity that resulted from operational efficiencies.
Severance and Ad Valorem Taxes. Severance and ad valorem taxes for the year ended December 31, 2023 increased $85.0 million compared to the year ended December 31, 2022. Severance taxes are based on the market value of our production at the wellhead, while ad valorem taxes are generally based on the assessed taxable value of our proved developed oil and gas properties and vary across the different counties in which we operate. Severance taxes for the year ended 2023 increased $63.4
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million compared to the same 2022 period primarily due to higher oil, natural gas and NGL revenues between periods. Ad valorem taxes between periods increased by $21.6 million due to (i) higher tax assessments on our oil and gas reserve values, (ii) incurring a full year of ad valorem taxes on the proved developed properties acquired in the Colgate Merger compared to four months in 2022, and (iii) additional expense incurred on the proved developed properties acquired in the Earthstone Merger on November 1, 2023.
Severance and ad valorem taxes as a percentage of total net revenues increased to 7.7% for the year ended December 31, 2023 as compared to 7.3% for the year ended December 31, 2022. This increase in rate was primarily the result of higher ad valorem taxes as discussed above.
Gathering, Processing and Transportation Expenses. Gathering, processing and transportation costs (“GP&T”) for the year ended December 31, 2023 decreased $8.6 million compared to the year ended December 31, 2022. Additionally, GP&T decreased on a per Boe basis from $2.80 for the year ended December 31, 2022 to $1.26 per Boe for the year ended December 31, 2023. These decreases are primarily due to a higher proportion of our GP&T costs being recognized as a reduction to our gas and NGL revenues for the year ended December 31, 2023 as compared to 2022. This classification of GP&T costs in revenues is required under ASC Topic 606, Revenue from contracts with Customers, whenever our gas processers transfer control of our raw gas at delivery points prior to, or at, the inlet of gas processing plants. Refer to Note 15—Revenues under Part II, Item 8 of this Annual Report for additional information on our natural gas gathering and processing contracts.
Depreciation, Depletion and Amortization. The following table summarizes our depreciation, depletion and amortization (“DD&A”) for the periods indicated:
| Year Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| (in thousands, except per Boe data) | 2023 | 2022 | ||||
| Depreciation, depletion and amortization | $ | 1,007,576 | $ | 444,678 | ||
| Depreciation, depletion and amortization per Boe | $ | 14.19 | $ | 12.73 |
For the year ended December 31, 2023, DD&A expense amounted to $1.0 billion, an increase of $562.9 million from 2022. The primary factor contributing to higher DD&A expense in 2023 was the increase in our overall production volumes between periods, which increased DD&A expense by $459.0 million period over period, while higher DD&A rates between periods increased DD&A expense by $103.9 million.
Our DD&A rate can fluctuate as a result of finding and development costs incurred, acquisitions, impairments, as well as changes in proved developed and proved undeveloped reserves. Our DD&A rate per Boe was $14.19 for the year ended December 31, 2023 compared to $12.73 in 2022. This increase in the rate between periods was primarily due to (i) the finding and development rate of approximately $10.50 per BOE for 2023, as incorporated in our DD&A computation and (ii) downward proved reserve revisions primarily because of decreasing oil prices during 2023.
General and Administrative Expenses. The following table summarizes our general and administrative (“G&A”) expenses for the periods indicated:
| Year Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| (in thousands) | 2023 | 2022 | ||||
| Cash general and administrative expenses | $ | 85,978 | $ | 60,584 | ||
| Stock-based compensation - equity awards | 75,877 | 113,759 | ||||
| Stock-based compensation - liability awards | — | (24,174) | ||||
| Stock-based compensation - cash settled awards | — | 9,385 | ||||
| General and administrative expenses | $ | 161,855 | $ | 159,554 |
G&A expenses for the year ended December 31, 2023 were $161.9 million compared to $159.6 million for the year ended December 31, 2022. Higher G&A in 2023 was the result of a $25.4 million increase in cash G&A between periods. This increase was primarily due to (i) higher payroll and employee-related costs associated with our G&A headcount, which increased from a year to date monthly average of 126 as of December 31, 2022 to 185 as of December 31, 2023 stemming from the Colgate and Earthstone Mergers; (ii) higher professional and legal fees between periods; and (iii) higher rent, software and office expenses between periods associated with the higher headcount. This was partially offset by a $23.1 million decrease in total stock-based compensation expense between periods. This decrease was largely due to (i) a $19.4 million net decrease in stock-based compensation expense related to liability classified awards that were settled in cash or reclassified as equity in 2022 (we no longer have any liability based equity awards outstanding); and (ii) a $6.5 million decrease in equity awards compensation costs associated with less expense recognized for the acceleration of certain awards for officer and employee exits stemming from the Colgate Merger, which totaled $40.0 million for the year ended December 31, 2023 as compared to $46.5 million for the year
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ended December 31, 2022. Refer to Note 7—Stock-Based Compensation under Part II, Item 8 of this Annual Report for additional information regarding these awards.
