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Energy 11

Filed: 12 Mar 21, 11:59am


UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON D.C. 20549 

 


 

FORM 10-K 

 


 

☑ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended: December 31, 2020

 

OR

 

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

 

COMMISSION FILE NUMBER: 000-55615

 

ENERGY 11, L.P.

(Exact name of Registrant as specified in its charter)

 

Delaware

46-3070515

(State or other jurisdiction of incorporation)

(I.R.S. Employer Identification Number)

  

120 W 3rd Street, Suite 220

 

Fort Worth, Texas

76102

(Address of principal executive office)

(Zip Code)

 

Registrant’s telephone number, including area code: (817) 882-9192

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

Trading Symbol

Name of each exchange on which registered

None

  

 

Securities registered pursuant to Section 12(g) of the Exchange Act:

 

Common Units of Limited Partnership Interest

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐  No ☑

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐  No ☑

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☑ No ☐

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☑ No ☐ 

 

 

 

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ☐

   

Accelerated filer ☐

Non-accelerated filer     ☑ 

   

Smaller reporting company   ☑

Emerging growth company   ☐

    

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). Yes ☐ No ☑

 

There is no established public market for the registrant’s outstanding limited partnership interests. The aggregate market value of the registrant’s limited partnership interests held by non-affiliates of the registrant as of June 30, 2020 was $0.

 

As of March 12, 2021, the Partnership had 18,973,474 common units outstanding. 

 

 

 

 

 

ENERGY 11, L.P.

 

FORM 10-K

 

Index

 

  

Page

Part I

 
 

Item 1. Business

5

 

Item 1A. Risk Factors

21

 

Item 1B. Unresolved Staff Comments

36

 

Item 2. Properties

36

 

Item 3. Legal Proceedings

36

 

Item 4. Mine Safety Disclosures

36

   

Part II

 
 

Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities

37

 

Item 6. Selected Financial Data

40

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

41

 

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

52

 

Item 8. Financial Statements and Supplementary Data

53

 

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

76

 

Item 9A. Controls and Procedures

76

 

Item 9B. Other Information

76

   

Part III

 
 

Item 10. Directors, Executive Officers and Corporate Governance

77

 

Item 11. Executive Compensation

79

 

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters

80

 

Item 13. Certain Relationships and Related Transactions, and Director Independence

81

 

Item 14. Principal Accounting Fees and Services

83

   

Part IV

 
 

Item 15. Exhibits, Financial Statement Schedules

84

 

Item 16. Form 10-K Summary

85

   

Signatures

86

 

 

 

FORWARD LOOKING STATEMENTS

 

Certain statements within this report may constitute forward-looking statements. Forward-looking statements are those that do not relate solely to historical fact. They include, but are not limited to, any statement that may predict, forecast, indicate or imply future results, performance, achievements or events. You can identify these statements by the use of words such as “may,” “will,” “could,” “anticipate,” “believe,” “estimate,” “expect,” “intend,” “predict,” “continue,” “further,” “seek,” “plan” or “project” and variations of these words or comparable words or phrases of similar meaning.

 

These forward-looking statements include such things as:

 

the easing of COVID-19 and the return to pre-existing conditions following the ultimate recovery therefrom;

references to future success in the Partnership’s drilling and marketing activities;

the Partnership’s business strategy;

estimated future capital expenditures;

estimated future distributions;

sales of the Partnership’s properties and other liquidity events;

competitive strengths and goals; and

other similar matters.

 

These forward-looking statements reflect the Partnership’s current beliefs and expectations with respect to future events and are based on assumptions and are subject to risks and uncertainties and other factors outside the Partnership’s control that may cause actual results to differ materially from those projected. Such factors include, but are not limited to, those described under “Risk Factors” and the following:

 

that the Partnership’s development of its oil and gas properties may not be successful or that the Partnership’s operations on such properties may not be successful;

the ability of the Partnership to meet its financial obligations due within one year;

the ability of the Partnership to negotiate a replacement to its Credit Facility, if necessary;

general economic, market, or business conditions;

changes in laws or regulations;

the risk that the wells in which the Partnership acquired an interest are productive, but do not produce enough revenue to return the investment made;

the risk that the wells the Partnership drills do not find hydrocarbons in commercial quantities or, even if commercial quantities are encountered, that actual production is lower than expected on the productive life of wells is shorter than expected;

current credit market conditions and the Partnership’s ability to obtain long-term financing for its property drilling activities in a timely manner and on terms that are consistent with what the Partnership projects when it invests in a property;

uncertainties concerning the price of oil and natural gas, which may decrease and remain low for prolonged periods; and

the risk that any hedging policy the Partnership employs to reduce the effects of changes in the prices of its production will not be effective.

 

Although the Partnership believes the expectations reflected in such forward-looking statements are based upon reasonable assumptions, the Partnership cannot assure investors that its expectations will be attained or that any deviations will not be material. Investors are cautioned that forward-looking statements speak only as of the date they are made and that, except as required by law, the Partnership undertakes no obligation to update these forward-looking statements to reflect any future events or circumstances. All subsequent written or oral forward-looking statements attributable to the Partnership or to individuals acting on its behalf are expressly qualified in their entirety by this section.

 

 

Item 1.  Business

 

Overview

 

Energy 11, L.P. (the “Partnership”) is a Delaware limited partnership formed to acquire producing and non-producing oil and natural gas properties onshore in the United States and to develop those properties. The initial capitalization of the Partnership of $1,000 occurred on July 9, 2013. The Partnership completed its best-efforts offering on April 24, 2017 with a total of approximately 19 million common units sold for gross proceeds of $374.2 million and proceeds net of offering costs of $349.6 million.

 

As of December 31, 2020, the Partnership owns an approximate 25% non-operated working interest in 243 producing wells, an estimated approximate 18% non-operated working interest in 21 wells in various stages of the drilling and completion process and future development sites in the Sanish field located in Mountrail County, North Dakota (collectively, the “Sanish Field Assets”). Whiting Petroleum Corporation (“Whiting”) (NYSE: WLL) operates substantially all of the Sanish Field Assets.

 

The general partner of the Partnership is Energy 11 GP, LLC (the “General Partner”).

 

Business Objective

 

The Partnership’s primary investment objectives are to (i) acquire producing and non-producing oil and gas properties with development potential, and to enhance the value of the properties through drilling and other development activities, (ii) make distributions to the holders of the common units, (iii) engage in a liquidity transaction after five – seven years, in which all properties are sold and the sales proceeds are distributed to the partners, merge with another entity, or list the common units on a national securities exchange, and (iv) permit holders of common units to invest in oil and gas properties in a tax efficient basis. The proceeds from the sale of the common units primarily have been used to acquire the Sanish Field Assets and develop these assets.

 

Investment and Drilling Activity

 

On December 18, 2015, the Partnership completed its first purchase in the Sanish field, acquiring an approximate 11% non-operated working interest in the Sanish Field Assets for approximately $159.6 million. On January 11, 2017, the Partnership closed on its second purchase, acquiring an additional approximate 11% non-operated working interest in the Sanish Field Assets for approximately $128.5 million. On March 31, 2017, the Partnership closed on its third purchase, acquiring an additional approximate average 10.5% non-operated working interest in 82 of the Partnership’s then 216 existing producing wells and 150 of the Partnership’s then 253 future development locations in the Sanish Field Assets for approximately $52.4 million.

 

During 2018, six wells were completed by the Partnership’s operators. Two wells were completed by and are being operated by Whiting; the Partnership has an approximate 29% non-operated working interest in these two wells. The other four wells were completed by and are operated by Oasis Petroleum North America, LLC; the Partnership has an approximate 8% non-operated working interest in these four wells. In total, the Partnership’s capital expenditures for the drilling and completion of these six wells were approximately $7.8 million.

 

During 2019 and first quarter of 2020, the Partnership elected to participate in the drilling and completion of 43 new wells (“Drilling Program”), primarily administered by Whiting, at an estimated cost to the Partnership of approximately $62 million. Through December 31, 2020, the Partnership had incurred approximately $42 million in capital expenditures related to the Drilling Program. Twenty-two (22) of the 43 wells have been completed and were producing at December 31, 2020; the Partnership has an approximate non-operated working interest of 23% in these 22 wells. The Partnership has an estimated approximate non-operated working interest of 18% in the remaining 21 wells that are in-process as of December 31, 2020. Due to the factors described below in “COVID-19, Demand, Liquidity and Going Concern Considerations,” Whiting suspended the Drilling Program during the second quarter of 2020. The timing for completion of a portion or all of the in-process wells within the Drilling Program is dependent upon several factors, including an increase in commodity pricing and available capital.

 

 

COVID-19, Demand, Liquidity and Going Concern Considerations

 

In December 2019, China reported an outbreak of a novel coronavirus (“COVID-19”) in its Wuhan province. COVID-19 rapidly spread worldwide, forcing governments around the world to take drastic measures to halt the outbreak. These measures included significant restrictions on travel, forced quarantines, stay-at-home requirements and the closure of businesses in many industries, creating extreme volatility in capital markets and the global economy. On March 11, 2020, the World Health Organization declared COVID-19 a pandemic, and on March 13, 2020, the United States declared a national emergency with respect to COVID-19.

 

Because of COVID-19’s impact to the global economy, demand for oil, natural gas and natural gas liquids (“NGL”) substantially declined in March 2020 and remained depressed through the remainder of 2020. This reduction in demand compounded an existing excess in supply of oil and natural gas, as the members of the Organization of the Petroleum Exporting Countries (“OPEC”) and Russia could not agree on daily production output of crude oil in March 2020. As a result, Russia announced its intention to increase production, and Saudi Arabia immediately countered with announced reductions to export prices. These factors led to oil prices falling in March 2020 and to 20-year lows in April 2020. In response, the General Partner approved the suspension of distributions to limited partners of the Partnership in March 2020. NYMEX oil prices stabilized around $40 per barrel of oil in June 2020 and through the third quarter of 2020. Oil prices continued to increase through the fourth quarter of 2020, approaching $50 per barrel of oil in December 2020.

 

In response to lower commodity prices and reduced demand, operators within the United States altered drilling programs and the related forecasted capital expenditures for those programs while also implementing other cost-saving measures, such as curtailing production or shutting in producing wells, during the second quarter of 2020. Further, Whiting and certain of its subsidiaries declared bankruptcy under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Southern District of Texas on April 1, 2020. Whiting completed its financial restructuring and emerged from bankruptcy protection in September 2020, but has yet to resume its Drilling Program. These factors have had and are anticipated to continue to have an adverse impact on the Partnership’s business and its financial condition.

 

At December 31, 2019, the Partnership had approximately $16 million available under its $40 million revolving credit facility (“Credit Facility”); the Partnership used that remaining availability in the first quarter of 2020 to partially fund capital expenditures within the Drilling Program. At the end of the first quarter of 2020, the Partnership had approximately $21 million in accrued capital expenditures to Whiting. As a result, the Partnership was not in compliance with certain covenants under its Credit Facility as of March 31, 2020. In July 2020, the Partnership entered into a letter agreement (“Letter Agreement”) with its lending group of its Credit Facility that, among other items, waived the non-compliance of certain covenants under the Credit Facility, accelerated the maturity date of the Credit Facility from September 30, 2022 to July 31, 2021 and permitted a term loan with an affiliate. Subsequently, the Partnership entered into a loan agreement for a one-year, $15 million term loan (“Affiliate Loan”), and proceeds from the Affiliate Loan plus cash on hand were used to pay the Partnership’s outstanding capital expenditures due to Whiting. The Partnership paid off the Affiliate Loan in full in the first quarter of 2021, so the Partnership’s outstanding debt obligations totaled $40 million on the date this Form 10-K was issued.

 

The Partnership’s ability to continue as a going concern is dependent on several factors including, but not limited to, (i) the Partnership’s ability to comply with its obligations under its loan agreements; (ii) refinancing its existing debt and/or securing additional capital; (iii) an increase in demand for oil and natural gas as the global economy recovers from the effects of the COVID-19 pandemic and the existing oversupply of oil in the United States; and (iv) an increase in oil and natural gas market prices, which will improve the Partnership’s cash flow generated from operations. The Partnership can provide no assurance that it will be able to achieve any of these objectives. Refinancing its existing debt or securing additional capital may not be available on favorable terms to the Partnership, if it is available at all. NYMEX oil prices have rebounded from April 2020 lows, approached $50 per barrel in December 2020 and reached $60 per barrel in February 2021, but there can be no assurance that economic activity and oil and natural gas market conditions, including commodity prices, will fully return and stabilize at pre-COVID-19 levels, or that the Partnership will be able to meet its operational obligations. If the Partnership is unable to refinance or repay its debt obligations or is unable to meet its operational obligations, the Partnership could be required to liquidate certain of its assets used for collateral to satisfy these obligations, which create the substantial doubt that exists about the ability of the Partnership to continue as a going concern for one year after the date these financial statements are issued.

 

Industry Operating Environment

 

In addition to the specific global macroeconomic factors described above in “COVID-19, Demand, Liquidity and Going Concern Considerations”, the oil and natural gas industry is affected by other factors that the Partnership generally cannot control, including real or perceived geopolitical risks in oil-producing regions of the world, particularly the Middle East; forecasted levels of global economic growth combined with forecasted global supply; supply levels of oil and natural gas due to exploration and development activities in the United States; environmental and climate change regulation; actions taken by OPEC; and the strength of the U.S. dollar in international currency markets. Natural gas prices vary in accordance with North American supply and demand and are also affected by imports and exports of NGL. Weather also has a significant impact on demand for natural gas since it is a primary heating source in the United States.

 

 

Consistent with non-operators of well interests within the industry, the Partnership engages in oil and natural gas well development by participating on a proportionate basis alongside third-party interests in wells drilled and completed in spacing units that include the Partnership’s acreage. The Partnership relies on its operators to propose, permit and initiate the drilling of wells. The Partnership assesses each drilling opportunity on a case-by-case basis and participates in wells that expect to meet a desired return based upon estimates of recoverable oil and natural gas, expected oil and gas prices, expertise of the operator, and completed well cost from each project, as well as other factors.

 

The Partnership’s operators generally market and sell the oil and natural gas extracted from Partnership wells. In addition, these operators coordinate the transportation of oil and natural gas production from wells in which the Partnership participates to appropriate pipelines or rail transport facilities pursuant to arrangements that such operators negotiate and maintain with various parties purchasing the production. The price at which Partnership production is sold is generally tied to a market spot price, and the differential between the market spot price and the Partnership’s realized sales price represents the imbedded transportation costs in moving the oil from wellhead to refinery and will fluctuate based on availability of pipeline, rail and other transportation methods.

 

Production, Prices and Production Cost History

 

The following table sets forth certain information regarding the production volumes, average prices received, and average production costs associated with the sale of oil, natural gas, and natural gas liquids for the periods indicated below.

 

  

Year Ended December 31,

  

Percent

 
  

2020

  

2019

  

Change

 
             

Sold production (BOE):

            

  Oil

  1,014,980   624,079   62.6%

  Natural gas

  176,246   148,034   19.1%

  Natural gas liquids

  158,050   126,516   24.9%

    Total

  1,349,276   898,629   50.1%
             

Average sales price per unit:

            

  Oil (per Bbl)

 $31.22  $49.58   -37.0%

  Natural gas (per Mcf)

  2.01   2.78   -27.7%

  Natural gas liquids (per Bbl)

  17.14   20.65   -17.0%

  Combined (per BOE)

  27.07   40.08   -32.5%
             

Average unit cost per BOE:

            

  Production costs

            

    Production expenses

  7.29   10.99   -33.7%

    Production taxes

  2.28   3.18   -28.3%

  Total production costs

  9.57   14.17   -32.5%

  Depreciation, depletion, amortization and accretion

  16.79   13.86   21.1%

 

Related Parties

 

The Partnership has, and is expected to continue to engage in, significant transactions with related parties. These transactions cannot be construed to be at arm’s length and the results of the Partnership’s operations may be different than if conducted with non-related parties. The General Partner’s Board of Directors oversees and reviews the Partnership’s related party relationships and is required to approve any significant modifications to any existing related party transactions, as well as any new significant related party transactions.

 

See further discussion of transactions with related parties in Note 8 titled “Related Parties” in Part II, Item 8 – Financial Statements and Supplementary Data, appearing elsewhere in this Annual Report on Form 10-K.

 

 

Partners Equity and Distributions

 

The Partnership completed its best-efforts offering of common units on April 24, 2017. As of the conclusion of the offering on April 24, 2017, the Partnership had completed the sale of approximately 19.0 million common units for total gross proceeds of $374.2 million and proceeds net of offerings costs of $349.6 million. David Lerner Associates, Inc. was the dealer manager for the Partnership’s best-efforts offering (the “Dealer Manager”). Under the agreement with the Dealer Manager, the Dealer Manager received a total of 6% in selling commissions and marketing expense allowance based on gross proceeds of the common units sold. The Dealer Manager will also be paid a contingent incentive fee, which is a cash payment of up to an amount equal to 4% of gross proceeds of the common units sold based on the performance of the Partnership. Based on the common units sold in the offering, the total contingent fee is a maximum of approximately $15.0 million, which will only be paid if Payout occurs, as defined below.

 

Prior to “Payout,” which is defined below, all of the distributions made by the Partnership, if any, will be paid to the holders of common units. Accordingly, the Partnership will not make any distributions with respect to the Incentive Distribution Rights (owned by the General Partner), with respect to Class B units or the contingent, incentive payments to the Dealer Manager, until Payout occurs.

 

The Partnership Agreement provides that Payout occurs on the day when the aggregate amount distributed with respect to each of the common units equals $20.00 plus the Payout Accrual. The Partnership Agreement defines “Payout Accrual” as 7% per annum simple interest accrued monthly until paid on the Net Investment Amount outstanding from time to time. The Partnership Agreement defines Net Investment Amount initially as $20.00 per common unit, regardless of the amount paid for the common unit. If at any time the Partnership distributes to holders of common units more than the Payout Accrual, the amount the Partnership distributes in excess of the Payout Accrual will reduce the Net Investment Amount. 

 

All distributions made by the Partnership after Payout, which may include all or a portion of the proceeds of the sale of all or substantially all of the Partnership’s assets, will be made as follows:

 

First, (i) to the Record Holders of the Incentive Distribution Rights, 35%; (ii) to the Record Holders of the Outstanding Class B units, pro rata based on the number of Class B units owned, 35% multiplied by a fraction, the numerator of which is the number of Class B units outstanding and the denominator of which is 100,000 (currently, there are 62,500 Class B units outstanding; therefore, Class B units could receive 21.875%); (iii) to the Dealer Manager, as the Dealer Manager contingent incentive fee paid under the Dealer Manager Agreement, 30%, and (iv) the remaining amount, if any (currently 13.125%), to the Record Holders of outstanding common units, pro rata based on their percentage interest until such time as the Dealer Manager receives the full amount of the Dealer Manager contingent incentive fee under the Dealer Manager Agreement;

 

Thereafter, (i) to the Record Holders of the Incentive Distribution Rights, 35%; (ii) to the Record Holders of the Outstanding Class B units, pro rata based on the number of Class B units owned, 35% multiplied by a fraction, the numerator of which is the number of Class B units outstanding and the denominator of which is 100,000 (currently, there are 62,500 Class B units outstanding; therefore, Class B units could receive 21.875%); (iii) the remaining amount to the Record Holders of outstanding common units, pro rata based on their percentage interest (currently 43.125%). 

 

All items of income, gain, loss and deduction will be allocated to each Partner’s capital account in a manner generally consistent with the distribution procedures outlined above.

 

As noted above, in March 2020, the General Partner approved the suspension of distributions to limited partners of the Partnership in response to recent market volatility and the impact on the Partnership’s operating cash flows. The Partnership has accumulated and will continue to accumulate unpaid distributions based on an annualized return of seven percent (7%), and all accumulated unpaid distributions are required to be paid before final Payout occurs, as defined above. As of December 31, 2020, the unpaid Payout Accrual totaled $1.181370 per common unit, or approximately $22 million. Pursuant to the Letter Agreement described above, the Partnership is not permitted to pay distributions without lender approval.

 

For the year ended December 31, 2020, the Partnership paid distributions of $0.241644 per common unit or $4.6 million. For the year ended December 31, 2019, the Partnership paid distributions of $1.396164 per common unit or $26.5 million.

 

 

Oil and Natural Gas Reserves

 

The table below summarizes the Partnership’s estimated net proved reserves as of December 31, 2020:

 

  

Number of wells

  

Oil
(MBbls)

  

Natural Gas
(MMcf)

  

NGL
(MBbls)

  

Total
(MBOE)

  

Standardized
Measure (2)

 
                      

(in thousands)

 

Proved Reserves (1)

                        

PDP Properties

  218   9,792   11,924   1,861   13,640  $76,164 

PDNP Properties

  25   897   1,069   168   1,243   6,228 

PUD Properties

  42   3,725   3,805   599   4,959   (9,505)

Total Proved Reserves

  285   14,414   16,798   2,628   19,842  $72,887 

 

(1)

 

The following terms have been used by the Partnership to classify its reserves: Proved developed producing reserves (“PDP”) are reserves that can be expected to be recovered through existing wells with existing equipment and operating methods. Proved developed non-producing reserves (“PDNP”) are proved oil and natural gas reserves that can be recovered through improved recovery only after the necessary equipment has been installed, or when the costs to do so are relatively minor. Proved undeveloped reserves (“PUD”) are reserves expected to be recovered from new wells on undrilled acreage, or from existing wells where a relatively major expenditure is required for development (reserves on undrilled acreage are limited to those drilling units offsetting productive units that are reasonably certain of production when drilled).

 

The Partnership’s proved reserves as of December 31, 2020 were calculated using oil and natural gas price parameters established by current SEC guidelines and accounting rules based on unweighted arithmetic average prices as of the first day of each of the twelve months ended on such date. The oil and natural gas prices used in computing the Partnership’s reserves as of December 31, 2020 were $39.57 per barrel of oil and $1.99 per MMcf of natural gas, before price differentials. Including the effect of price differential adjustments, the average realized prices used in computing the Partnership’s reserves as of December 31, 2020 were $32.08 per barrel of oil, $(0.55) per MMcf of natural gas and $5.54 per barrel of NGL. See “Note 9 — Supplementary Information on Oil, Natural Gas and Natural Gas Liquid Reserves (Unaudited)” in the accompanying notes to consolidated financial statements included elsewhere in this report for information concerning proved reserves.

    
 

(2)

 

The standardized measure of discounted future net cash flows represents the estimated future net revenue, discounted at a rate of 10% per annum, after income taxes and with no price or cost escalation, in accordance with Accounting Standards Codification Topic 932 – Extractive Activities – Oil and Gas. Because the Partnership was formed as a limited partnership, the Partnership is not subject to federal taxes in the calculation of the standardized measure. In addition, there are no entity level or gross receipts taxes in North Dakota, where all Partnership wells are located, that would give rise to an additional state tax provision.

 

The table above represents estimates only. Reserves estimates are based upon various assumptions, including assumptions required by the SEC relating to oil and natural gas prices, drilling and operating expenses, capital expenditures, taxes and availability of funds. The process of estimating reserves is complex. This process requires significant decisions and assumptions in the evaluation of available geological, geophysical, engineering and economic data for each reservoir. Furthermore, different reserve engineers may make different estimates of reserves and cash flow based on the same available data and these differences may be significant. Therefore, these estimates are not precise. Actual future production, oil and natural gas prices, revenues, taxes, development expenditures, operating expenses and quantities of recoverable oil and natural gas reserves will most likely vary from those estimated. In addition, the Partnership may adjust estimates of proved reserves to reflect production history, results of exploration and development, prevailing oil and natural gas prices and other factors, many of which are beyond its control. Prices for oil at December 31, 2020 were above the 2020 average prices using the parameters established by the SEC. Therefore, due to the volatility of the market, a period of sustained higher or lower prices will have a positive or negative impact to the estimated quantities and present values of the Partnership’s reserves.

 

 

Proved Undeveloped Reserves (PUD)

 

At December 31, 2020, the Partnership had PUDs of approximately 4,959 MBOE, or approximately 25% of total proved reserves. Total PUDs at December 31, 2019 were 11,980 MBOE. The following table reflects the changes in PUDs during 2020: 

 

  

BOE

 

Proved undeveloped reserves, December 31, 2019

  11,980,151 

Revisions of previous estimates (1)

  (5,501,947)

Extensions, discoveries and other additions

  - 

Conversion to proved developed reserves (2)

  (1,519,525)

Proved undeveloped reserves acquired

  - 

Proved undeveloped reserves, December 31, 2020

  4,958,679 

(1)

The annual review of the PUDs resulted in a negative revision of approximately 5,502 MBOE. This revision was the result of 5,409 MBOE of downward adjustments attributable to changes in the future drill schedule, 121 MBOE of downward adjustments caused by lower oil, natural gas and NGL prices when comparing the Partnership’s reserve estimates at December 31, 2020 and December 31, 2019, and 28 MBOE of upward adjustments attributable to changes in natural gas shrink and NGL yield when comparing the Partnership’s reserves at December 31, 2020 to December 31, 2019.

  

(2)

The Partnership completed 11 new wells during 2020. The Partnership already converted four of these 11 wells from PUD to proved developed reserves at December 31, 2019 because they were substantially complete and the costs to bring to production were relatively minor. The Partnership converted the other 7 completed wells to proved developed reserves during 2020, which resulted in a downward adjustment to PUDs of 1,520 MBOE.

 

Under current SEC requirements, PUD reserves may only be booked if they relate to wells scheduled to be drilled within five years of their date of original booking unless specific circumstances justify a longer time. The Partnership will be required to remove current PUDs if the Partnership does not drill those reserves within the required five-year time frame, unless specific circumstances justify a longer time. The Partnership removed a portion of its PUDs during the second quarter of 2020 in conjunction with the significant drop in commodity prices caused by COVID-19 as the Partnership did not anticipate all PUD locations would be drilled within the five-year time frame. All of the Partnership’s PUDs at December 31, 2020 are scheduled to be drilled within five years of the date they were initially recorded. However, since the Partnership is not the operator of any of its oil and natural gas properties, it is difficult to predict with certainty the timing of drilling and completion of wells currently classified as PUD reserves. Historically, energy commodity prices have been volatile, and due to geopolitical risks in oil producing regions of the world as well as global supply and demand concerns, the Partnership continues to expect significant price volatility. Sustained lower prices for oil and natural gas may cause the Partnership in the future to forecast less capital to be available for development of its PUDs, which may cause the Partnership to decrease the number of PUDs it expects to develop within the five-year time frame. In addition, lower oil and natural gas prices may cause the Partnership’s PUDs to become uneconomic to develop, which would cause the Partnership to remove them from the proved undeveloped category. 

 

Internal Controls Over Reserve Estimates and Qualifications of Technical Persons

 

The Partnership’s policies and practices regarding internal controls over the recording of reserves is structured to objectively and accurately estimate its oil and gas reserves quantities and present values in compliance with rules, regulations and guidance provided by the SEC, as well as established industry practices used by independent engineering firms and the Partnership’s peers, and in accordance with the SPE 2007 Standards promulgated by the Society of Petroleum Engineers. The Partnership engaged Pinnacle Energy Services, LLC (“Pinnacle Energy”) to prepare the reserve estimates for all of the Partnership’s assets for the year ended December 31, 2020 in this annual report. Pinnacle Energy founder J.P. Dick has over 30 years of experience in the oil and natural gas industry, with exposure to reserves and reserve related valuations and issues during that time and is a Registered Professional Engineer in the states of Texas and Oklahoma. Further qualifications include a Bachelor of Science in petroleum engineering, extensive internal and external reserve training, and asset evaluation and management. In addition, Mr. Dick is an active participant in industry reserve seminars, professional industry groups and is a member of the Society of Petroleum Engineers.

 

The Partnership’s controls over reserve estimates include engaging Pinnacle Energy as the Partnership’s independent petroleum engineer. The Partnership provided information about its oil and natural gas properties, including production profiles, prices and costs, to Pinnacle Energy and they prepared estimates of the Partnership’s reserves attributable to the Partnership’s properties. All of the information regarding reserves in this annual report on Form 10-K is derived from the report of Pinnacle Energy, which is included as an exhibit to this annual report on Form 10-K.

 

 

The Partnership’s management works closely with Pinnacle Energy to ensure the integrity, accuracy and timeliness of data that is furnished to them for their reserve estimation process as well as to review properties and discuss the methods and assumptions used by Pinnacle Energy in their preparation of the year-end reserve estimates. The Partnership’s management also reviews the methods and assumptions used by Pinnacle Energy in the preparation of year-end reserve estimates and assesses them for reasonableness. The Board of Directors of the General Partner also meets with the Partnership’s President and management to discuss matters and policies related to the Partnership’s reserves. 

 

The Partnership’s methodologies include reviews of production trends, analogy to comparable properties, and/or volumetric analysis. Performance methods are preferred. Reserve estimates for proved undeveloped properties are based primarily on volumetric analysis or analogy to offset production in the same or similar fields. The Partnership applies and maintains internal controls, including but not limited to the following, to ensure the reliability of reserves estimations:

 

 

no employee’s compensation is tied to the amount of reserves booked;

 

the Partnership follows comprehensive SEC-compliant internal policies to determine and report proved reserves;

 

reserve estimates are made by experienced reservoir engineers or under their direct supervision;

 

annual review by the Board of Directors of the General Partner of the Partnership’s year-end reserve estimates prepared by Pinnacle Energy; and

 

semi-annually, the Board of Directors of the General Partner reviews all significant reserves changes and all new proved undeveloped reserves additions.

 

Total Productive Wells

 

The following table sets forth information with respect to the Partnership’s ownership interest in productive wells as of December 31, 2020:

 

  

December 31, 2020

 
  

Gross

  

Net

 

Oil wells:

        

Sanish Field

  244   61.4 

 

Of the total well count for 2020, none are multiple completions.

 

Productive wells are producing wells and wells the Partnership deems mechanically capable of production, including shut-in wells, wells waiting for completion, plus wells that are drilled/cased and completed, but waiting for pipeline hook-up.  At December 31, 2020, the Partnership had 243 currently producing wells and one shut-in well. A gross well is a well in which the Partnership owns a working interest. The number of net wells represents the sum of fractional working interests the Partnership owns in gross wells.

 

Developed and Undeveloped Acreage Position

 

The following table sets forth information with respect to the Partnership’s gross and net developed and undeveloped oil and natural gas acreage under lease as of December 31, 2020, all of which is located in the State of North Dakota in the United States: 

 

  

Acreage allocated to developed properties

  

Acreage allocated to undeveloped wellsites

  

Total Acres

 
  

Gross

  

Net

  

Gross

  

Net

  

Gross

  

Net

 

Sanish Field, Mountrail County, ND

  17,603   5,453   17,675   5,475   35,278   10,928 

 

As is customary in the oil and natural gas industry, the Partnership can generally retain an interest in undeveloped acreage through drilling activity that establishes commercial production sufficient to maintain the leases or by paying delay rentals during the remaining primary term of leases. The oil and natural gas leases in which the Partnership has an interest are for varying primary terms and, if production under a lease continues from developed lease acreage beyond the primary term, the Partnership is entitled to hold the lease for as long as oil or natural gas is produced. The oil and natural gas properties consist primarily of oil and natural gas wells and interests in developed leasehold acreage.

 

 

Undeveloped Acreage Expirations

 

The Partnership has no undeveloped acreage expirations as all acreage is held by production.

 

Delivery Commitments

 

As of December 31, 2020, the Partnership had no commitments to deliver a fixed quantity of oil or natural gas.

 

Marketing and Customers

 

The market for the Partnership’s oil and natural gas production depends on factors beyond its control, including the extent of domestic production and imports of oil and natural gas, the proximity and capacity of natural gas pipelines and other transportation facilities, the demand for oil and natural gas, the marketing of competitive fuels and the effect of state and federal regulation. The oil and natural gas industry also competes with other industries in supplying the energy and fuel requirements of industrial, commercial and individual consumers.

 

Whiting, as the primary operator of Partnership’s properties, operates 98% of the Partnership’s wells and sold approximately 99% of the Partnership’s production on the Partnership’s behalf in 2020.

 

Title to Properties

 

As is customary in the Partnership’s industry, a preliminary review of title records, which may include opinions or reports of appropriate professionals or counsel, was made at the time the Partnership acquired its properties. The Partnership believes that its title to all of the various interests set forth above is satisfactory and consistent with the standards generally accepted in the oil and gas industry, subject only to immaterial exceptions that do not detract substantially from the value of the interests or materially interfere with their use in the Partnership’s operations. The interests owned by the Partnership may be subject to one or more royalty, overriding royalty, or other outstanding interests (including disputes related to such interests) customary in the industry. The interests may additionally be subject to obligations or duties under applicable laws, ordinances, rules, regulations, and orders of arbitral or governmental authorities. In addition, the interests may be subject to burdens such as net profits interests, liens incident to operating agreements and current taxes, development obligations under oil and gas leases, and other encumbrances, easements, and restrictions, none of which detract substantially from the value of the interests or materially interfere with their use in the Partnership’s operations.

 

Insurance

 

Since the Partnership is not the operator of any of its properties, the Partnership relies on the insurance of the operators of its properties, of which the Partnership’s share of the cost is allocated back to the Partnership through the joint operating agreement. The Partnership’s operators have insurance policies that include coverage for general liability (includes sudden and accidental pollution), physical damage to its oil and gas properties, control of well, auto liability, marine liability, worker’s compensation and employer’s liability, among other things.

 

The Partnership re-evaluates the purchase of insurance, coverage limits and deductibles annually. Future insurance coverage for the oil and gas industry could increase in cost and may include higher deductibles or retentions. In addition, some forms of insurance may become unavailable in the future or unavailable on terms that are economically acceptable. No assurance can be given that the Partnership will be able to maintain insurance in the future at rates that the Partnership considers reasonable and the Partnership may elect to self-insure or maintain only catastrophic coverage for certain risks in the future.

 

Competition

 

The oil and natural gas industry is highly competitive. The Partnership will encounter strong competition from independent oil and gas companies, master limited partnerships and from major oil and gas companies in contracting for drilling equipment and arranging the services of trained personnel. Many of these competitors have financial and technical resources and staffs substantially larger than those of the Partnership.

 

The Partnership also may be affected by competition for drilling rigs, human resources and the availability of related equipment. In the past, the oil and natural gas industry has experienced shortages of drilling rigs, equipment, pipe and personnel, which have delayed development drilling and other exploitation activities and have caused significant price increases. The Partnership is unable to predict when, or if, such shortages may occur or how they would affect the Partnership’s development and exploitation program. 

 

 

Seasonal Nature of Business

 

Seasonal weather conditions and lease stipulations can limit the Partnership’s drilling and producing activities and other operations in certain areas where the Partnership may acquire producing properties. These seasonal anomalies can pose challenges for meeting the Partnership’s drilling objectives and increase competition for equipment, supplies and personnel during the drilling season, which could lead to shortages and increased costs or delay the Partnership’s operations. Generally, demand for natural gas is higher in summer and winter months. In addition, certain natural gas users utilize natural gas storage facilities and purchase some of their anticipated winter natural gas requirements during off–peak months. This can lessen seasonal demand fluctuations.

