Gulfport Energy and Wexford Capital Part V: Parsing Gulfport's cash flow statement

From the last 10Q here are Gulfport Energy's revenue numbers for the past three months:

	Three Months Ended March 31,
		2012				2011
Revenues:
Oil and condensate sales		$	64,004,000			$	45,196,000
Gas sales			613,000				720,000
Natural gas liquids sales			806,000				659,000
Other income			38,000				63,000
			65,461,000				46,638,000

They had $65 million in revenue.

Net income was $26.7 million dollars.

Here is the cash flow statement for operating cash flows:

		Three Months Ended March 31,
		2012				2011
Cash flows from operating activities:
Net income		$	26,869,000			$	21,174,000
Adjustments to reconcile net income to net cash provided by operating activities:
Accretion of discount - Asset Retirement Obligation			176,000				159,000
Depletion, depreciation and amortization			21,395,000				12,158,000
Stock-based compensation expense			681,000				77,000
Loss from equity investments			268,000				316,000
Interest income - note receivable			—				(36,000	)
Unrealized loss on derivative instruments			266,000				—
Amortization of loan commitment fees			112,000				110,000
Changes in operating assets and liabilities:
Increase in accounts receivable			(1,718,000	)			(5,419,000	)
Increase in accounts receivable - related party			(463,000	)			(160,000	)
(Increase) decrease in prepaid expenses			(57,000	)			618,000
Increase (decrease) in accounts payable and accrued liabilities			22,431,000				(709,000	)
Settlement of asset retirement obligation			(531,000	)			—
Net cash provided by operating activities			69,429,000				28,288,000

The cash generated was - believe it or not - slightly larger than the revenue - and over 40 million higher than profits. Part of that was depletion (depreciation adds to cash flow). Most the rest was simply an increase in accounts payable of 22 million.

Here is the cash flow from investing for that three months:

Cash flows from investing activities:
Additions to other property, plant and equipment			(82,000	)			(13,000	)
Additions to oil and gas properties			(84,778,000	)			(33,285,000	)
Proceeds from sale of other property, plant and equipment			140,000				—
Proceeds from sale of oil and gas properties			—				1,384,000
Advances on note receivable to related party			—				(1,319,000	)
Contributions to investment in Grizzly Oil Sands ULC			(67,063,000	)			(4,878,000	)
Distributions from investment in Tatex Thailand II, LLC			200,000				—
Contributions to investment in Tatex Thailand III, LLC			(483,000	)			(895,000	)
Contributions to investment in Muskie Holdings LLC			(312,000	)			—
Contributions to investment in Timber Wolf Terminals LLC			(1,000,000	)			—
Contributions to investment in Windsor Midstream LLC			(7,021,000	)			—
Net cash used in investing activities			(160,399,000	)			(39,006,000	)

In those three months they invested $160 million but only had cash flows of $69 million and earnings of $26.7 million.

How did they finance this?

As noted the company had to finance $160 million of investing activities from only $26.7 million in operating earnings. This presents financing issues.

Firstly the company (as noted) ran up its accrued liabilities.

Then the company borrowed $10 million dollars.

But mostly the company ran down its cash holdings from $93 million to $13 million.

Where did those cash holdings come from?

The cash holdings did not represent past profits. What they were was proceeds from equity issuance. The company cash flow statement in 2011 shows $307 million in equity issuance - much of which has gone into investing in various quarters. The cash is now heavily depleted (note only $13 million is left).

If they intend on investing at these rates they will need to raise more capital.

What were the investments?

In the last quarter they invested $67 million in Grizzly Oil Sands. That is controlled by Wexford.

They also invested in Tatex, Muskie, Timberwolf and Windsor. All of these are Wexford entities.

Indeed they invested more than their entire revenue in Wexford Entities.

But they also added $85 million to oil and gas properties. A fair bit of that was with respect to the Permian Basin properties (they drilled wells and acquired acreage). Those assets are also being sold to a Wexford controlled entity. Other releases have envisaged a sale of that entity which will raise some cash allowing them to continue to invest.

I read many 10K and 10Q filings. Few are this fascinating.






John

Gulfport Energy and Wexford Capital (Part IV): What is left after Gulfport sells the Permian Assets to a Wexford Related party?

In the last post I demonstrated that 12.885 million out of 19.367 million barrels of oil equivalent (BOE) in "proved reserves" was being sold by Gulfport to a related party of Wexford. These were the Permian Basin fields as per the table below.