Merger and integration expense. Merger and integration expense for the year ended December 31, 2023 was $125.3 million. compared to $77.4 million for the year ended December 31, 2022. Merger and integration expense incurred during the year ended December 31, 2023 consisted of (i) $63.4 million in bankers’ advisory, legal, consultancy and accounting fees associated with the Earthstone Merger; (ii) $43.5 million in severance and related benefits associated with employee terminations that occurred in 2023 in connection with the Earthstone Merger; and (iii) $18.4 million in costs incurred during 2023 related to the Colgate Merger primarily related to employee severance charges and integration and consulting expenses. During the year ended December 31, 2022, merger and integration expense primarily consisted of (i) $40.0 million in bankers’ advisory fees related to the Colgate Merger; (ii) $24.0 million in severance and related benefits associated with employee terminations that occurred in connection with the Colgate Merger; and (iii) legal, accounting and consultancy fees.
Exploration and Other Expenses. The following table summarizes exploration and other expenses for the periods indicated:
| Year Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| (in thousands) | 2023 | 2022 | ||||
| Geological and geophysical costs | $ | 11,342 | $ | 7,401 | ||
| Stock-based compensation - equity awards | 2,541 | 2,721 | ||||
| Other expenses | 5,454 | 1,256 | ||||
| Exploration and other expenses | $ | 19,337 | $ | 11,378 |
Exploration and other expenses were $19.3 million for the year ended December 31, 2023 compared to $11.4 million for the year ended December 31, 2022. Exploration and other expenses mainly consist of topographical studies, geographical and geophysical (“G&G”) projects, salaries and expenses of G&G personnel and include other operating costs. The period over period increase was primarily related to (i) higher G&G personnel costs associated with increased headcount; (ii) increased costs incurred on G&G projects and seismic studies; and (iii) $1.5 million in costs incurred in 2023 associated with nonrecurring legal settlements.
Other Income and Expense.
Interest Expense. The following table summarizes interest expense for the periods indicated:
| Year Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| (in thousands) | 2023 | 2022 | ||||
| Credit Facility | $ | 30,049 | $ | 15,974 | ||
| 5.375% Senior Notes due 2026 | 15,557 | 15,557 | ||||
| 7.75% Senior Notes due 2026 | 23,250 | 7,750 | ||||
| 6.875% Senior Notes due 2027 | 24,500 | 24,500 | ||||
| 8.00% Senior Notes due 2027 | 7,333 | — | ||||
| 3.25% Convertible Senior Notes due 2028 | 5,525 | 5,525 | ||||
| 5.875% Senior Notes due 2029 | 41,125 | 13,708 | ||||
| 9.875% Senior Notes due 2031 | 8,229 | — | ||||
| 7.00% Senior Notes due 2032 | 12,347 | — | ||||
| Amortization of debt issuance costs, debt discount and debt premium | 16,078 | 15,652 | ||||
| Interest capitalized | (7,813) | (3,021) | ||||
| Other interest expense | 1,029 | — | ||||
| Total | $ | 177,209 | $ | 95,645 |
Interest expense was $81.6 million higher for the year ended December 31, 2023 compared to the year ended December 31, 2022 mainly due to (i) $58.5 million in additional interest expense incurred from the senior notes that were assumed in the Colgate and Earthstone Mergers; (ii) $14.1 million in higher interest expense incurred on our credit facility due to a higher weighted average borrowings outstanding and effective interest rate during 2023; and (iii) $12.3 million in interest incurred on our Senior Notes due 2032 that were issued in September 2023.