 

Environmental, Health and Safety Matters and Regulation

 

The Partnership’s operations are subject to stringent and complex federal, state and local laws and regulations that govern the oil and natural gas industry, as well as regulations that protect the environment from the discharge of materials into the environment.  These laws and regulations may, among other things:

 

 

require the acquisition of various permits before drilling commences;

 

require the installation of pollution control equipment in connection with operations;

 

place restrictions or regulations upon the use or disposal of the material utilized in the Partnership’s operations;

 

restrict the types, quantities and concentrations of various substances that can be released into the environment or used in connection with drilling, production and transportation activities;

 

limit or prohibit drilling activities on lands lying within wilderness, wetlands and other protected areas;

 

require remedial measures to mitigate or remediate pollution from former and ongoing operations, and may also require site restoration, pit closure and plugging of abandoned wells; and

 

require the expenditure of significant amounts in connection with worker health and safety.

 

These laws, rules and regulations may also restrict the rate of oil and natural gas production below the rate that would otherwise be possible. The regulatory burden on the oil and natural gas industry increases the cost of doing business in the industry and consequently affects profitability. Additionally, Congress and federal, state and local agencies frequently revise environmental laws and regulations, and such changes could result in increased costs for environmental compliance, such as waste handling, permitting, or cleanup for the oil and natural gas industry and could have a significant impact on the Partnership’s operating costs. In general, the oil and natural gas industry has been the subject of increased legislation and regulatory attention with respect to environmental matters. The trend of more expansive and stricter environmental regulation may continue for the long term.

 

The following is a summary of some of the existing laws, rules and regulations to which the Partnership’s business operations are subject.

 

Solid and Hazardous Waste Handling

 

The federal Resource Conservation and Recovery Act, or RCRA, and comparable state statutes regulate the generation, transportation, treatment, storage, disposal and cleanup of hazardous solid waste. Although oil and natural gas waste generally is exempt from regulations as hazardous waste under RCRA, the Partnership expects its operators to generate waste as a routine part of their operations that may be subject to RCRA. Although a substantial amount of the waste expected to be generated is regulated as non–hazardous solid waste rather than hazardous waste, there is no guarantee that the Environmental Protection Agency (“EPA”) or individual states will not adopt more stringent requirements for the handling of non–hazardous or exempt waste or categorize some non–hazardous or exempt waste as hazardous in the future.

 

Comprehensive Environmental Response, Compensation and Liability Act

 

The Comprehensive Environmental Response, Compensation and Liability Act, or CERCLA, imposes strict, joint and several liability for costs of investigation and remediation and for natural resource damages without regard to fault or legality of the original conduct, on certain classes of persons with respect to the release into the environment of substances designated under CERCLA as hazardous substances. These classes of persons, or so-called potentially responsible parties, or PRPs, include the current and past owners or operators of a site where the release occurred and anyone who disposed or arranged for the disposal of a hazardous substance found at the site. CERCLA also authorizes the EPA and, in some instances, third parties to take actions in response to threats to public health or the environment and to seek to recover from the PRPs the costs of such action. Many states have adopted comparable or more stringent state statutes.

 

 

Although CERCLA generally exempts “petroleum” from the definition of hazardous substance, in the course of the Partnership’s operators’ expected operations, the operators will generate wastes that may fall within CERCLA’s definition of hazardous substance and may dispose of these wastes at disposal sites owned and operated by others. Comparable state statutes may not provide a comparable exemption for petroleum, and there is no guarantee that federal law will not adopt more stringent requirements with respect to the petroleum substances. The Partnership may also be the owner of sites on which hazardous substances have been released.  If contamination is discovered at a site on which the Partnership is or has been an owner or to which the Partnership sent hazardous substances, the Partnership could be liable for the costs of investigation and remediation and natural resources damages. Further, the Partnership could be required to suspend or cease operations in contaminated areas.

 

The Partnership may own producing properties that have been used for oil and natural gas exploration and production for many years. Hazardous substances, wastes or hydrocarbons may have been released on or under the Partnership’s properties, or on or under other locations, including offsite locations, where such substances have been taken for disposal. In addition, some of the properties the Partnership has acquired may have been operated by third parties or by previous owners or operators whose treatment and disposal of hazardous substances, wastes, or hydrocarbons were not under Partnership control. These properties and the substances disposed or released on them may be subject to CERCLA, RCRA and analogous state laws. In the future, the Partnership could be required to remediate property, including groundwater, containing or impacted by previously disposed wastes (including wastes disposed or released by prior owners or operators, or property contamination, including groundwater contamination by prior owners or operators) or to perform remedial plugging operations to prevent future or mitigate existing contamination.

 

Clean Water Act

 

The Federal Water Pollution Control Act, also known as the Clean Water Act, and analogous state laws impose restrictions and strict controls with respect to the discharge of pollutants, including spills and leaks of produced water and other oil and natural gas wastes, into state waters and waters of the United States. The discharge of pollutants into regulated waters is prohibited, except in accordance with the terms of a permit issued by the EPA or an analogous state agency. The Clean Water Act also prohibits the discharge of dredge and fill material in regulated waters, including wetlands, unless authorized by a permit issued by the U.S. Army Corps of Engineers. The EPA has issued final rules outlining its position on the federal jurisdictional reach over waters of the United States. Litigation surrounding this rule is ongoing. Federal and state regulatory agencies can impose administrative, civil and criminal penalties, as well as require remedial or mitigation measures, for non–compliance with discharge permits or other requirements of the Clean Water Act and analogous state laws and regulations. In the event of an unauthorized discharge of wastes, the Partnership may be liable for penalties and cleanup and response costs. The federal Clean Water Act only regulates surface waters. However, most of the state analogs to the Clean Water Act also regulate discharges which impact groundwater.

 

In 2018, the EPA commenced a management study of oil and gas extraction wastewater from both conventional extraction and unconventional extraction such as hydraulic fracturing. The purpose of this study is to understand if support exists for new regulations that would allow for a broader discharge of oil and gas extraction wastewater directly to surface waters under the Clean Water Act’s National Pollutant Discharge Elimination System, in addition to the primary existing disposal methods of underground injection or discharge to centralized wastewater treatment facilities. The EPA produced a report of its findings in May 2020, which did not announce any new regulatory requirements regarding oil and gas extraction wastewater. In January 2021, the EPA published its final Effluent Guidelines Program Plan 14, its biennial plan for new and revised effluent limitations guidelines and standards for industrial wastewater discharges. Plan 14 discusses several ongoing regulatory actions, including upcoming revisions to increase flexibility for centralized waste treaters of produced water from oil and gas extraction.

 

Safe Drinking Water Act and Hydraulic Fracturing

 

Many of the properties the Partnership owns will require additional drilling operations to fully develop the reserves attributable to the properties. Hydraulic fracturing involves the injection of water, sand and chemicals under pressure into formations to fracture the surrounding rock and stimulate production. Hydraulic fracturing activities are typically regulated by state oil and gas commissions but not at the federal level, as the federal Safe Drinking Water Act expressly excludes regulation of these fracturing activities (except for fracturing activities involving the use of diesel).

 

 

In prior sessions, Congress has considered legislation to amend the federal Safe Drinking Water Act to remove the exemption for hydraulic fracturing operations and require reporting and disclosure of chemicals used by the oil and natural gas industry in the hydraulic fracturing process. This legislation has not passed. A number of states, local and regional regulatory authorities have or are considering hydraulic fracturing regulation and other regulations imposing new or more stringent permitting, disclosure and well construction requirements on hydraulic fracturing operations or restricting or banning hydraulic fracturing. Further, the EPA has issued an effluent limitations guideline prohibiting the discharge of wastewater from onshore unconventional oil and natural gas extraction facilities to publicly owned treatment plants.

 

In December 2016, the EPA released its final report on the potential impacts of hydraulic fracturing on drinking water resources, concluding that “water cycle” activities associated with hydraulic fracturing may impact drinking water resources “under some circumstances,” including water withdrawals for fracturing in times or areas of low water availability; surface spills during the management of fracturing fluids, chemicals or produced water; injection of fracturing fluids into wells with inadequate mechanical integrity; injection of fracturing fluids directly into groundwater resources; discharge of inadequately treated fracturing wastewater to surface waters; and disposal or storage of fracturing wastewater in unlined pits. This report could result in additional regulatory scrutiny that could make it more difficult to perform hydraulic fracturing and increase the Partnership’s costs of compliance and business.

 

If new laws or regulations imposing significant restrictions or conditions on hydraulic fracturing activities are adopted in areas where the Partnership owns properties that require additional drilling, the Partnership could incur substantial compliance costs and such requirements could adversely delay or restrict its ability to conduct fracturing activities on its assets. In December 2017, the Bureau of Land Management (“BLM”) rescinded its own rule from 2015 that would have required oil and gas companies to seek approval from BLM before conducting hydraulic fracturing operations on public lands and for companies to disclose the chemicals used in fracking fluid.

 

Oil Pollution Act

 

The primary federal law for oil spill liability is the Oil Pollution Act, or OPA, which amends and augments oil spill provisions of the Clean Water Act and imposes certain duties and liabilities on certain “responsible parties” related to the prevention of oil spills and damages resulting from such spills in or threatening United States waters or adjoining shorelines. A liable “responsible party” includes the owner or operator of a facility, vessel or pipeline that is a source of an oil discharge or that poses the substantial threat of discharge, or in the case of offshore facilities, the lessee or permittee of the area in which a discharging facility is located. OPA assigns joint and several liability, without regard to fault, to each liable party for oil removal costs and a variety of public and private damages. Although defenses exist to the liability imposed by OPA, they are limited. In the event of an oil discharge or substantial threat of discharge on properties it owns, the Partnership may be liable for costs and damages.

 

Air Emissions

 

The operations of the Partnership’s operators are subject to the federal Clean Air Act, or CAA, and analogous state laws and local ordinances governing the control of emissions from sources of air pollution. The CAA and analogous state laws require new and modified sources of air pollutants to obtain permits prior to commencing construction. Major sources of air pollutants are subject to more stringent, federally imposed requirements including additional permits. Federal and state laws designed to control hazardous (or toxic) air pollutants, might require installation of additional controls. Administrative enforcement actions for failure to comply strictly with air pollution regulations or permits are generally resolved by payment of monetary fines and correction of any identified deficiencies. Alternatively, regulatory agencies could bring lawsuits for civil penalties or seek injunctive relief, requiring the Partnership to forego construction, modification or operation of certain air emission sources.

 

On April 17, 2012, the EPA issued final rules that subject oil and natural gas production, processing, transmission and storage operations to regulation. The EPA rules include standards for completions of hydraulically fractured natural gas wells. Before January 1, 2015, these standards required owners/operators to reduce volatile organic compound, or VOC, emissions from natural gas not sent to the gathering line during well completion either by flaring, using a completion combustion device, or by capturing the natural gas using green completions with a completion combustion device. Beginning January 1, 2015, operators must capture the natural gas and make it available for use or sale, which can be done through the use of “green completions.” The standards are applicable to newly fractured wells and also existing wells that are refractured. Further, the finalized regulations established specific new requirements for emissions from compressors, controllers, dehydrators, storage tanks, natural gas processing plants and certain other equipment. In August 2020, the EPA finalized a rule that removed sources in the transmission and storage segment from regulation under the 2012 and 2016 New Source Performance Standards (“NSPS”) for the oil and natural gas industry for ozone-forming VOCs and for greenhouse gases (“GHGs”) from methane.

 

 

In 2016, the EPA had expanded its regulatory coverage with the addition of new rules limiting methane emissions from new or modified sites and equipment. In August 2020, the EPA also finalized a rule that rescinded the methane requirements in the 2016 NSPS for the production and processing segments of the oil and natural gas industry.

 

This final rule also made amendments to the fugitive emissions monitoring requirements in the 2016 NSPS for the oil and natural gas industry that included: changes to the frequency for monitoring fugitive emissions (also known as “leaks”) at well sites and compressor stations, requirements for pneumatic pumps at well sites, and reduced requirements for professional engineer certifications.

 

The Biden administration has pledged to review or reverse many Trump-era environmental policies, and it appears some or all of these recent changes to the 2016 NSPS for the oil and gas industry are in the spotlight of this initiative.

 

In addition, in March 2018, the EPA proposed to withdraw “control technique guidelines” the EPA had previously issued to assist states in developing reasonably achievable control technology requirements for sources of volatile organic compounds. The Obama administration had originally issued these guidelines as part of its strategy to reduce methane emissions.

 

In November 2018, the EPA revised a previously stayed rule defining site aggregation for air permitting purposes. Under this rule, it is possible that some sites could require additional permitting under the Clean Air Act, an outcome that could result in costs and delays to the Partnership’s operations. However, this rule revival is being challenged in court.

 

On November 18, 2016, the BLM published a final rule that was intended to reduce waste of natural gas from venting, flaring, and leaks during oil and natural gas production activities on onshore Federal and Indian leases. Unlike the somewhat overlapping EPA regulations, which apply to new, modified and reconstructed sources, the BLM’s 2016 rule was drafted to address existing facilities, including a substantial number of existing wells that are likely to be marginal or low-producing, including leak detection and repair and other requirements regarding methane emissions. BLM issued a final rule in September 2018 that reduced certain compliance burdens deemed to be unnecessary, including requirements to write waste minimization plans, meet methane capture targets and use equipment that meets certain technical standards. BLM’s rule was challenged and struck down in federal court in 2020, although it is possible the Biden administration will reintroduce this type of regulation.

 

In March 2019, the EPA announced a voluntary disclosure program for new owners of upstream oil and natural gas exploration and facilities. The program was developed to encourage new owners of these facilities to participate because it provided regulatory certainty and clearly defined civil penalty mitigation beyond what was offered by the EPA’s existing self-disclosure policies. In December 2019, the EPA temporarily expanded its voluntary self-audit and disclosure program for upstream oil and natural gas facilities by giving existing owners the opportunity to find, correct, and self-disclose Clean Air Act violations.

 

National Environmental Policy Act

 

Oil and natural gas exploration and production activities on federal lands may be subject to the National Environmental Policy Act, or NEPA, which requires federal agencies, including the Department of Interior, to evaluate major agency actions having the potential to significantly impact the environment. In the course of such evaluations, an agency will prepare an environmental assessment that assesses the potential direct, indirect and cumulative impacts of a proposed project and, if necessary, will prepare a more detailed environmental impact statement that may be made available for public review and comment. All proposed exploration and development plans on federal lands require governmental permits that are subject to the requirements of NEPA. This process has the potential to delay or impose additional conditions upon the development of oil and natural gas projects.

 

The Trump administration EPA issued regulations that significantly changed how a NEPA analysis is conducted. Key changes included eliminating cumulative impact analysis, revising the definition of effects, narrowing what actions are subject to NEPA review, and allowing project proponents a greater role in the environmental review of their own projects. The Biden administration has pledged to review many of these changes, which may result in their reversal.

 

Climate Change Legislation

 

More stringent laws and regulations relating to climate change and GHG emissions may be adopted in the future and could cause the Partnership to incur material expenses in complying with them. Both houses of Congress have considered legislation to reduce emissions of GHGs, but no legislation has yet passed. In the absence of comprehensive federal legislation on GHG emission control, the EPA attempted to require the permitting of GHG emissions; although the Supreme Court struck down the permitting requirements, it upheld the EPA’s authority to control GHG emissions when a permit is required due to emissions of other pollutants.

 

 

The EPA has adopted a mandatory GHG emissions reporting program that imposes reporting and monitoring requirements on various types of facilities and industries including onshore and offshore oil and natural gas production, processing, transmission, storage, and distribution facilities.

 

The Biden administration has declared efforts to manage and control climate change a priority, evidenced by the immediate re-commitment of the United States to the Paris Agreement. It is possible this will result in additional federal initiatives to regulate greenhouse gas emissions. In January 2021, the Trump administration EPA issued a rule requiring the EPA to find that an individual industry, such as the power sector or oil and gas operators, collectively emits at least 3% of total U.S. greenhouse gases before setting emissions controls. Only the electric power sector would currently satisfy that requirement, according to the EPA’s own calculations. The Biden administration is likely to make an effort to reverse this rule.

 

Nonetheless, because of the lack of any comprehensive legislative program addressing GHGs, there is still a great deal of uncertainty as to how and whether federal regulation of GHGs might take place. In addition to possible federal regulation, a number of states, individually and regionally as well as some localities, also are considering or have implemented GHG regulatory programs or other steps to reduce GHG emissions. These potential regional, state and local initiatives may result in so-called cap and trade programs, under which overall GHG emissions are limited and GHG emissions are then allocated and sold, and possibly other regulatory requirements, that could result in the Partnership incurring material expenses to comply, e.g., by being required to purchase or to surrender allowances for GHGs resulting from its operations. The federal, regional and local regulatory initiatives also could adversely affect the marketability of the oil and natural gas the Partnership produces. The impact of such future programs cannot be predicted, but the Partnership does not expect its operations to be affected any differently than other similarly situated domestic competitors.

 

Endangered Species Act

 

The Endangered Species Act (“ESA”) was established to protect endangered and threatened species. Pursuant to that act, if a species is listed as threatened or endangered, restrictions may be imposed on activities that would harm the species or that would adversely affect that species’ habitat. Similar protections are offered to migratory birds under the Migratory Bird Treaty Act. The Partnership’s operators may conduct operations on oil and natural gas leases that have species that are listed and species that could be listed as threatened or endangered under the act. The U.S. Fish and Wildlife Service designates the species’ protected habitat as part of the effort to protect the species. A protected habitat designation or the mere presence of threatened or endangered species could result in material restrictions to use of the land and may materially delay or prohibit land access for oil and natural gas development. It also may adversely impact the value of the affected properties that the Partnership owns. The designation of previously unprotected species as threatened or endangered in areas where the Partnership might conduct operations could result in limitations or prohibitions on its activities and could adversely impact the value of its leases.

 

In August 2019, the Fish and Wildlife Service finalized revisions to ESA regulations that somewhat loosened procedures for listing species, recovery, reclassifications and critical habitat designations. The rules removed the requirement that listing, delisting or reclassification of species be made “without reference to possible economic or other impacts of such determination.” The rules also further relaxed the protection afforded to species listed as “threatened” from those that are endangered, with the protection for “threatened” species being made on more of a case-by-case basis. The Trump administration EPA also issued several Endangered Species Act decisions in the final days of 2020 that have been targeted by the Biden administration for review and possible reversal.

 

OSHA and Other Laws and Regulation

 

The Partnership is subject to the requirements of the federal Occupational Safety and Health Act, or OSHA, and comparable state statutes. These laws and the implementing regulations strictly govern the protection of the health and safety of employees. The OSHA hazard communication standard, the EPA community right–to–know regulations under Title III of CERCLA and similar state statutes require that the Partnership organize and/or disclose information about hazardous materials used or produced in the Partnership’s operations.

 

Other Regulation of the Oil and Natural Gas Industry

 

The oil and natural gas industry is extensively regulated by numerous federal, state, local and tribal authorities. Rules and regulations affecting the oil and natural gas industry are under constant review for amendment or expansion, which could increase the regulatory burden and the potential for financial sanctions for noncompliance. Also, numerous departments and agencies, both federal and state, are authorized by statute to issue rules and regulations binding on the oil and natural gas industry and its individual members, some of which carry substantial penalties for failure to comply. Although the regulatory burden on the oil and natural gas industry increases the Partnership’s cost of doing business and, consequently, affects the Partnership’s profitability, these burdens generally do not affect the Partnership any differently or to any greater or lesser extent than they affect other companies in the industry with similar types, quantities and locations of production.

 

 

Drilling and Production

 

Statutes, rules and regulations affecting exploration and production undergo constant review and often are amended, expanded and reinterpreted, making difficult the prediction of future costs or the impact of regulatory compliance attributable to new laws and statutes. The regulatory burden on the oil and natural gas industry increases the cost of doing business and, consequently, affects its profitability. The drilling and production operations performed by the Partnership’s contracted operators are subject to various types of regulation at the federal, state and local levels. These types of regulation include requiring permits for the drilling of wells, drilling bonds and reports concerning operations. Most states and some counties and municipalities in which the Partnership operates also regulate one or more of the following:

 

 

the location of wells;

 

the method of drilling, completing and operating wells;

 

the surface use and restoration of properties upon which wells are drilled;

 

the plugging and abandoning of wells;

 

the marketing, transportation and reporting of production;

 

notice to surface owners and other third parties; and

 

produced water and waste disposal.

 

State and federal regulations are generally intended to prevent waste of oil and natural gas, protect correlative rights to produce oil and natural gas between owners in a common reservoir or formation, control the amount of oil and natural gas produced by assigning allowable rates of production and control contamination of the environment. Pipelines and natural gas plants operated by other companies that provide midstream services to the Partnership are also subject to the jurisdiction of various federal, state and local authorities, which can affect the Partnership’s operations. State laws also regulate the size and shape of drilling and spacing units or proration units governing the pooling of oil and natural gas properties.

 

States generally impose a production, ad valorem or severance tax with respect to the production and sale of oil and natural gas within their respective jurisdictions. States do not generally regulate wellhead prices or engage in other, similar direct economic regulation, but there can be no assurance they will not do so in the future.

 

In addition, a number of states, such as North Dakota where the Partnership’s properties are located, and some tribal nations have enacted surface damage statutes, or SDAs. These laws are designed to compensate for damage caused by oil and natural gas development operations. Most SDAs contain entry notification and negotiation requirements to facilitate contact between operators and surface owners/users. Most also contain bonding requirements and require specific payments by the operator to surface owners/users in connection with exploration and producing activities. Costs and delays associated with SDAs could impair operational effectiveness and increase development costs.

 

The Partnership will not control the availability of transportation and processing facilities that may be used in the marketing of its production. For example, the Partnership may have to shut–in a productive natural gas well because of a lack of available natural gas gathering or transportation facilities.

 

If the Partnership conducts operations on federal, state or Indian oil and natural gas leases, these operations must comply with numerous regulatory restrictions, including various non–discrimination statutes, royalty and related valuation requirements, and certain of these operations must be conducted pursuant to certain on-site security regulations and other appropriate permits issued by BLM, Bureau of Safety and Environmental Enforcement, Bureau of Indian Affairs, tribal or other appropriate federal, state and/or Indian tribal agencies.

 

The Mineral Leasing Act of 1920, or the Mineral Act, prohibits ownership of any direct or indirect interest in federal onshore oil and natural gas leases by a foreign citizen or a foreign entity except through equity ownership in a corporation formed under the laws of the United States or of any U.S. State or territory, and only if the laws, customs, or regulations of their country of origin or domicile do not deny similar or like privileges to citizens or entities of the United States. If these restrictions are violated, the oil and natural gas lease can be canceled in a proceeding instituted by the United States Attorney General. The Partnership qualifies as an entity formed under the laws of the United States or of any U.S. State or territory. Although the regulations promulgated and administered by the BLM pursuant to the Mineral Act provide for agency designations of non–reciprocal countries, there are presently no such designations in effect. It is possible that the holders of the Partnership’s common units may be citizens of foreign countries and do not own their common units in a U.S. corporation or even if such interest is held through a U.S. corporation, their country of citizenship may be determined to be non–reciprocal countries under the Mineral Act. In such event, any federal onshore oil and natural gas leases held by the Partnership could be subject to cancellation based on such determination.

 

 

Federal Regulation of Oil, Natural Gas and Natural Gas Liquids, including Regulation of Transportation

 

The availability, terms and cost of transportation service significantly affect sales of natural gas. The interstate transportation and sale for resale of natural gas are subject to federal regulation, including regulation of the terms, conditions and rates for interstate transportation, storage and various other matters, primarily by the Federal Energy Regulatory Commission (“FERC”). The intrastate transportation, local distribution and retail sale of natural gas generally are subject to state regulation. FERC’s regulations for interstate natural gas transmission in some circumstances may also affect the intrastate transportation of natural gas.

 

FERC regulates the rates, terms and conditions applicable to the interstate transportation of natural gas by pipelines under the Natural Gas Act as well as under Section 311 of the Natural Gas Policy Act of 1978. FERC also authorizes the construction and operation of interstate natural gas pipelines under the Natural Gas Act (“NGA”).

 

Under FERC’s current regulatory regime, interstate natural gas transportation services must be provided on an open-access, non-discriminatory basis at cost-based rates or at market-based rates if the transportation market at issue is sufficiently competitive. Among other things, the FERC-regulated tariffs, under which interstate pipelines provide such open-access transportation service, contain strict limits on the means by which a shipper releases its pipeline capacity to another potential shipper, which provisions include FERC’s “shipper-must-have-title” rule. Violations by a shipper (i.e., a pipeline customer) of FERC’s capacity release rules or shipper-must-have-title rule could subject a shipper to substantial penalties from FERC.

 

With respect to its review of applications for the construction and operation of interstate natural gas pipeline facilities under the NGA, FERC must comply with environmental review requirements of NEPA.

 

Wellhead natural gas sale prices are unregulated. Sales of condensate and natural gas liquids are not currently regulated and are made at market prices. The Partnership cannot predict whether new legislation to regulate natural gas might be proposed, what proposals, if any, might actually be enacted by Congress or the various state legislatures, and what effect, if any, the proposals might have on the operations of the properties the Partnership owns.

 

Sales of the Partnership’s oil and natural gas liquids are also affected by the availability, terms and costs of transportation. The rates, terms, and conditions applicable to the interstate transportation of oil and natural gas liquids by pipelines are regulated by the FERC under the Interstate Commerce Act (“ICA”). The FERC has implemented a simplified and generally applicable ratemaking methodology for interstate oil and natural gas liquids pipelines to fulfill the requirements of Title XVIII of the Energy Policy Act of 1992 comprised of an indexing system to establish ceilings on interstate oil and natural gas liquids pipeline rates. In 2017, FERC issued a declaratory holding that certain arrangements between an oil pipeline and its marketing affiliate would violate the ICA’s anti-discrimination provisions. FERC held that providing transportation service to affiliates at what is essentially the variable cost of the movement, while requiring non-affiliated shippers to pay the (higher) filed tariff rate, would violate the ICA. Rehearing of this order is pending before FERC.

 

Gathering service, which occurs on pipeline facilities located upstream of FERC-jurisdictional interstate transportation services, is regulated by the states onshore and in state waters. Depending on changes in the function performed by particular pipeline facilities, FERC has in the past reclassified certain FERC-jurisdictional transportation facilities as non-jurisdictional gathering facilities and FERC has reclassified certain non-jurisdictional gathering facilities as FERC-jurisdictional transportation facilities. Any such changes could result in an increase to the Partnership’s costs of transporting gas to point-of-sale locations.

 

The pipelines used to gather and transport natural gas being produced by the Partnership are also subject to regulation by the U.S. Department of Transportation (“DOT”) under the Natural Gas Pipeline Safety Act of 1968, as amended (“NGPSA”), the Pipeline Safety Act of 1992, as reauthorized and amended (“Pipeline Safety Act”), and the Pipeline Safety, Regulatory Certainty, and Job Creation Act of 2011. The DOT Pipeline and Hazardous Materials Safety Administration (“PHMSA”) has established a risk–based approach to determine which gathering pipelines are subject to regulation and what safety standards regulated gathering pipelines must meet.

 

Transportation of the Partnership’s oil, natural gas liquids and purity components (ethane, propane, butane, iso–butane, and natural gasoline) by rail is also subject to regulation by the DOT’s PHMSA and the DOT’s Federal Railroad Administration (“FRA”) under the Hazardous Materials Regulations, including Emergency Orders by the FRA. Revisions to PHMSA gathering line regulations and liquids pipelines regulations could result in the Partnership incurring significant expenses.

 

 

Exports of US Oil Production and Natural Gas Production

 

At the end of 2015, the U.S. Congress voted to end a decades-old prohibition of exports of oil produced in the lower 48 states of the U.S. Under the NGA, the U.S. Department of Energy (“DOE”) authorizes exports of U.S.-produced natural gas, including exports of natural gas by pipelines connecting U.S. natural gas production to pipelines in Mexico and Canada. Under the NGA, FERC authorizes the construction and operation of natural gas pipeline facilities crossing the U.S. border used to export U.S.-produced natural gas. In addition, under the NGA, the DOE authorizes the export of liquefied natural gas (“LNG”) through LNG export facilities, while FERC authorizes the siting and construction of onshore and near-shore LNG export terminals. From 2012 through the end of 2020, DOE authorized large-scale, long-term exports of lower-48-U.S.-produced LNG and compressed natural gas totaling 46.94 billion cubic feet per day of natural gas to countries with which the U.S. has not entered into a free trade agreement providing for national treatment for trade in natural gas. In 2020, DOE issued a Final Policy Statement discontinuing its practice of granting a standard 20-year export term for long-term authorizations to export domestically produced natural gas from the lower-48 states to non-FTA countries, and adopting a term through December 31, 2050, as the standard export term for long-term non-FTA authorizations. Under DOE’s Policy Statement, holders of existing non-FTA authorizations may file an application with DOE requesting to amend its authorization to extend its export term through December 31, 2050.

 

Other Regulation

 

In addition to the regulation of oil and natural gas pipeline transportation rates, the oil and natural gas industry generally is subject to compliance with various other federal, state and local regulations and laws. Some of those laws relate to occupational safety, resource conservation and equal employment opportunity. The Partnership does not believe that compliance with these laws will have a material adverse effect upon its operations. 

 

Employees

 

The Partnership has no officers, directors or employees. Instead, the General Partner manages the day-to-day affairs of the Partnership, and all decisions regarding the management of the Partnership are made by the Board of Directors of the General Partner and its officers. The General Partner utilizes the services of qualified third parties and consultants for specific projects, such as the preparation of the Partnership’s reserve estimates. The Board of Directors of the General Partner does not receive any salary, bonus or consulting fees for serving on the board of directors or managing the Partnership’s business. For more detail, refer to Part III, Items 10, 11 and 13, respectively, of this Form 10-K.

 

General Corporate Information

 

Energy 11, L.P. is a Delaware limited partnership founded in 2013 with principal offices at 120 W 3rd Street, Suite 220, Fort Worth, Texas 76102. The Partnership’s phone number is (817) 882-9192 and its website address is www.energyeleven.com. The Partnership makes available, free of charge through its Internet website, its annual report on Form 10-K and quarterly reports on Form 10-Q, and amendments to those reports filed or furnished pursuant to section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after the Partnership electronically files such material with, or furnishes it to, the SEC. Information contained on the Partnership’s website is not incorporated by reference into this report.

 

 

Item 1A. Risk Factors

 

Risks Related to the Partnerships Business, Financial Condition, Results of Operations and Cash Flows

 

The Partnership has substantial liquidity needs and may not be able to obtain sufficient liquidity to continue as a going concern.

 

In addition to the cash requirements necessary to fund ongoing operations, including scheduled debt service obligations and payment of incurred capital expenditures and general and administrative costs, the Partnership may incur significant professional fees and other costs to obtain alternative financing. There can be no assurance that cash on hand and cash flows from operations in a period of sustained lower commodity prices will be sufficient to continue to fund the Partnership’s operations, including debt service, for any significant period of time. 

 

The Partnership may not be able to refinance the obligations due under its Credit Facility.

 

The full amount of the Partnership’s obligations under its Credit Facility are due and payable on July 31, 2021. The Partnership is actively seeking to refinance its obligations under the Credit Facility, but no assurance can be given that such a refinancing will be available on terms acceptable to the Partnership or on any terms whatsoever. If the lenders were to enforce the obligations outstanding under the Credit Facility when they become due, the Partnership would be required to pay approximately $40 million (as of December 31, 2020) to the lenders.

 

The Partnership may not be able to obtain waivers of future covenant violations under its Credit Facility.

 

In July 2020, the Partnership received a waiver from its lender group that suspended certain covenant calculations and waived certain other defaults under the Credit Facility. If the Partnership violates covenants under the Credit Facility in the future and is unable to obtain waivers, the lenders will have the right to accelerate all of the outstanding indebtedness under the Credit Facility. If the lenders were to accelerate all of the obligations outstanding under the Credit Facility, the Partnership would be required to pay approximately $40 million (as of December 31, 2020) to the lenders.

 

The Partnership and its lender group entered into a Letter Agreement in July 2020 that amended certain sections of the Credit Facility, including a restriction on the Partnerships ability to make distributions to holders of its common units. Other amendments may limit the Partnerships ability to capitalize on acquisitions and other business opportunities.

 

The Partnership’s Credit Facility contains covenants limiting the Partnership’s ability to make distributions, incur indebtedness, grant liens, make acquisitions, make investments or dispositions and engage in transactions with affiliates, as well as covenants requiring the Partnership to maintain certain financial ratios and tests. In addition, the borrowing base under the Partnership’s Credit Facility is subject to periodic review by its lender. Difficulties in the credit markets may cause the banks to be more restrictive when redetermining the Partnership’s borrowing base.

 

Crude oil prices declined significantly in the first quarter of 2020 and into the second quarter of 2020. If oil, natural gas or other hydrocarbon prices decrease and/or remain depressed for a prolonged period, cash flows from operations will decline and cash available for distributions will be impacted.

 

The Partnership’s revenue, profitability and cash flow depend upon the prices for oil, natural gas and other hydrocarbons. The prices the Partnership will receive for its production will be volatile and a drop in prices can significantly affect its financial results and adversely affect the Partnership’s ability to obtain credit, maintain its borrowing capacity and to repay indebtedness, all of which can affect the Partnership’s ability to pay distributions. Changes in prices have a significant impact on the value of the Partnership’s reserves and on its cash flows. Prices may fluctuate widely in response to relatively minor changes in supply and demand, market uncertainty and a variety of additional factors that are beyond the Partnership’s control, such as:

 

 

the domestic and foreign supply of and demand for oil, natural gas and other hydrocarbons;

 

regulations which may prevent or limit the export of oil, natural gas and other hydrocarbons;

 

the amount of added production from development of unconventional natural gas reserves;

 

the price and quantity of foreign imports of oil, natural gas and other hydrocarbons;

 

the level of consumer product demand;

 adverse weather conditions, natural disasters and global health concerns, such as the COVID-19 coronavirus outbreak in early 2020;
 the value of the U.S. dollar relative to the currencies of other countries;
 overall domestic and global economic conditions;

 

 

 

political and economic conditions and events in foreign oil and natural gas producing countries, including embargoes, continued hostilities in the Middle East and other sustained military campaigns, conditions in South America, China and Russia, and acts of terrorism or sabotage;

 

the ability of members of the Organization of Petroleum Exporting Countries to agree to and maintain oil price and production controls;

 

technological advances affecting energy production and consumption;

 

domestic and foreign governmental regulations and taxation;

 

the impact of energy conservation efforts; 

 

the proximity and capacity of oil, natural gas and other hydrocarbon pipelines and other transportation facilities to its production;

 

speculation as to the future price of oil and natural gas and the speculative trading of oil and natural gas futures contracts;

 

price and availability of competitors’ supplies of oil and natural gas; and

 

the price and availability of alternative fuels.