																												Proved Reserves
Field		NRI/WI (1)				Productive Wells (2)								Non-Productive Wells								Developed Acreage (3)								Gas				Oil				Total
		Percentages				Gross				Net				Gross				Net				Gross				Net				MBOE				MBOE				MBOE
West Cote Blanche Bay Field (4)			80.108/100				95				95				189				189				5,668				5,668				352				3,617				3,969
E. Hackberry Field (5)			79.424/100				30				30				93				93				3,291				3,291				226				1,606				1,832
W. Hackberry Field			87.5/100				2				2				23				23				592				592				—				76				76
Permian Basin			35.4/46.87				121				57				—				—				8,880				4,119				2,008				10,877				12,885
Niobrara Formation			39.7/47.9				6				3				2				1				3,954				1,977				26				500				526
Williston Basin (6)			2.8/3.3				6				.2				—				—				1,708				132				7				67				74
Overrides/Royalty Non-operated			Various				133				.2				—				—				—				—				3				2				5
Total							393				187.4				307				306				24,093				15,779				2,622				16,745				19,367

The table is from the 10K.

Given that most the reserves and most the cash flows of Gulfport are being sold to a related party it is worth considering the quality of the assets left. After all - if you are a Gulfport shareholder that is what you are buying.

Lets just take the Niobrara acreage.

The claim of half a million barrels of oil in the Niobrara raised my eyebrows because I thought most that acreage was locked up. Indeed it was this claim that attracted me (as a short) to Gulfport in the first place. I wanted to see what they based their claim of half a million barrels of proved oil on.

Here is what the 10K says about the Niobrara acreage:

Location and Land 

Effective as of April 1, 2010, we acquired leasehold interests in the Niobrara Formation in northwestern Colorado, and held leases for 14,993 acres as of December 31, 2011. We are the operator on the acreage. 

Area History 

The Niobrara Formation is a shale oil rock formation located in Colorado, Northwest Kansas, Southwest Nebraska, and Southeast Wyoming. Oil and natural gas can be found at depths of 3,000 to 14,000 feet and is drilled both vertically and horizontally. The Upper Cretaceous Niobrara formation has emerged as another potential crude oil resource play in various basins throughout the northern Rocky Mountain region. As with most resource plays, the Niobrara has a history of producing through conventional technology with some of the earliest production dating back to the early 1900s. Natural fracturing has played a key role in producing the Niobrara historically due to the low porosity and low permeability of the formation. Because of this, conventional production has been very localized and limited in area extent. We believe the Niobrara can be produced on a more widespread basis using today’s horizontal multi-stage fracture stimulation technology where the Niobrara is thermally mature. 

Geology 

The Niobrara Formation oil play in northwestern Colorado is located between the Piceance Basin to the south and the Sand Wash Basin to the north. Rocks mainly consist of interbedded organic-rich shales, calcareous shales and marlstones. It is the fractured marlstone intervals locally known as the Buck Peak, Tow Creek and Wolf Mountain benches that account for the majority of the areas production. These fractured carbonate reservoirs are associated with anticlinal, synclinal and monoclinal folds, and fault zones. This proven oil accumulation is considered to be continuous in nature and lightly explored. Source rocks are predominantly oil prone and thermally mature with respect oil generation. The producing intervals are geologically equivalent to the Niobrara reservoirs of the DJ and Powder River Basins which are currently emerging as a major crude resource play. 

Production Status 

In the fourth quarter of 2011, our net production from our Niobrara acreage was 3,390 BOE, or an average of 37 BOE per day, 100% of which was from oil. From January 1, 2012 through January 31, 2012, our average daily net production from our Niobrara acreage was 41 BOE, 100% of which was from oil. 

Facilities 

There are typical land oil and gas processing facilities in the Niobrara Formation. Our facilities located at well locations include storage tank batteries, oil/gas/water separation equipment and pumping units. 

Recent and Future Activity 

We drilled three gross (1.5 net) wells at Niobrara during 2011. We have completed a 60 square mile 3-D seismic survey over our Craig Dome prospect, have received a processed version of the seismic and are selecting future drilling locations. We currently intend to drill five to seven gross wells at Niobrara during 2012.

Production - net - was 37 barrels of oil per day during the fourth quarter of 2011. In January they raised this to 41 barrels of oil per day.

The most recent 10Q filing contains this text.

Niobrara Formation. Effective as of April 1, 2010, we acquired leasehold interests in the Niobrara formation in Colorado and held leases for approximately 14,993 acres as of March 31, 2012. Aggregate net production from the Niobrara play during the three months ended March 31, 2012 was approximately 2,638 BOE, or 29 BOE per day. During April 2012, average daily net production in Niobrara was approximately 66 BOE due to completion of our 2011 drilling activity.