Our weighted average borrowings outstanding under our Credit Agreement were $357.0 million during 2023 compared to $235.5 million in 2022. Our Credit Agreement’s weighted average effective interest rate was 7.1% and 4.5% for the years ended December 31, 2023 and 2022, respectively, due to higher rates on our variable-rate borrowings between periods.
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Net Gain (Loss) on Derivative Instruments. Net gains and losses are a function of (i) changes in derivative fair values associated with fluctuations in the forward price curves for the commodities underlying each of our hedge contracts outstanding and (ii) monthly cash settlements on any closed out hedge positions during the period.
The following table presents gains and losses on our derivative instruments for the periods indicated:
| Year Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| (in thousands) | 2023 | 2022 | ||||
| Realized cash settlement gains (losses) | $ | 99,410 | $ | (120,105) | ||
| Non-cash mark-to-market derivative gain (loss) | 14,606 | 77,737 | ||||
| Total | $ | 114,016 | $ | (42,368) |
Income Tax Expense: The following table summarizes our pre-tax income and income tax expense for the periods indicated.
| Year Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| (in thousands) | 2023 | 2022 | ||||
| Income before income taxes | $ | 1,035,648 | $ | 870,132 | ||
| Income tax expense | (155,945) | (120,292) |
Our provision for income taxes for the years ended December 31, 2023 and 2022 differs from the amounts that would be provided by applying the statutory U.S. federal income tax rate of 21% to pre-tax book income primarily due to (i) the portion of pre-tax net income that is attributable to our non-controlling interest and which is therefore not taxable to the Company; (ii) other permanent differences; (iii) state income taxes; and (iv) any changes during the period in our deferred tax asset valuation allowance.
For the year ended December 31, 2023 we generated pre-tax net income of $1.0 billion and recorded income tax expense of $155.9 million. The primary factors decreasing our income tax expense below the U.S. statutory rate was the portion of pre-tax income that was attributable to our non-controlling interest partners and not taxable to the Company.
During the year ended December 31, 2022, generated pre-tax net income of $870.1 million and recorded income tax expense of $120.3 million. The primary factors decreasing our income tax expense below the U.S. statutory rate was (i) the portion of pre-tax income that was attributable to our non-controlling interest partners, and (ii) the release of our deferred tax valuation allowance due to the generation of net income in the current year.
For the Year Ended December 31, 2022 Compared to the Year Ended December 31, 2021
Refer to Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in the 2022 Annual Report on Form 10-K filed with the SEC for a discussion of the results of operations for the year ended December 31, 2022 compared to the year ended December 31, 2021.
Liquidity and Capital Resources
Overview
Our drilling and completion activities require us to make significant capital expenditures. Historically, our primary sources of liquidity have been cash flows from operations, borrowings under our revolving credit facility, proceeds from offerings of debt or equity securities, or proceeds from the sale of oil and gas properties. Our future cash flows are subject to a number of variables, including oil and natural gas prices, which have been and will likely continue to be volatile. Lower commodity prices can negatively impact our cash flows and our ability to access debt or equity markets, and sustained low oil and natural gas prices could have a material and adverse effect on our liquidity position. To date, our primary uses of capital have been for drilling and development capital expenditures and the acquisition of oil and natural gas properties.
We continually evaluate our capital needs and compare them to our capital resources. Our total capital expenditures incurred for the year ended December 31, 2023 were $1.5 billion. We expect our total drilling, completion and facilities cash capital expenditures budget for 2024 to be between $1.9 billion to $2.1 billion. We funded our capital expenditures for 2023 entirely from cash flows from operations, and we expect to fund our 2024 capital expenditures budget entirely from cash flows from operations given our anticipated level of oil and gas production, current commodity prices and our commodity hedge positions in place.
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Because we are the operator of a high percentage of our acreage, we can control the amount and timing of our capital expenditures. Accordingly, we can choose to defer or accelerate a portion of our planned capital expenditures depending on a variety of factors, including but not limited to: prevailing and anticipated prices for oil and natural gas; oil storage or transportation constraints; the success of our drilling activities; the availability of necessary equipment, infrastructure and capital; the receipt and timing of required regulatory permits and approvals; seasonal conditions; property or land acquisition costs; and the level of participation by other working interest owners.