 

Decreased oil, natural gas and other hydrocarbon prices will decrease Partnership revenues, and may also reduce the amount of oil, natural gas or other hydrocarbons that the Partnership can economically produce. If decreases occur, or if estimates of development costs increase, production data factors change or drilling results deteriorate, accounting rules may require the Partnership to write down, as a non–cash charge to earnings, the carrying value of its oil and natural gas properties for impairments. The Partnership is required to perform impairment tests on its assets whenever events or changes in circumstances lead to a reduction of the estimated useful life or estimated future cash flows that would indicate that the carrying amount may not be recoverable or whenever management’s plans change with respect to those assets. The Partnership may incur impairment charges in the future, which could have a material adverse effect on its results of operations in the period taken and the Partnership’s ability to borrow funds under a credit facility, which may adversely affect the Partnership’s ability to make cash distributions to holders of its common units and service its debt obligations.

 

The widespread outbreak of COVID-19 has significantly adversely impacted and disrupted, and is expected to continue to adversely impact and disrupt, the Partnerships business and the industry in which the Partnership operates.

 

In December 2019, China reported an outbreak of COVID-19 in its Wuhan province. On March 11, 2020, the World Health Organization declared COVID-19 a pandemic, and on March 13, 2020, the United States declared a national emergency with respect to COVID-19. COVID-19 has spread worldwide, forcing governments around the world to take drastic measures to halt the outbreak. These measures include significant restrictions on travel, forced quarantines, stay-at-home requirements and the closure of businesses in many industries, creating extreme volatility in capital markets and the global economy.

 

COVID-19’s impact to the global economy, in particular the oil and gas industry, has been unprecedented, as reduced demand for fossil fuels has resulted in a significant decline in commodity prices during March and April 2020. The Partnership experienced a decline in anticipated revenue during March 2020 and through 2020 due to commodity price declines. If demand for oil and gas as well as commodity prices remain low in 2021, the Partnership’s business will be negatively impacted. The Partnership cannot give any assurance as to when demand will return to more normal levels or if commodity prices will increase.

 

The COVID-19 pandemic and related restrictions aimed at mitigating its spread have caused the General Partner to modify certain of the Partnership’s business practices, including limiting employee travel, encouraging work-from-home practices and other social distancing measures. Such measures may cause disruptions to the Partnership’s business and operational plans, which may include shortages of employees, contractors and subcontractors. There is no certainty that these or any other future measures will be sufficient to mitigate the risks posed by the disease, including the risk of infection of key employees, and the Partnership’s ability to perform certain functions could be impaired by these new business practices. For example, the Partnership’s reliance on technology has necessarily increased due to the General Partner’s encouragement of remote communications and other work-from-home practices, which could make the Partnership more vulnerable to cyber-attacks.

 

The spread of COVID-19 has caused severe disruptions in the global economy, specifically the oil and gas industry, and could potentially create widespread business continuity issues of an as yet unknown magnitude and duration.

 

COVID-19 has caused severe economic, market and other disruptions worldwide. In many respects, it is too early to quantify the long-term ramifications of COVID-19 on the global economy as well as oil and gas industry, the Partnership’s operators and the Partnership’s business. Further, it is currently not possible to predict how long the COVID-19 pandemic will last or the time that it will take for economic activity to return to prior levels. As a result, the Partnership cannot provide an estimate of the overall impact of COVID-19 on its business or when, or if, the Partnership and its operators will be able to resume normal, pre-COVID-19 operations. Nevertheless, sustained lower oil and gas prices and reduced demand resulting from COVID-19 present material uncertainty and risk with respect to the Partnership’s business, financial performance and condition, operating results and cash flows. In addition, low oil and natural gas prices may cause the Partnership’s undrilled wellsites to become uneconomic to develop.

 

 

As domestic demand for crude oil has declined substantially due to COVID-19, the General Partner cannot ensure that there will be a physical market for the Partnerships production at economic prices until markets stabilize.

 

As a result of low commodity prices, the operators of the Partnership’s wells have and may curtail a portion of the Partnership’s estimated crude oil production and may store rather than sell additional crude oil production in the near future. Additionally, an excess supply of oil could lead to further curtailments by those operators. While the Partnership believes that the shutting-in of such production will not impact the productivity of such wells when reopened, there is no assurance the Partnership will not have a degradation in well performance upon returning those wells to production. The storing or shutting in of a portion of the Partnership’s production can also result in increased costs under midstream and other contracts. Any of the foregoing could result in an adverse impact on the Partnership’s revenues, financial position and cash flows.

 

The Partnership may not have sufficient cash from operations following the establishment of cash reserves and payment of fees and expenses, including cost reimbursements to the General Partner, to enable the Partnership to make cash distributions to holders of its common units under its cash distribution policy.

 

The Partnership may not have sufficient available cash each month to enable it to make cash distributions to the holders of common units. The amount of cash the Partnership can distribute on its common units principally depends upon the amount of cash the Partnership generates from its operations, which will fluctuate from month to month based on, among other things:

 

 

the amount of oil, natural gas and natural gas liquids the Partnership produces;

 

the prices at which the Partnership sells its production;

 

the Partnership’s ability to hedge commodity prices at economically attractive prices;

 

the level of the Partnership’s capital expenditures, including its costs to participate in wells;

 

the level of the Partnership’s operating and administrative costs including reimbursement to the General Partner; and

 

the level of the Partnership’s interest expense, which depends on the amount of its indebtedness and the interest payable thereon.

 

In addition, the actual amount of cash the Partnership will have available for distribution will depend on other factors, some of which are beyond the Partnership’s control, including:

 

 

contractual restrictions on the payment of distributions contained in the Letter Agreement to the Credit Facility;

 

the amount of cash reserves established by the General Partner for the proper conduct of the Partnership’s business and for capital expenditures, which may be substantial;

 

the cost of operations, infrastructure and drilling;

 

the Partnership’s debt service requirements and other liabilities;

 

fluctuations in the Partnership’s working capital needs;

 

the Partnership’s ability to borrow funds;

 

the timing and collectability of receivables; and

 

prevailing economic conditions.

 

As a result of these factors, the amount of cash the Partnership distributes to holders of its common units may fluctuate significantly from month to month.

 

The Partnership has limited control over the activities on its properties.

 

At December 31, 2020, Whiting operates 98% of the properties in which the Partnership holds a working interest. The Partnership has limited ability to influence or control the operation or future development of the non-operated properties or the amount of capital expenditures that it is required to fund. The failure of Whiting, or the Partnership’s other operators, to adequately perform operations, breach the applicable agreements or failure to act in ways that are in the Partnership’s best interest could reduce the Partnership’s production and revenues. The Partnership’s dependence on Whiting and other working interest owners for these projects and the Partnership’s limited ability to influence or control the operation and future development of these properties could materially adversely affect the realization of the Partnership’s targeted returns on capital in drilling or acquisition activities and lead to unexpected future costs.

 

 

The Partnership participates in oil and gas leases with third parties who may not be able to fulfill their commitments to the Partnerships projects.

 

The Partnership owns less than 100% of the working interest in the Sanish Field Assets, and other parties own the remaining portion of the working interests. Financial risks are inherent in any operation where the cost of drilling, equipping, completing and operating wells is shared by more than one person or entity. The Partnership could be held liable for joint activity obligations of other working interest owners, such as nonpayment of costs and liabilities arising from the actions of other working interest owners. In addition, declines in oil, natural gas and NGL prices may increase the likelihood that some of the other working interest owners, particularly those that are smaller and less established, will not be able to fulfill their joint activity obligations. Another working interest owner may be unable or unwilling to pay its share of project costs, and, in some cases, may declare bankruptcy. In the event any of the Partnership’s co-owners do not pay their share of such costs, the Partnership would likely have to pay its share of those costs, and the Partnership may be unsuccessful in any efforts to recover these costs from its partners, which could materially adversely affect the Partnership’s financial position.

 

The Partnerships results from operations may be impacted by a lack of geographical diversification.

 

All of the Partnership’s assets are located in concentrated areas of the Williston Basin in Mountrail County, North Dakota. While other companies and limited partnerships may have the ability to manage their risk by diversification, the narrow geographic focus of the Partnership’s business means that it may be impacted more acutely by factors affecting its industry or the region in which the Partnership operates than it would if its asset locations were more diversified. The Partnership may be disproportionately exposed to the effects of regional supply and demand factors, delays or interruptions of production from wells in this area caused by governmental regulation, processing or transportation capacity constraints, market limitations, weather events or interruption of the processing or transportation of oil or natural gas. Additionally, the Partnership may be exposed to further risks, such as changes in field-wide rules and regulations that could cause the Partnership to permanently or temporarily shut-in all of its wells within the Williston Basin. The Partnership does not currently intend to broaden the geographic scope of its asset base.

 

The Partnership depends on oil and natural gas transportation and processing facilities and other assets that are owned by third parties.

 

The marketability of Partnership oil and natural gas depends in part on the availability, proximity and capacity of pipeline systems, processing facilities, oil trucking fleets and rail transportation assets owned by third parties. The lack of available capacity on these systems and facilities, whether as a result of proration, physical damage, scheduled maintenance, legal or other reasons such as suspension of service due to legal challenges (see below regarding the Dakota Access Pipeline), could result in a substantial increase in costs, the shut-in of producing wells or the delay or discontinuance of development plans for the Sanish Field Assets. The negative effects arising from these and similar circumstances may last for an extended period of time.

 

The Dakota Access Pipeline (“DAPL”), a major pipeline running out of the Williston Basin, is subject to publicized ongoing litigation that could threaten its continued operation. In July 2020, a federal district court ordered DAPL to be shut down no later than August 6, 2020, pending the completion of an environmental impact statement that is expected to take at least a year to complete. The district court’s shut-down order was subsequently temporarily stayed by a federal circuit court of appeals, and DAPL currently remains operational. But a court-ordered shut-down remains possible, and there is no guarantee that DAPL will be permitted to resume or continue operations following the completion of the environmental review or any outstanding litigation.

 

Any significant curtailment in gathering system or pipeline capacity, or the unavailability of sufficient third-party trucking or rail capacity, could adversely affect the Partnership’s results of operations and financial condition.

 

The Partnership and the operators of its properties may encounter obstacles to marketing the Partnerships share of oil, natural gas and other hydrocarbons, which could adversely impact the Partnerships revenues.

 

The marketability of the Partnership’s production will depend upon numerous factors beyond the Partnership’s control, including the availability and capacity of natural gas gathering systems, pipelines and other transportation and processing facilities that the Partnership expects to be owned by third parties. Transportation space on the gathering systems and pipelines the Partnership expects to utilize is occasionally limited or unavailable due to repairs or improvements to facilities or due to space being utilized by other companies that have priority transportation agreements. The Partnership’s access to transportation and processing options and the marketing of the Partnership’s production can also be affected by U.S. federal and state regulation of oil and natural gas production and transportation, as well as the other risks discussed above. The availability of markets is beyond the Partnership’s control. If market factors dramatically change, the impact on the Partnership’s revenues could be substantial and could adversely affect the Partnership’s ability to produce and market oil, natural gas and natural gas liquids, the value of the Partnership’s common units and the Partnership’s ability to pay distributions on the Partnership’s common units and service the Partnership’s debt obligations.

 

 

The Partnership may be required to shut-in wells or delay initial production for lack of a viable market or because of the inadequacy or unavailability of pipeline, gathering system, processing, treating, fractionation or refining capacity. When that occurs, the Partnership will be unable to realize revenue from such wells until the inadequacy or unavailability is remedied. This can result in considerable delays from the initial discovery of a reservoir to the actual production of the oil and natural gas and realization of revenues.

 

The Partnership will need additional funding for the Sanish Field Assets in order to retain its full interest therein.

 

The Partnership anticipates that it will be obligated to significantly invest in drilling capital expenditures within the next five years to participate in drilling activity in the Sanish Field Assets without becoming subject to non-consent penalties under the joint operating agreements governing those properties. The Partnership will depend, at least in part, on increased cash flow from operations and increased availability under its Credit Facility to fund the anticipated capital expenditures needed to retain its full interest in the Sanish Field Assets. None of these funding sources is guaranteed, and if the Partnership is unable to obtain all of this funding, it may lose all or a portion of the assets acquired, and the Partnership’s results of operations will be negatively affected accordingly.

 

Property interests that the Partnership has purchased or of which the Partnership participates in the development may not produce as projected and the Partnership may be unable to realize reserve potential, which could adversely affect the Partnerships cash available for distribution.

 

The Partnership’s completed acquisitions and any decision to participate in the development of a property the Partnership owns required or will require an assessment of recoverable reserves, title, future oil, natural gas and natural gas liquids prices, operating costs, potential environmental hazards, potential tax and ERISA liabilities, and other liabilities and similar factors. Reserve estimates may be prepared by the operators or third parties for the operators of properties. The Partnership has engaged and may engage its own third-party petroleum engineers to review such reserve estimate reports and provide the Partnership with an independent assessment of the reserve estimates. The process of estimating oil and gas reserves is complex. It requires interpretations of available technical data and various assumptions, including assumptions relating to economic factors such as future oil and gas prices, drilling and operating expenses, capital expenditures, taxes and the availability of funds, all of which can be difficult to predict with accuracy. As a result, estimated quantities of proved reserves and projections of future production rates and the timing of development expenditures may prove to be inaccurate. Inspections may not always be performed on every well, and potential problems, such as ground water contamination and other environmental conditions and deficiencies in the mechanical integrity of equipment are not necessarily observable even when an inspection is undertaken. Any unidentified problems could result in material liabilities and costs that negatively impact the Partnership’s financial conditions and results of operations and its ability to make cash distributions to holders of its common units and service its debt obligations.

 

Additional potential risks at the acquisition date and those related to development include, among other things:

 

 

incorrect assumptions regarding the future prices of oil, natural gas and other hydrocarbons or the future operating or development costs of properties;

 

incorrect estimates of the reserves and projected development results attributable to a property the Partnership owns;

 

drilling, operating and other cost overruns;

 

an inability to integrate successfully the properties the Partnership has acquired;

 

the assumption of liabilities;

 

the diversion of management’s attention from other business concerns; and

 

losses of key employees.

 

The Partnership could experience periods of higher costs if oil and natural gas prices rise or as drilling activity otherwise increases in the Partnerships area of operations. Higher costs could reduce the Partnerships profitability and cash flow.

 

Historically, capital and operating costs typically rise during periods of sustained increasing oil, natural gas and NGL prices. These cost increases result from a variety of factors beyond the Partnership’s control as drilling activity increases, such as increases in the cost of electricity, tubular goods, water, sand and other disposable materials used in fracture stimulation and other raw materials that the Partnership and its vendors will rely upon, and the cost of services and labor especially those required in horizontal drilling and completion. Historically, oil and natural gas prices have fluctuated resulting in fluctuating levels of drilling activity in the U.S. oil and natural gas industry. Lower prices typically lead to lower costs of some drilling and completion equipment, services, materials and supplies. As commodity prices rise or stabilize or drilling activity otherwise increases, these lower cost levels may not be sustainable over long periods. As a result, such costs may rise faster than selling prices thereby negatively impacting the Partnership’s profitability, cash flow and causing it to possibly reconfigure or reduce its drilling program.

 

 

The Partnerships hedging transactions will expose it to counterparty credit risk.

 

Historically, the Partnership has engaged in hedging transactions to reduce, but not eliminate, the effect of volatility in oil, gas and other hydrocarbon prices. The Partnership may also engage in hedging transaction in future periods. Hedging transactions will expose the Partnership to risk of financial loss if a counterparty fails to perform under a derivative contract. Disruptions in the financial markets could lead to sudden changes in a counterparty’s liquidity, which could impair its ability to perform under the terms of the derivative contract. The Partnership is unable to predict sudden changes in a counterparty’s creditworthiness or ability to perform. Even if the Partnership does accurately predict sudden changes, its ability to negate the risk may be limited depending upon market conditions.

 

During periods of falling commodity prices, such as those that occurred in late 2008, 2012 and early 2020, the Partnership’s hedge receivable positions will increase, which increases the Partnership’s exposure. If the creditworthiness of the Partnership’s counterparties deteriorates and results in their nonperformance, the Partnership could incur a significant loss.

 

The Partnerships hedging activities could result in financial losses or could reduce the Partnerships net income, which may adversely affect the Partnerships ability to pay cash distributions to holders of its common units.

 

To achieve more predictable cash flows and to reduce the Partnership’s exposure to fluctuations in the prices of oil, natural gas and other hydrocarbons, the Partnership has and may enter into hedging arrangements for a significant portion of its estimated future production. If the Partnership experiences a sustained material interruption in its production, the Partnership might be forced to satisfy all or a portion of its hedging obligations without the benefit of the cash flows from the Partnership’s sale of the underlying physical commodity, resulting in a substantial diminution of its liquidity.

 

The Partnership’s ability to use hedging transactions to protect it from future price declines will be dependent upon oil and natural gas prices at the time the Partnership enters into hedging transactions and the Partnership’s future levels of hedging, and as a result its future net cash flows may be more sensitive to commodity price changes. Additionally, it may not be possible or economic to hedge all of the hydrocarbons the Partnership produces because of the lack of a market for such hedges or other reasons. The Partnership may hedge certain hydrocarbons it produces by entering into swaps, collars or other contracts covering hydrocarbons the Partnership considers to be priced similarly to the hydrocarbons it produces, and could be subject to losses if the prices for the hydrocarbons the Partnership produces do not match the hydrocarbons the Partnership contracts for.

 

The Partnership’s policy is to hedge a portion of its near–term estimated production. The prices at which the Partnership hedges its production in the future will be dependent upon commodity prices at the time the Partnership enters into these transactions, which may be substantially higher or lower than current oil, natural gas and other hydrocarbon prices. Accordingly, the Partnership’s price hedging strategy may not protect it from significant declines in oil and natural gas prices received for its future production. Conversely, the Partnership’s hedging strategy may limit its ability to realize cash flows from commodity price increases. It is also possible that a substantially larger percentage of the Partnership’s future production will not be hedged as compared with the next few years, which would result in its oil, natural gas and natural gas liquids revenues becoming more sensitive to commodity price changes. The General Partner will not be liable for any losses the Partnership incurs as a result of the Partnership’s hedging policy or the implementation of that policy.

 

The Partnership plans to rely on drilling to fully develop the properties the Partnership has acquired. If drilling is unsuccessful, the Partnerships cash available for distributions and financial condition will be adversely affected.

 

The Partnership has acquired oil and gas properties that are not fully developed, and require that the Partnership engages in drilling to fully exploit the reserves attributable to the properties. The Partnership’s drilling, completed by its operators, will involve numerous risks, including the risk that the Partnership will not encounter commercially productive oil or natural gas reservoirs. The Partnership may incur significant expenditures to drill and complete wells, including cost overruns. Additionally, current geoscience technology may not allow the Partnership to know conclusively, prior to drilling a well, that oil or natural gas is present or economically producible. The costs of drilling and completing wells are often uncertain, and it is possible that the Partnership will make substantial expenditures on drilling and not discover reserves in commercially viable quantities. These expenditures will reduce cash available for distribution to holders of the Partnership’s common units and for servicing any debt obligations.

 

The Partnership’s drilling operations may be curtailed, delayed or cancelled as a result of a variety of factors, including:

 

 

unexpected drilling or operating conditions;

 

facility or equipment failure or accidents;

 

shortages or delays in the availability of drilling rigs and equipment and in hiring qualified personnel;

 

adverse weather conditions;

 

shortages of water required for hydraulic fracturing or other operations;

 

 

 

compliance with environmental and governmental requirements;

 

reductions in oil or gas prices;

 

proximity to and capacity of transportation and processing facilities;

 

title problems;

 

encountering abnormal pressures or unusual, unexpected or irregular geological formations;

 

pipeline ruptures;

 

fires, blowouts, craterings and explosions; and

 

uncontrollable flows of oil or natural gas or well fluids.

 

Even if drilled, completed wells may not produce quantities of oil or natural gas that are economically viable or that meet earlier estimates of economically recoverable reserves. A productive well may become uneconomic if water or other deleterious substances are encountered, which impair or prevent the production of oil and/or natural gas from the well. The Partnership’s overall drilling success rate or drilling success rate for activity within a particular project area may decline. Unsuccessful drilling activities could result in a significant decline in the Partnership’s production and revenues and materially harm its operations and financial condition by reducing available cash and resources.

 

The Partnership’s continued success depends upon its ability to develop oil and gas reserves that are economically recoverable.

 

In addition, the Partnership’s future oil and natural gas production will depend on the Partnership’s success developing its assets to add to its reserves. If the Partnership is unable to replace reserves through drilling, the Partnership’s level of production and cash flows will be adversely affected. In general, production from oil and natural gas properties declines as reserves are depleted, with the rate of decline depending on reservoir characteristics. The Partnership’s total proved reserves decline as reserves are produced unless the Partnership conducts other successful development activities. The Partnership’s ability to make the necessary capital investment to maintain and expand its asset base of oil and natural gas reserves would be impaired to the extent cash flow from operations is reduced and external sources of capital become limited or unavailable. The Partnership may not be successful in developing its assets to increase its reserves.

 

The Partnerships business is subject to operational risks that will not be fully insured, which, if they were to occur, could adversely affect the Partnerships financial condition or results of operations and, as a result, the Partnerships ability to pay distributions to holders of its common units and service its debt obligations.

 

The Partnership’s business activities are subject to operational risks, including:

 

 

damages to equipment caused by natural disasters such as earthquakes, adverse weather conditions, including tornadoes, hurricanes, drought and flooding;

 

unexpected formations and pressures;

 

facility or equipment malfunctions;

 

pipeline ruptures or spills;

 

fires, blowouts, craterings and explosions;

 

release of toxic gasses;

 

uncontrollable flows of oil or natural gas or well fluids; and

 

surface fluid spills, saltwater contamination, and surface or ground water contamination from petroleum constituents or hydraulic fracturing chemical additives.

 

Any of these events could adversely affect the Partnership’s ability to conduct operations or cause substantial losses, including personal injury or loss of life, damage to or destruction of property, natural resources and equipment, pollution or other environmental contamination, loss of wells, regulatory penalties, suspension cessation or of operations, and attorneys’ fees and other expenses incurred in the prosecution or defense of litigation and could also result in requirements to remediate, regulatory investigations, and/or the interruption of the Partnership’s business and/or the business of third parties.

 

As is customary in the industry, the operator of the properties maintains insurance against some but not all of these risks. The Partnership may elect not to obtain insurance if it believes that the cost of available insurance is excessive relative to the perceived risks presented. Losses could therefore occur for uninsurable or uninsured risks or in amounts in excess of existing insurance coverage. The occurrence of an event that is not fully covered by insurance could have a material adverse impact on the Partnership’s business activities, financial condition, results of operations and ability to pay distributions to holders of its common units and service its debt obligations.

 

 

Risks Related to Investment in the Partnership

 

The Partnership depends on key personnel, the loss of any of whom could materially adversely affect future operations.

 

The Partnership’s success will depend to a large extent upon the efforts and abilities of Messrs. Knight, McKenney, Keating and Mallick, the executive officers of the General Partner. The loss of the services of one or more of these key employees could have a material adverse effect on the Partnership. The Partnership does not maintain key-man life insurance with respect to any employees. The Partnership’s business will also be dependent upon its ability to attract and retain qualified personnel. Acquiring and keeping these personnel could prove more difficult or cost substantially more than estimated. This could cause the Partnership to incur greater costs or prevent it from pursuing its acquisition and development strategy as quickly as the Partnership would otherwise wish to do.

 

The common units are not liquid and your ability to resell your common units will be limited by the absence of a public trading market and substantial transfer restrictions.

 

The common units generally will not be liquid because there is not a readily available market for the sale of common units, and one is not expected to develop.  Further, although the Partnership Agreement contains provisions designed to permit the listing of common units on a national securities exchange, the Partnership does not currently intend to list the common units on any exchange or in the over-the-counter market.

 

Distributions to the Partnerships common unitholders may not be sourced from its cash generated from operations but from indebtedness, and therefore the Partnerships distributions during certain periods may exceed earnings and cash flows from operations, and this will decrease the Partnerships distributions in the future; furthermore, the Partnership cannot guarantee that investors will receive any specific return on their investment.

 

The General Partner has the right to make distributions from the proceeds of borrowings and capital contributions. Offering proceeds that are returned to investors as part of distributions to them will not be available for investments in oil and gas properties. In addition, during certain periods, the Partnership expects that distributions may exceed the amount of earnings and cash flows from operations during such periods. The payment of distributions will decrease the cash available to invest in the Partnership’s oil and gas properties and will reduce the amount of distributions the Partnership may make in the future. The Partnership cannot and does not guarantee that investors will receive any specific return on their investment.

 

Moreover, as amended through the Letter Agreement executed in July 2020, the Partnership is not permitted to make distributions without lender approval, and a portion of the Partnership’s cash flow is used to pay interest on the Credit Facility. Interest and principal payments on the Credit Facility will reduce the cash available to finance the Partnership’s operations and other business activities and could limit the Partnership’s flexibility in planning for or reacting to changes in the Partnership’s business and the industry in which it operates.

 

If the General Partner elects to cause the Partnership to make distributions rather than reinvesting the cash flow in its business, the Partnership may be required to sell or farm-out properties or to elect not to participate in exploration or development drilling activities on its properties, which activities could turn out to be profitable.

 

If the Partnership were presented with an exploration or development drilling or other opportunity on its properties, and funding the opportunity would require the Partnership’s cash that is required in order to follow its distribution policy or for other purposes approved by the General Partner, the General Partner may elect to cause the Partnership to sell or farm-out the opportunity or decline to participate in the opportunity, even if the General Partner determines that the opportunity could have a favorable rate of return. The General Partner will have the right to cause the Partnership to participate in opportunities that will use the Partnership’s cash otherwise than in accordance with the distribution policy if the General Partner determines that pursuing such opportunity is in the best interests of the Partnership.

 

The General Partner will be subject to conflicts of interest in operating the Partnership, including conflicts of interest arising out of the General Partners ownership of the incentive distribution rights. The Partnership Agreement limits the General Partners fiduciary duties to the Partnership in connection with these conflicts of interest.

 

The General Partner is subject to conflicts of interest in operating the Partnership’s business. These conflicts include:

 

 

Conflicts caused by the incentive distribution rights held by the General Partner, which may cause it to conduct operations that are riskier to the Partnership, or to sell properties, in order to generate distributions from the incentive distribution rights;

 

Conflicts caused by the sale of properties to programs that have or may be formed by the General Partner and its affiliates in the future; and

 Conflicts caused by competition for management time and attention with other oil and gas partnerships and with other business activities in which management of the General Partner are or may be involved.

 

 

The Partnership Agreement provides that the General Partner will have no liability to the Partnership or the holders of the common units for decisions made, if such decisions are made in good faith. In addition, the Partnership Agreement provides that if the General Partner receives a fairness opinion regarding the sale price of a property or in connection with a merger or the listing of the Partnership’s common units on a national securities exchange, including transactions that involve affiliates of the General Partner, the General Partner will be deemed to have acted in good faith.

 

The General Partner has sole responsibility for conducting the Partnerships business and managing its operations. The General Partner and its affiliates will have conflicts of interest, which may permit them to favor their own interests to the detriment of holders of the Partnerships common units.

 

Conflicts of interest may arise between the General Partner and its respective affiliates on the one hand, and the Partnership and the holders of its common units, on the other hand. In resolving these conflicts of interest, the General Partner may favor its own interests and the interests of its owners over the interests of holders of the Partnership’s common units. These conflicts include, among others, the following situations:

 

 

neither the Partnership Agreement nor any other agreement requires affiliates of the General Partner to pursue a business strategy that favors the Partnership or to refer any business opportunity to the Partnership;

 

the General Partner determines the amount and timing of its asset purchases and sales, capital expenditures and borrowings, each of which can affect the amount of cash that is distributed to holders of the Partnership’s common units or used to service its debt obligations;

 

the General Partner controls the enforcement of obligations owed to the Partnership by the General Partner and its affiliates; and

 

the General Partner decides whether to retain separate counsel, accountants or others to perform services for the Partnership.

 

Amounts paid to the General Partner regardless of success of the Partnerships activities will reduce the cash the Partnership has available for distribution.

 

The General Partner and its affiliates have and will receive reimbursement of third-party costs incurred in connection with the Partnership’s business activities and will be reimbursed for general and administrative costs of the General Partner allocable to the Partnership as described in “Compensation” within the Partnership’s prospectus, regardless of the Partnership’s success in acquiring, developing and operating properties. The fees and direct costs to be paid to the General Partner will reduce the amount of cash distributions to investors. With respect to third-party costs, the General Partner has sole discretion on behalf of the Partnership to select the provider of the services or goods and the provider’s compensation.

 

Because the General Partner has discretion to determine the amount and timing of any distribution the Partnership may make, there is no guarantee that cash distributions will be paid by the Partnership in any amount or frequency even if its operations generate revenues.

 

The timing and amount of distributions will be determined in the sole discretion of the General Partner. The level of distributions, when made, will primarily be dependent upon the Partnership’s levels of revenue, among other factors. Distributions may be reduced or deferred, in the discretion of the General Partner, to the extent that the Partnership’s revenues are used or reserved for any of the following:

 

 

compensation and fees paid to the General Partner and its affiliates as described above in “— Amounts paid to the General Partner regardless of success of the Partnership’s activities will reduce the cash available for distribution;”

 

repayment of borrowings and regularly scheduled debt service payments;

 

drilling and completing new wells;

 

cost overruns on drilling, completion or operating activities;

 

remedial work to improve a well’s producing capability;

 

the acquisition of producing and non-producing oil and gas leasehold interests considered in the best interest of the Partnership by the General Partner;

 

uninsured losses from operational risks including liability for environmental damages;

 

direct costs and general and administrative expenses of the Partnership;

 

reserves, including a reserve for the estimated costs of eventually plugging and abandoning the wells; or

 

indemnification of the General Partner and its affiliates by the Partnership for losses or liabilities incurred in connection with the Partnership’s activities.

 

Further, because the Partnership’s investments will be in depleting assets, unless reinvested, Partnership revenues and the amount available for distribution to partners will decline with the passage of time. Accordingly, there can be no assurance that the Partnership will be able to make regular distributions or that distributions will be made at any consistent rate or frequency.

 

 

The Partnership may be unable to sell its properties, merge with another entity or list the common units on a national securities exchange within its planned timeline or at all.

 

Beginning five to seven years after the termination of the Partnership’s public offering, the Partnership plans either to sell its properties and distribute the proceeds of the sale, after payment of liabilities and expenses, to its partners; merge with another entity; or list the common units on a national securities exchange. The decision to sell the Partnership’s properties or merge with another entity will be based on a number of factors, including the domestic and foreign supply of and demand for oil, natural gas and other hydrocarbons, commodity prices, demand for oil and natural gas assets in general, the value of the Partnership’s assets, the projected amount of the Partnership’s oil and gas reserves, general economic conditions and other factors that are out of the Partnership’s control. In addition, the ability to list the Partnership’s common units on a national securities exchange will depend on a number of factors, including the state of the U.S. securities markets, the Partnership’s ability to meet the listing requirements of national securities exchanges, securities laws and regulations and other factors. If the Partnership is unable to either sell its properties, merge or list the common units on a national securities exchange in accordance with its current plans, you may be unable to sell or otherwise transfer your common units and you may lose some or all of your investment. While the Partnership plans to seek a liquidity event within five to seven years, the Partnership Agreement does not obligate the General Partner to cause a liquidity event within that timeline. The timing of a liquidity event will be dependent upon many factors, including prevailing market conditions, and the Partnership Agreement gives the Partnership flexibility on timing so that the Partnership is not forced to act during periods of low oil and gas prices, or other disadvantageous situations.

 

The General Partner may cause the Partnership not to participate with the operator in the drilling of wells on the Partnerships properties.

 

If the Partnership has the opportunity to participate in wells, the General Partner may decide to sell or farmout the well. Also, if a well is proposed under an operating agreement for one of the properties the Partnership owns, the General Partner may cause the Partnership to “non-consent” the well under the applicable operating agreement. Non-consenting a well will generally cause the Partnership not to be obligated to pay the costs of the well, but the Partnership will not be entitled to the proceeds of production from the well until a penalty is received by the parties that drilled the well. If the General Partner makes the decision to sell, farmout or non-consent a well or other development activity, the Partnership Agreement provides that the General Partner will have no liability to the Partnership so long as the decision is made in good faith.

 

Fees and cost reimbursements that must be paid to the General Partner and the Dealer Manager regardless of success of the Partnerships activities will reduce the cash the Partnership has available for distribution.

 

The General Partner and its affiliates have and will receive reimbursement of third-party costs incurred in connection with the Partnership’s business activities and will be reimbursed for general and administrative costs of the General Partner allocable to the Partnership regardless of the Partnership’s success in acquiring, developing and operating properties. The Dealer Manager is eligible to receive the contingent, incentive fee after Payout, as defined in the Prospectus. The fees and direct costs to be paid to the General Partner and the Dealer Manager will reduce the amount of cash distributions to investors.

 

Risks Related to Laws, Regulations, Cybersecurity and Other External Factors

 

The Partnership is subject to complex federal, state, local and other laws and regulations that could adversely affect the cost, manner or feasibility of conducting the Partnerships operations.

 

The Partnership’s business is subject to complex and stringent laws and regulations governing the acquisition, development, operation, production and marketing of oil and gas, taxation, safety matters and the discharge of materials into the environment. In order to conduct the Partnership’s operations in compliance with these laws and regulations, the operator(s) of the Partnership’s properties must obtain and maintain numerous permits, approvals and certificates from various federal, state and local governmental authorities. Failure or delay in obtaining and maintaining regulatory approvals or drilling permits could have a material adverse effect on the Partnership’s ability to develop its properties, and receipt of drilling permits with onerous conditions could increase the Partnership’s compliance costs. In addition, regulations or executive orders regarding resource conservation practices and the protection of correlative rights may affect the Partnership’s operations by limiting the quantity of oil, natural gas and natural gas liquids the Partnership may produce and sell.

 

The Partnership is subject to federal, state and local laws and regulations as interpreted and enforced by governmental authorities possessing jurisdiction over various aspects of the exploration, production and transportation of oil, natural gas and natural gas liquids. While the cost of compliance with these laws is not expected to be material to the Partnership’s operations, the possibility exist that new laws, regulations, executive orders or enforcement policies could be more stringent and significantly increase the Partnership’s compliance costs. If the Partnership is not able to recover the resulting costs through insurance or increased revenues, the Partnership’s ability to pay distributions to holders of the Partnership’s common units and service the Partnership’s debt obligations could be adversely affected. 

 

 

Federal and state legislative initiatives, including executive orders,  relating to hydraulic fracturing could result in increased costs and additional operating restrictions or delays, and even could result in the Partnership ceasing business operations.

 

Hydraulic fracturing is used to stimulate production of hydrocarbons, particularly natural gas, from dense rock formations. The hydraulic fracturing process involves the injection of water, sand and chemicals under pressure into the formation to fracture the surrounding rock and stimulate production. The operators of the properties the Partnership owns will routinely use hydraulic fracturing techniques in most drilling and completion programs. In past legislative sessions, legislation was introduced before Congress to provide for federal regulation of hydraulic fracturing using materials other than diesel under the Safe Drinking Water Act and to require disclosure of the chemicals used in the fracturing process; this legislation has not passed. At the state and local levels, some jurisdictions have adopted, and others are considering adopting, requirements that could impose more stringent permitting, public disclosure of fracturing chemicals or well construction requirements on hydraulic fracturing activities, as well as bans on hydraulic fracturing activities.