So for the first quarter the production fell to average only 29 BOE per day after averaging 41 BOE per day in January.

41 BOE per day in January implies production of 1271 barrels (approx) in January (being 41 BOE per day times 31 days).

We are told that production in the quarter was 2638 barrels. Simple arithmetic implies that production in February and March was 1367 BOE. Assuming 60 days in those months (29 in February, 31 in March) we get production of 22.8 barrels per day. A fairly sharp drop from 41 BOE per day in January. This may be a decline rate or it may be weather or other shut-in (we do not know). However shut-ins are more likely in January so decline is a reasonable guess.

After completing drilling activity for 2011 the production rose to 66 BOE per day.

These are not big numbers and production drops seem large. Indeed flow rates almost halved within the first quarter.

However the company states that 500 thousand barrels of oil in reserves are proven in this field.

It is a cliché that you only know what the reserves of an oil field were when the last barrel is produced. There are many fields that have surprised to the downside and some that have surprised to the upside.

I will leave it to my readers to judge - whether on the basis of the relatively small production and high decline rates demonstrated - they regard the 500 thousand barrels of proved reserves listed here as a solid number.





John

Gulfport Energy and Wexford Capital: Part 3

Gulfport Energy - as I have shown in Part 1 and Part 2 - is intertwined with Connecticut based hedge fund group Wexford Capital. All their substantial assets are either jointly owned or operated or both by Wexford entities. The Chairman of the board of Gulfport is - at least in part - a Wexford man.

However Wexford have over the past few years dramatically reduced their holding in Gulfport. In the 30 April 2009 proxy Charles E Davidson (the principal of Wexford) spoke for 15,235,786 shares or just over 35 percent of the company.

After years of sustained selling by Wexford and sustained issuance by Gulfport, Wexford's ownership position is about two thirds lower.

Despite Wexford's reduced holding Gulfport remains tied to Wexford.

Wexford and Gulfport are still doing related party transactions. On 7 May (ie this month) they announced a transaction whereby they are selling their Permian assets in exchange for a stake in a soon-to-be-listed entity called Diamond Back.

There was no specific press release for this transaction - but it was announced via a long 8K. On May 8 they announced their quarterly results which briefly described this transaction. To quote the earnings release:

As previously announced, on May 7, 2012, Gulfport entered into a contribution agreement with Diamondback Energy, Inc. ("Diamondback Energy"), in which Gulfport agreed to contribute, prior to the closing of Diamondback Energy's initial public offering, all of Gulfport's oil and natural gas interests in the Permian Basin in exchange for (i) common stock representing 35% of Diamondback Energy's outstanding common stock immediately prior to the closing of its initial public offering and (ii) approximately $63.6 million to be paid to Gulfport upon closing of such offering, subject to adjustment. Gulfport's obligation to complete the proposed contribution is subject to various closing conditions, including Gulfport's satisfaction with the terms of the Diamondback offering.

The earnings release however does not include the observation that this is a related party transaction. You had to go to the 8K for that. Here is what the 8K says:

On May 7, 2012, Gulfport Energy Corporation (“Gulfport”) entered into a Contribution Agreement (the “Contribution Agreement”) with Diamondback Energy, Inc. (“Diamondback”). Diamondback was incorporated on December 30, 2011 for purposes of undertaking an initial public offering (“Diamondback IPO”) of its common stock, par value $0.01 per share (the “Common Stock”), pursuant to a Registration Statement on Form S-1 (Registration No. 333-179502) initially filed with the Securities and Exchange Commission on February 13, 2012. Diamondback has not conducted and will not conduct any material operations prior to the transactions described below. Prior to the completion of the Diamondback IPO, Diamondback will acquire all the outstanding equity interests in Windsor Permian LLC (“Windsor Permian”), which as of March 31, 2012, owned and operated approximately 30,025 net acres of oil and gas interests in the Permian Basin in West Texas. 

Under the terms of the Contribution Agreement, Gulfport agreed to contribute to Diamondback, prior to the closing of the Diamondback IPO, all of its oil and gas interests in the Permian Basin in exchange for (i) shares of Common Stock representing 35% of Diamondback’s outstanding Common Stock immediately prior to the closing of the Diamondback IPO and (ii) $63,590,050.00 in the form of a non-interest bearing promissory note, which will be repaid in full upon the closing of the Diamondback IPO with a portion of the net proceeds from that offering. The aggregate consideration payable to Gulfport is subject to a post-closing cash adjustment based on changes in Windsor Permian’s working capital, long-term debt and other items referred to in the Contribution Agreement as of the date of the contribution. Windsor Permian is the operator of the acreage to be contributed by Gulfport. Gulfport’s obligation to make this contribution is contingent upon, among other things, the contribution to Diamondback of all the outstanding equity interests in Windsor Permian by DB Energy Holdings LLC (“DB Holdings”), Gulfport’s satisfaction with the terms of the Diamondback IPO and customary closing conditions. Under the contribution agreement, Gulfport is generally responsible for all liabilities and obligations with respect to the contributed properties arising prior to the contribution and Diamondback is responsible for such liabilities and obligations arising after the contribution. 