In August 2023, we announced our merger with Earthstone, and it was completed on November 1, 2023. As a result of the Earthstone Merger, our future operational plans, cash flows and leverage profile, among others things, as a combined entity has changed, and such changes include (i) assuming $1.05 billion of Earthstone’s senior notes, (ii) refinancing Earthstone’s credit facility borrowings outstanding at closing with borrowings under our facility, and (iii) funding of transaction costs incurred related to the Earthstone Merger. Additionally, during the year ended 2023, we issued $1.0 billion of 7.00% 2032 Senior Notes, with the net proceeds being used to repay indebtedness outstanding under our credit facility, including a portion of the debt we assumed upon closing of the Earthstone Merger.
We plan to return capital to shareholders through a combination of base dividends plus a variable return program, including variable dividends, share repurchases or a combination of both. During each quarter for the year ended December 31, 2023, we declared and paid a quarterly cash dividend of $0.05 per share of Class A Common Stock and a quarterly cash distribution of $0.05 per Common Unit of OpCo. In addition, during the year ended December 31, 2023, our Board of Directors also declared and paid total variable cash dividends of $0.17 per share of Class A Common Stock and total variable cash distributions of $0.17 per Common Unit of OpCo. The cash dividends and distributions paid to common unitholders totaled $236.0 million for the year ended December 31, 2023. Additionally, we repurchased 7.2 million shares of Class C Common Stock for $86.5 million and 2.8 million shares of Class A Common Stock for $37.9 million under our stock repurchase program during the year ended December 31, 2023.
The stock repurchase program can be used to reduce our shares of common stock outstanding. Such repurchases would be made at terms and prices determined by us based upon prevailing market conditions, applicable legal requirements, available liquidity, compliance with our debt agreements and other factors. In addition, we may, from time to time, seek to retire or purchase our outstanding senior notes through cash purchases and/or exchanges for debt in open-market purchases, privately negotiated transactions or otherwise.
We cannot ensure that cash flows from operations or other sources of needed capital will be available at acceptable terms or at all. Further, our ability to access the public or private debt or equity capital markets at economic terms in the future will be affected by general economic conditions, the domestic and global oil and financial markets, our operational and financial performance, the value and performance of our debt or equity securities, prevailing commodity prices and other macroeconomic factors outside of our control.
Analysis of Cash Flow Changes
The following table summarizes our cash flows for the periods indicated:
| Year Ended December 31, | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| (in thousands) | 2023 | 2022 | 2021 | |||||||
| Net cash provided by operating activities | $ | 2,213,499 | $ | 1,371,671 | $ | 525,619 | ||||
| Net cash used in investing activities | (1,578,379) | (1,205,049) | (226,476) | |||||||
| Net cash (used in) provided by financing activities | (631,188) | (106,625) | (297,547) |
Cash Flows from 2023 Compared to 2022. For the year ended December 31, 2023, we generated $2.2 billion of cash from operating activities, an increase of $841.8 million from 2022. Cash provided by operating activities increased primarily due to higher production volumes, higher cash settlements on derivatives as well as the timing of our receivable collections for the year ended December 31, 2023 as compared to the same 2022 period. These increasing factors were partially offset by lower realized prices for all commodities, higher lease operating expenses, severance and ad valorem taxes, interest expense, merger and integration expense and cash G&A expense for the year ended December 31, 2023. Refer to Results of Operations for more information on the impact of volumes and prices on revenues and on fluctuations in our operating expenses between periods.
For the year ended December 31, 2023, cash flows from operating activities, cash on hand, $1.0 billion in proceeds from the issuance of our 2032 Senior Notes and sales proceeds from divestitures together with contingent consideration of $175.4 million from the sale of oil and natural gas properties were used to: fund $1.5 billion of drilling and development cash expenditures; repay $830.0 million of borrowings outstanding from Earthstone’s credit facility that were assumed at closing of the Earthstone Merger; repay net borrowings of $385.0 million under our Credit Agreement; pay $236.0 million in dividends and cash distributions to holders of our Common Units; fund acquisitions of oil and gas properties of $234.3 million; and repurchase $162.4 million of our common stock.