 

On January 27, 2021, the Biden administration signed an executive order directing the Secretary of the Interior to temporarily stop issuing new oil and gas leases on federal lands, allowing time to review and reset the federal government’s oil and gas leasing program. The Partnership’s existing leases and permits are operational and held by production, and therefore not impacted by this executive order. In the event that new or more stringent federal, state, or local legal restrictions relating to the hydraulic fracturing process are adopted in areas where the Partnership owns producing properties, the Partnership could incur potentially significant added costs to comply with such requirements, experience delays or curtailment in the pursuit of exploration, development, or production activities, and perhaps even be precluded from participating in drilling wells. More widespread or prolonged moratoriums or prohibitions of hydraulic fracturing could, depending on the makeup of the Partnership’s assets, cause the Partnership to cease business operations.

 

Additional regulatory scrutiny by the EPA could make it difficult to perform hydraulic fracturing, impact the Partnerships ability to conduct business, and increase the Partnerships costs of compliance and doing business.

 

Hydraulic fracturing is typically regulated by state oil and natural gas commissions, but the EPA has asserted federal regulatory authority pursuant to the Safe Drinking Water Act over certain hydraulic fracturing activities involving the use of diesel. The EPA has announced an initiative under the Toxic Substance Control Act to develop regulations governing the disclosure and evaluation of hydraulic fracturing chemicals. The EPA also issued a pretreatment standard for the discharge of wastewater resulting from hydraulic fracturing activities, prohibiting the discharges of wastewater pollutants from onshore unconventional oil and gas extraction to publicly owned treatment works. In December 2016, the EPA released its final report “Hydraulic Fracturing for Oil and Gas: Impacts from the Hydraulic Fracturing Water Cycle on Drinking Water Resources in the United States.” This report concluded that hydraulic fracturing can impact drinking water resources in certain circumstances but also noted that certain data gaps and uncertainties limited the EPA’s assessment. The historic trend of more expansive and stricter environmental regulation may continue for the long term. Any additional regulatory actions taken by the EPA could increase the costs of the Partnership’s operations or result in additional operating restrictions or delays. Restrictions on hydraulic fracturing could reduce the amount of oil and natural gas that the Partnership ultimately is able to produce. 

 

The Partnerships financial condition and results of operations may be materially adversely affected if the Partnership incurs costs and liabilities due to a failure to comply with environmental regulations or a release of hazardous substances into the environment.

 

The Partnership may incur significant costs and liabilities as a result of environmental requirements applicable to the operation of its wells, gathering systems and other facilities. These costs and liabilities could arise under a wide range of federal, state and local environmental laws and regulations, including, for example:

 

 

the Clean Air Act, or the CAA, and comparable state laws and regulations that impose obligations related to emissions of air pollutants;

 

the Clean Water Act and comparable state laws and regulations that impose obligations related to discharges of pollutants into regulated water;

 

the Resource Conservation and Recovery Act, or RCRA, and comparable state laws that impose requirements for the handling and disposal of waste from the Partnership’s facilities;

 the Comprehensive Environmental Response, Compensation, and Liability Act, or CERCLA, and comparable state laws that regulate the cleanup of hazardous substances that may have been released at properties currently or previously owned or operated by the Partnership or at locations to which the Partnership has sent waste for disposal;
 the Safe Drinking Water Act and state or local laws and regulations related to underground injection (including hydraulic fracturing);
 the Endangered Species Act and comparable state and local laws and regulations which protect endangered and threatened species and the ecosystems on which they depend;
 the National Environmental Policy Act and comparable state statutes which ensure that environmental issues are adequately addressed in decisions involving major governmental actions (including the leasing of government land);
 the Oil Pollution Act, or OPA, which subject responsible parties to liability for removal costs and damages arising from an oil spill in waters of the U.S.; and
 emergency planning and community right to know regulations under the Title III of CERCLA and similar state statutes require that the Partnership organizes and/or discloses information about hazardous materials used or produced in its operations.

 

 

Failure to comply with these laws and regulations may trigger a variety of administrative, civil and criminal enforcement measures, including the assessment of monetary penalties, the imposition of remedial requirements, and the issuance of orders enjoining future operations. Certain environmental statutes, including CERCLA, OPA and analogous state laws and regulations, impose strict joint and several liability for costs required to clean up and restore sites where hazardous substances or other waste products have been disposed of or otherwise released. More stringent laws and regulations, including any related to climate change and greenhouse gases, may be adopted in the future. Moreover, it is not uncommon for neighboring landowners and other third parties to file claims for personal injury and property damage allegedly caused by the release of hazardous substances or other waste products into the environment.

 

Climate change legislation or regulations restricting emissions of greenhouse gases, or GHGs, could result in increased operating costs and reduced demand for the oil, natural gas and natural gas liquids the Partnership produces.

 

In the absence of comprehensive federal legislation on GHG emission control, the EPA attempted to require the permitting of GHG emissions. Although the Supreme Court struck down the permitting requirements, it upheld the EPA’s authority to control GHG emissions when a permit is required due to emissions of other pollutants. These permitting provisions, to the extent applicable to the Partnership’s operations, could require the operator(s) of the Partnership’s properties to implement emission controls or other measures to reduce GHG emissions and the Partnership could incur additional costs to satisfy those requirements. Further, the EPA has adopted rules to regulate methane emissions, including from new and modified oil and gas production sources and natural gas processing and transmission sources, and has announced its intention to regulate methane emissions from existing oil and gas sources. Although some of these requirements have been rescinded under the Trump administration, the Biden administration has pledged to scrutinize these changes and possibly reverse them. The broader recent trend of more expansive and stricter climate change regulation may continue for the long term, including with the Biden administration’s return to the Paris Agreement global treaty to curb greenhouse gas emissions.

 

In addition, the EPA requires the reporting of GHG emissions from specified large GHG emission sources including onshore and offshore oil and natural gas production facilities and onshore oil and natural gas processing, transmission, storage and distribution facilities, which may include facilities the Partnership owns. Reporting of GHG emissions from such facilities is required on an annual basis. Should the operator(s) of the Partnership’s properties trigger the reporting requirement, the Partnership will incur costs associated with the reporting obligation.

 

In past legislative sessions, Congress considered legislation to reduce emissions of GHGs and many states and regions have adopted or have considered measures to reduce GHG emission reduction levels, often involving the planned development of GHG emission inventories and/or cap and trade programs. Most of these cap and trade programs work by requiring major sources of emissions or major producers of fuels to acquire and surrender emission allowances. Federal efforts at a cap and trade program have not moved forward in Congress. Some members of Congress have publicly indicated an intention to introduce legislation to curb the EPA’s regulatory authority over GHGs. The adoption and implementation of any legislation or regulatory programs imposing reporting obligations on, or limiting emissions of GHGs from, equipment and operations on the Partnership’s properties could require the Partnership to incur costs to reduce emissions of GHGs associated with the Partnership’s operations or could adversely affect demand for the oil, natural gas and natural gas liquids that the Partnership produces.

 

Significant physical effects of climatic change have the potential to damage the Partnerships facilities, disrupt the Partnerships production activities and cause the Partnership to incur significant costs in preparing for or responding to those effects.

 

In an interpretative guidance on climate change disclosures, the SEC indicates that climate change could have an effect on the severity of weather (including hurricanes and floods), sea levels, the arability of farmland, and water availability and quality. If such effects were to occur, the operations that the Partnership plans to engage in may be adversely affected. Potential adverse effects could include damages to the Partnership’s facilities from powerful winds or rising waters in low lying areas, disruption of the Partnership’s production activities either because of climate-related damages to the Partnership’s facilities or the Partnership’s costs of operation potentially arising from such climatic effects, less efficient or non-routine operating practices necessitated by climate effects or increased costs for insurance coverages in the aftermath of such effects. Significant physical effects of climate change could also have an indirect effect on the Partnership’s financing and operations by disrupting the transportation or process related services provided by midstream companies, service companies or suppliers with whom the Partnership has a business relationship. The Partnership may not be able to recover through insurance some or any of the damages, losses or costs that may result from potential physical effects of climate change. Should drought conditions occur, the Partnership’s ability to obtain water in sufficient quality and quantity could be impacted and in turn, the Partnership’s ability to perform hydraulic fracturing operations could be restricted or made more costly. 

 

 

Cyber-attacks targeting systems and infrastructure used by the oil and gas industry may adversely impact the Partnerships operations.

 

The Partnership’s business has become increasingly dependent on digital technologies to conduct certain exploration, development, production and financial activities. The Partnership depends on digital technology to estimate quantities of oil and gas reserves, process and record financial and operating data, analyze seismic and drilling information, and communicate with the general partner and third-party partners. Unauthorized access to the Partnership’s seismic data, reserves information or other proprietary information could lead to data corruption, communication interruption, or other operational disruptions in the Partnership’s exploration or production operations. Also, computers control nearly all of the oil and gas distribution systems in the United States and abroad, which are necessary to transport the Partnership’s production to market. A cyber-attack involving the Partnership’s information systems and related infrastructure, or that of the Partnership’s business associates, could negatively impact the Partnership’s operations in a variety of ways, including but not limited to, the following:

 

 

Unauthorized access to seismic data, reserves information, strategic information, or other sensitive or proprietary information could have a negative impact on the Partnership’s ability to compete for oil and gas resources;

 

Data corruption, communication interruption, or other operational disruption during drilling activities could result in failure to reach the intended target or a drilling incident;

 

Data corruption or operational disruptions of production-related infrastructure could result in a loss of production, or accidental discharge;

 

A cyber-attack on a vendor or service provider could result in supply chain disruptions which could delay or halt the Partnership’s major development projects;

 

A cyber-attack on third party gathering, pipeline, or rail transportation systems could delay or prevent the Partnership from transporting and marketing its production, resulting in a loss of revenues;

 

A cyber-attack involving commodities exchanges or financial institutions could slow or halt commodities trading, thus preventing the Partnership from marketing its production or engaging in hedging activities, resulting in a loss of revenues;

 

A cyber-attack which halts activities at a power generation facility or refinery using natural gas as feed stock could have a significant impact on the natural gas market, resulting in reduced demand for the Partnership’s production, lower natural gas prices, and reduced revenues;

 

A cyber-attack on a communications network or power grid could cause operational disruption resulting in loss of revenues;

 

A cyber-attack on the Partnership’s automated and surveillance systems could cause a loss in production and potential environmental hazards;

 

A deliberate corruption of the Partnership’s financial or operating data could result in events of non-compliance which could then lead to regulatory fines or penalties; and

 

A cyber-attack resulting in the loss or disclosure of, or damage to, the Partnership’s or any of its customer’s or supplier’s data or confidential information could harm the Partnership’s business by damaging its reputation, subjecting it to potential financial or legal liability, and requiring it to incur significant costs, including costs to repair or restore its systems and data or to take other remedial steps.

 

All of the above could negatively impact the Partnership’s operational and financial results. Additionally, certain cyber incidents, such as surveillance, may remain undetected for an extended period. As cyber threats continue to evolve, the Partnership may be required to expend significant additional resources to continue to modify or enhance its protective measures or to investigate and remediate any information security vulnerabilities. Additionally, the growth of cyber-attacks has resulted in evolving legal and compliance matters which impose significant costs that are likely to increase over time.

 

Loss of Partnership information and computer systems could adversely affect the Partnerships business.

 

The Partnership will be heavily dependent on information systems and computer-based programs of its operators, including well operations information, seismic data, electronic data processing and accounting data. If any of such programs or systems were to fail or create erroneous information in the hardware or software network infrastructure, possible consequences include the Partnership’s loss of communication links, inability of the Partnership’s operators to find, produce, process and sell oil and natural gas and inability to automatically process commercial transactions or engage in similar automated or computerized business activities. Any such consequence could have a material adverse effect on the Partnership’s business.

 

 

Tax Risks to Common Unitholders

 

The Partnerships tax treatment depends on its status as a partnership for U.S. federal income tax purposes and not being subject to a material amount of entity-level taxation by individual states. If the Internal Revenue Service treats the Partnership as a corporation or the Partnership becomes subject to a material amount of entity-level taxation for state tax purposes, it would reduce the amount of cash available for distribution to the Partnerships common unitholders.

 

The anticipated after-tax economic benefit of an investment in the common units depends largely on the Partnership being treated as a partnership for U.S. federal income tax purposes. The Partnership has not requested, and does not plan to request, a ruling from the Internal Revenue Service (“IRS”) on this or any other tax matter affecting it.

 

If the Partnership was treated as a corporation for U.S. federal income tax purposes, the Partnership would pay federal income tax on the Partnership’s taxable income at the corporate tax rate, which, effective January 1, 2018, is currently a maximum of 21% and likely would pay state income tax at varying rates. Distributions to you would generally be taxed again as corporate distributions, and no income, gains, losses or deductions would flow through to you. Because a tax would be imposed upon the Partnership as a corporation, cash available for distribution to you would be substantially reduced. Therefore, treatment of the Partnership as a corporation would result in a material reduction in the anticipated cash flows and after-tax return to the unitholders, likely causing a substantial reduction in the value of the Partnership’s common units.

 

Current law may change so as to cause the Partnership to be treated as a corporation for U.S. federal income tax purposes or otherwise subject the Partnership to entity-level taxation. In addition, because of widespread state budget deficits and other reasons, several states have ways to subject partnerships to entity-level taxation through the imposition of state income, franchise and other forms of taxation. Imposition of such taxes on the Partnership will reduce the cash available for distribution to a unitholder.

 

You may be required to pay taxes on income from the Partnership even if you do not receive any cash distributions from the Partnership.

 

Because holders of the Partnership’s common units will be treated as partners to whom the Partnership will allocate taxable income which could be different in amount than the cash the Partnership distributes, you will be required to pay any federal income taxes and, in some cases, state and local income taxes on your share of the Partnership’s taxable income even if you receive no cash distributions from the Partnership.  You may not receive cash distributions from the Partnership equal to your share of the Partnership’s taxable income or even equal to the tax liability that results from that income.

 

You may not qualify for percentage depletion deductions, and even if you do so qualify, you will be required to determine, and maintain records supporting, your deduction.

 

Percentage depletion is generally available with respect to common unitholders who qualify under the independent producer exemption contained in Internal Revenue Code (“Code”) Section 613A(c). For this purpose, an independent producer is a person not directly or indirectly involved in the retail sale of oil, natural gas, or derivative products or the operation of a major refinery. The Partnership cannot determine whether or provide any assurance that you will qualify as an independent producer. Further, if you do qualify as an independent producer, you are required to determine the amount of your allowed percentage depletion deduction and maintain records supporting such determination.

 

The Partnership cannot assure you that it will meet the requirements for you to deduct intangible drilling and development costs.

 

Federal tax law places substantial limits on taxpayers’ ability to deduct intangible drilling and development costs (“IDCs”). Generally speaking, an “operator” is permitted to elect to currently deduct, or capitalize and deduct ratably over a 60-month period, costs that are properly characterized as IDCs that the operator incurs in connection with the drilling and development of oil and natural gas wells. For purposes of deducting IDCs, an “operator” is generally defined as one that owns a working or an operating interest in an oil or gas well. If the Partnership determines that it is an “operator” with respect to its oil and gas wells, the Partnership’s determination is not binding on the IRS. The IRS may assert that the Partnership is not an “operator” with respect to one or more of its oil or gas wells at the time that IDCs are incurred. If the IRS were successful in such a challenge, the Partnership and, therefore, you, would not be entitled to deduct the IDCs incurred in connection with such wells.

 

 

If the Partnership is eligible to deduct IDCs, the Partnership cannot assure you that IDCs will be deductible in any given year.

 

If the Partnership is deemed to be an operator with respect to one or more of its oil or gas wells, its classification of a cost as an IDC is not binding on the IRS. The IRS may reclassify an item classified by the Partnership as an IDC as a cost that must be capitalized or that is not deductible.

 

The IRS could challenge the timing of the Partnerships deductions of IDCs, which could result in an increase your tax liabilities.

 

IDCs are generally deductible when the well to which the costs relate is drilled. In some cases, IDCs may be paid in one year for a well that is not drilled until the following year. In those cases, the prepaid IDCs will not be deductible until the year when the well is drilled unless (i) drilling on the well to which the prepayment relates starts within 90 days after the end of the year the prepayment is made or (ii) it is reasonable to expect that the well will be fully drilled within 3-1/2 months of the prepayment. All of the Partnership’s wells may not be drilled during the year when the Partnership pays IDCs pursuant to a drilling contract. As a result, the Partnership could fail to satisfy the requirements to deduct the IDCs in the year when paid and/or the IRS may challenge the timing of the Partnership’s deduction of prepaid IDCs.

 

The deduction for IDCs may not be available to you if you do not have passive income.

 

If you invest in the Partnership, your share of the Partnership’s deduction for IDCs in the year you invest will be a passive loss that can be used to offset only passive income. Such deductions cannot be used to offset “active” income, such as salary and bonuses, or portfolio income, such as dividends and interest income. Any unused passive loss from IDCs may be carried forward indefinitely by you to offset your passive income in subsequent taxable years. Certain taxpayers are not subject to the passive loss rules.

 

On the disposition of property by the Partnership or of common units by you, certain deductions for IDCs, depletion, and depreciation must be recaptured as ordinary income.

 

You may be required to recapture as ordinary income certain deductions for IDCs, depletion, and depreciation on disposition of property by the Partnership or on disposition of the Partnership’s common units.

 

Certain federal income tax deductions currently available with respect to oil and natural gas exploration and development may be eliminated as a result of future legislation.

 

The U.S. legislature regularly considers budget proposals that may impact many tax incentives and deductions that are currently used by U.S. oil and gas companies. Among others, budget provisions may include: repeal of the deduction of IDC; repeal of the percentage depletion deduction for oil and gas properties; repeal of the domestic manufacturing tax deduction for oil and gas companies; and an increase in the amortization period for geological and geophysical costs of independent producers.

 

The passage of any legislation as a result of these proposals or any other similar changes in U.S. federal income tax laws could increase the amount of the Partnership’s taxable income allocable to you. The Partnership is unable to predict whether any of these changes, or other proposals, will ultimately be enacted. Any modifications to the federal income tax laws or interpretations thereof may or may not be applied retroactively. Any such changes could negatively impact the value of an investment in the Partnership’s common units.

 

Holders of common units may be subject to a limit on the ability to deduct interest expense incurred by the Partnership.

 

In general, the Partnership is entitled to a deduction for interest paid or accrued on indebtedness properly allocable to the Partnership’s trade or business during its taxable year. However, for taxable years beginning after December 31, 2017, the Partnership’s deduction for “business interest” is limited to the sum of the Partnership’s business interest income and 30% of “adjusted taxable income.” For the purposes of this limitation, the Partnership’s adjusted taxable income is computed without regard to any business interest expense or business interest income, and in the case of taxable years beginning before January 1, 2022, any deduction allowable for depreciation, amortization, or depletion.

 

These rules were modified in 2020 by the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”). Under the CARES Act, the Partnership may elect to increase the amount of business interest it is allowed to deduct by increasing the 30% limitation to 50% of adjusted taxable income for its 2019 and 2020 taxable years. Further, in determining the interest deductibility limitation for the Partnership’s 2020 taxable year, under the CARES Act, the Partnership may elect to utilize the amount of adjusted taxable income generated in its 2019 taxable year.

 

 

Item 1B. Unresolved Staff Comments

 

None

 

Item 2. Properties

 

Information regarding the Partnership’s properties is contained in Item 1 – Business, Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Item 8 – Financial Statements and Supplementary Data: Note 3. Oil and Gas Investments, appearing elsewhere within this Annual Report on Form 10-K.

 

Item 3.  Legal Proceedings

 

At the end of the period covered by this Annual Report on Form 10-K, the Partnership was not a party to any material, pending legal proceedings.

 

Item 4.  Mine Safety Disclosures

 

Not applicable.

 

 

 

 

 

Part II

 

Item 5.  Market For Registrants Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities

 

Common Units

 

As of December 31, 2020, there were approximately 19.0 million common units outstanding, which were held by approximately 4,800 limited partners. There is currently no established public trading market in which the Partnership’s common units are traded.

 

Solely to assist trustees and custodians of individual retirement accounts (“IRAs”) containing an investment in the Partnership’s common units and to assist broker-dealers in meeting their customer account statement reporting obligations under Financial Industry Regulatory Authority (“FINRA”) rules for investments in the Partnership, the Partnership announced an estimated per common unit value of the Partnership’s common units as of December 31, 2020 of $7.23 per common unit, as further described below. There can be no assurance that this estimated value per common unit, or the method used to estimate such value, complies with requirements applicable to a trustee’s, custodian’s or broker-dealer’s obligations with respect to IRAs or FINRA’s reporting requirements.

 

The fair value estimate of the Partnership’s common units was based upon a third-party valuation, performed by Pinnacle Energy Services of Oklahoma City, Oklahoma, of the Partnership’s oil and natural gas properties and management’s estimate of the fair value of the Partnership’s other assets and liabilities as of December 31, 2020. The developed per common unit value range is $6.06 – $8.54. The Partnership utilized the mid-point of the assumptions discussed below to determine the estimated value per common unit above. The following is a summary of the details of the fair value estimate:

 

 

(in thousands, except per common unit data)

 

Estimate at 12/31/20

 
  

(unaudited)

 
     

Estimated fair value of oil and gas properties

 $178,543 

Estimated fair value of cash and cash equivalents

  2,464 

Estimated fair value of other assets and liabilities, net

  2,128 

Estimated fair value of outstanding debt

  (46,000

)

Estimated fair value of equity

 $137,135 
     

Common units outstanding

  18,973 
     

Estimated value per common unit

 $7.23 

 

Since the Partnership’s common units are not listed on a national securities exchange, no material public market exists for the Partnership’s common units. As a result, although not prepared for generally accepted accounting purposes, the value estimate of the Partnership’s oil and gas properties was derived from unobservable inputs and was based on the income approach as outlined in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 820, Fair Value Measurements and Disclosures. In the income approach, the estimated value of the Partnership’s oil and gas properties was calculated from a discounted cash flow model using consolidated projected cash flows of the Partnership’s reserves, as well as a discount rate based on market conditions at December 31, 2020. An additional market-based adjustment was made to reflect the probability of successful future development of the Partnership’s oil and gas reserves at December 31, 2020. The Partnership’s cash and cash equivalents are all highly liquid with maturities of three months or less and the fair market value approximates the carrying value. The Partnership’s other assets and liabilities include receivables from the sale of oil, natural gas and natural gas liquids, accounts payable and accrued expenses, which are short-term in nature, and the carrying value of these assets and liabilities approximates fair value at December 31, 2020. The carrying value of the Partnership’s outstanding debt was considered to approximate fair value at December 31, 2020 based on general market conditions and its maturity. The valuation methodology and calculations were reviewed by management of the Partnership and considered reasonable. The estimated value was not based on an appraisal of the Partnership’s assets.

 

 

As with any methodology used to estimate value, the methodology employed by the Partnership was based upon a number of estimates and assumptions that may not be accurate or complete and may not accurately reflect future conditions. The estimates and assumptions underlying the estimated value involve judgments with respect to, among other things, future economic, competitive, regulatory and financial market conditions and future business decisions which may not be realized and that are inherently subject to significant business, economic, competitive and regulatory uncertainties and contingencies, including, among others, risks and uncertainties described in the periodic reports filed by the Partnership with the Securities and Exchange Commission (“SEC”), all of which are difficult to predict and many of which are beyond the control of the Partnership. Further, different parties using different assumptions and estimates could derive a different estimated value per common unit, which could be significantly different from the Partnership’s estimated value per common unit.

 

The estimated per common unit value does not represent: (i) the amount at which the Partnership’s common units would trade on a national securities exchange, (ii) the amount a limited partner would obtain if he or she tried to sell his or her common units or (iii) the amount limited partners would receive if the Partnership liquidated its assets and distributed the proceeds after paying all expenses and liabilities. Accordingly, with respect to the estimated value per common unit, the Partnership can give no assurance that:

 

 

a limited partner would be able to resell his or her common units at this estimated value;

 

a limited partner would ultimately realize distributions per common unit equal to the estimated value per common unit upon liquidation of the Partnership’s assets and settlement of its liabilities or a sale of the Partnership (in part because estimated values do not necessarily indicate the price at which individual assets or the Partnership could be sold, oil and gas property values fluctuate and change, and the estimated value may not take into account the expenses associated with such a sale);

 

the Partnership’s common units would trade at a price equal to or greater than the estimated value per common unit if they were listed on a national securities exchange;

 

the methodology used to estimate the value per common unit would be acceptable to FINRA or for compliance with requirements applicable to a trustee’s or custodian’s obligations with respect to IRAs; or

 

any or all of the assumptions used in estimating the value per common unit will prove to be accurate or complete.

 

The estimated value reflects the fact that the estimate was calculated as of a point in time. The value of the Partnership’s common units will likely change over time and will be influenced by changes to the value of individual assets, changes in the oil and gas industry, as well as changes and developments in the energy and capital markets. The Partnership does not intend to update or otherwise revise the above information to reflect circumstances existing after the date when made or to reflect the occurrence of future events, even in the event that any or all of the assumptions underlying the information are no longer appropriate.

 

As discussed above, the estimated value of the Partnership’s oil and gas properties was determined based on various market level assumptions, including but not limited to commodity market prices, discount rates and processing and transportation costs. The following is a list of key assumptions used in the calculation of the estimated value of the Partnership’s oil and gas properties, a component of the estimated value per common unit:

 

 

NYMEX oil strip pricing as of January 1, 2021, which ranges from $48.26 per barrel to $44.95 per barrel as of January 1, 2021 to December 31, 2025, and an increase of 3% thereafter with price cap at $75.00 per barrel

 

NYMEX gas strip pricing as of January 1, 2021, which ranges from $2.67 per Mcf to $2.50 per Mcf as of January 1, 2021 to December 31, 2025, and an increase of 3% thereafter with price cap of $4.50 per Mcf

 

Differentials to NYMEX strip pricing due to product processing, transportation or contract terms

 

o

Weighted average oil differential of $7.49 per barrel of oil

 

o

Weighted average natural gas differential of $2.54 per Mcf of natural gas

 

o

Natural gas liquids (NGL) pricing determined using 14.0% of NYMEX oil price

 

o

Weighted average natural gas shrink of 30.2%

 oNGL yield of 109.57 barrels per MMcf of wet gas
 

Discount rate – 10.0%

 

Risk adjustments to calculated present value

 

o

Proved developed producing (PDP) assets – 5.0%

 

o

Proved developed non-producing (PDNP) assets – 10.0%

 

o

Proved undeveloped (PUD) assets to be drilled within five years – 15.0%

 

o

Proved undeveloped (PROB) assets to be drilled between five and ten years – 25.0%

 

o

Proved undeveloped (POSS) assets to be drilled after ten years – 35.0%

 

 

 

Total lease operating and workover expenses per well estimated at $8.50 per barrel of oil

 

Gross capital expenditures to drill and complete future development locations estimated at $7.4 million per well

 

A change in any of the assumptions would likely produce a different estimated value per common unit. For example:

 

 

An increase in the discount rate assumption of 100 basis points would decrease the per common unit value range by approximately $1.09 per common unit, all other assumptions remaining the same;

 

A decrease in the discount rate assumption of 100 basis points would increase the per common unit value range by approximately $1.31 per common unit, all other assumptions remaining the same;

 

An increase in the average NYMEX oil and natural gas strip pricing assumptions of 500 basis points would increase the per common unit value range by approximately $1.13 per common unit, all other assumptions remaining the same;

 

A decrease in the average NYMEX oil and natural gas strip pricing assumptions of 500 basis points would decrease the per common unit value range by approximately $1.17 per common unit, all other assumptions remaining the same;

 

An increase of 500 basis points in the risk adjustment percentage to calculated present value per reserve category would decrease the per common unit value range by approximately $0.55 per common unit, all other assumptions remaining the same; and

 

A decrease of 500 basis points in the risk adjustment percentage to calculated present value per reserve category would increase the per common unit value range by approximately $0.54 per common unit, all other assumptions remaining the same.

 

Class B Units

 

As of December 31, 2020 and 2019, the outstanding Class B units totaled 62,500. The Partnership may issue up to 37,500 additional Class B units. The Class B units provide for certain distribution rights described below.

 

Incentive Distribution Rights and Contingent Incentive Fee

 

The General Partner received the Incentive Distribution Rights upon closing of the minimum offering in August 2015. Under the agreement with the Dealer Manager, the Dealer Manager will be paid a contingent incentive fee, which is a cash payment of up to an amount equal to 4% of gross proceeds of the common units sold based on the performance of the Partnership. Based on the common units sold in the Partnership’s offering, the total contingent fee is approximately $15.0 million. The Partnership will not make any distributions with respect to the Incentive Distribution Rights or the contingent, incentive payments to the Dealer Manager, until Payout occurs, as described below.

 

Distribution Policy

 

Prior to “Payout,” which is defined below, all of the distributions made by the Partnership, if any, will be paid to the holders of common units.  Accordingly, the Partnership will not make any distributions with respect to the Incentive Distribution Rights or with respect to Class B units and will not make the contingent, incentive payments to the Dealer Manager, until Payout occurs.

 

The Partnership Agreement provides that Payout occurs on the day when the aggregate amount distributed with respect to each of the common units equals $20.00 plus the Payout Accrual.  The Partnership Agreement defines “Payout Accrual” as 7% per annum simple interest accrued monthly until paid on the Net Investment Amount outstanding from time to time.  The Partnership Agreement defines Net Investment Amount initially as $20.00 per common unit, regardless of the amount paid for the common unit.  If at any time the Partnership distributes to holders of common units more than the Payout Accrual, the amount the Partnership distributes in excess of the Payout Accrual will reduce the Net Investment Amount.

 

 

All distributions made by the Partnership after Payout, which may include all or a portion of the proceeds of the sale of all or substantially all of the Partnership’s assets, will be made as follows:

 

First, (i) to the Record Holders of the Incentive Distribution Rights, 35%; (ii) to the Record Holders of the Outstanding Class B units, pro rata based on the number of Class B units owned, 35% multiplied by a fraction, the numerator of which is the number of Class B units outstanding and the denominator of which is 100,000 (currently, there are 62,500 Class B units outstanding; therefore, Class B units could receive 21.875%); (iii) to the Dealer Manager, as the Dealer Manager contingent incentive fee paid under the Dealer Manager Agreement, 30%, and (iv) the remaining amount, if any (currently 13.125%), to the Record Holders of outstanding common units, pro rata based on their percentage interest until such time as the Dealer Manager receives the full amount of the Dealer Manager contingent incentive fee under the Dealer Manager Agreement;

 

Thereafter, (i) to the Record Holders of the Incentive Distribution Rights, 35%; (ii) to the Record Holders of the Outstanding Class B units, pro rata based on the number of Class B units owned, 35% multiplied by a fraction, the numerator of which is the number of Class B units outstanding and the denominator of which is 100,000 (currently, there are 62,500 Class B units outstanding; therefore, Class B units could receive 21.875%); (iii) the remaining amount to the Record Holders of outstanding common units, pro rata based on their percentage interest (currently 43.125%). 

 

All items of income, gain, loss and deduction will be allocated to each Partner’s capital account in a manner generally consistent with the distribution procedures outlined above.

 

In March 2020, the General Partner approved the suspension of distributions to limited partners of the Partnership in response to recent market volatility and the impact on the Partnership’s operating cash flows. The Partnership has accumulated and will continue to accumulate unpaid distributions based on an annualized return of seven percent (7%), and all accumulated unpaid distributions are required to be paid before final Payout occurs, as defined above. As of December 31, 2020, the unpaid Payout Accrual totaled $1.181370 per common unit, or approximately $22 million. Pursuant to the Letter Agreement described above, the Partnership is not permitted to pay distributions without lender approval.

 

For the year ended December 31, 2020, the Partnership paid distributions of $0.241644 per common unit or $4.6 million. For the year ended December 31, 2019, the Partnership paid distributions of $1.396164 per common unit or $26.5 million.

 

Neither the Partnership nor the General Partner has adopted an equity compensation plan.

 

Item 6.  Selected Financial Data

 

Not applicable.

 

 

Item 7.  Managements Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion and analysis should be read in conjunction with Item 8 – the Consolidated Financial Statements and Notes thereto, the introduction of Part I regarding “Forward-Looking Statements,” and Item 1A – Risk Factors appearing elsewhere in this Annual Report on Form 10-K.

 

Overview

 

Energy 11, L.P. (the “Partnership”) was formed as a Delaware limited partnership. The General Partner is Energy 11 GP, LLC (the “General Partner”).  The initial capitalization of the Partnership of $1,000 occurred on July 9, 2013. The Partnership began offering common units of limited partner interest (the “common units”) on a best-efforts basis on January 22, 2015, the date the Partnership’s initial Registration Statement on Form S-1 (File No. 333-197476) was declared effective by the SEC. The Partnership completed its best-efforts offering on April 24, 2017. Total common units sold were approximately 19.0 million for gross proceeds of $374.2 million and proceeds net of offering costs of $349.6 million.

 

As of December 31, 2020, the Partnership owns an approximate 25% non-operated working interest in 243 producing wells, an estimated approximate 18% non-operated working interest in 21 wells in various stages of the drilling and completion process and future development sites in the Sanish field located in Mountrail County, North Dakota (collectively, the “Sanish Field Assets”). Whiting Petroleum Corporation (“Whiting”) (NYSE: WLL) operates substantially all of the Sanish Field Assets.

 

The Partnership has no officers, directors or employees. Instead, the General Partner manages the day-to-day affairs of the Partnership, and all decisions regarding the management of the Partnership are made by the Board of Directors of the General Partner and its officers.

 

The Partnership was formed to acquire and develop oil and gas properties located onshore in the United States. On December 18, 2015, the Partnership completed its first purchase in the Sanish field, acquiring an approximate 11% non-operated working interest in the Sanish Field Assets for approximately $159.6 million. On January 11, 2017, the Partnership closed on its second purchase in the Sanish field, acquiring an additional approximate 11% non-operated working interest in the Sanish Field Assets for approximately $128.5 million. On March 31, 2017, the Partnership closed on its third purchase in the Sanish field, acquiring an additional approximate average 10.5% non-operated working interest in 82 of the Partnership’s then 216 existing producing wells and 150 of the Partnership’s then 253 future development locations in the Sanish Field Assets for approximately $52.4 million.

 

During 2018, six wells were completed by the Partnership’s operators. Two wells were completed by and are being operated by Whiting; the Partnership has an approximate 29% non-operated working interest in these two wells. The other four wells were completed by and are operated by Oasis; the Partnership has an approximate 8% non-operated working interest in these four wells. In total, the Partnership’s capital expenditures for the drilling and completion of these six wells were approximately $7.8 million.