In connection with the contribution, Gulfport and Diamondback will enter into an Investor Rights Agreement in which Gulfport will have the right, for so long as Gulfport beneficially owns more than 10% of Diamondback’s outstanding Common Stock, to designate one individual as a nominee to serve on Diamondback’s board of directors. Such nominee, if elected to Diamondback’s board, will also serve on each committee of the board so long as he or she satisfies the independence and other requirements for service on the applicable committee of the board. So long as Gulfport has the right to designate a nominee to Diamondback’s board and there is no Gulfport nominee actually serving as a Diamondback director, Gulfport shall have the right to appoint one individual as an advisor to the board who shall be entitled to attend board and committee meetings. Gulfport will also be entitled to certain information rights and Diamondback will grant Gulfport certain demand and “piggyback” registration rights obligating Diamondback to register with the SEC any shares of Common Stock owned by Gulfport. 

The preceding descriptions of the Contribution Agreement and the Investor Rights Agreement are qualified in their entirety by reference to the full text of such agreements, copies of which are attached as Exhibits 10.1 and 10.2, respectively, to this Current Report on Form 8-K and are incorporated herein by reference. 

Diamondback, Windsor Permian and DB Holdings are entities controlled by Wexford Capital LP (“Wexford”). Charles E. Davidson, the Chairman and Chief Investment Officer of Wexford, beneficially owned approximately 9.5% of Gulfport’s outstanding common stock as of March 13, 2012. Mike Liddell, Gulfport’s Chairman of the Board and a director of Gulfport, currently serves as the operating member and chairman of Windsor Permian and has an interest in DB Holdings. A special committee of the Board of Directors consisting solely of independent directors negotiated and approved this transaction on behalf of Gulfport.

The related party nature of this transaction requires (and is being granted) a committee of the independent directors.


How important are the Permian assets?

The last annual report (10K) contained a table with Gulfport's proved reserves by field:

																													Proved Reserves
Field		NRI/WI (1)				Productive Wells (2)								Non-Productive Wells								Developed Acreage (3)								Gas				Oil				Total
		Percentages				Gross				Net				Gross				Net				Gross				Net				MBOE				MBOE				MBOE
West Cote Blanche Bay Field (4)			80.108/100				95				95				189				189				5,668				5,668				352				3,617				3,969
E. Hackberry Field (5)			79.424/100				30				30				93				93				3,291				3,291				226				1,606				1,832
W. Hackberry Field			87.5/100				2				2				23				23				592				592				—				76				76
Permian Basin			35.4/46.87				121				57				—				—				8,880				4,119				2,008				10,877				12,885
Niobrara Formation			39.7/47.9				6				3				2				1				3,954				1,977				26				500				526
Williston Basin (6)			2.8/3.3				6				.2				—				—				1,708				132				7				67				74
Overrides/Royalty Non-operated			Various				133				.2				—				—				—				—				3				2				5
Total							393				187.4				307				306				24,093				15,779				2,622				16,745				19,367

12.9 million of the 19.4 million barrels of oil equivalent in the proved reserves is in the Permian Basin. On this table Gulfport has sold the bulk of its proved reserves to a related party.

In their defence - after the transaction they own 35 percent of the related party which is lower but not massively lower than their prior ownership of the field. All that has happened is that they have lost control of the assets which they directly owned and are now owned by a Wexford entity. In this I presume the Wexford interests in those assets were also contributed and on similar terms. [I do not know - I am just giving Wexford the benefit of my doubt...]

Whatever: losing control means that they also lose control of the cash flows from these assets. Moreover as they own less than 80 percent of the assets if they get these cash flows out there will be a tax event. The 8K quoted above envisages a sell-down of the assets. This transaction does not make sense from a tax perspective unless that sell-down happens. So I presume a sell-down is expected.

As a shareholder it seems you are swapping productive assets you know for some cash which will (presumably) be used to develop other assets. Some of that cash only arrives when the IPO of Diamondback happens. There is nothing obviously wrong with that - but the related-party nature of the transaction does raise governance risks which make shareholders dependent on the non-executive directors to guard their interests.

John