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Cash Flows from 2022 Compared to 2021. For the year ended December 31, 2022, we generated $1.4 billion of cash from operating activities, an increase of $846.1 million from 2021. Cash provided by operating activities increased primarily due to higher realized prices for oil and gas, higher production volumes, and the timing of vendor payments during 2022 as compared to 2021. These increasing factors were partially offset by higher merger and integration expense, severance and ad valorem taxes, lease operating expenses, GP&T, cash G&A expense and the timing of our receivable collections for the year ended December 31, 2022 as compared to the same 2021 period.
For the year ended December 31, 2022, cash flows from operating activities and net borrowings under our revolving credit facility were used to fund $771.6 million of drilling and development cash expenditures, finance $496.7 million of net cash consideration paid for the Colgate Merger, repay $400.0 million of borrowings outstanding from Colgate’s credit facility that were assumed at closing of the Colgate Merger and pay a total cash dividend and distribution to noncontrolling interest owners of $27.9 million.
Credit Agreement
OpCo, our consolidated subsidiary, has a five-year secured revolving Credit Agreement with a syndicate of banks maturing in February 2027 that, as of December 31, 2023, had a borrowing base of $4.0 billion and elected commitments of $2.0 billion. As of December 31, 2023, we had no borrowings outstanding and $2.0 billion in available borrowing capacity, which was net of $5.7 million in letters of credit outstanding.
The Credit Agreement contains restrictive covenants that limit our ability to, among other things: (i) incur additional indebtedness; (ii) make investments and loans; (iii) enter into mergers; (iv) make restricted payments; (v) repurchase or redeem junior debt; (vi) enter into commodity hedges exceeding a specified percentage of our expected production; (vii) enter into interest rate hedges exceeding a specified percentage of its outstanding indebtedness; (viii) incur liens; (ix) sell assets; and (x) engage in transactions with affiliates.
The Credit Agreement also requires OpCo to maintain compliance with the following financial ratios:
(i) a current ratio, which is the ratio of OpCo’s consolidated current assets (including an add back of unused commitments under the revolving credit facility and excluding non-cash derivative assets and certain restricted cash) to its consolidated current liabilities (excluding the current portion of long-term debt under the Credit Agreement and non-cash derivative liabilities), of not less than 1.0 to 1.0; and
(ii) a leverage ratio, as defined within the Credit Agreement as the ratio of total funded debt to consolidated EBITDAX (as defined within the Credit Agreement) for the most recent quarter annualized, of not greater than 3.5 to 1.0.
The Credit Agreement includes fall away covenants, lower interest rates and reduced collateral requirements that OpCo may elect if OpCo is assigned an Investment Grade Rating (as defined within the Credit Agreement).
OpCo was in compliance with the covenants and financial ratios under the Amended Credit Agreement described above through the filing of this Annual Report.
For further information on the Credit Agreement, refer to Note 5—Long-Term Debt under Item 8 of this Annual Report.
Convertible Senior Notes
On March 19, 2021, OpCo issued $150.0 million in aggregate principal amount of Convertible Senior Notes. On March 26, 2021, OpCo issued an additional $20.0 million of Convertible Senior Notes pursuant to the exercise of the underwriters’ over-allotment option to purchase additional notes. These issuances resulted in aggregate net proceeds to OpCo of $163.6 million, which were used to repay borrowings outstanding under the Credit Agreement and to fund the cost of entering in to capped call spread transactions of $14.7 million. Subsequently in April 2021, we redeemed at par all of our Senior Secured Notes (defined below), which was the intended use of proceeds from the Convertible Senior Notes offering.
The Convertible Senior Notes are fully and unconditionally guaranteed on a senior unsecured basis by the Company and each of OpCo’s current subsidiaries that guarantee OpCo’s outstanding Senior Unsecured Notes as defined below.