 

During 2019 and first quarter of 2020, the Partnership elected to participate in the drilling and completion of 43 new wells (“Drilling Program”), primarily administered by Whiting, at an estimated cost to the Partnership of approximately $62 million. Through December 31, 2020, the Partnership had incurred approximately $42 million in capital expenditures related to the Drilling Program. Twenty-two (22) of the 43 wells have been completed and were producing at December 31, 2020; the Partnership has an approximate non-operated working interest of 23% in these 22 wells. The Partnership has an estimated approximate non-operated working interest of 18% in the remaining 21 wells that are in-process as of December 31, 2020. Due to the factors described below in “Demand, Liquidity and Going Concern Considerations,” Whiting suspended the Drilling Program during the second quarter of 2020. See additional detail in “Oil and Natural Gas Properties” below. The timing for completion of a portion or all of the in-process wells within the Drilling Program is dependent upon several factors, including an increase in commodity pricing and available capital.

 

Demand, Liquidity and Going Concern Considerations

 

To fund a portion of the capital expenditures under the Drilling Program described above, the Partnership used all remaining availability under its Credit Facility by March 31, 2020, and as of June 30, 2020, the Partnership had approximately $20 million in accrued operating and capital expenditures due to Whiting. New production from completed wells was expected to enhance the Partnership’s operating performance throughout 2020, providing incremental cash flow from operations to fund the Partnership’s investment in its undrilled acreage. However, due to the severe negative impacts to the global oil and gas industry as described in “Current Price Environment” below, Whiting declared bankruptcy under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Southern District of Texas on April 1, 2020, then subsequently suspended the Drilling Program during the second quarter of 2020. As a result, these factors had an adverse impact on the Partnership’s business and its financial condition.

 

 

In July 2020, the Partnership entered into a letter agreement (“Letter Agreement”) with its lending group of its Credit Facility that, among other items, waived the non-compliance of certain covenants under the Credit Facility, accelerated the maturity date of the Credit Facility from September 30, 2022 to July 31, 2021 and permitted a term loan with an affiliate. Subsequently, the Partnership entered into a loan agreement for a one-year, $15 million term loan (“Affiliate Loan”), and proceeds from the Affiliate Loan plus cash on hand were used to pay its outstanding capital expenditures due to Whiting. The Partnership paid off the Affiliate Loan in full in the first quarter of 2021, so the Partnership’s outstanding debt obligations totaled $40 million on the date this Form 10-K was issued.

 

The Partnership’s ability to continue as a going concern is dependent on several factors including, but not limited to, (i) the Partnership’s ability to comply with its obligations under its loan agreements; (ii) refinancing its existing debt and/or securing additional capital; (iii) an increase in demand for oil and natural gas as the global economy recovers from the effects of the COVID-19 pandemic and the existing oversupply of oil in the United States; and (iv) an increase in oil and natural gas market prices, which will improve the Partnership’s cash flow generated from operations. The Partnership can provide no assurance that it will be able to achieve any of these objectives. Refinancing its existing debt or securing additional capital may not be available on favorable terms to the Partnership, if it is available at all. NYMEX oil prices have rebounded from April 2020 lows, approached $50 per barrel in December 2020 and reached $60 per barrel in February 2021, but there can be no assurance that economic activity and oil and natural gas market conditions, including commodity prices, will return and stabilize at pre-COVID-19 levels, or that the Partnership will be able to meet its operational obligations. If the Partnership is unable to refinance or repay its debt obligations or is unable to meet its operational obligations, the Partnership could be required to liquidate certain of its assets used for collateral to satisfy these obligations, which create the substantial doubt that exists about the ability of the Partnership to continue as a going concern for one year after the date these financial statements are issued.

 

Current Price Environment

 

Oil, natural gas and natural gas liquids (“NGL”) prices are determined by many factors outside of the Partnership’s control. Historically, world-wide oil and natural gas prices and markets have been subject to significant change and may continue to be in the future. Global macroeconomic factors contributing to uncertainty within the industry include real or perceived geopolitical risks in oil-producing regions of the world, particularly the Middle East; forecasted levels of global economic growth combined with forecasted global supply; supply levels of oil and natural gas due to exploration and development activities in the United States; environmental and climate change regulation; actions taken by the Organization of the Petroleum Exporting Countries (“OPEC”); and the strength of the U.S. dollar in international currency markets.

 

In December 2019, China reported an outbreak of a novel coronavirus (“COVID-19”) in its Wuhan province. COVID-19 rapidly spread worldwide, forcing governments around the world to take drastic measures to halt the outbreak. These measures included significant restrictions on travel, forced quarantines, stay-at-home requirements and the closure of businesses in many industries, creating extreme volatility in capital markets and the global economy. On March 11, 2020, the World Health Organization declared COVID-19 a pandemic, and on March 13, 2020, the United States declared a national emergency with respect to COVID-19.

 

Because of COVID-19’s impact to the global economy, demand for oil, natural gas and NGL substantially declined in March 2020 and remained depressed through the remainder of 2020. In addition to the outbreak of COVID-19 during the first quarter of 2020, Saudi Arabia and Russia, two of the largest worldwide producers of crude oil, engaged in a price war during March and April 2020. Russia did not participate in production cuts coordinated by OPEC, which led to Saudi Arabia lowering crude oil prices and both countries substantially increasing daily output of crude oil. The increase in Saudi and Russian oil output along with sustained production by other global producers, including the United States, stressed the oil and gas industry’s capacity to store excess oil and gas. Despite Saudi Arabia, Russia, the United States and other OPEC members reaching agreements throughout 2020 to cut daily production, congested supply chain channels and excess crude oil and natural gas inventory weighed negatively on commodity prices while demand remained low during COVID-19.

 

These factors led to oil prices falling in March 2020 and to 20-year lows in April 2020, when the average daily NYMEX futures closing prices for the month was $16.70. NYMEX oil prices did stabilize around $40 per barrel of oil in June 2020 and through the third quarter of 2020. The average NYMEX futures closing price was $42.70 for the fourth quarter of 2020, and NYMEX daily spot prices for oil approached $50 per barrel in late December 2020.

 

 

The following table lists average NYMEX prices for oil and natural gas for the years ended December 31, 2020 and 2019.

 

  

Year Ended December 31,

  

Percent

 
  

2020

  

2019

  

Change

 

Average market closing prices (1)

            

     Oil (per Bbl)

 $39.26  $56.96   -31.1%

     Natural gas (per Mcf)

 $2.03  $2.56   -20.7%

(1)

Based on average NYMEX futures closing prices (oil) and NYMEX/Henry Hub spot prices (natural gas)

 

As specified by the SEC, the prices for oil, natural gas and NGL used to calculate the Partnership’s reserves are based on the unweighted arithmetic average prices as of the first day of each of the twelve months during the years ended December 31, 2020 and 2019. The oil and natural gas prices used in computing the Partnership’s reserves as of December 31, 2020 were $39.57 per barrel of oil and $1.99 per MMcf of natural gas, before price differentials. Including the effect of price differential adjustments, the average realized prices used in computing the Partnership’s reserves as of December 31, 2020 were $32.08 per barrel of oil, $(0.55) per MMcf of natural gas and $5.54 per barrel of NGL. The oil and natural gas prices used in computing the Partnership’s reserves as of December 31, 2019 were $55.69 per barrel of oil and $2.58 per MMcf of natural gas, before price differentials. Including the effect of price differential adjustments, the average realized prices used in computing the Partnership’s reserves as of December 31, 2019 were $47.70 per barrel of oil, $(0.03) per MMcf of natural gas and $8.91 per barrel of NGL.

 

Results of Operations for Years 2020 and 2019

 

Partnership revenues are highly sensitive to changes in oil and natural gas prices and to levels of production, and future growth is dependent on the Partnership’s ability to add reserves in excess of production. The Partnership faces the challenge of natural production volume declines. As reservoirs are depleted, oil and natural gas production from Partnership wells will decrease. In evaluating financial condition and operating performance, the most important indicators on which the Partnership focuses are (1) total quarterly sold production in barrel of oil equivalent (“BOE”) units, (2) average sales price per unit for oil, natural gas and natural gas liquids, (3) production costs per BOE and (4) capital expenditures.

 

The following is a summary of the results from operations, including production, of the Partnership’s non-operated working interest for the years ended December 31, 2020 and 2019.

 

  

Year Ended December 31,

 
  

2020

  

Percent of

Revenue

  

2019

  

Percent of

Revenue

  

Percent
Change

 

Total revenues

 $36,522,076   100.0% $36,019,602   100.0%  1.4%

Production expenses

  9,839,539   26.9%  9,873,634   27.4%  -0.3%

Production taxes

  3,075,056   8.4%  2,861,995   7.9%  7.4%

Depreciation, depletion, amortization and accretion

  22,654,849   62.0%  12,451,435   34.6%  81.9%

General, administration and other expense

  1,577,317   4.3%  1,303,570   3.6%  21.0%
                     

Sold production (BOE):

                    

  Oil

  1,014,980       624,079       62.6%

  Natural gas

  176,246       148,034       19.1%

  Natural gas liquids

  158,050       126,516       24.9%

    Total

  1,349,276       898,629       50.1%
                     

Average sales price per unit:

                    

  Oil (per Bbl)

 $31.22      $49.58       -37.0%

  Natural gas (per Mcf)

  2.01       2.78       -27.7%

  Natural gas liquids (per Bbl)

  17.14       20.65       -17.0%

  Combined (per BOE)

  27.07       40.08       -32.5%
                     

Average unit cost per BOE:

                    

  Production expenses

  7.29       10.99       -33.7%

  Production taxes

  2.28       3.18       -28.3%

  Depreciation, depletion, amortization and accretion

  16.79       13.86       21.1%
                     

Capital expenditures

 $18,985,025      $25,934,419         

 

 

Oil, natural gas and NGL revenues

 

For the years ended December 31, 2020 and 2019, revenues for oil, natural gas and NGL sales were $36.5 million and $36.0 million, respectively. Revenues for the sale of oil were $31.7 million and $30.9 million, which resulted in realized prices of $31.22 and $49.58 per barrel, respectively. Revenues for the sale of natural gas were $2.1 million and $2.5 million, which resulted in realized prices of $2.01 and $2.78 per Mcf, respectively. Revenues for the sale of NGL were $2.7 million and $2.6 million, which resulted in realized prices of $17.14 and $20.65 per barrel of oil equivalent (“BOE”) of production, respectively. Average realized prices in the fourth quarter of 2020 were approximately $36.41 per barrel of oil, $2.34 per Mcf of natural gas and $22.27 per BOE of NGL, compared to fourth quarter of 2019 realized prices of approximately $49.92 per barrel of oil, $2.14 per Mcf of natural gas and $20.28 per BOE of NGL.

 

The realized prices per barrel of oil above are based upon the NYMEX benchmark price less a cost to distribute the oil, or the differential. Oil price differentials primarily represent the transportation costs in moving produced oil at the wellhead to a refinery and are based on the availability of pipeline, rail and other transportation methods out of the Sanish field. Due to produced oil from the Sanish field exceeding demand and reduced storage capacity available at refineries, the Partnership’s oil price differential increased during the second quarter of 2020. However, as market supply and demand imbalances began to stabilize in July 2020, the Partnership’s oil price differential returned to historical levels during the third and fourth quarters of 2020. In July 2020, a federal judge ruled that two significant pipelines that transport oil and natural gas from North Dakota fields, including the Sanish field, must suspend operations due to environmental review and disputes over right to use land owned by Native Americans (this ruling was later stayed on appeal and the case remains active in court). If use of the region pipelines is suspended at a future date, the Partnership anticipates its differential would increase.

 

The Partnership’s results for the year ended December 31, 2020 were negatively impacted by the Partnership’s realized sales prices for oil, natural gas and NGLs, which decreased, in comparison to the year ended December 31, 2019, due to (i) a decline in market commodity prices (described in “Current Price Environment” above) and (ii) a significant increase in the oil differential during the second quarter of 2020. Realized sales prices for natural gas and NGLs were also negatively impacted in 2020 due to processing and transportation constraints, discussed above in “Current Price Environment” and below in “Production Expenses”, as product leaves the Sanish field.

 

The Partnership’s increase in sold production volumes for the year ended December 31, 2020 helped offset the negative impact of lower realized sales prices. Since the fourth quarter of 2019, the Partnership has completed 22 new wells, which led to increases in the Partnership’s sold production volumes of oil, natural gas and NGL throughout 2020 when compared to 2019. In addition, the Partnership’s operators did not curtail production or shut-in a significant number of producing wells during 2020, so the Partnership benefited from stable production throughout 2020. Sold production for the Sanish Field Assets was approximately 3,800 BOE per day for the fourth quarter of 2020 and approximately 3,700 BOE per day for the year ended December 31, 2020. In comparison, production for the Sanish Field Assets was approximately 2,400 BOE per day for the fourth quarter of 2019 and approximately 2,500 BOE for the year ended December 31, 2019. Sold production volumes for oil, natural gas and NGLs during 2019 were impacted by (i) natural production declines; and (ii) production from some of the Partnership’s existing producing wells being temporarily suspended, starting in the second quarter of 2019, due to the commencement of the Drilling Program.

 

If operators are unable to produce, process and sell oil and natural gas at economical prices, the operators in the Sanish field may curtail daily production, shut-in producing wells or seek other cost-cutting measures, and could continue so long as producing is uneconomical. Consequently, any of these measures could significantly impact the Partnership’s oil, natural gas and NGL production. Further, production is dependent on the investment in existing wells and the development of new wells. The Partnership has 21 wells currently in various stages of drilling and completion, and the timing of completion of these wells is unknown at this time. Therefore, the Partnership may experience natural production declines until market conditions improve and some or all of the 21 in-process wells are completed. See further discussion of the Partnership’s investment in new wells “Liquidity and Capital Resources” below.

 

Operating costs and expenses

 

Production expenses

 

Production expenses are daily costs incurred by the Partnership to bring oil and natural gas out of the ground and to market, along with the daily costs incurred to maintain producing properties. Such costs include field personnel compensation, saltwater disposal, utilities, maintenance, repairs and servicing expenses related to the Partnership’s oil and natural gas properties, along with the gathering and processing contract in effect for the extraction, transportation and treatment of natural gas.

 

 

For the years ended December 31, 2020 and 2019, production expenses were $9.8 million and $9.9 million, respectively, and production expenses per BOE of sold production were $7.29 and $10.99, respectively. The year-over-year change in total production expenses was minimal for the years ended December 31, 2020 and 2019; however, the operating environment in the Willison Basin was altered due to the severe impacts of COVID-19. The implementation of cost-saving measures by its operators allowed the Partnership to save on routine expenses to maintain producing wells, but higher gathering and transportation costs contributed to higher costs to sell Partnership production. As a result, the Partnership’s lease operating expenses decreased by approximately 29% in 2020 (as compared to 2019), but marketing, gathering and processing costs increased by 20% in 2020 (as compared to 2019). Workover expenses were also higher in 2020, when compared to 2019, a result of the Partnership’s operators incurring costs to return certain wells to production that were in close proximity to new drillings completed under the Drilling Program.

 

Production expenses for the fourth quarters of 2020 and 2019 were $2.8 million and $1.9 million, respectively, and production expenses per BOE of sold production were $8.07 and $8.44, respectively. Production expenses per BOE for the fourth quarter of 2020 and year ended December 31, 2020 were below production expenses per BOE of the same periods of 2019 primarily due to the increase in sold production volumes.

 

Production taxes

 

Taxes on the production and extraction of oil and gas are regulated and set by North Dakota tax authorities. Production taxes for the years ended December 31, 2020 and 2019 were $3.1 million (8% of revenue) and $2.9 million (8% of revenue), respectively. Production taxes as a percentage of revenue may fluctuate dependent upon the ratio of sales of natural gas and NGL to total sales. Taxes on the sale of gas and NGL products are less than taxes levied on the sale of oil based on current rates as a percentage of sale price. Production taxes for the fourth quarters of 2020 and 2019 were $0.9 million (8% of revenue) and $0.7 million (8% of revenue), respectively.

 

General and administrative expenses

 

General and administrative costs for the years ended December 31, 2020 and 2019 were $1.6 million and $1.3 million, respectively. The principal components of general and administrative expense are accounting, legal and consulting fees. The increase in general and administrative costs in 2020, compared to 2019, is primarily due to higher legal fees incurred to protect the Partnership’s rights under joint operating agreements with its operators.

 

Depreciation, depletion, amortization and accretion (DD&A)

 

DD&A of capitalized drilling and development costs of producing oil, natural gas and NGL properties are computed using the unit-of-production method on a field basis based on total estimated proved developed oil, natural gas and NGL reserves. Costs of acquiring proved properties are depleted using the unit-of-production method on a field basis based on total estimated proved developed and undeveloped reserves. DD&A for the years ended December 31, 2020 and 2019 was $22.7 million and $12.5 million, and DD&A per BOE of sold production was $16.79 and $13.86, respectively. DD&A for the fourth quarters of 2020 and 2019 was $6.1 million and $3.0 million, and DD&A per BOE of sold production was $17.26 and $13.56, respectively.

 

The increase in DD&A expense per BOE of production in 2020 is primarily due to the decrease of the Partnership’s estimated proved undeveloped reserves (“PUDs”) resulting from (i) changes to the Partnership’s future drilling schedule and (ii) investment in new wells during the fourth quarter of 2019 and first quarter of 2020.

 

Loss on derivatives, net

 

Participation in the oil and gas industry exposes the Partnership to risks associated with potentially volatile changes in energy commodity prices, and therefore, the Partnership’s future earnings are subject to these risks. Periodically, the Partnership utilizes derivative contracts to manage the commodity price risk on the Partnership’s future oil production it will produce and sell and to reduce the effect of volatility in commodity price changes to provide a base level of cash flow from operations. In accordance with the Letter Agreement discussed in “Financing” below, the Partnership is required to maintain a risk management program to manage the commodity price risk on the Partnership’s future oil and natural gas production for the period from August 31, 2020 until the next borrowing base redetermination date (first quarter of 2021). In August 2020, the Partnership established its risk management program by entering into costless collar derivative contracts for future oil and natural gas produced by the Sanish Field Assets during the period from August 2020 through February 2021.

 

 

The Partnership did not designate its derivative instruments as hedges for accounting purposes and did not enter into such instruments for speculative trading purposes. As a result, when derivatives do not qualify or are not designated as a hedge, the changes in the fair value are recognized on the Partnership’s consolidated statements of operations as a gain or loss on derivative instruments. The following table presents settlements of its matured derivative instruments and the non-cash, mark-to-market net loss recorded during the periods presented.

 

  

Year Ended

December 31, 2020

  

Year Ended

December 31, 2019

 

Settlements on matured derivatives, net

 $146,710  $13,310 

Loss on mark-to-market of derivatives, net

  (418,910)  (183,850)

Loss on derivatives, net

 $(272,200) $(170,540)

 

The mark-to-market gains or losses recorded for the years ended December 31, 2020 and 2019 represent the change in fair value of the Partnership’s derivative instruments held at period-end. These unrealized gains and losses do not represent actual settlements and no payments were made to or from the counterparty.

 

The Partnership realized a net gain of approximately $147,000 on the settlement of matured derivative contracts during the year ended December 31, 2020. The Partnership’s oil production contracts that expired during the year ended December 31, 2020 represented 372,000 barrels of oil, and the net settlement gain was approximately $107,000, or $0.29 per barrel of oil. The Partnership’s natural gas production contracts that expired during the year ended December 31, 2020 represented 330,000 Mcf of produced natural gas, and settlement gains were approximately $40,000, or $0.12 per Mcf.

 

The Partnership realized a net loss of approximately $138,000 on the settlement of matured derivative contracts during the fourth quarter of 2020. The Partnership’s oil production contracts that expired during the fourth quarter of 2020 represented 168,000 barrels of oil, and the settlement loss was approximately $150,000, or $0.89 per barrel of oil. The Partnership’s natural gas production contracts that expired during the fourth quarter of 2020 represented 190,000 Mcf of produced natural gas, and the settlement gain was approximately $12,000, or $0.06 per Mcf.

 

The Partnership realized gains of approximately $13,000 on the settlement of matured derivative contracts during the fourth quarter and year ended December 31, 2019. The Partnership’s oil production contracts that expired during the fourth quarter and year ended December 31, 2019 represented 85,000 barrels of oil, and settlement gains were approximately $13,000, or $0.16 per barrel of oil.

 

The table below summarizes the Partnership’s outstanding derivative contracts (costless collars – purchased put options and written call options) on the Partnership’s future oil production as of December 31, 2020.

 

Settlement Period

 

Product

 

Volume

 

Floor / Ceiling Prices ($)

01/2021 - 02/2021

 

Oil (bbls)

 

              30,000

 

 37.50 / 44.50

01/2021 - 02/2021

 

Oil (bbls)

 

              30,000

 

 38.00 / 44.25

01/2021 - 02/2021

 

Oil (bbls)

 

              30,000

 

 38.00 / 44.00

01/2021 - 02/2021

 

Oil (bbls)

 

              15,000

 

 38.00 / 44.50

01/2021 - 02/2021

 

Gas (MMBtu)

 

            120,000

 

 2.50 / 3.05

 

Interest expense, net

 

Interest expense, net, for the years ended December 31, 2020 and 2019 was $1.9 million and $0.9 million, respectively. The primary component of Interest expense, net, for the year ended December 31, 2020 was interest expense on the Credit Facility and the Affiliate Loan discussed below in “Financing.” The primary component of Interest expense, net for the year ended December 31, 2019 was interest expense on the Credit Facility. Additional borrowings and an increase to the interest rate under the Credit Facility along with the addition of the Affiliate Loan led to the increase in the Partnership’s interest expense in 2020.

 

 

Supplemental Non-GAAP Measure

 

The Partnership uses “Adjusted EBITDAX”, defined as earnings before (i) interest expense, net; (ii) income taxes; (iii) depreciation, depletion, amortization and accretion, (iv) exploration expenses; and (v) (gain)/loss on the mark-to-market of derivative instruments, as a key supplemental measure of its operating performance. This non-GAAP financial measure should be considered along with, but not as alternatives to, net income, operating income, cash flow from operating activities or other measures of financial performance presented in accordance with GAAP. Adjusted EBITDAX is not necessarily indicative of funds available to fund the Company’s cash needs, including its ability to make cash distributions. Although Adjusted EBITDAX, as calculated by the Partnership, may not be comparable to Adjusted EBITDAX as reported by other companies that do not define such terms exactly as the Partnership defines such terms, the Partnership believes this supplemental measure is useful to investors when comparing the Partnership’s results between periods and with other energy companies.

 

The Partnership believes that the presentation of Adjusted EBITDAX is important to provide investors with additional information (i) to provide an important supplemental indicator of the operational performance of the Partnership’s business without regard to financing methods and capital structure, and (ii) to measure the operational performance of the Partnership’s operators.

 

The following table reconciles the Partnership’s GAAP net income to Adjusted EBITDAX for the years ended December 31, 2020 and 2019.

 

  

Year Ended
December 31, 2020

  

Year Ended
December 31, 2019

 

Net income

 $(2,805,323) $8,480,450 

Interest expense, net

  1,908,438   877,978 

Depreciation, depletion, amortization and accretion

  22,654,849   12,451,435 

Exploration expenses

  -   - 

Non-cash loss on mark-to-market of derivatives

  418,910   183,850 

   Adjusted EBITDAX

 $22,176,874  $21,993,713 

 

Liquidity and Capital Resources

 

Historically, the Partnership’s principal sources of liquidity were cash on hand, the cash flow generated from the Sanish Field Assets, and availability under the Credit Facility, if any. As of December 31, 2020, the Partnership had borrowed $40 million under its Credit Facility, which represents all availability. In July 2020, the Partnership utilized the proceeds from the Affiliate Loan (described below in “Financing”) and cash on hand to repay amounts outstanding to Whiting of approximately $19 million (upon payment of the outstanding amounts, Whiting released all liens it had asserted against the Sanish Field Assets). At December 31, 2020, the Partnership held unrestricted cash and cash equivalents of $1.6 million and for the year ended December 31, 2020, the Partnership generated $20.7 million in cash flows from operations. As discussed in “Demand, Liquidity and Going Concern Considerations” above, there are no assurances that cash on hand and cash flow from operations will be sufficient to continue to fund the Partnership’s operations and repay its indebtedness, described in “Financing” below.

 

Financing

 

Revolving Credit Facility

 

At December 31, 2020, the Partnership’s outstanding balance on the Credit Facility was $40 million, and the interest rate for the Credit Facility was 4.25%.

 

On July 21, 2020, the Partnership entered into the Letter Agreement with its lending group that amended and modified the Credit Facility. The modifications include, among other items, the following:

 

 

-

Maturity date was changed from September 30, 2022 to July 31, 2021;

 

-

Interest rate was changed to the prime rate plus 1.00%, with an interest rate floor of 4.00% (an increase of 50 basis points from the rate prior to the Letter Agreement);

 

-

Any future Partnership distributions to limited partners require lender approval;

 

 

 

-

The definition of current ratio excludes the Affiliate Loan (discussed below) from the definition of liabilities; and

 

-

As additional collateral for the loan, the Partnership established and funded a bank account with its lender in the amount of $1.6 million, to be used for interest payments until maturity (the balance of this collateral bank account at December 31, 2020 was approximately $0.9 million and is included in Restricted cash and cash equivalents on the Partnership’s December 31, 2020 consolidated balance sheet).

 

In addition to the modification of certain terms of the Credit Facility, the Letter Agreement waived the defaults by the Partnership that existed prior to signing the Letter Agreement, including not meeting the current ratio covenant as of March 31, 2020, the Partnership not filing its first quarter financial statements within 60 days of March 31, 2020 and the non-payment by the Partnership of amounts due to Whiting. The Letter Agreement also waived the Partnership’s calculation of the current ratio covenant at June 30, 2020. The Letter Agreement also allowed for the Affiliate Loan, discussed below, and permitted payments under the Affiliate Loan if certain conditions were met.

 

In consideration for the modifications, amendments and waivers described above to the Amended Loan Agreement, the Letter Agreement required an amendment fee to Lender of $40,000.

 

The Credit Facility contains mandatory prepayment requirements, customary affirmative and negative covenants and events of default. Certain of the financial covenants, each as defined in the Amended Loan Agreement, include:

 

 

A maximum ratio of funded debt to trailing 12-month EBITDAX of 3.50 to 1.00

 

A minimum ratio of current assets to current liabilities of 1.00 to 1.00 (“Current Ratio”)

 

A minimum ratio of EBITDAX to cash interest expense of 2.50 to 1.00 for trailing 12-month period

 

The Partnership was in compliance with its applicable covenants at December 31, 2020. If the Partnership is not in compliance with its covenants in future periods, it may not be able to obtain waivers and the outstanding balance under the Credit Facility may become due on demand at that time. See additional information in “Note 4. Debt” in Part II, Item 8 – Financial Statements and Supplementary Data included elsewhere within this Form 10-K.

 

Term Loan from Affiliate

 

On July 21, 2020, the Partnership, as borrower, entered into a loan agreement with GKDML, LLC (“GKDML”), which provides for an unsecured, one-year term loan (“Term Loan” or “Affiliate Loan”) in the amount of $15 million. GKDML is owned and managed by Glade M. Knight and David S. McKenney, the Chief Executive Officer and the Chief Financial Officer, respectively, of the General Partner. The Term Loan bears interest at a variable rate based on LIBOR plus a margin of 2.00%, with a LIBOR floor of 0%. Interest is payable monthly. The Term Loan contains mandatory prepayment requirements, customary affirmative and negative covenants and events of default. At December 31, 2020, the outstanding balance on the Term Loan was $6 million, the interest rate for the Term Loan was approximately 2.1% and the Partnership was in compliance of all applicable covenants.

 

To provide the proceeds for the Term Loan, GKDML entered into a loan agreement with Bank of America, N.A. on July 21, 2020 (“GKDML Loan”). The GKDML Loan has substantially the same terms as the Term Loan and is personally guaranteed by Messrs. Knight and McKenney. GKDML, Mr. Knight and Mr. McKenney have not and will not receive any consideration for providing the Term Loan or guaranty to the GKDML Loan; however, under the Term Loan, the Partnership is required to reimburse GKDML for all costs of the GKDML Loan. The Term Loan may be prepaid at any time with no penalty and in any amount, but any amounts repaid may not be reborrowed.

 

Partners Equity

 

The Partnership completed its best-efforts offering of common units on April 24, 2017. As of the conclusion of the offering on April 24, 2017, the Partnership sold approximately 19.0 million common units for total gross proceeds of $374.2 million and proceeds net of offering costs of $349.6 million.

 

Under the agreement with the Dealer Manager, the Dealer Manager received a total of 6% in selling commissions and a marketing expense allowance based on gross proceeds of the common units sold. The Dealer Manager will also be paid a contingent incentive fee, which is a cash payment of up to an amount equal to 4% of gross proceeds of the common units sold based on the performance of the Partnership. Based on the common units sold in the offering, the total contingent fee is a maximum of approximately $15.0 million, which will only be paid if Payout occurs, as defined in “Distributions” below.

 

 

Distributions

 

See the definition and discussion of “Payout” in Note 7. Capital Contribution and Partners’ Equity in Part II, Item 8 – Financial Statements and Supplementary Data.

 

In March 2020, the General Partner approved the suspension of distributions to limited partners of the Partnership in response to market volatility resulting from COVID-19 and the impact on the Partnership’s operating cash flows. The Partnership has accumulated and will continue to accumulate unpaid distributions based on an annualized return of seven percent (7%), and all accumulated unpaid distributions are required to be paid before final Payout occurs. As of December 31, 2020, the unpaid Payout Accrual totaled $1.181370 per common unit, or approximately $22 million. As discussed in “Financing” above and pursuant to the Letter Agreement, the Partnership is not permitted to pay distributions without lender approval.

 

For the year ended December 31, 2020, the Partnership paid distributions of $0.241644 per common unit or $4.6 million. For the year ended December 31, 2019, the Partnership paid distributions of $1.396164 per common unit or $26.5 million. The Partnership generated $20.7 million in cash flow from operations for the years ended December 31, 2020 and 2019, respectively. 

 

Oil and Gas Properties

 

Drilling Program 

 

The Partnership incurred approximately $19.0 million and $25.9 million in capital expenditures for the years ended December 31, 2020 and 2019, respectively.

 

During the second half of 2019 and the first quarter of 2020, the Partnership elected to participate in the Drilling Program, primarily administered by Whiting, at an estimated cost to the Partnership of approximately $62 million. Through December 31, 2020, the Partnership has incurred approximately $42 million in capital expenditures related to the Drilling Program. As of December 31, 2020, 22 of these wells have been completed and 21 were in process. The timing for the completion of these 21 in-process wells is uncertain, as completion of the wells is not in the Partnership’s control. Based upon information from its operators, the Partnership estimates it will incur approximately $12 to $15 million in capital expenditures related to the Drilling Program in 2021, indicating all 21 in-process wells are not anticipated to be completed in 2021. The factors described in “Current Price Environment” along with the uncertainty of when Whiting will resume the Drilling Program make it difficult to predict the amount and timing of capital expenditures for 2021 and beyond. Estimated capital expenditures could be significantly different from amounts actually invested.

 

In addition to the approximate $20 million in estimated capital expenditures to be incurred to complete the 43 wells within the Drilling Program, the Partnership anticipates that it may be obligated to invest $25 to $35 million in capital expenditures from 2021 through 2025 to participate in new well development in the Sanish Field without becoming subject to non-consent penalties under the joint operating agreements governing the Sanish Field Assets. As discussed in “Demand, Liquidity and Going Concern Considerations”, the Partnership’s liquidity is currently dependent upon cash from operations and if it is not able to generate sufficient cash to fund capital expenditures, it may not be able to complete its obligations under the currently suspended Drilling Program or participate fully in future wells. If an operator elects to complete drilling or other significant capital expenditure activity and the Partnership is unable to fund the capital expenditures, the General Partner may decide to farmout the well. Also, if a well is proposed under the operating agreement for one of the properties the Partnership owns, the General Partner may elect to “non-consent” the well. Non-consenting a well will generally cause the Partnership not to be obligated to pay the costs of the well, but the Partnership will not be entitled to the proceeds of production from the well until a penalty is received by the parties that drilled the well.

 

Oil, Natural Gas and NGL Reserves 

 

The Partnership decreased its proved undeveloped reserves (“PUD”) during the second quarter of 2020 as a result of lower oil and natural gas prices as well as changes in the planned timing of drilling and completing PUD reserve locations outside of the SEC five-year window. See Note 9. Supplementary Information on Oil, Natural Gas and Natural Gas Liquid Reserves (Unaudited) in Part II, Item 8 – Financial Statements and Supplementary Data for complete information on the Partnership’s reserves as of December 31, 2020.

 

 

Contractual Commitments

 

The following is a summary of the Partnership’s significant contractual obligations as of December 31, 2020:

 

      

Payments Due by Period (in thousands)

 
  

Total

  

1 year

  

2-3 years

  

4-5 years

  

Over 5 years

 

Revolving credit facility

 $40,000  $40,000  $-  $-  $- 

Affiliate term loan

  6,000   6,000   -   -   - 

Estimated interest payments (1)

  1,058   1,058   -   -   - 
  $47,058  $47,058  $-  $-  $- 

(1)

The interest payments as estimated assume no principal repayments until the Credit Facility and Affiliate Loan maturity dates of July 31, 2021 and July 21, 2021, respectively. The estimated interest payments are based on the Partnership’s interest rates at December 31, 2020.

 

As described in the “Subsequent Events” section below, the Partnership paid off the remaining $6.0 million balance of the Affiliate Loan during the first quarter of 2021.

 

Transactions with Related Parties

 

The Partnership has, and is expected to continue to engage in, significant transactions with related parties. These transactions cannot be construed to be at arm’s length and the results of the Partnership’s operations may be different than if conducted with non-related parties. The General Partner’s Board of Directors oversees and reviews the Partnership’s related party relationships and is required to approve any significant modifications to existing related party transactions, as well as any new significant related party transactions.

 

See further discussion in Note 8. Related Parties in Part II, Item 8 – Financial Statements and Supplementary Data and in Part III, Item 13 — Certain Relationships and Related Transactions, and Director Independence, appearing elsewhere in this Annual Report on Form 10-K.

 

Critical Accounting Policies and Estimates

 

The discussion and analysis of the Partnership’s financial condition and results of operations is based upon the consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these consolidated financial statements requires the Partnership to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures about contingent assets and liabilities. Certain of the Partnership’s accounting policies involve estimates and assumptions to such an extent that there is reasonable likelihood that materially different amounts could have been reported under different conditions or if different assumptions had been used. The Partnership bases these estimates and assumptions on historical experience and on various other information and assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Estimates and assumptions about future events and their effects cannot be perceived with certainty and, accordingly, these estimates may change as additional information is obtained, as more experience is acquired, as the Partnership’s operating environment changes and as new events occur.

 

The Partnership’s critical accounting policies are important to the portrayal of both its financial condition and results of operations and require the Partnership to make difficult, subjective or complex assumptions or estimates about matters that are uncertain. The Partnership would report different amounts in its consolidated financial statements, which could be material, if the Partnership used different assumptions or estimates. The Partnership believes that the following are the critical accounting policies used in the preparation of its consolidated financial statements.

 

Oil and Natural Gas Properties

 

The Partnership accounts for its oil and natural gas properties using the successful efforts method of accounting. Under this method, costs of productive exploratory wells, development dry holes and productive wells and undeveloped leases are capitalized. Oil and natural gas lease acquisition costs are also capitalized. Exploration costs, including personnel costs, certain geological and geophysical expenses and delay rentals for oil and natural gas leases, are charged to expense during the period the costs are incurred. Exploratory drilling costs are initially capitalized but charged to expense if and when the well is determined not to have found reserves in commercial quantities.

 

 

No gains or losses are recognized upon the disposition of proved oil and natural gas properties except in transactions such as the significant disposition of an amortizable base that significantly affects the unit–of–production amortization rate. Sales proceeds are credited to the carrying value of the properties.

 

The application of the successful efforts method of accounting requires managerial judgment to determine the proper classification of wells designated as development or exploratory which will ultimately determine the proper accounting treatment of the costs incurred. The results from a drilling operation can take considerable time to analyze and the determination that commercial reserves have been discovered requires both judgment and industry experience. Wells may be completed that are assumed to be productive and actually deliver oil, natural gas and natural gas liquids in quantities insufficient to be economic, which may result in the abandonment of the wells at a later date. Wells are drilled that have targeted geologic structures that are both developmental and exploratory in nature, and an allocation of costs is required to properly account for the results. Delineation seismic incurred to select development locations within an oil and natural gas field is typically considered a development cost and capitalized, but often these seismic programs extend beyond the reserve area considered proved and management must estimate the portion of the seismic costs to expense. The evaluation of oil and natural gas leasehold acquisition costs requires managerial judgment to estimate the fair value of these costs with reference to drilling activity in a given area. Drilling activities in an area by other companies may also effectively condemn leasehold positions.

 

The successful efforts method of accounting can have a significant impact on the operational results reported when the Partnership is entering a new exploratory area in hopes of finding an oil and natural gas field that will be the focus of future developmental drilling activity. The initial exploratory wells may be unsuccessful and will be expensed. Seismic costs can be substantial, which will result in additional exploration expenses when incurred.

 

Impairment

 

The Partnership assesses its proved oil and natural gas properties for possible impairment whenever events or circumstances indicate that the recorded carrying value of the properties may not be recoverable. Such events include a projection of future reserves that will be produced from a field, the timing of this future production, future costs to produce the oil, natural gas and natural gas liquids and future inflation levels. If the carrying amount of the properties exceeds the sum of the estimated undiscounted future net cash flows, the Partnership recognizes an impairment expense equal to the difference between the carrying value and the fair value of the properties, which is estimated to be the expected present value of the future net cash flows. Estimated future net cash flows are based on existing reserves, forecasted production and cost information and management’s outlook of future commodity prices. The underlying commodity prices used in the determination of the Partnership’s estimated future net cash flows are based on NYMEX forward strip prices at the end of the period, adjusted by field or area for estimated location and quality differentials, as well as other trends and factors that management believes will impact realizable prices. Future operating costs estimates are also developed based on a review of actual costs by field or area. Downward revisions in estimates of reserve quantities or expectations of falling commodity prices or rising operating costs could result in a reduction in undiscounted future cash flows and could indicate a property impairment.

 

Estimates of Oil, Natural Gas and Natural Gas Liquids Reserves

 

The Partnership’s estimates of proved reserves are based on the quantities of oil, natural gas and natural gas liquids which, by analysis of geoscience and engineering data, can be estimated with reasonable certainty to be economically producible – from a given date forward, from 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 estimate. Reserves for proved developed producing wells were estimated using production performance and material balance methods. Certain new producing properties with little production history were forecast using a combination of production performance and analogy to offset production, both of which provide accurate forecasts. Non–producing reserve estimates for both developed and undeveloped properties were forecast using either volumetric and/or analogy methods. These methods provide accurate forecasts due to the mature nature of the properties targeted for development and an abundance of subsurface control data.

 

The accuracy of any reserve estimate is a function of the quality of available data, engineering and geological interpretation and judgment. For example, the Partnership must estimate the amount and timing of future operating costs, severance taxes, development costs and workover costs, all of which may vary considerably from actual results. In addition, as prices and cost levels change from year to year, the estimate of proved reserves also changes. Any significant variance in these assumptions could materially affect the estimated quantity and value of the Partnership’s reserves. Independent reserve engineers prepare the Partnership’s reserve estimates at the end of each year.

 

 

Despite the inherent imprecision in these engineering estimates, the Partnership’s reserves are used throughout the Partnership’s financial statements. For example, since the Partnership uses the units–of–production method to amortize the costs of our oil and natural gas properties, the quantity of reserves could significantly impact its depreciation, depletion and amortization expense. The Partnership’s reserves are also the basis of the Partnership’s supplemental oil and natural gas disclosures.

 

Revenue Recognition

 

The Partnership is bound by a joint operating agreement with the operator of each of its producing wells. Under the joint operating agreement, the Partnership’s proportionate share of production is marketed at the discretion of the operators. The Partnership typically satisfies its performance obligations upon transfer of control of its products and records the related revenue in the month production is delivered to the purchaser. As the Partnership does not operate its properties, it receives actual oil, natural gas, and NGL sales volumes and prices, net of costs incurred by the operators, two to three months after the date production is delivered by the operator. At the end of each month when the performance obligation is satisfied, the variable consideration can be reasonably estimated and amounts due from the Partnership’s operators are accrued in Oil, natural gas and natural gas liquids revenue receivable in the consolidated balance sheets. Variances between the Partnership’s estimated revenue and actual payments are recorded in the month the payment is received; differences have been and are insignificant. As a result, the variable consideration is not constrained. The Partnership has elected to utilize the practical expedient in ASC 606 that states the Partnership is not required to disclose the transaction price allocated to remaining performance obligations if the variable consideration is allocated entirely to a wholly unsatisfied performance obligation. Each delivery of product 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.

 

Virtually all of the Partnership’s contracts’ pricing provisions are tied to a market index, with certain adjustments based on, among other factors, whether a well delivers to a gathering or transmission line, quality of oil, natural gas and natural gas liquids and prevailing supply and demand conditions, so that prices fluctuate to remain competitive with other available suppliers.

 

Recent Accounting Standards

 

See Note 2. Summary of Significant Accounting Policies in Part II, Item 8 – Financial Statements and Supplementary Data for a summary of recent accounting standards.

 

Subsequent Events

 

During the first quarter of 2021, the Partnership paid off the remaining $6 million balance on its Affiliate Loan with GKDML, LLC. The Partnership did not incur a penalty for prepayment.

 

Item 7A. Quantitative and Qualitative Disclosure About Market Risk

 

Information regarding the Partnership’s hedging programs to mitigate commodity risks is contained in Item 1 – Business, Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Item 8 – Financial Statements and Supplementary Data: Note 6. Risk Management, appearing elsewhere within this Annual Report on Form 10-K.

 

The Partnership also has a variable interest rate on its Credit Facility that is subject to market changes in interest rates. Information regarding the Partnership’s Credit Facility is contained in Item 1 – Business, Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Item 8 – Financial Statements and Supplementary Data: Note 4. Debt, appearing elsewhere within this Annual Report on Form 10-K.

 

 

 

Item 8. Financial Statements and Supplementary Data

 

Financial Statements

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

General Partner and Unitholders

Energy 11, L.P.

 

Opinion on the financial statements

 

We have audited the accompanying consolidated balance sheets of Energy 11, L.P. (a Delaware limited partnership) and subsidiary (the “Partnership���) as of December 31, 2020 and 2019, the related consolidated statements of operations, partners’ equity, and cash flows for each of the two years in the period ended December 31, 2020, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Partnership as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2020, in conformity with accounting principles generally accepted in the United States of America.

 

Going concern

 

The accompanying financial statements have been prepared assuming that the Partnership will continue as a going concern. As discussed in Note 1 to the financial statements, the Partnership has substantial debt that is due within one year of the report date which raises substantial doubt about the Partnership’s ability to continue as a going concern. Management’s plans in regard to this matter is also described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

 

Basis for opinion

 

These financial statements are the responsibility of the Partnership’s management. Our responsibility is to express an opinion on the Partnership’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Partnership is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Partnership’s internal control over financial reporting. Accordingly, we express no such opinion.

 

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

Critical audit matter

 

The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the general partners as those charged with governance of the Partnership and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.

 

Estimation of proved reserves as it relates to the calculation and recognition of depreciation, depletion and amortization expense, and assessment of potential impairment

 

 

As described in Note 2 to the consolidated financial statements, the Partnership accounts for its oil and natural gas properties using the successful efforts method of accounting, which requires management to make estimates of proved oil, natural gas and natural gas liquid reserve volumes and associated future cash flows to calculate depletion expense and assess its oil and natural gas properties for potential impairment. To estimate the proved oil and natural gas reserves and future cash flows, management makes significant estimates and assumptions, including but not limited to forecasting the production decline rate of producing oil and natural gas properties and forecasting the timing of development and volumes of production associated with the Partnership’s development plan for undeveloped properties. In addition, the estimation of proved oil and natural gas reserves is also impacted by management’s judgments and estimates regarding the financial performance of wells associated with proved oil and natural gas reserves to determine if wells are expected to be economical with reasonable certainty under the appropriate pricing assumptions required in the estimation of depletion expense and potential impairment assessments. We identified the estimation of proved oil and natural gas reserves as it relates to the calculation and recognition of depreciation, depletion and amortization expense and the assessment of potential impairment as a critical audit matter.

 

The principal considerations for our determination that the estimation of proved oil and natural gas reserves as it relates to the calculation and recognition of depreciation, depletion and amortization expense and the assessment of potential impairment as a critical audit matter is that relatively minor changes in certain inputs and assumptions, which require a high degree of subjectivity and are necessary to estimate the volume and future cash flows of the Partnership’s proved oil and natural gas reserves could have a significant impact on the measurement of depreciation, depletion and amortization expense and the assessment of potential impairment.

 

Our audit procedures related to the estimation of proved oil and natural gas reserves as it relates to the calculation and recognition of depreciation, depletion and amortization expense and the assessment of potential impairment included the following, among others:

 

 

We evaluated the level of knowledge, skill, and ability of the Partnership’s reservoir engineering specialists and their relationship to the Partnership, made inquiries of those reservoir engineers regarding the process followed and judgments made to estimate the Partnership’s proved reserve volumes, and read the reserve reports prepared by the Partnership’s reservoir engineering specialists.

 

We tested the accuracy of the Partnership’s depletion calculations and impairment evaluation that included these proved reserve reports.

 

We evaluated sensitive inputs and assumptions used to determine proved reserve volumes and other financial inputs and assumptions, including certain assumptions derived from the Partnership’s accounting records. These assumptions included historical pricing differentials, future operating costs, estimated capital costs, and ownership interests. We tested management’s process for determining the assumptions, including examining underlying support, on a sample basis. Specifically, our audit procedures involved testing management’s assumptions as follows:

 

o

Compared the estimated pricing differentials used in the reserve reports to realized prices related to revenue transactions recorded in the current year;

 

o

Evaluated the models used to estimate the operating costs at year-end and compared to historical operating costs;

 

o

Compared the models used to determine the future capital expenditures and compared estimated future capital expenditures used in the reserve reports to amounts expended for recently drilled and completed wells;

 

o

Evaluated the working and net revenue interests used in the reserve reports by inspecting land and division order records;

 

o

Evaluated historical conversion rates, the Partnership’s ability to fund and management’s intent and ability to develop the proved undeveloped properties, and correspondence and other information from significant joint operators; and

 

o

Applied analytical procedures to the reserve reports by comparing to historical actual results and to the prior year and preceding period reserve reports.

 

 

/s/ GRANT THORNTON LLP

 

We have served as the Partnership’s auditor since 2015.

 

Oklahoma City, Oklahoma

March 12, 2021

 

 

Energy 11, L.P.

Consolidated Balance Sheets

 

  

December 31,

  

December 31,

 
  

2020

  

2019

 
         

Assets

        

Cash and cash equivalents

 $1,608,301  $348,550 

Restricted cash and cash equivalents

  855,518   0 

Oil, natural gas and natural gas liquids revenue receivable

  5,890,971   5,857,926 

Other current assets

  257,524   284,652 

Total Current Assets

  8,612,314   6,491,128 
         

Oil and natural gas properties, successful efforts method, net of accumulated depreciation,

depletion and amortization of $75,765,289 and $53,186,165, respectively

  323,200,183   326,758,636 

Total Assets

 $331,812,497  $333,249,764 
         

Liabilities

        

Revolving credit facility

 $40,000,000  $0 

Affiliate term loan

  6,000,000   0 

Accounts payable and accrued expenses

  3,299,810   19,877,209 

Derivative liability

  602,760   183,850 

Total Current Liabilities

  49,902,570   20,061,059 
         

Revolving credit facility

  0   24,000,000 

Asset retirement obligations

  1,564,105   1,452,734 

Total Liabilities

  51,466,675   45,513,793 
         

Partners Equity

        

Limited partners' interest (18,973,474 common units issued and outstanding, respectively)

  280,347,549   287,737,698 

General partner's interest

  (1,727)  (1,727)

Class B Units (62,500 units issued and outstanding, respectively)

  0   0 

Total Partners’ Equity

  280,345,822   287,735,971 
         

Total Liabilities and Partners’ Equity

 $331,812,497  $333,249,764 

 

See notes to consolidated financial statements.

 

 

Energy 11, L.P.

Consolidated Statements of Operations

 

  

Year Ended

  

Year Ended

 
  

December 31, 2020

  

December 31, 2019

 
         

 Revenues

        

 Oil

 $31,686,698  $30,940,480 

 Natural gas

  2,126,001   2,466,601 

 Natural gas liquids

  2,709,377   2,612,521 

 Total revenue

  36,522,076   36,019,602 
         

 Operating costs and expenses

        

 Production expenses

  9,839,539   9,873,634 

 Production taxes

  3,075,056   2,861,995 

 General and administrative expenses

  1,577,317   1,303,570 

 Depreciation, depletion, amortization and accretion

  22,654,849   12,451,435 

 Total operating costs and expenses

  37,146,761   26,490,634 
         

 Operating income (loss)

  (624,685)  9,528,968 
         

 Loss on derivatives, net

  (272,200)  (170,540)

 Interest expense, net

  (1,908,438)  (877,978)

 Total other expense, net

  (2,180,638)  (1,048,518)
         

 Net income (loss)

 $(2,805,323) $8,480,450 
         

 Basic and diluted net income (loss) per common unit

 $(0.15) $0.45 
         

 Weighted average common units outstanding - basic and diluted

  18,973,474   18,973,474 

 

See notes to consolidated financial statements.

 

 

Energy 11, L.P.

Consolidated Statements of Partners Equity

 

  

Limited Partner

  

Class B Units

  

General Partner

  

Total Partners'

 
  

Common Units

  

Amount

  

Units

  

Amount

  

Amount

  

Equity

 

Balance December 31, 2018

  18,973,474   305,747,329   62,500   -   (1,727)  305,745,602 
                         

Distributions declared and paid to common units ($1.396164 per unit)

  -   (26,490,081)  -   -   -   (26,490,081)

2019 Net income

  -   8,480,450   -   -   -   8,480,450 

Balance December 31, 2019

  18,973,474  $287,737,698   62,500  $-  $(1,727) $287,735,971 
                         

Distributions declared and paid to common units ($0.241644 per unit)

  -   (4,584,826)  -   -   -   (4,584,826)

2020 Net loss

  -   (2,805,323)  -   -   -   (2,805,323)

Balance December 31, 2020

  18,973,474  $280,347,549   62,500  $-  $(1,727) $280,345,822 

 

See notes to consolidated financial statements.

 

 

Energy 11, L.P.

Consolidated Statements of Cash Flows

 

  

Year Ended

  

Year Ended

 
  

December 31, 2020

  

December 31, 2019

 
         

Cash flow from operating activities:

        

Net income (loss)

 $(2,805,323) $8,480,450 
         

Adjustments to reconcile net income to cash from operating activities:

        

Depreciation, depletion, amortization and accretion

  22,654,849   12,451,435 

Loss on mark-to-market of derivatives

  418,910   183,850 

Non-cash expenses

  113,140   47,492 
         

Changes in operating assets and liabilities:

        

Oil, natural gas and natural gas liquids revenue receivable

  (33,045)  411,316 

Other current assets

  23,609   (11,410)

Accounts payable and accrued expenses

  321,085   (885,454)
         

Net cash flow provided by operating activities

  20,693,225   20,677,679 
         

Cash flow from investing activities:

        

Additions to oil and natural gas properties

  (35,876,529)  (7,609,391)
         

Net cash flow used in investing activities

  (35,876,529)  (7,609,391)
         

Cash flow from financing activities:

        

Cash paid for loan costs

  (116,601)  (114,984)

Proceeds from revolving credit facility

  16,000,000   10,200,000 

Proceeds from affiliate term loan

  15,000,000   0 

Payments on affiliate term loan

  (9,000,000)  0 

Distributions paid to limited partners

  (4,584,826)  (26,490,081)
         

Net cash flow provided by (used in) financing activities

  17,298,573   (16,405,065)
         

Increase (decrease) in cash, cash equivalents and restricted cash

  2,115,269   (3,336,777)

Cash, cash equivalents and restricted cash, beginning of period

  348,550   3,685,327 
         

Cash, cash equivalents and restricted cash, end of period

 $2,463,819  $348,550 
         

Interest paid

 $1,837,470  $849,322 
         

Supplemental non-cash information:

        

Accrued capital expenditures related to additions to oil and natural gas properties

 $1,531,828  $18,423,332 

 

See notes to consolidated financial statements.

 

 

Energy 11, L.P.

Notes to Consolidated Financial Statements

December 31, 2020

 

Note 1. Partnership Organization

 

Energy 11, L.P. (together with its wholly-owned subsidiary, the “Partnership”) is a Delaware limited partnership formed to acquire producing and non-producing oil and natural gas properties onshore in the United States and to develop those properties. The initial capitalization of the Partnership of $1,000 occurred on July 9, 2013. The Partnership completed its best-efforts offering on April 24, 2017 with a total of approximately 19 million common units sold for gross proceeds of $374.2 million and proceeds net of offering costs of $349.6 million.

 

As of December 31, 2020, the Partnership owns an approximate 25% non-operated working interest in 243 producing wells, an estimated approximate 18% non-operated working interest in 21 wells in various stages of the drilling and completion process and future development sites in the Sanish field located in Mountrail County, North Dakota (collectively, the “Sanish Field Assets”). Whiting Petroleum Corporation (“Whiting”) (NYSE: WLL) operates substantially all of the Sanish Field Assets.

 

The general partner of the Partnership is Energy 11 GP, LLC (the “General Partner”). The General Partner manages and controls the business affairs of the Partnership.

 

The Partnership’s fiscal year ends on December 31.

 

COVID-19, Demand, Liquidity and Going Concern Considerations 

 

During 2019 and the first quarter of 2020, the Partnership elected to participate in the drilling and completion of 43 new wells (“Drilling Program”), primarily administered by Whiting, at an estimated cost of approximately $62 million to the Partnership. Through the first quarter of 2020, approximately 14 wells under the Drilling Program had been completed and production from additional wells to be completed under the Drilling Program were expected to enhance the Partnership’s operating performance throughout 2020, providing incremental cash flow from operations to fund the Partnership’s investment in its undrilled acreage.

 

In December 2019, China reported an outbreak of a novel coronavirus (“COVID-19”) in its Wuhan province. COVID-19 rapidly spread worldwide, forcing governments around the world to take drastic measures to halt the outbreak. These measures included significant restrictions on travel, forced quarantines, stay-at-home requirements and the closure of businesses in many industries, creating extreme volatility in capital markets and the global economy. On March 11, 2020, the World Health Organization declared COVID-19 a pandemic, and on March 13, 2020, the United States declared a national emergency with respect to COVID-19. Because of COVID-19’s impact to the global economy, demand for oil, natural gas and natural gas liquids (“NGL”) substantially declined in March 2020 and remained depressed through the remainder of 2020. This reduction in demand compounded an existing excess in supply of oil and natural gas, as the members of the Organization of the Petroleum Exporting Countries (“OPEC”) and Russia could not agree on daily production output of crude oil in March 2020. As a result, Russia announced its intention to increase production, and Saudi Arabia immediately countered with announced reductions to export prices. These factors led to oil prices falling in March 2020 and to 20-year lows in April 2020. In response, the General Partner approved the suspension of distributions to limited partners of the Partnership in March 2020.

 

Operators within the United States altered drilling programs and the related forecasted capital expenditures for those programs, and implemented other cost-saving measures, such as curtailing production or shutting in producing wells, during the second quarter of 2020. The financial impact of COVID-19 forced Whiting and certain of its subsidiaries to declare bankruptcy under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Southern District of Texas on April 1, 2020. Whiting then subsequently suspended the Drilling Program. Even though Whiting completed its financial restructuring and emerged from bankruptcy protection in September 2020, Whiting has yet to resume the Drilling Program.

 

 

At December 31, 2019, the Partnership had approximately $16 million available under its $40 million revolving credit facility (“Credit Facility”); the Partnership used that remaining availability in the first quarter of 2020 to partially fund capital expenditures within the Drilling Program. At the end of the first quarter of 2020, the Partnership had approximately $21 million in accrued capital expenditures to Whiting. As a result, the Partnership was not in compliance with certain covenants under its Credit Facility as of March 31, 2020. In July 2020, the Partnership entered into a letter agreement (“Letter Agreement”) with its lending group of its Credit Facility that, among other items, waived the non-compliance of certain covenants under the Credit Facility, accelerated the maturity date of the Credit Facility from September 30, 2022 to July 31, 2021 and permitted a term loan with an affiliate. Subsequently, the Partnership entered into a loan agreement for a one-year, $15 million term loan (“Affiliate Loan”), and proceeds from the Affiliate Loan plus cash on hand were used to pay its outstanding capital expenditures due to Whiting. As of December 31, 2020, the Partnership’s outstanding debt obligations total $46 million and are current on the Partnership’s consolidated balance sheet as both the Credit Facility and Affiliate Loan now mature in July 2021.

 

The Partnership’s ability to continue as a going concern is dependent on several factors including, but not limited to, (i) the Partnership’s ability to comply with its obligations under its loan agreements; (ii) refinancing its existing debt and/or securing additional capital; (iii) an increase in demand for oil and natural gas as the global economy recovers from the effects of the COVID-19 pandemic and the existing oversupply of oil in the United States; and (iv) an increase in oil and natural gas market prices, which will improve the Partnership’s cash flow generated from operations. The Partnership can provide no assurance that it will be able to achieve any of these objectives. Refinancing its existing debt or securing additional capital may not be available on favorable terms to the Partnership, if it is available at all. There can be no assurance that economic activity and oil and natural gas market conditions, including commodity prices, will fully return and stabilize at pre-COVID-19 levels, or that the Partnership will be able to meet its operational obligations. If the Partnership is unable to refinance or repay its debt obligations or is unable to meet its operational obligations, the Partnership could be required to liquidate certain of its assets used for collateral to satisfy these obligations, which create the substantial doubt that exists about the ability of the Partnership to continue as a going concern for one year after the date these financial statements are issued.

 

The financial statements included herein do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classifications of liabilities that may result from the possible inability of the Partnership to continue as a going concern.

 

Note 2. Summary of Significant Accounting Policies

 

Basis of Presentation

 

The accompanying consolidated financial statements of the Partnership have been prepared in accordance with United States generally accepted accounting principles (“US GAAP”). The consolidated financial statements include the accounts of the Partnership and its subsidiaries.

 

Cash, Cash Equivalents and Restricted Cash and Cash Equivalents

 

Cash and cash equivalents consist of highly liquid investments with original maturities of three months or less. Restricted cash as of December 31, 2020 of $0.9 million represents required collateral under the Letter Agreement (see Note 4. Debt) with the Partnership’s lender.

 

The fair market value of cash and cash equivalents approximates their carrying value. Cash balances may at times exceed federal depository insurance limits.

 

Property and Depreciation, Depletion and Amortization

 

The Partnership accounts for its oil and natural gas properties using the successful efforts method of accounting. Under this method, costs of productive exploratory wells, development dry holes and productive wells and undeveloped leases are capitalized. Oil and natural gas lease acquisition costs are also capitalized. Exploration costs, including personnel costs, certain geological and geophysical expenses and delay rentals for oil and natural gas leases, are charged to expense during the period the costs are incurred. Exploratory drilling costs are initially capitalized but charged to expense if and when the well is determined not to have found reserves in commercial quantities.

 

No gains or losses are recognized upon the disposition of proved oil and natural gas properties except in transactions such as the significant disposition of an amortizable base that significantly affects the unit–of–production amortization rate. Sales proceeds are credited to the carrying value of the properties.

 

 

The application of the successful efforts method of accounting requires managerial judgment to determine the proper classification of wells designated as development or exploratory which will ultimately determine the proper accounting treatment of the costs incurred. The results from a drilling operation can take considerable time to analyze and the determination that commercial reserves have been discovered requires both judgment and industry experience. Wells may be completed that are assumed to be productive and actually deliver oil, natural gas and natural gas liquids in quantities insufficient to be economic, which may result in the abandonment of the wells at a later date. Wells are drilled that have targeted geologic structures that are both developmental and exploratory in nature, and an allocation of costs is required to properly account for the results. Delineation seismic incurred to select development locations within an oil and natural gas field is typically considered a development cost and capitalized, but often these seismic programs extend beyond the reserve area considered proved and management must estimate the portion of the seismic costs to expense. The evaluation of oil and natural gas leasehold acquisition costs requires managerial judgment to estimate the fair value of these costs with reference to drilling activity in a given area. Drilling activities in an area by other companies may also effectively condemn leasehold positions.

 

Impairment

 

The Partnership assesses its proved oil and natural gas properties for possible impairment whenever events or circumstances indicate that the recorded carrying value of the properties may not be recoverable. Such events include a projection of future reserves that will be produced from a field, the timing of this future production, future costs to produce the oil, natural gas and natural gas liquids and future inflation levels. If the carrying amount of the properties exceeds the sum of the estimated undiscounted future net cash flows, the Partnership recognizes an impairment expense equal to the difference between the carrying value and the fair value of the properties, which is estimated to be the expected present value of the future net cash flows. Estimated future net cash flows are based on existing reserves, forecasted production and cost information and management’s outlook of future commodity prices. Where probable and possible reserves exist, an appropriately risk adjusted amount of these reserves is included in the impairment evaluation. The underlying commodity prices used in the determination of our estimated future net cash flows are based on NYMEX forward strip prices at the end of the period, adjusted by field or area for estimated location and quality differentials, as well as other trends and factors that management believes will impact realizable prices. Future operating costs estimates are also developed based on a review of actual costs by field or area. Downward revisions in estimates of reserve quantities or expectations of falling commodity prices or rising operating costs could result in a reduction in undiscounted future cash flows and could indicate a property impairment.

 

Accounts Receivable and Concentration of Credit Risk

 

Substantially all the Partnership’s accounts receivable is due from the operators of the Partnership’s oil and natural gas properties in North Dakota (the operators have accounts receivable from purchasers of oil, natural gas and NGLs). Oil, natural gas and NGL sales receivables are generally unsecured. This industry and location concentration has the potential to impact the Partnership’s overall exposure to credit risk, in that the purchasers of the Partnership’s oil, natural gas and NGLs and the operators of the properties the Partnership has an interest in may be similarly affected by changes in economic, industry or other conditions. At December 31, 2020, the Partnership did not reserve for bad debt expense, as all amounts are deemed collectible. For the year ended December 31, 2020, the Partnership’s oil, natural gas and NGL sales were through 4 operators. Whiting is the operator of 98% of the Partnership’s producing properties. All oil and natural gas producing activities of the Partnership are in North Dakota and represent substantially all of the business activities of the Partnership.

 

Asset Retirement Obligation

 

The Partnership has significant obligations to remove tangible equipment and facilities and restore land at the end of oil and natural gas production operations. The removal and restoration obligations are primarily associated with site reclamation, dismantling facilities and plugging and abandoning wells. Estimating the future restoration and removal costs is difficult and requires management to make estimates and judgments because most of the removal obligations are many years in the future and contracts and regulations often have vague descriptions of what constitutes removal. Asset removal technologies and costs are constantly changing, as are regulatory, political, environmental, safety and public relations considerations.

 

The Partnership records an asset retirement obligation (“ARO”) and capitalizes the asset retirement cost in oil and natural gas properties in the period in which the retirement obligation is incurred based upon the fair value of an obligation to perform site reclamation, dismantle facilities or plug and abandon wells. After recording these amounts, the ARO is accreted to its future estimated value using an assumed cost of funds and the additional capitalized costs are depreciated on a unit-of-production basis.

 

 

Inherent in the present value calculation are numerous assumptions and judgments including the ultimate settlement amounts, inflation factors, credit adjusted discount rates, timing of settlement and changes in the legal, regulatory, environmental and political environments. To the extent future revisions of these assumptions impact the present value of the existing asset retirement obligation, a corresponding adjustment is made to the oil and natural gas property balance.

 

The following table shows the activity for the years ended December 31, 2020 and 2019, relating to the Partnership’s asset retirement obligations:

 

Balance as of December 31, 2018

 $1,294,067 

  Well additions

  87,019 

  Accretion

  71,648 

  Revisions in estimated cash flows

  0 

Balance as of December 31, 2019

 $1,452,734 

  Well additions

  35,647 

  Accretion

  75,724 

  Revisions in estimated cash flows

  0 

Balance as of December 31, 2020

 $1,564,105 

 

Income Tax

 

The Partnership is taxed as a partnership for federal and state income tax purposes. No provision for income taxes has been recorded since the liability for such taxes is that of each of the partners rather than the Partnership. The Partnership’s income tax returns are subject to examination by the federal and state taxing authorities, and changes, if any, could adjust the individual income tax of the partners.

 

The Partnership has evaluated whether any material tax position taken will more likely than not be sustained upon examination by the appropriate taxing authority and believes that all such material tax positions taken are supportable by existing laws and related interpretations.

 

Environmental Costs

 

As the Partnership is directly involved in the extraction and use of natural resources, it is subject to various federal, state and local provisions regarding environmental and ecological matters. Compliance with these laws may necessitate significant capital outlays. The Partnership does not believe the existence of current environmental laws or interpretations thereof will materially hinder or adversely affect the Partnership’s business operations; however, there can be no assurances of future effects on the Partnership of new laws or interpretations thereof. Since the Partnership does not operate any wells where it owns an interest, actual compliance with environmental laws is controlled by the well operators, with the Partnership being responsible for its proportionate share of the costs involved.

 

Environmental liabilities are recognized when it is probable that a loss has been incurred and the amount of that loss is reasonably estimable. Environmental liabilities, when accrued, are based upon estimates of expected future costs. At December 31, 2020 and 2019, there were no such costs accrued.

 

Use of Estimates

 

Preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts and disclosures reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

 

Of these estimates and assumptions, management considers the estimation of oil, natural gas and NGL reserves to be the most significant. These estimates affect the unaudited standardized measure disclosures, as well as depreciation, depletion and amortization (“DD&A”) and impairment calculations. On an annual basis, the Partnership’s independent consulting petroleum engineer, with assistance from the Partnership, prepares estimates of oil, natural gas and NGL reserves based on available geologic and seismic data, reservoir pressure data, core analysis reports, well logs, analogous reservoir performance history, production data and other available sources of engineering, geological and geophysical information. For DD&A purposes, and as required by the guidelines and definitions established by the Securities and Exchange Commission (“SEC”), the reserve estimates were based on average individual product prices during the 12-month period prior to December 31, determined as an unweighted arithmetic average of the first-day-of-the-month price for each month within such period excluding escalations based upon future conditions. For impairment purposes, projected NYMEX forward strip prices for oil, natural gas and NGL as estimated by management are used. Oil, natural gas and NGL prices are volatile and largely affected by worldwide production and consumption and are outside the control of management. Projected future oil, natural gas and NGL pricing assumptions are used by management to prepare estimates of oil, natural gas and NGL reserves used in formulating management’s overall operating decisions.

 

 

The Partnership does not operate its oil and natural gas properties and, therefore, receives actual oil, natural gas and NGL sales volumes and prices (in the normal course of business) more than a month later than the information is available to the operators of the wells. This being the case, the most current available production data is gathered from the appropriate operators, and oil, natural gas and NGL index prices local to each well are used to estimate the accrual of revenue on these wells. The oil, natural gas and NGL sales revenue accrual can be impacted by many variables including rapid production decline rates, production curtailments by operators, the shut-in of wells with mechanical problems and rapidly changing market prices for oil, natural gas and NGLs. These variables could lead to an over or under accrual of oil, natural gas and NGL sales at the end of any particular quarter. However, the Partnership adjusts the estimated accruals of revenue to actual production in the period actual production is determined.

 

Revenue Recognition

 

The Partnership is bound by a joint operating agreement with the operator of each of its producing wells. Under the joint operating agreement, the Partnership’s proportionate share of production is marketed at the discretion of the operators. The Partnership typically satisfies its performance obligations upon transfer of control of its products and records the related revenue in the month production is delivered to the purchaser. As the Partnership does not operate its properties, it receives actual oil, natural gas, and NGL sales volumes and prices, net of costs incurred by the operators, two to three months after the date production is delivered by the operator. At the end of each month when the performance obligation is satisfied, the variable consideration can be reasonably estimated and amounts due from the Partnership’s operators are accrued in Oil, natural gas and natural gas liquids revenue receivable in the consolidated balance sheets. Variances between the Partnership’s estimated revenue and actual payments are recorded in the month the payment is received; differences have been and are insignificant. As a result, the variable consideration is not constrained. The Partnership has elected to utilize the practical expedient in ASC 606 that states the Partnership is not required to disclose the transaction price allocated to remaining performance obligations if the variable consideration is allocated entirely to a wholly unsatisfied performance obligation. Each delivery of product 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.

 

Virtually all of the Partnership’s contracts’ pricing provisions are tied to a market index, with certain adjustments based on, among other factors, whether a well delivers to a gathering or transmission line, quality of oil, natural gas and natural gas liquids and prevailing supply and demand conditions, so that prices fluctuate to remain competitive with other available suppliers.

 

Reclassifications

 

Certain prior period amounts in the consolidated financial statements have been reclassified to conform to the current period presentation with no effect on previously reported net income (loss), partners’ equity or cash flows.

 

Net Income (Loss) Per Common Unit

 

Basic net income (loss) per common unit is computed as net income (loss) divided by the weighted average number of common units outstanding during the period. Diluted net income (loss) per unit is calculated after giving effect to all potential common units that were dilutive and outstanding for the period. There were 0 common units with a dilutive effect for the years ended December 31, 2020 and 2019. As a result, basic and diluted outstanding common units were the same. The Class B Units and Incentive Distribution Rights are not included in net income (loss) per common unit until such time that it is probable Payout (as discussed in Note 7) would occur.

 

Recently Adopted Accounting Standards

 

In March 2020, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2020-04, Reference Rate Reform (Topic 848), which provides optional guidance through December 31, 2022 to ease the potential burden in accounting for, or recognizing the effects of, reference rate reform on financial reporting. The amendments in ASU No. 2020-04 apply to contract modifications that replace a reference rate affected by reference rate reform, providing optional expedients regarding the measurement of hedge effectiveness in hedging relationships that have been modified to replace a reference rate. While the guidance in ASU No. 2020-04 became effective upon issuance, the provisions of the ASU did not have a material impact on the Partnership’s consolidated financial statements and related disclosures as of December 31, 2020.