The Convertible Senior Notes bear interest at an annual rate of 3.25% and are due on April 1, 2028 unless earlier repurchased, redeemed or converted. The Convertible Senior Notes may become convertible prior to April 1, 2028, upon the occurrence of certain events or conditions being met as disclosed in Note 5—Long-Term Debt under Item 8 of this Annual Report. As of December 31, 2023, certain conditions have been met, and as a result, noteholders have the right to convert their Convertible Senior Notes during the first quarter of 2023. OpCo can settle the Convertible Senior Notes by paying or delivering cash, shares of the Class A Common Stock, or a combination of cash and Class A Common Stock, at OpCo’s election.
In connection with the Convertible Senior Notes issuance, OpCo entered into privately negotiated capped call spread transactions (the “Capped Call Transactions”), that are expected to reduce potential dilution to our Class A Common Stock upon a conversion and/or offset any cash payments OpCo is required to make in excess of the principal amount of the Convertible Senior
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Notes, subject to a cap. The Capped Call Transactions have an initial strike price of $6.28 per share of Class A Common Stock and an initial capped price of $8.4525 per share of Class A Common Stock (each subject to certain customary adjustments per the agreements).
Senior Notes
On November 1, 2023, in connection with the Earthstone Merger, OpCo entered into supplemental indentures whereby all of Earthstone’s outstanding senior notes were assumed and became the senior unsecured debt of OpCo. The senior notes assumed by OpCo included $550 million of 8.00% senior notes due 2027 (the “2027 8.00% Senior Notes”) and $500 million of 9.875% senior notes due 2031 (the “2031 Senior Notes”). We recorded the acquired senior notes at their fair values as of the Earthstone Merger closing date, which were equal to 102.86% of par (a $15.7 million premium) for the 2027 8.00% Senior Notes and 107.37% of par (a $36.8 million premium) for the 2031 Senior Notes.
On September 12, 2023, OpCo issued at par $500 million of 7.00% senior notes due 2032 (the “Existing Notes”) in a 144A private placement. On December 13, 2023, OpCo issued additional notes under the indenture dated September 12, 2023 that totaled an additional $500 million of 7.00% senior notes (together with the Existing Notes, the “2032 Senior Notes”), which resulted in aggregate net proceeds of $982.5 million, after deducting the issuance discount of $2.5 million and debt issuance costs of $15.0 million. The 2032 Senior Notes are treated as a single series of securities and will vote together as a single class, and have substantially identical terms, other than the issue date and issue price.
On September 1, 2022, in connection with the Colgate Merger, OpCo entered into supplemental indentures whereby all of Colgate’s outstanding senior notes were assumed at the Colgate Merger closing date and became the senior unsecured debt of OpCo. The senior notes assumed by OpCo included $300 million of 7.75% senior notes due 2026 (the “2026 7.75% Senior Notes”) and $700 million of 5.875% senior notes due 2029 (the “2029 Senior Notes”). We recorded the acquired senior notes at their fair value as of the Colgate Merger closing, which were equal to 100% of par for the 2026 7.75% Senior Notes and 93.68% of par (a $49.3 million debt discount) for the 2029 Senior Notes.
On November 30, 2017, OpCo issued $400.0 million of 5.375% senior notes due 2026 (the “2026 5.375% Senior Notes”) and on March 15, 2019, OpCo issued $500.0 million of 6.875% senior notes due 2027 (the “2027 6.875% Senior Notes” and, together with the 2027 8.00% Senior Notes, 2031 Senior Notes, 2032 Senior Notes, 2026 5.375% Senior Notes, 2029 Senior Notes and the 2026 7.75% Senior Notes, the “Senior Unsecured Notes”) in 144A private placements. In May 2020, $110.6 million aggregate principal amount of the 2026 5.375% Senior Notes and $143.7 million aggregate principal amount of the 2027 6.875% Senior Notes were validly tendered and exchanged by certain eligible bondholders for consideration consisting of $127.1 million aggregate principal amount of 8.00% second lien senior secured notes, which were fully redeemed at par in connection with the Convertible Senior Notes issuance during the second quarter of 2021.
The Senior Unsecured Notes are fully and unconditionally guaranteed on a senior unsecured basis by the Company and each of OpCo’s current subsidiaries that guarantee OpCo’s Credit Agreement.