 

 

Note 3. Oil and Gas Investments

 

On December 18, 2015, the Partnership completed its first purchase in the Sanish field, acquiring an approximate 11% non-operated working interest in the Sanish Field Assets for approximately $159.6 million. On January 11, 2017, the Partnership closed on its second purchase in the Sanish field, acquiring an additional approximate 11% non-operated working interest in the Sanish Field Assets for approximately $128.5 million. On March 31, 2017, the Partnership closed on its third purchase in the Sanish field, acquiring an additional approximate average 10.5% non-operated working interest in 82 of the Partnership’s then 216 existing producing wells and 150 of the Partnership’s then 253 future development locations in the Sanish Field Assets for approximately $52.4 million.

 

During 2018, 6 wells were completed by the Partnership’s operators. In total, the Partnership’s capital expenditures for the drilling and completion of these six wells were approximately $7.8 million.

 

During 2019 and the first quarter of 2020, the Partnership elected to participate in the Drilling Program primarily administered by Whiting, which includes the drilling and completion of 43 new wells in the Sanish field. NaN (22) of 43 wells have been completed and were producing at December 31, 2020; the Partnership has an approximate non-operated working interest of 23% in these 22 wells. The Partnership has an estimated approximate non-operated working interest of 18% in the remaining 21 wells that are in-process as of December 31, 2020. In total, the Partnership’s estimated share of capital expenditures for the drilling and completion of these 43 wells is approximately $62 million, of which approximately $42 million was incurred as of December 31, 2020. Whiting suspended the Drilling Program during the second quarter of 2020 in response to the significant reduction in demand for oil caused by COVID-19 and the oversupply of oil in the United States. The timing for completion of a portion or all of the in-process wells within the Drilling Program is dependent upon several factors, including an increase in commodity pricing and available capital. The Partnership estimates it may incur approximately $12 to $15 million in capital expenditures, if Whiting resumes its Drilling Program, in 2021. However, low commodity prices, market supply and demand imbalances and Whiting’s performance after emerging from bankruptcy protection in September 2020 make it difficult to predict the amount and timing of capital expenditures for 2021, and estimated capital expenditures could be significantly different from amounts actually invested.

 

Evaluation for Potential Impairment of Oil and Natural Gas Investments

 

The Partnership assesses its proved oil and natural gas properties for possible impairment whenever events or circumstances indicate that the recorded carrying value of its oil and gas properties may not be recoverable. The Partnership considered the declines in the current and forecasted operating cash flows resulting from COVID-19 and sustained lower commodity prices to be potential indicators of impairment and, as a result, performed a test of recoverability for the Sanish Field Assets. Estimated future net cash flows calculated in the recoverability test were based on existing reserves, forecasted production and cost information and management’s outlook of future commodity prices. The underlying commodity prices used in the determination of the Partnership’s estimated future net cash flows were based on NYMEX forward strip prices as of January 1, 2021, adjusted by field or area for estimated location and quality differentials, as well as other trends and factors that management believed will impact realizable prices. Future operating cost estimates were based on actual historical costs of the Sanish Field Assets. The Partnership’s recoverability analyses did not identify any impairment losses as of December 31, 2020.

 

If current macro-economic conditions continue or worsen, the carrying value of the Partnership’s oil and natural gas properties may not be recoverable and impairment losses could be recorded in future periods.

 

Note 4. Debt

 

Revolving Credit Facility

 

On November 21, 2017, the Partnership, as the borrower, entered into a loan agreement (the “Loan Agreement”) between and among the Partnership and Simmons Bank, as administrative agent and the lenders party thereto (the “Lender”), which provided for a revolving credit facility with an approved initial commitment amount of $20 million, subject to borrowing base restrictions. The maturity date was November 21, 2019. Effective September 30, 2019, the Partnership entered into an amendment and restatement of the Loan Agreement (the “Amended Loan Agreement”) with the Lender, which provided for the Credit Facility with an approved initial commitment of $40 million (the “Revolver Commitment Amount”), subject to borrowing base restrictions. The terms of the Amended Loan Agreement were generally similar to the Partnership’s existing revolving credit facility and included the following: (i) a maturity date of September 30, 2022; (ii) subject to certain exceptions, an interest rate, which did not change from the existing revolving credit facility, equal to the London Inter-Bank Offered Rate (LIBOR) plus a margin ranging from 2.50% to 3.50%, depending upon the Partnership’s borrowing base utilization, as calculated under the terms of the Amended Loan Agreement; (iii) an increase to the borrowing base from $30 million to an initially stipulated $40 million; and (iv) an increase to the mortgage and lenders’ first lien position from 80% to 90% of the Partnership’s owned producing oil and natural gas properties.

 

 

At closing of the Amended Loan Agreement in October 2019, the Partnership paid an origination fee of 0.45% on the change in Revolver Commitment Amount of the Credit Facility (increase from $20 million on previous credit facility to $40 million under revised Credit Facility, or $20 million), or $90,000. The Partnership is also required to pay an unused facility fee of 0.50% on the unused portion of the Revolver Commitment Amount, based on the amount of borrowings outstanding during a quarter.

 

On July 21, 2020, the Partnership entered into the Letter Agreement with the Lender that amended and modified the Amended Loan Agreement. The modifications to the Amended Loan Agreement include, among other items, the following:

 

 

-

Maturity date was changed from September 30, 2022 to July 31, 2021;

 

-

Interest rate was changed to the prime rate plus 1.00%, with an interest rate floor of 4.00% (an increase of 50 basis points from the rate prior to the Letter Agreement);

 

-

Any future Partnership distributions to limited partners require lender approval;

 

-

The definition of current ratio excludes the Affiliate Loan (discussed below) from the definition of liabilities; and

 

-

As additional collateral for the loan, the Partnership established and funded a bank account with its lender in the amount of $1.6 million, to be used for interest payments until maturity (the balance of this collateral bank account at December 31, 2020 was approximately $0.9 million and is included in Restricted cash and cash equivalents on the Partnership’s December 31, 2020 consolidated balance sheet).

 

Also, under the Letter Agreement, the Partnership is required to maintain a risk management program to manage the commodity price risk of the Partnership’s future oil and natural gas sales. The risk management program must cover at least 80% of the Partnership’s projected total production of oil and natural gas for the period from August 31, 2020 until the next borrowing base redetermination date (first quarter of 2021). See more information on the Partnership’s hedging program in Note 6. Risk Management.

 

In addition to the modification of certain terms of the Credit Facility, the Letter Agreement waived the defaults by the Partnership that existed prior to signing the Letter Agreement, including not meeting the current ratio covenant as of March 31, 2020, the Partnership not filing its first quarter financial statements within 60 days of March 31, 2020 and the non-payment by the Partnership of amounts due to Whiting. The Letter Agreement also waived the Partnership’s calculation of the current ratio covenant at June 30, 2020. The Letter Agreement allowed for the Affiliate Loan, discussed below, and permitted payments under the Affiliate Loan if certain conditions were met.

 

In consideration for the modifications, amendments and waivers described above to the Amended Loan Agreement, the Letter Agreement required an amendment fee to the Lender of $40,000.

 

The Credit Facility contains mandatory prepayment requirements, customary affirmative and negative covenants and events of default. Certain of the financial covenants, each as defined in the Amended Loan Agreement, include:

 

 

A maximum ratio of funded debt to trailing 12-month EBITDAX of 3.50 to 1.00

 

A minimum ratio of current assets to current liabilities of 1.00 to 1.00 (“Current Ratio”)

 

A minimum ratio of EBITDAX to cash interest expense of 2.50 to 1.00 for trailing 12-month period

 

The Partnership was in compliance with its applicable covenants at December 31, 2020. If the Partnership is not in compliance with its covenants in future periods, it may not be able to obtain waivers and the outstanding balance under the Credit Facility may become due on demand at that time.

 

At December 31, 2020, the outstanding balance on the Credit Facility was $40 million, and the interest rate for the Credit Facility was 4.25%. As of December 31, 2020 and 2019, the outstanding balance on the Credit Facility was $40 million and $24.0 million, respectively, which approximates its fair market value. The Partnership estimated the fair value of its Credit Facility by discounting the future cash flows of the instrument at estimated market rates consistent with the maturity of a debt obligation with similar credit terms and credit characteristics, which are Level 3 inputs under the fair value hierarchy. Market rates take into consideration general market conditions and maturity.

 

 

Term Loan from Affiliate

 

On July 21, 2020, the Partnership, as borrower, entered into a loan agreement with GKDML, LLC (“GKDML”), which provides for an unsecured, one-year term loan (“Term Loan” or “Affiliate Loan”) in the amount of $15 million. GKDML is owned and managed by Glade M. Knight and David S. McKenney, the Chief Executive Officer and the Chief Financial Officer, respectively, of the General Partner. The Term Loan bears interest at a variable rate based on LIBOR plus a margin of 2.00%, with a LIBOR floor of 0%. Interest is payable monthly. The Term Loan contains mandatory prepayment requirements, customary affirmative and negative covenants and events of default. At December 31, 2020, the outstanding balance on the Term Loan was $6 million, the interest rate for the Term Loan was approximately 2.1% and the Partnership was in compliance of all applicable covenants.

 

To provide the proceeds for the Term Loan, GKDML entered into a loan agreement with Bank of America, N.A. on July 21, 2020 (“GKDML Loan”). The GKDML Loan has substantially the same terms as the Term Loan and is personally guaranteed by Messrs. Knight and McKenney. GKDML, Mr. Knight and Mr. McKenney have not and will not receive any consideration for providing the Term Loan or guaranty to the GKDML Loan; however, under the Term Loan, the Partnership is required to reimburse GKDML for all costs of the GKDML Loan. The Term Loan may be prepaid at any time with no penalty and in any amount, but any amounts repaid may not be reborrowed.

 

Note 5. Fair Value of Financial Instruments

 

The Partnership follows authoritative guidance related to fair value measurement and disclosure, which establishes a three-level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy categorizes assets and liabilities measured at fair value into one of three different levels depending on the observability of the inputs employed in the measurement using market participant assumptions at the measurement date. Categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The three levels are defined as follows:

 

Level 1: Quoted prices in active markets for identical assets

 

Level 2: Significant other observable inputs – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, either directly or indirectly, for substantially the full term of the financial instrument

 

Level 3: Significant unobservable inputs

 

The Partnership’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and the consideration of factors specific to the asset or liability. The Partnership’s policy is to recognize transfers in or out of a fair value hierarchy as of the end of the reporting period for which the event or change in circumstances caused the transfer. The Partnership has consistently applied the valuation techniques discussed above for all periods presented. During the years ended December 31, 2020 and 2019, there were no transfers in or out of Level 1, Level 2, or Level 3 assets and liabilities measured on a recurring basis.

 

 

As required, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The following table sets forth by level within the fair value hierarchy the Partnership’s financial assets and liabilities that were accounted for at fair value on a recurring basis as of December 31, 2020 and 2019.

 

  

Fair Value Measurements at December 31, 2020

 
  

Quoted Prices in
Active Markets for Identical Assets
(Level 1)

  

Significant Other Observable Inputs
(Level 2)

  

Significant Unobservable Inputs
(Level 3)

 

Commodity derivatives - current liabilities

 $0  $(602,760) $0 

Total

 $0  $(602,760) $0 

 

  

Fair Value Measurements at December 31, 2019

 
  

Quoted Prices in
Active Markets for Identical Assets
(Level 1)

  

Significant Other Observable Inputs
(Level 2)

  

Significant Unobservable Inputs
(Level 3)

 

Commodity derivatives - current liabilities

 $0  $(183,850) $0 

Total

 $0  $(183,850) $0 

 

The Level 2 instruments presented in the table above consist of Partnership’s costless collar commodity derivative instruments. The fair value of the Partnership’s derivative financial instruments is determined based upon future prices, volatility and time to maturity, among other things. Counterparty statements are utilized to determine the value of the commodity derivative instruments and are reviewed and corroborated using various methodologies and significant observable inputs. The fair value of the commodity derivatives noted above are included in the Partnership’s consolidated balance sheets as Derivative Liability at December 31, 2020 and 2019. See additional detail in Note 6. Risk Management.

 

Fair Value of Other Financial Instruments

 

The carrying value of the Partnership’s cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities reflect these items’ cost, which approximates fair value based on the timing of the anticipated cash flows, current market conditions and short-term maturity of these instruments. In addition, see Note 4. Debt for the fair value discussion on the Partnership’s debt.

 

Note 6. Risk Management

 

Participation in the oil and gas industry exposes the Partnership to risks associated with potentially volatile changes in energy commodity prices, and therefore, the Partnership’s future earnings are subject to these risks. Periodically, the Partnership utilizes derivative contracts to manage the commodity price risk on the Partnership’s future oil production it will produce and sell and to reduce the effect of volatility in commodity price changes to provide a base level of cash flow from operations. The Partnership settled three derivative contracts during the first quarter of 2020, and in accordance with the Letter Agreement discussed in Note 4. Debt, the Partnership is required to maintain a risk management program to manage the commodity price risk on the Partnership’s future oil and natural gas production for the period from August 31, 2020 until the next borrowing base redetermination date (first quarter of 2021). In August 2020, the Partnership established its risk management program by entering into costless collar derivative contracts for future oil and natural gas produced by the Sanish Field Assets during the period from August 2020 through February 2021. All derivative instruments are recorded on the Partnership’s balance sheet as assets or liabilities measured at fair value.

 

As of December 31, 2020 and 2019, the Partnership’s derivative instruments were in a loss position; therefore, current liabilities of approximately $0.6 million and $0.2 million, respectively, which approximate fair value, were recognized as Derivative Liability on the Partnership’s consolidated balance sheets.

 

 

The Partnership determined the estimated fair value of derivative instruments using a market approach based on several factors, including quoted market prices in active markets and quotes from third parties, among other things. The Partnership also performed an internal valuation to ensure the reasonableness of third-party quotes. In consideration of counterparty credit risk, the Partnership assessed the possibility of whether the counterparty to the derivative would default by failing to make any contractually-required payments. Additionally, the Partnership considered that the counterparty is of substantial credit quality and had the financial resources and willingness to meet its potential repayment obligations associated with the derivative transactions. See additional discussion above in Note 5. Fair Value of Financial Instruments.

 

The Partnership has not designated its derivative instruments as hedges for accounting purposes and has not entered into such instruments for speculative trading purposes. As a result, when derivatives do not qualify or are not designated as a hedge, the changes in the fair value are recognized on the Partnership’s consolidated statements of operations as a gain or loss on derivative instruments. The following table presents settlements of matured derivative instruments and non-cash losses on open derivative instruments for the periods presented. Settlements on matured derivatives below reflect a realized net gain on derivative contracts which matured during the period, calculated as the difference between the contract price and the market settlement price. The mark-to-market (non-cash) losses below represent the change in fair value of derivative instruments which were held at period-end.

 

  

Year Ended

December 31, 2020

  

Year Ended

December 31, 2019

 

Settlements on matured derivatives, net

 $146,710  $13,310 

Loss on mark-to-market of derivatives, net

  (418,910)  (183,850)

Loss on derivatives, net

 $(272,200) $(170,540)

 

The Partnership generally uses costless collar derivative contracts, which establish floor and ceiling prices on future anticipated production. The Partnership did not pay or receive a premium related to the costless collars, and the contracts are settled monthly. The following table reflects the open costless collar derivative instruments as of December 31, 2020.

 

Settlement Period

 

Basis

 

Product

 

Volume

 

Floor / Ceiling Prices ($)

 

Fair Value of Asset (Liability) at
December 31, 2020

 

01/2021 - 02/2021

 

NYMEX

 

Oil (bbls)

  30,000 

 37.50 / 44.50

 $(174,600)

01/2021 - 02/2021

 

NYMEX

 

Oil (bbls)

  30,000 

 38.00 / 44.25

  (184,350)

01/2021 - 02/2021

 

NYMEX

 

Oil (bbls)

  30,000 

 38.00 / 44.00

  (194,850)

01/2021 - 02/2021

 

NYMEX

 

Oil (bbls)

  15,000 

 38.00 / 44.50

  (67,590)

01/2021 - 02/2021

 

Henry Hub

 

Gas (MMBtu)

  120,000 

 2.50 / 3.05

  18,630 
           $(602,760)

 

The Partnership’s outstanding derivative instrument is covered by an International Swap Dealers Association Master Agreement (“ISDA”) entered into with the counterparty. The ISDA may provide that as a result of certain circumstances, such as cross-defaults, a counterparty may require all outstanding derivative instruments under an ISDA to be settled immediately. The Partnership has netting arrangements with the counterparty that provide for offsetting payables against receivables from separate derivative instruments. The use of derivative instruments involves the risk that the Partnership’s counterparty will be unable to meet the financial terms of such instruments.

 

Note 7. Capital Contribution and Partners Equity

 

At inception, the General Partner and organizational limited partner made initial capital contributions totaling $1,000 to the Partnership. Upon closing of the minimum offering the organizational limited partner withdrew its initial capital contribution of $990, the General Partner received Incentive Distribution Rights (defined below), and was reimbursed for its documented third-party out-of-pocket expenses incurred in organizing the Partnership and offering the common units.

 

The Partnership completed its best-efforts offering of common units on April 24, 2017. As of the conclusion of the offering on April 24, 2017, the Partnership had completed the sale of approximately 19.0 million common units for total gross proceeds of $374.2 million and proceeds net of offerings costs of $349.6 million.

 

 

Under the agreement with the Dealer Manager, the Dealer Manager received a total of 6% in selling commissions and a marketing expense allowance based on gross proceeds of the common units sold. The Dealer Manager will also be paid a contingent incentive fee, which is a cash payment of up to an amount equal to 4% of gross proceeds of the common units sold based on the performance of the Partnership. Based on the common units sold in the best-efforts offering, the total contingent fee is approximately $15.0 million.

 

Prior to “Payout,” which is defined below, all of the distributions made by the Partnership, if any, will be paid to the holders of common units. Accordingly, the Partnership will not make any distributions with respect to the Incentive Distribution Rights (owned by the General Partner), the Class B units or the contingent, incentive payments to the Dealer Manager, until Payout occurs.

 

The Partnership Agreement provides that Payout occurs on the day when the aggregate amount distributed with respect to each of the common units equals $20.00 plus the Payout Accrual. The Partnership Agreement defines “Payout Accrual” as 7% per annum simple interest accrued monthly until paid on the Net Investment Amount outstanding from time to time. The Partnership Agreement defines Net Investment Amount initially as $20.00 per common unit, regardless of the amount paid for the common unit. If at any time the Partnership distributes to holders of common units more than the Payout Accrual, the amount the Partnership distributes in excess of the Payout Accrual will reduce the Net Investment Amount.

 

All distributions made by the Partnership after Payout, which may include all or a portion of the proceeds of the sale of all or substantially all of the Partnership’s assets, will be made as follows:

 

First, (i) to the Record Holders of the Incentive Distribution Rights, 35%; (ii) to the Record Holders of the Outstanding Class B units, pro rata based on the number of Class B units owned, 35% multiplied by a fraction, the numerator of which is the number of Class B units outstanding and the denominator of which is 100,000 (currently, there are 62,500 Class B units outstanding; therefore, Class B units could receive 21.875%); (iii) to the Dealer Manager, as the Dealer Manager contingent incentive fee paid under the Dealer Manager Agreement, 30%, and (iv) the remaining amount, if any (currently 13.125%), to the Record Holders of outstanding common units, pro rata based on their percentage interest until such time as the Dealer Manager receives the full amount of the Dealer Manager contingent incentive fee under the Dealer Manager Agreement;

 

Thereafter, (i) to the Record Holders of the Incentive Distribution Rights, 35%; (ii) to the Record Holders of the Outstanding Class B units, pro rata based on the number of Class B units owned, 35% multiplied by a fraction, the numerator of which is the number of Class B units outstanding and the denominator of which is 100,000 (currently, there are 62,500 Class B units outstanding; therefore, Class B units could receive 21.875%); (iii) the remaining amount to the Record Holders of outstanding common units, pro rata based on their percentage interest (currently 43.125%). 

 

All items of income, gain, loss and deduction will be allocated to each Partner’s capital account in a manner generally consistent with the distribution procedures outlined above.

 

In March 2020, the General Partner approved the suspension of distributions to limited partners of the Partnership in response to market volatility resulting from COVID-19 and the impact on the Partnership’s operating cash flows. The Partnership has accumulated and will continue to accumulate unpaid distributions based on an annualized return of seven percent (7%), and all accumulated unpaid distributions are required to be paid before final Payout occurs, as defined above. As discussed in Note 4. Debt and pursuant to the Letter Agreement, the Partnership is not permitted to pay distributions without lender approval. As of December 31, 2020, the unpaid Payout Accrual totaled $1.181370 per common unit, or approximately $22 million.

 

For the year ended December 31, 2020, the Partnership paid distributions of $0.241644 per common unit, or $4.6 million. For the year ended December 31, 2019, the Partnership paid distributions of $1.396164 per common unit or $26.5 million.

 

Note 8. Related Parties

 

The members of the General Partner are affiliates of Glade M. Knight, Chairman and Chief Executive Officer, David S. McKenney, Chief Financial Officer, Anthony F. Keating, III, Co-Chief Operating Officer and Michael J. Mallick, Co-Chief Operating Officer. Mr. Knight and Mr. McKenney are also the Chief Executive Officer and Chief Financial Officer of Energy Resources 12 GP, LLC, the general partner of Energy Resources 12, L.P. (“ER12”), a limited partnership that also invests in producing and non-producing oil and gas properties on-shore in the United States. Entities owned by Messrs. Keating and Mallick own non-voting, Class B units in the general partner of ER12.

 

 

The Partnership has, and is expected to continue to engage in, significant transactions with related parties. These transactions cannot be construed to be at arm’s length and the results of the Partnership’s operations may be different than if conducted with non-related parties. The General Partner’s Board of Directors oversees and reviews the Partnership’s related party relationships and is required to approve any significant modifications to any existing related party transactions, as well as any new significant related party transactions.

 

For the years ended December 31, 2020 and 2019, approximately $381,000 and $319,000 of general and administrative costs were incurred by a member of the General Partner and have been or will be reimbursed by the Partnership. At December 31, 2020 and 2019, approximately $52,000 and $83,000, respectively, was due to/from members of the General Partner; these costs are included in Accounts payable and accrued expenses in the consolidated balance sheets.

 

On January 31, 2018, the Partnership entered into a cost sharing agreement with ER12 that gave ER12 access to the Partnership’s personnel and administrative resources, including accounting, asset management and other day-to-day management support. The cost sharing agreement reduced these accounting and asset management costs to the Partnership, as these shared day-to-day costs were split evenly between the two partnerships. The shared costs were based on actual costs incurred with no mark-up or profit to the Partnership. Any other direct third-party costs were paid by the party receiving the services. The compensation due to Clifford J. Merritt, President of the General Partner, was also a shared cost between the Partnership and ER12 for the years ended December 31, 2020 and 2019. The Partnership leases office space in Oklahoma City, Oklahoma on a month-to-month basis from an affiliate of the General Partner; because the office space is shared between the Partnership and ER12, the monthly payments of $8,537 made in 2019 and 2020 were evenly split between the two partnerships in accordance with the cost sharing agreement. For the years ended December 31, 2020 and 2019, approximately $268,000 and $285,000, respectively, of expenses subject to the cost sharing agreement were incurred by the Partnership and have been reimbursed by ER12. At December 31, 2019, approximately $85,000 was due to the Partnership from ER12 and is included in Other current assets in the consolidated balance sheet. In October 2020, the cost sharing agreement was terminated by ER12, effective December 31, 2020.

 

On December 1, 2020, the Partnership entered into an Administrative Services Agreement (the “ASA”) with Regional Energy Investors, L.P. d/b/a Regional Energy Management (the “Administrator”) and ER12, whereby the Administrator will provide administrative, operating and professional services necessary and useful to the Partnership. Costs and expenses attributable to the services performed by the Administrator under the ASA will be reimbursed by the Partnership. All Administrator costs and expenses will be accumulated (based on actual costs incurred with no mark-up or profit to the Administrator) and approved by the Partnership prior to reimbursement. Costs and expenses to be reimbursed under the ASA may include, but are not limited to, employee wages and benefits, rent for office space and network and information technology support. Other expenses, such as business travel costs and accounting, legal or banking services, may not be incurred by the Administrator on behalf of the Partnership without prior express written consent of the Partnership.

 

The ASA is effective January 1, 2021, and the Initial Term of the ASA will extend until the earlier of (a) five years or (b) when the Partnership and/or ER12 ceases to own its respective oil and natural gas assets. Provided the ASA is not terminated by any party via 60-day written notice at the conclusion of the Initial Term, the ASA will be automatically renewed for additional one-year periods. If a party to the ASA materially breaches the terms and conditions of the ASA and the breach has not been cured with 30 days of written notification of said breach, the ASA may be terminated with immediate effect.

 

The Administrator will also assist Energy Resources 12 GP, LLC, the general partner of ER12 (“ER12’s General Partner”), with the day-to-day operations of ER12. ER12 currently pays ER12’s General Partner an annual management fee of 0.5% of the total gross equity proceeds raised by ER12 in its best-efforts offering. Under the ASA, ER12’s General Partner will pay one-half of its annual management fee to the Administrator in exchange for the services to be provided under the ASA. This fee is only applicable to ER12 and does not apply to the Partnership. The Administrator is owned by entities that are controlled by Messrs. Keating and Mallick.

 

E11 Incentive Holdings, LLC (“Incentive Holdings”) was the owner of all Class B units outstanding (62,500) as of March 31, 2017. During the second quarter of 2017, Incentive Holdings transferred substantially all of its assets; on April 5, 2017, Incentive Holdings transferred 18,125 of the 62,500 Class B units to E11 Incentive Carry Vehicle, LLC, an affiliate of Incentive Holdings, for de minimis consideration. On April 6, 2017, the remaining 44,375 Class B units were acquired by Regional Energy Incentives, LP in exchange for approximately $98,000. Regional Energy Incentives, LP is owned by entities that are controlled by Messrs. Keating, Mallick and McKenney. The Class B units entitle the holder to certain distribution rights after Payout, as described in Note 7. Capital Contribution and Partners’ Equity.

 

 

Note 9. Supplementary Information on Oil, Natural Gas and Natural Gas Liquid Reserves (Unaudited)

 

Aggregate Capitalized Costs

 

The aggregate amount of capitalized costs of oil, natural gas and NGL properties and related accumulated depreciation, depletion and amortization as of December 31, 2020 and 2019 is as follows:

 

  

2020

  

2019

 

Producing properties

 $229,234,243  $217,356,850 

Non-producing

  169,731,229   162,587,950 
   398,965,472   379,944,800 

Accumulated depreciation, depletion and amortization

  (75,765,289)  (53,186,164)

Net capitalized costs

 $323,200,183  $326,758,636 

 

Costs Incurred

 

For the years ended December 31, 2020 and 2019, the Partnership incurred the following costs in oil and natural gas producing activities:

 

  

2020

  

2019

 

Development costs

 $19,020,672  $26,021,438 

 

Estimated Quantities of Proved Oil, NGL and Natural Gas Reserves

 

The following unaudited information regarding the Partnership’s oil, natural gas and NGL reserves is presented pursuant to the disclosure requirements promulgated by the SEC and the FASB.

 

Proved oil and natural gas reserves are those quantities of oil, natural gas and NGLs which, by analysis of geosciences and engineering data, can be estimated with reasonable certainty to be economically producible – from a given date forward, from 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. Existing economic conditions include prices and costs at which economic producibility from a reservoir is to be determined. The price shall be the average price during the 12-month period prior to the ending date of the period covered by the report, determined as an unweighted arithmetic average of the first-day-of-the-month price for each month within such period, unless prices are defined by contractual arrangements, excluding escalations based upon future conditions. The project to extract the hydrocarbons must have commenced, or the operator must be reasonably certain that it will commence the project within a reasonable time. The area of the reservoir considered as proved includes: (i) the area identified by drilling and limited by fluid contacts, if any, and (ii) adjacent undrilled portions of the reservoir that can, with reasonable certainty, be judged to be continuous with it and to contain economically producible oil or natural gas on the basis of available geoscience and engineering data. In the absence of data on fluid contacts, proved quantities in a reservoir are limited by the lowest known hydrocarbons as seen in a well penetration unless geoscience, engineering or performance data and reliable technology establishes a lower contact with reasonable certainty. Where direct observation from well penetrations has defined a highest known oil elevation and the potential exists for an associated natural gas cap, proved oil reserves may be assigned in the structurally higher portions of the reservoir only if geoscience, engineering or performance data and reliable technology establish the higher contact with reasonable certainty. Reserves which can be produced economically through application of improved recovery techniques (including, but not limited to, fluid injection) are included in the proved classification when: (i) successful testing by a pilot project in an area of the reservoir with properties no more favorable than in the reservoir as a whole, the operation of an installed program in the reservoir or an analogous reservoir, or other evidence using reliable technology establishes the reasonable certainty of the engineering analysis on which the project or program was based; and (ii) the project has been approved for development by all necessary parties and entities, including governmental entities.

 

The independent consulting petroleum engineering firm of Pinnacle Energy of Oklahoma City, OK, prepared estimates of the Partnership’s oil, natural gas and NGL reserves as of December 31, 2020, 2019 and 2018.

 

 

The Partnership’s net proved oil, NGL and natural gas reserves, all of which are located in the contiguous United States, as of December 31, 2020, 2019 and 2018, have been estimated by the Partnership’s independent consulting petroleum engineering firm. Estimates of reserves were prepared by the use of appropriate geologic, petroleum engineering and evaluation principles and techniques that are in accordance with SEC rules and regulations along with practices generally recognized by the petroleum industry as presented in the publication of the Society of Petroleum Engineers entitled “Standards Pertaining to the Estimating and Auditing of Oil and Gas Reserves Information (Revision as of February 19, 2007).” The method or combination of methods used in the analysis of each reservoir was tempered by experience with similar reservoirs, stage of development, quality and completeness of basic data and production history.

 

For depletion-type reservoirs or those whose performance disclosed a reliable decline in producing-rate trends or other diagnostic characteristics, reserves were estimated by the application of appropriate decline curves or other performance relationships. In the analyses of production-decline curves, reserves were estimated only to the limits of economic production or to the limit of the production licenses as appropriate. Accordingly, these estimates should be expected to change, and such changes could be material and occur in the near term as future information becomes available. “Revisions of previous estimates” in the table below represent changes in previous reserve estimates, either upward or downward, resulting from a change in economic factors, such as commodity prices, operating costs or development costs, or resulting from information obtained from the Partnership’s production history.

 

The rollforward of net quantities of proved developed and undeveloped oil, natural gas and NGL reserves are summarized as follows:

 

  

Proved Reserves

 
  

Oil

  

Natural Gas

  

NGLs

     
  

(Bbls)

  

(Mcf)

  

(Bbls)

  

Total (BOE)

 

December 31, 2018

  19,557,273   23,040,536   3,987,383   27,384,745 

   Acquisition

  0   0   0   0 

   Extensions, discoveries and other additions (1)

  1,101,604   1,167,115   163,884   1,460,007 

   Revisions of previous estimates (2)

  (1,213,675)  456,464   (710,685)  (1,848,283)

   Production

  (624,079)  (888,208)  (126,516)  (898,629)

December 31, 2019

  18,821,123   23,775,907   3,314,066   26,097,840 

   Acquisition

  0   0   0   0 

   Extensions, discoveries and other additions

  0   0   0   0 

   Revisions of previous estimates (3)

  (3,391,968)  (5,920,203)  (527,522)  (4,906,190)

   Production

  (1,014,980)  (1,057,474)  (158,050)  (1,349,276)

December 31, 2020

  14,414,175   16,798,230   2,628,494   19,842,374 

(1)

In 2019, extensions, discoveries and other additions of 1,460 MBOE were primarily attributable to successful drilling by the Partnership’s primary operator in the Sanish field.

  

(2)

Revisions to previous estimates decreased proved reserves by a net amount of 1,848 MBOE. These revisions result from 1,216 MBOE of downward adjustments attributable to well performance when comparing the Partnership’s reserve estimates at December 31, 2019 to December 31, 2018, 511 MBOE of downward adjustments caused by lower oil, natural gas and NGL prices when comparing the Partnership’s reserve estimates at December 31, 2019 to December 31, 2018, and 121 MBOE of downward adjustments attributable to changes in the future drill schedule.

  

(3)

Revisions to previous estimates decreased proved reserves by a net amount of 4,906 MBOE. These revisions result from 5,409 MBOE of downward adjustments attributable to changes in the future drill schedule and 1,619 MBOE of downward adjustments caused by lower oil, natural gas and NGL prices when comparing the Partnership’s reserve estimates at December 31, 2020 to December 31, 2019, offset by 2,122 of upward adjustments attributable to well performance when comparing the Partnership’s reserve estimates at December 31, 2020 to December 31, 2019.

 

 

In accordance with SEC Regulation S-X, Rule 4-10, as amended, the Partnership uses the 12-month average price calculated as the unweighted arithmetic average of the spot price on the first day of each month within the 12-month period prior to the end of the reporting period. The oil and natural gas prices used in computing the Partnership’s reserves as of December 31, 2020 were $39.57 per barrel of oil and $1.99 per MMcf of natural gas, before price differentials. Including the effect of price differential adjustments, the average realized prices used in computing the Partnership’s reserves as of December 31, 2020 were $32.08 per barrel of oil, $(0.55) per MMcf of natural gas and $5.54 per barrel of NGL. The oil and natural gas prices used in computing the Partnership’s reserves as of December 31, 2019 were $55.69 per barrel of oil and $2.58 per MMcf of natural gas, before price differentials. Including the effect of price differential adjustments, the average realized prices used in computing the Partnership’s reserves as of December 31, 2019 were $47.70 per barrel of oil, $(0.03) per MMcf of natural gas and $8.91 per barrel of NGL.

 

Net quantities of proved developed and proved undeveloped reserves at December 31, 2020, 2019 and 2018 are summarized in the table below. The net quantities classified as proved developed reserves at December 31, 2019 include 4 proved developed non-producing (“PDNP”) wells converted to producing, as these wells were substantially complete at December 31, 2019 and the costs to bring to production were relatively minor.