The indentures governing the Senior Unsecured Notes contain covenants that, among other things and subject to certain exceptions and qualifications, limit OpCo’s ability and the ability of OpCo’s restricted subsidiaries to: (i) incur or guarantee additional indebtedness or issue certain types of preferred stock; (ii) pay dividends on capital stock or redeem, repurchase or retire capital stock or subordinated indebtedness; (iii) transfer or sell assets; (iv) make investments; (v) create certain liens; (vi) enter into agreements that restrict dividends or other payments from their subsidiaries to them; (vii) consolidate, merge or transfer all or substantially all of their assets; (viii) engage in transactions with affiliates; and (ix) create unrestricted subsidiaries. OpCo was in compliance with these covenants as of December 31, 2023 and through the filing of this Annual Report.
For further information on our Convertible Senior Notes and Senior Unsecured Notes, refer to Note 5—Long-Term Debt under Item 8 of this Annual Report.
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Obligations and Commitments
We routinely enter into or extend operating and transportation agreements, office and equipment leases, drilling rig contracts, among others, in the ordinary course of business. The following table summarizes our obligations and commitments as of December 31, 2023 to make future payments under long-term contracts for the time periods specified below.
| (in thousands) | 2024 | 2025 | 2026 | 2027 | 2028 | Thereafter | Total | |||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Operating leases(1) | $ | 35,112 | $ | 14,721 | $ | 5,204 | $ | 2,895 | $ | 2,705 | $ | 6,045 | $ | 66,682 | ||||||||||||
| Financing leases(2) | 753 | 718 | 684 | 652 | 621 | 12,146 | 15,574 | |||||||||||||||||||
| Purchase obligations(3) | 57,581 | 57,575 | 5,200 | — | — | — | 120,356 | |||||||||||||||||||
| Development obligation(4) | 20,000 | 20,000 | 20,000 | — | — | — | 60,000 | |||||||||||||||||||
| Asset retirement obligations(5) | 974 | 9,735 | 12,095 | 326 | 150 | 98,137 | 121,417 | |||||||||||||||||||
| Long term debt obligations(6) | — | — | 589,448 | 906,351 | 170,000 | 2,200,000 | 3,865,799 | |||||||||||||||||||
| Cash interest expense on long-term debt obligations(7) | 280,917 | 280,917 | 245,664 | 186,063 | 161,897 | 359,088 | 1,514,546 | |||||||||||||||||||
| Total | $ | 395,337 | $ | 383,666 | $ | 878,295 | $ | 1,096,287 | $ | 335,373 | $ | 2,675,416 | $ | 5,764,374 |
(1) Operating leases consist of our office rental agreements, drilling rig contracts and other wellhead equipment. Please refer to Note 16—Leases under Part II, Item 8 of this Annual Report for details on our operating lease commitments.
(2) Financing leases consist of our ground lease related to the office building we purchased in Midland, Texas. The lease term is ninety-nine years and as a result, the commitments above have been shown at their current present value. Please refer to Note 16—Leases under Part II, Item 8 of this Annual Report for details on our financing lease commitments.
(3) Consists of an energy purchase agreement to buy a minimum amount of electricity at a fixed price or pay for underutilization as well as a take-or-pay agreement to purchase a minimum volume of frac sand at a fixed price. The obligations reported above represent our remaining minimum financial commitments pursuant to the terms of these contracts as of December 31, 2023, however actual expenditures may exceed the minimum commitments presented above.
(4) Consists of obligations that are tied to our future drilling, completion and water connection activity in Reeves County, Texas that will require repayment if certain performance obligations through September 2026 are not met.
(5) Asset retirement obligations reflect the present value of the estimated future costs associated with the plugging and abandonment of oil and gas wells and the related land restoration in accordance with applicable laws and regulations.
(6) Long-term debt consists of the principal amounts of our senior notes due as of December 31, 2023.
(7) Cash interest expense on our senior notes is estimated assuming no principal repayment until the maturity of the instruments. Cash interest expense on the Credit Agreement includes unused commitment fees and assumes no additional principal borrowings, repayments or changes to commitments under the agreement through the instrument due date.
Recently Issued Accounting Standards
There were no significant new accounting standards adopted or new accounting pronouncements that would have a potential effect on us as of December 31, 2023.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these statements requires us to make certain assumptions, judgments and estimates that affect the reported amounts of assets, liabilities, revenues and expenses, as well as, the disclosure of contingent assets, contingent liabilities and commitments as of the date of our financial statements. We base our assumptions and estimates on historical experience and other sources that we believe to be reasonable at the time. Actual results may vary from our estimates due to changes in circumstances, weather, politics, global economics, commodity prices, production performance, drilling results, mechanical problems, general business conditions and other factors. A summary of our significant accounting policies can be found in Note 1—Basis of Presentation and Summary of Significant Accounting Policies under Item 8 of this Annual Report.
We have outlined certain of our accounting policies below which require the application of significant judgment by our management.
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Oil and Natural Gas Reserve Quantities
We use the successful efforts method of accounting for our oil and gas producing activities. The successful efforts method inherently relies on the estimation of proved crude oil, natural gas and NGL reserves. Reserve quantities and the related estimates of future net cash flows are used as inputs to our calculation of depletion, evaluation of proved properties for impairment, assessment of the expected realizability of our deferred income tax assets, and the standardized measure of discounted future net cash flows computations.
The process of estimating quantities of proved reserves is inherently imprecise and relies on the following: i) interpretations and judgment of available geological, geophysical, engineering and production data; ii) certain economic assumptions, some of which are mandated by the SEC, such as commodity prices; and iii) assumptions and estimates of underlying inputs such as operating expenses, capital expenditures, plug and abandonment costs and taxes. All of these assumptions may differ substantially from actual results, which could result in a significant change in our estimated quantities of proved reserves and their future net cash flows. We continually make revisions to reserve estimates throughout the year as additional information becomes available, and we make changes to depletion rates in the same reporting period that changes to reserve estimates are made.
Business Combinations
From time to time, we may acquire assets and assume liabilities in transactions accounted for as business combinations, such as the Earthstone Merger. In connection with the Earthstone Merger, we allocated the $2.9 billion of purchase price consideration to the assets acquired and liabilities assumed based on estimated fair values as of the Earthstone Merger closing date.
For business and asset acquisitions, we generally recognize the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in the acquiree at their estimated fair values on the acquisition date. Determining fair value requires management’s judgment and involves the use of significant estimates and assumptions with respect to projections of future production volumes, forecasted development costs, pricing and cash flows, discount rates, expectations regarding customer contracts and relationships, reserve risk adjustment factors and other management estimates. The judgments made in the determination of the estimated fair value assigned to the assets acquired, liabilities assumed and any noncontrolling interest, as well as the estimated useful life of each asset and the duration of each liability, can materially impact the financial statements in periods after acquisition. See Note 2—Business Combinations in Item 8 of this Annual Report on Form 10-K.
Impairment of Oil and Natural Gas Properties
We assess our proved properties for impairment when events or changes in circumstances indicate that the carrying value of such proved property assets may not be recoverable. For purposes of an impairment evaluation, our proved oil and natural gas properties must be grouped at the lowest level for which independent cash flows can be identified. If the sum of the undiscounted estimated cash flows from the use of the asset group and its eventual disposition is less than the carrying value of an asset group, the carrying value is written down to its estimated fair value. Fair value for the purpose of measuring impairment write-downs are calculated using the present value of expected future cash flows that are estimated to be generated from the asset group. Fair value estimates are based on projected financial information which we believe to be reasonably likely to occur, as of the date that the impairment write-down is being measured. However, such future cash flow estimates are based on numerous assumptions that can materially affect our estimates, and such assumptions are subject to change with variations in commodity prices, production performance, drilling results, operating and development costs, underlying oil and gas reserve quantities, and other internal or external factors.
Unproved properties consist of the costs we incurred to acquire undeveloped leasehold acreage as well as the costs we incurred to acquire unproved reserves. Unproved properties with individually significant acquisition costs are periodically assessed for impairment based on remaining lease term, drilling results, reservoir performance, seismic interpretation or changes in future plans to develop acreage. Unproved properties which are not individually significant are amortized by prospect, based on our historical experience, current drilling plan, existing geological data and average remaining lease terms. Changes in our assumptions as to the estimated nonproductive portion of our undeveloped leases could result in additional impairment charges.
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