 

  

Oil

  

Natural Gas

  

NGLs

     
  

(Bbls)

  

(Mcf)

  

(Bbls)

  

Total (BOE)

 

Proved developed reserves:

                

   December 31, 2018

  9,195,064   12,333,784   2,134,478   13,385,173 

   December 31, 2019

  9,771,596   14,232,526   1,974,006   14,117,690 

   December 31, 2020

  10,688,857   12,992,674   2,029,392   14,883,695 
                 

Proved undeveloped reserves:

                

   December 31, 2018

  10,362,209   10,706,752   1,852,905   13,999,573 

   December 31, 2019

  9,049,527   9,543,381   1,340,060   11,980,151 

   December 31, 2020

  3,725,318   3,805,556   599,102   4,958,679 

 

The following details the changes in proved undeveloped reserves (PUD) for 2019 and 2020:

 

  

BOE

 

Proved undeveloped reserves, December 31, 2018

  13,999,573 

   Revisions of previous estimates (1)

  (365,470)

   Extensions, discoveries and other additions (2)

  1,460,007 

   Conversion to proved developed reserves (3)

  (3,113,959)

   Proved undeveloped reserves acquired

  0 

Proved undeveloped reserves, December 31, 2019

  11,980,151 

   Revisions of previous estimates (4)

  (5,501,947)

   Extensions, discoveries and other additions

  0 

   Conversion to proved developed reserves (5)

  (1,519,525)

   Proved undeveloped reserves acquired

  0 

Proved undeveloped reserves, December 31, 2019

  4,958,679 

(1)

The annual review of the PUDs resulted in a negative revision of approximately 365 MBOE. This revision was the result of 244 MBOE of downward adjustments attributable to changes in natural gas shrink and NGL yield when comparing the Partnership’s reserves at December 31, 2018 to December 31, 2019 and 121 MBOE of downward adjustments attributable to changes in the future drill schedule.

  

(2)

In 2019, extensions, discoveries and other additions of 1,460 MBOE were primarily attributable to successful drilling by the Partnership’s primary operator in the Sanish field.

  

(3)

The Partnership completed 11 new wells during 2019. In addition, the Partnership had four wells at December 31, 2019 classified as PDNP that were substantially complete and the costs to bring to production were relatively minor. Therefore, the Partnership converted the 11 completed wells and the four PDNP wells from PUD to proved developed reserves, which resulted in a downward adjustment to PUDs of 3,114 MBOE.

 

 

(4)

The annual review of the PUDs resulted in a negative revision of approximately 5,502 MBOE. This revision was the result of 5,409 MBOE of downward adjustments attributable to changes in the future drill schedule, 121 MBOE of downward adjustments caused by lower oil, natural gas and NGL prices when comparing the Partnership’s reserve estimates at December 31, 2020 and December 31, 2019, and 28 MBOE of upward adjustments attributable to changes in natural gas shrink and NGL yield when comparing the Partnership’s reserves at December 31, 2020 to December 31, 2019.

  

(5)

The Partnership completed 11 new wells during 2020. As discussed in (3) above, the Partnership already converted four of these 11 wells from PUD to proved developed reserves at December 31, 2019 because they were substantially complete and the costs to bring to production were relatively minor. Therefore, the Partnership converted the other 7 completed wells to proved developed reserves during 2020, which resulted in a downward adjustment to PUDs of 1,520 MBOE.

 

Based upon current information from its operators, the Partnership anticipates all current PUD locations will be drilled and converted to PDP within five years of the date they were added. PUD locations and associated reserves which are no longer projected to be drilled within five years from the date they were first booked as proved undeveloped reserves have been removed as revisions at the time that determination was made.

 

Standardized Measure of Discounted Future Net Cash Flows

 

Accounting standards prescribe guidelines for computing a standardized measure of future net cash flows and changes therein relating to estimated proved reserves. The Partnership has followed these guidelines, which are briefly discussed below.

 

Future cash inflows and future production and development costs are determined by applying the trailing unweighted 12-month arithmetic average of the first-day-of-the-month individual product prices and year-end costs to the estimated quantities of oil, natural gas and NGL to be produced. Actual future prices and costs may be materially higher or lower than the unweighted 12-month arithmetic average of the first-day-of-the-month individual product prices and year-end costs used. For each year, estimates are made of quantities of proved reserves and the future periods during which they are expected to be produced based on continuation of the economic conditions applied for such year.

 

The resulting future net cash flows are reduced to present value amounts by applying a 10% annual discount factor. The assumptions used to compute the standardized measure are those prescribed by the FASB and, as such, do not necessarily reflect the Partnership’s expectations of actual revenue to be derived from those reserves nor their present worth. The limitations inherent in the reserve quantity estimation process, as discussed previously, are equally applicable to the standardized measure computations since these estimates affect the valuation process.

 

  

2020

  

2019

 

Future cash inflows

 $467,805,216  $926,512,000 

Future production costs

  (197,152,040)  (297,812,320)

Future development costs

  (58,641,300)  (120,692,304)

Future net cash flows

  212,011,876   508,007,376 

10% annual discount

  (139,125,116)  (301,184,896)

Standardized measure of discounted future net cash flows

 $72,886,760  $206,822,480 

 

Changes in the standardized measure of discounted future net cash flows are as follows:

 

  

2020

  

2019

 

Standardized measure at beginning of period

 $206,822,480  $304,884,875 

Changes resulting from:

        

   Acquisition of reserves

  0   0 

   Extensions, discoveries and other additions

  0   21,876,159 

   Sales of oil, natural gas and NGLs, net of production costs

  (23,607,481)  (23,283,973)

   Net changes in prices and production costs

  (129,957,704)  (100,417,683)

   Development costs incurred during the period

  19,020,672   26,021,438 

   Revisions to previous estimates

  (63,132,466)  (27,133,641)

   Accretion of discount

  20,710,927   30,530,765 

   Change in estimated future development costs

  43,030,332   (25,655,460)

Standardized measure of discounted future net cash flows

 $72,886,760  $206,822,480 

 

 

Note 10. Quarterly Financial Data (Unaudited)

 

The following is a summary of quarterly results of operations for the years ended December 31, 2020 and 2019.

 

  

2020

 
  

First Quarter

  

Second Quarter

  

Third Quarter

  

Fourth Quarter

 

Total revenue

 $11,103,534  $4,752,518  $9,650,268  $11,051,756 

Net income (loss)

 $2,933,427  $(4,441,521) $(879,896) $(417,333)

Basic and diluted net income (loss) per common share

 $0.15  $(0.23) $(0.05) $(0.02)

 

  

2019

 
  

First Quarter

  

Second Quarter

  

Third Quarter

  

Fourth Quarter

 

Total revenue

 $10,091,345  $9,317,659  $7,339,109  $9,271,489 

Net income

 $2,339,974  $1,959,063  $1,794,044  $2,387,369 

Basic and diluted net income per common share

 $0.12  $0.10  $0.09  $0.13 

 

Note 11. Subsequent Events

 

During the first quarter of 2021, the Partnership paid off the remaining $6 million balance on its Affiliate Loan with GKDML, LLC. The Partnership did not incur a penalty for prepayment.

 

 

 

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

None

 

Item 9A. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

In accordance with Rules 13a-15 and 15d-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), the Partnership carried out an evaluation, under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer of the General Partner, of the effectiveness of the Partnership’s disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer of the General Partner concluded that the Partnership’s disclosure controls and procedures were effective as of December 31, 2020 to provide reasonable assurance that information required to be disclosed in the Partnership’s reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. The Partnership’s disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed in reports filed or submitted under the Exchange Act is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer of the General Partner, as appropriate, to allow timely decisions regarding required disclosure.

 

Managements Annual Report on Internal Control Over Financial Reporting

 

Partnership management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act. The Partnership has performed an evaluation under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer of the General Partner, of the effectiveness of our internal control over financial reporting. Partnership management assessed the effectiveness of its internal control over financial reporting as of December 31, 2020. Partnership management used the criteria set forth in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) to perform its assessment. Based on this assessment, Partnership management, including the Chief Executive Officer and Chief Financial Officer of the General Partner, concluded, that as of December 31, 2020, the Partnership’s internal control over financial reporting was effective based on those criteria.

 

Changes in Internal Control Over Financial Reporting

 

There has been no change in the Partnership’s internal control over financial reporting during the quarter ended December 31, 2020 that has materially affected, or is reasonably likely to materially affect, the Partnership’s internal control over financial reporting.

 

Item 9B. Other Information

 

None

 

 

 

PART III

 

Item 10. Directors, Executive Officers, and Corporate Governance

 

Directors and Executive Officers of the General Partner

 

As is the case with many partnerships, the Partnership does not directly employ officers, directors or employees. Its operations and activities are managed by the Board of Directors and executive officers of the General Partner. References to directors and executive officers are references to the directors and executive officers of the General Partner.

 

The following table sets forth the names, ages and offices of the present directors and executive officers of the General Partner as of December 31, 2020.

 

Name

 

Age

 

Position

Glade M. Knight

 

76

 

Chairman of the Board and Chief Executive Officer

David S. McKenney

 

58

 

Director and Chief Financial Officer and Secretary

Anthony Francis “Chip” Keating III

 

41

 

Director and Co-Chief Operating Officer

Michael J. Mallick

 

58

 

Director and Co-Chief Operating Officer

Clifford J. Merritt

 

60

 

President

 

The following is a biographical summary of the business experience of these directors and executive officers:

 

Glade M. Knight. Mr. Knight has been the Chairman of the Board and Chief Executive Officer of the General Partner since its formation in July 2013. Mr. Knight is also part owner of and the Chief Executive Officer of Energy Resources 12 GP, LLC, the general partner of Energy Resources 12, L.P., a partnership focused on investments in the oil and gas industry. Mr. Knight is the founder and has served as Executive Chairman of Apple Hospitality REIT, Inc. since May 2014, and previously served as Chairman and Chief Executive Officer since its inception. Mr. Knight was also the founder of each of the former Apple REIT Companies and served as their Chairman and Chief Executive Officer from inception until the companies were sold to a third party or merged with Apple Hospitality REIT, Inc. In addition, Mr. Knight served as Chairman and Chief Executive Officer of Cornerstone Realty Income Trust, Inc. from 1993 until it merged with a subsidiary of Colonial Properties Trust in 2005. Following the merger in 2005 until April 2011, Mr. Knight served as a trustee of Colonial Properties Trust. Cornerstone Realty Income Trust, Inc. owned and operated apartment communities in Virginia, North Carolina, South Carolina, Georgia and Texas. Mr. Knight is the founding Chairman of Southern Virginia University in Buena Vista, Virginia. He also is a member of the Advisory Board to the Graduate School of Real Estate and Urban Land Development at Virginia Commonwealth University. Additionally, he serves on the National Advisory Council for Brigham Young University and is a founding member of the University’s Entrepreneurial Department of the Graduate School of Business Management. On February 12, 2014, Mr. Knight, Apple REIT Seven, Inc. (“Apple Seven”), Apple REIT Eight, Inc. (“Apple Eight”), Apple REIT Nine, Inc. (“Apple Nine”) and their related advisory companies entered into settlement agreements with the SEC. Along with Apple REIT Seven, Apple REIT Eight, Apple REIT Nine and their advisory companies, and without admitting or denying the SEC’s allegations, Mr. Knight consented to the entry of an administrative order, under which Mr. Knight and the noted companies each agreed to cease and desist from committing or causing any violations of Sections 13(a), 13(b)(2)(A), 13(b)(2)(B), 14(a), and 16(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and Rules 12b-20, 13a-1, 13a-13, 13a-14, 14a-9, and 16a-3 thereunder.

 

David S. McKenney. Mr. McKenney has been a Director and Chief Financial Officer and Secretary of the General Partner since its formation in July 2013. Mr. McKenney is also part owner of and the Chief Financial Officer of Energy Resources 12 GP, LLC, the general partner of Energy Resources 12, L.P., a partnership focused on investments in the oil and gas industry. Mr. McKenney was the President of Capital Markets of Apple REIT Ten, Inc. from its inception until it merged with Apple Hospitality REIT, Inc. in September 2016. Mr. McKenney previously served as President of Capital Markets for Apple Hospitality REIT, Inc. In addition, Mr. McKenney was the President of Capital Markets of Apple REIT Six, Inc., a real estate investment trust, from 2004 until the company merged with an affiliate of Blackstone Real Estate Partners VII in May 2013. Mr. McKenney served in the same capacity for Apple Hospitality Five, Inc., a lodging REIT, from 2002 until the company was sold to Inland American Real Estate Trust, Inc. in October of 2007, and Apple Hospitality Two, Inc., a lodging REIT, from 2001 until the company was sold to an affiliate of ING Clarion in May of 2007. From 1994 to 2001, Mr. McKenney served as Senior Vice President and Treasurer of Cornerstone Realty Income Trust, Inc., a REIT that owned and operated apartment communities in Virginia, North Carolina, South Carolina, Georgia and Texas. From 1992 to 1994, Mr. McKenney served as Chief Financial Officer for The Henry A. Long Company, a regional development firm located in Washington, D.C. From 1988 to 1992, Mr. McKenney served as a Controller at Bozzuto & Associates, a regional developer of apartments and condominiums in the Washington, D.C. area. Mr. McKenney holds Bachelor of Science degrees in Accounting and Management Information Systems from James Madison University.

 

 

Anthony “Chip Francis Keating III. Mr. Keating has been a Director and Co-Chief Operating Officer of the General Partner since its formation in July 2013. Through an entity controlled by Mr. Keating, Mr. Keating owns Class B, non-voting units in Energy Resources 12 GP, LLC, the general partner of Energy Resources 12, L.P., a partnership focused on investments in the oil and gas industry. Mr. Keating has been a principal with Rock Creek Capital, a real estate and oil and gas investment company, since March 2010. Mr. Keating also is an officer of the General Partner of Regional Energy Investors, LP, a partnership that provides consulting services in the oil and gas industry. He served on the board of Apple REIT Ten, Inc. until the merger with Apple Hospitality REIT, Inc. in September 2016. He is currently the past President of the board of The Children’s Hospital Foundation in Oklahoma City and a Director of the Oklahoma State Troopers Foundation, Inc. Mr. Keating also serves as a director for OU Medicine and as a trustee for the University Hospital Authorities Trust. Mr. Keating is a former Director and Gubernatorial appointee of The Oklahoma Law Enforcement Retirement System and in December 2020, Mr. Keating completed a two-year commitment to Oklahoma Governor Kevin J. Stitt as his Cabinet Secretary for Public Safety. Prior to founding Rock Creek Capital, Mr. Keating served as the Real Estate Development Manager for Chesapeake Energy Corporation in Oklahoma City, Oklahoma from March 2007 to March 2010. While at Chesapeake, Mr. Keating closed and transacted over $850 million in real estate transactions ranging from corporate headquarters, sale leasebacks, field offices, investment properties and raw land in urban natural gas plays for drill sites. Prior to joining Chesapeake, Mr. Keating worked as a commercial real estate broker with Trammell Crow Company from August 2004 to March 2007. While at Trammell Crow Company, he specialized in tenant representation and investment sales. Before joining Trammell Crow Company, he spent over three years as an Oklahoma State Trooper from May 2001 to August 2004. Mr. Keating received a Bachelor of Business Administration from Southern Methodist University.

 

Michael J. Mallick. Mr. Mallick has been a Director and Co-Chief Operating Officer of the General Partner since its formation in July 2013. Through an entity controlled by Mr. Mallick, Mr. Mallick owns Class B, non-voting units in Energy Resources 12 GP, LLC, the general partner of Energy Resources 12, L.P., a partnership focused on investments in the oil and gas industry. Mr. Mallick also is an officer of the General Partner of Regional Energy Investors, LP, a partnership that provides consulting services in the oil and gas industry. Mr. Mallick is the founder of Fort Worth, Texas-based Mallick Group, Inc., a real estate and energy-related investment firm. Mr. Mallick is a principal investor in various entities and serves as the principal officer of sponsoring and managing partners for numerous and diverse real estate investments and energy-related interests funded with established co-investment relationships with high net worth private investors, institutional investors and lenders. Mr. Mallick’s varied experience includes development of the 349-room Horseshoe Bay Marriott Resort Hotel, located in Horseshoe Bay, Texas (financed with a national pension fund); Sierra Vista, a redevelopment initiative in a public/private partnership with the City of Fort Worth, Texas, including the assemblage and acquisition of approximately 300 acres located within a concentration of blight inside the central city and resulting in environmental remediation and demolition of 1,000 crime-ridden apartment units and new quality affordable housing and shopping; and acquisition of a large multi-property portfolio of properties financed via a structured private placement offering with multiple institutional investors. Mr. Mallick serves on the Board of Directors of the Oklahoma State Troopers Foundation, Inc.

 

Clifford J. Merritt. On December 18, 2015, Mr. Merritt was appointed as President of the General Partner. Mr. Merritt had been a consultant to us since July 1, 2014, and to other private exploration and development companies since November 2013. Prior to that time and since 2004 he was employed by Chesapeake Energy Corporation. From 2010 to 2013 he served as Chesapeake’s Vice President Land – Southern Division and from 2005 to 2010 as Chesapeake’s Land Manager – Barnett Shale District. Before joining Chesapeake, he worked for Okland Oil, Ricks Exploration and Concho Resources during the years of 1990 through 2003, each of which is an independent oil and gas company. He has a B.B.A. from the University of Central Oklahoma. During his career, Mr. Merritt has been involved and managed the Land functions of numerous acquisitions and divestitures of oil and gas properties and supervised the drilling and completion of over 2,000 oil and gas wells throughout multiple states in the continental US. Additionally, Mr. Merritt provides consulting services to Regional Energy Investors, LP.

 

The General Partner

 

The General Partner is Energy 11 GP, LLC, which was formed in 2013 and has no operating history. The General Partner was formed and is owned by companies controlled by Glade M. Knight, David S. McKenney, Anthony “Chip” F. Keating III, and Michael J. Mallick.

 

The General Partner will not receive a management or similar fee for acting as General Partner and will not receive an offering and organization fee for organizing the Partnership. The Partnership will reimburse the General Partner and its affiliates for all general and administrative expenses incurred by the General Partner and its affiliates in managing the Partnership’s business. These costs and expenses will include the direct and indirect costs and expenses of employee compensation, rental, office supplies, travel and entertainment, printing, legal, accounting, advertising, marketing and overhead. The beneficial owners of the General Partner are not employees of the General Partner, and do not receive salary or other compensation from the General Partner or Partnership other than reimbursement of third-party costs and expenses and with respect to their equity interests in the Partnership. 

 

 

Code of Ethics

 

The General Partner has adopted a Code of Business Conduct and Ethics that applies to the executive officers of the General Partner and other persons performing services for the General Partner and the Partnership, generally. This Code of Business Conduct and Ethics is posted on the Partnership’s website, at www.energyeleven.com.

 

Audit and Compensation Committee

 

The Partnership does not have a formal compensation committee and the General Partner’s Board of Directors serves as the audit committee. Because the Partnership does not have and is not seeking to list any securities on a national securities exchange or on an inter-dealer quotation system, the Partnership is not subject to some of the corporate governance requirements of the SEC or of any national securities exchange or inter-dealer quotation system. For example, the Partnership is not required to have a board of directors comprised of a majority of independent directors or to have an audit committee comprised of independent directors. Accordingly, the Board of Directors has not made any determination as to whether any of the members of the Board of Directors or committees thereof would qualify as independent under the listing standards of any national securities exchange or any inter-dealer quotation system or under any other independence definition. Additionally, for the same reason, the Partnership has not yet determined whether any of its directors is an audit committee financial expert.

 

Item 11. Executive Compensation

 

Summary Compensation

 

The following table summarizes, with respect to each of the Chief Executive Officer and the two other most highly compensated officers of the General Partner (the “Named Executive Officers”), information relating to the compensation paid by the Partnership for services rendered in all capacities during the fiscal years ended December 31, 2020 and 2019. Since the only person being paid any compensation by the Partnership or the General Partner is Mr. Merritt, the Named Executive Officers only include Mr. Knight, the Chief Executive Officer, and Mr. Merritt.

 

Name and Principal Position:

 

Year

 

Salary

  

Bonus

  

All Other 

Compensation

  

Total

 
                   

Glade M. Knight

 

2020

 $  $  $  $ 

Chairman of the Board and Chief Executive Officer

 

2019

 $  $  $  $ 
                   

Clifford J. Merritt

 

2020

 $203,712  $  $  $203,712 

President

 

2019

 $203,480  $20,000  $  $223,480 

 

The Partnership does not directly employ any of the persons responsible for managing its business. Instead, the General Partner manages the Partnership’s day-to-day affairs and provides the Partnership with management and operating services. The owners of the General Partner will be reimbursed for documented out-of-pocket travel, entertainment and similar expenses incurred by them in connection with attending board of directors’ meetings or managing the Partnership’s business. The owners of the General Partner will not receive any salary, bonus or consulting fees for serving on the board of directors or managing the Partnership’s business other than distributions in accordance with the incentive distribution rights, if any.

 

For the years ended December 31, 2020 and 2019, the Partnership paid Mr. Merritt annual base compensation of $400,000 and basic health benefits. Because the services of Mr. Merritt were included as a shared cost under the Partnership’s cost sharing agreement with Energy Resources 12, L.P. (“ER12”), Mr. Merritt’s base compensation, bonus and basic health benefits were split evenly between the Partnership and ER12. Mr. Merritt also has a 5% interest in the General Partner’s incentive distribution rights.

 

Outstanding Equity Awards at Fiscal Year-End

 

There were no outstanding equity awards for the named executive officers as of December 31, 2020, other than the Incentive Distribution Rights.

 

 

Compensation of Directors

 

The employee and non-employee members of the General Partner’s board of directors do not receive compensation for their services as directors. However, the directors may be reimbursed for their expenses in attending board meetings.

 

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

The following table sets forth as of March 1, 2021 the beneficial ownership of the Partnership’s common units and Class B units that are owned by:

 

 

all persons who, to the knowledge of the Partnership’s management team, beneficially own more than 5% of the Partnership’s common units;

 

 

each executive officer of the General Partner; and

 

 

all current directors and executive officers of the General Partner as a group.

 

Name of Beneficial Owner

 

Common Units Beneficially Owned

  

Percentage of Common Units Beneficially Owned

  

Class B Units Beneficially Owned

  

Percentage of Class B Units Beneficially Owned

 

Glade M. Knight

120 W. 3rd Street, Suite 220

Fort Worth, Texas 76102

  5,000   *   -   - 

David S. McKenney

120 W. 3rd Street, Suite 220

Fort Worth, Texas 76102

  5,000   *   4,437   7

%

Anthony Francis "Chip" Keating III

120 W. 3rd Street, Suite 220

Fort Worth, Texas 76102

  5,000   *   19,969   32

%

Michael J. Mallick

120 W. 3rd Street, Suite 220

Fort Worth, Texas 76102

  5,000   *   19,969   32

%

Cliff Merritt

120 W. 3rd Street, Suite 220

Fort Worth, Texas 76102

  -   -   -   - 

Directors and principal officers as a group (5 persons)

  20,000   *   44,375   71

%


* Less than 1% of outstanding common units.

 

Class B Units

 

Regional Energy Incentives, LP, owned by entities that are controlled by Mr. Keating, Mr. Mallick and Mr. McKenney, owns 44,375 Class B units. The address of Regional Energy Incentives, LP is 3715 Camp Bowie Blvd, Fort Worth, Texas 76107. The remaining 18,125 Class B units are owned by E11 Incentive Carry Vehicle, LLC, an affiliate of Incentive Holdings, LLC. The address of E11 Incentive Carry Vehicle, LLC is 301 NW 63rd Street, Suite 400, Oklahoma City, Oklahoma 73116.

 

The Partnership may issue up to 37,500 additional Class B units, the amount of Class B units canceled in conjunction with the 2016 termination of the management services agreement the Partnership had with its former manager.

 

 

Ownership of the General Partner

 

The General Partner is a limited liability company. The members of the General Partner and the membership interest owned are as follows:

 

 

GKOG, LLC, owns a 25% membership interest in the General Partner. GKOG, LLC is a limited liability company owned by Mr. Knight and his immediate family.

 

 

DMOG, LLC owns a 25% membership interest in the General Partner. DMOG, LLC is a limited liability company owned by Mr. McKenney and his immediate family.

 

 

CFK Energy, LLC owns a 25% membership interest in the General Partner. CFK Energy, LLC is a limited liability company owned by Mr. Keating and his immediate family.

 

 

Pope Energy Investors, LP, a limited partnership, owns a 25% membership interest in the General Partner. The General Partner and the limited partner interests of Pope Energy Investors, LP are owned by Mr. Mallick and his immediate family.

 

Each member of the General Partner has the right to appoint one person to the General Partner’s board of directors. All decisions regarding the business of the General Partner and the Partnership will be made by the board of directors of the General Partner at meetings of the board of directors at which a quorum is present. The presence of a majority of the directors constitutes a quorum, and the vote of a majority of a quorum constitutes a decision by the board of directors.

 

The owners of the members of the General Partner have granted each other the right of first refusal to acquire any interests in the members of the General Partner that the owners propose to sell. If the owners of the members of the General Partner do not exercise the right of first refusal, the purchaser of the owner of the General Partner will have the right to appoint a member to the board of directors, and if a person or group of affiliated persons were to acquire a controlling interest in three of the owners of the General Partner, the person would be able to control the General Partner and the Partnership. The Partnership Agreement does not give the holders of common units the right to cause an owner of the General Partner to exercise its buy-sell right, or provide the holders the right to consent to or otherwise approve the transfer by an owner of the General Partner of its membership interest in the General Partner. The General Partner does, however, agree not to permit a change of control of the General Partner to occur. A change of control is defined as a person who is not currently a beneficial owner of the General Partner or a “qualifying owner” becoming the beneficial owner of 50% or more of the membership interest in the General Partner. A qualifying owner generally is defined as the following with respect to the current beneficial owners of the General Partner: conservators, guardians, executors, administrators, and similar persons of any trust, private foundation or custodianship that such beneficial owner, his spouse, lineal descendants or estate is a beneficiary.

 

Securities Authorized for Issuance under Equity Compensation Plans

 

The Partnership does not have any equity compensation plans.

 

Item 13. Certain Relationships and Related Transactions, and Director Independence

 

Reimbursement of Expenses to General Partner in Connection with Operations of the Partnership

 

The Partnership will also reimburse the General Partner and the General Partner’s affiliates for their general and administrative costs allocable to the Partnership. These expenses will include compensation expense, rent, travel, and other general and administrative and overhead expenses. Currently, the only business of the General Partner is to act as General Partner of the Partnership, and all of the General Partner’s general and administrative costs will be paid by the Partnership. If affiliates of the General Partner form other partnerships or engage in other oil and gas activities, the General Partner will allocate its general and administrative costs to the Partnership and other partnerships or businesses in a manner deemed reasonable by the General Partner.

 

During the years ended December 31, 2020 and 2019, approximately $381,000 and $319,000, respectively, of related party costs were incurred by a member of the General Partner and have been or will be reimbursed by the Partnership in connection with its operations.

 

 

Incentive Distribution Rights

 

On the initial closing date, the Partnership issued incentive distribution rights, which are nonvoting limited partner interests that entitle the holder of such rights to 35% of all amounts distributed by the Partnership after Payout occurs, to the General Partner.

 

Cost Sharing Agreement

 

On January 31, 2018, the Partnership entered into a cost sharing agreement with Energy Resources 12, L.P. (“ER12”) that gave ER12 access to the Partnership’s personnel and administrative resources. The personnel provide accounting, asset management and other day-to-day management support for both partnerships. The shared day-to-day costs were split evenly between the two partnerships and any direct third-party costs are paid by the party receiving the services. The shared costs were based on actual costs incurred with no mark-up or profit to the Partnership. For the years ended December 31, 2020 and 2019, approximately $268,000 and $285,000, respectively, of expenses subject to the cost sharing agreement were incurred by the Partnership and have been reimbursed by ER12. The agreement was terminated by ER12 in October 2020, effective December 31, 2020.

 

Consulting Fees to Clifford Merritt

 

On December 18, 2015, the General Partner appointed Clifford J. Merritt as its President. Prior to being appointed President, Mr. Merritt provided consulting services to the General Partner. For the years ended December 31, 2020 and 2019, the General Partner agreed to pay Mr. Merritt an annual base compensation of $400,000 plus basic health benefits. Under the cost sharing agreement described above, Mr. Merritt’s compensation and benefits were split evenly between the Partnership and ER12. As a result, for the years ended December 31, 2020 and 2019, Mr. Merritt was paid $203,712 and $223,480, respectively, by the Partnership. Effective January 1, 2021, the General Partner has agreed to pay Mr. Merritt an annual base compensation of $175,000, plus benefits, and will be paid through the Administrative Services Agreement described below.

 

Office Lease

 

On July 1, 2016, the Partnership entered into a one-year lease agreement with an affiliate of the General Partner for office space in Oklahoma City, Oklahoma. Under the terms of the agreement, the Partnership made twelve monthly payments of $8,537. The terms of the agreement continued on a month-to-month basis at the same monthly rate for all of 2019 and 2020. The month-to-month office space lease was a shared cost between the Partnership and ER12 under the cost sharing agreement described above. Therefore, for the years ended December 31, 2020 and 2019, the Partnership paid $51,222 in both periods to the affiliate of the General Partner. This month-to-month lease with an affiliate of the General Partner was terminated on December 31, 2020. Effective January 1, 2021, lease payments for office space in Oklahoma City will be paid under the terms and conditions of the Administrative Services Agreement described below.

 

Administrative Services Agreement

 

On December 1, 2020, the Partnership entered into an Administrative Services Agreement (the “ASA”) with Regional Energy Investors, L.P. d/b/a Regional Energy Management (the “Administrator”) and ER12, whereby the Administrator will provide administrative, operating and professional services necessary and useful to the Partnership. Costs and expenses attributable to the services performed by the Administrator under the ASA will be reimbursed by the Partnership. All Administrator costs and expenses will be accumulated (based on actual costs incurred with no mark-up or profit to the Administrator) and approved by the Partnership prior to reimbursement. Costs and expenses to be reimbursed under the ASA may include, but are not limited to, employee wages and benefits, rent for office space and network and information technology support. Other expenses, such as business travel costs and accounting, legal or banking services, may not be incurred by the Administrator on behalf of the Partnership without prior express written consent of the Partnership.

 

The ASA is effective January 1, 2021, and the Initial Term of the ASA will extend until the earlier of (a) five years or (b) when the Partnership and/or ER12 ceases to own its respective oil and natural gas assets. Provided the ASA is not terminated by any party via 60-day written notice at the conclusion of the Initial Term, the ASA will be automatically renewed for additional one-year periods. If a party to the ASA materially breaches the terms and conditions of the ASA and the breach has not been cured with 30 days of written notification of said breach, the ASA may be terminated with immediate effect.

 

 

The Administrator will also assist Energy Resources 12 GP, LLC, the general partner of ER12 (“ER12’s General Partner”), with the day-to-day operations of ER12. ER12 currently pays ER12’s General Partner an annual management fee of 0.5% of the total gross equity proceeds raised by ER12 in its best-efforts offering. Under the Agreement, ER12’s General Partner will pay one-half of its annual management fee to the Administrator in exchange for the services to be provided under the ASA. This fee is only applicable to ER12 and does not apply to the Partnership. The Administrator is owned by entities that are controlled by Anthony F. Keating, III and Michael J. Mallick, Co-Chief Operating Officers of the General Partner.

 

GKDML, LLC

 

On July 21, 2020, the Partnership, as borrower, entered into a loan agreement with GKDML, LLC (“GKDML”), which provides for an unsecured, one-year term loan in the amount of $15 million. GKDML is owned and managed by Glade M. Knight and David S. McKenney, the Chief Executive Officer and the Chief Financial Officer, respectively, of the General Partner. GKDML, Mr. Knight and Mr. McKenney have not and will not receive any consideration for providing the term loan. See more details of this affiliate loan in Note 4 titled “Debt” in Part II, Item 8 – Financial Statements and Supplementary Data, appearing elsewhere in this Annual Report on Form 10-K.

 

Director Independence

 

Because the Partnership does not have a class of securities listed on any national securities exchange, national securities association or inter-dealer quotation system, the Partnership is not required to have a board of directors comprised of a majority of independent directors under SEC rules or any listing standards. Accordingly, the Board of Directors of the General Partner has not made any determination as to whether the non-employee directors satisfy any independence requirements applicable to board members under the rules of the SEC or any national securities exchange, inter-dealer quotation system or any other independence definition.

 

Item 14. Principal Accountant Fees and Services

 

Grant Thornton LLP (“Grant Thornton”) has audited the Partnership’s consolidated financial statements for the most recent fiscal year ended December 31, 2020. Grant Thornton was selected and appointed as the Partnership’s independent registered public accounting firm on March 18, 2015.

 

For the fiscal years ended December 31, 2020 and 2019, fees paid or payable to Grant Thornton for services performed in connection with the audit of the 2020 financial statements, the audit of the 2019 financial statements, reviews of SEC comment letters, issuance of consents and 2020 and 2019 interim reviews are as follows:

 

Audit Fees

 

  

Year Ended December 31, 2020

  

Year Ended December 31, 2019

 
         

Audit fees

 $195,000  $184,500 

Audit-related fees

      

Tax fees

      

All other fees

      

Total

 $195,000  $184,500 

 

Pre-Approval Policies and Procedures

 

The General Partner currently has no Board committees. The Board of Directors has adopted policies regarding the pre-approval of auditor services. Specifically, the Board of Directors approves all services provided by the independent public accountants. The Board of Directors reviews the actual and budgeted fees for the independent public accountants periodically at regularly scheduled board meetings. All services provided by Grant Thornton during the years ended December 31, 2020 and 2019 were approved by the Board of Directors.

 

 

PART IV

 

Item 15. Exhibits and Financial Statement Schedules

 

(a) Documents filed as part of this report:

 

1. Financial Statements:

 

(i) Report of Independent Registered Public Accounting Firm – Grant Thornton LLP

 

(ii) Consolidated Balance Sheets as of December 31, 2020 and December 31, 2019

 

(iii) Consolidated Statements of Operations for the years ended December 31, 2020 and 2019

 

(iv) Consolidated Statements of Partners’ Equity for the years ended December 31, 2020 and 2019

 

(v) Consolidated Statements of Cash Flows for the years ended December 31, 2020 and 2019

 

(vi) Notes to Financial Statements

 

2. Financial Statement Schedules:

 

(i) All schedules are omitted as they are not applicable, not required or the required information is included in the consolidated financial statements or notes thereto.

 

3. Exhibits:

 

The following exhibits are included, or incorporated by reference, in this Annual Report on Form 10-K, for the year ended December 31, 2020 (and are numbered in accordance with Item 601 of Regulation S-K). Exhibits incorporated by reference to this Form 10-K as listed below are available at www.sec.gov.

 

EXHIBIT

NUMBER

 

Description Of Exhibit

   

1.1

 

Exclusive Dealer Manager Agreement with David Lerner Associates, Inc. (incorporated by reference from Exhibit 1.1 to Amendment No. 7 to the Partnership’s Registration Statement on Form S-1 filed on December 31, 2014)

2.1

 

Exclusive Option Agreement dated November 3, 2016 among Energy 11 Operating Company, LLC, Kaiser-Whiting, LLC, and Don P. Millican (incorporated by reference from Exhibit 2.1 to the Partnership’s Current Report on Form 8-K filed on November 4, 2016)

2.2

 

Interest Purchase Agreement dated January 4, 2017 among Energy 11 Operating Company, LLC, Kaiser-Whiting, LLC, and the owners of Kaiser-Whiting, LLC (incorporated by reference from Exhibit 2.1 to the Partnership’s Current Report on Form 8-K filed on January 12, 2017)

2.3

 

First Amendment to Interest Purchase Agreement by and among Energy 11 Operating Company, LLC, a Delaware limited liability company, Kaiser-Whiting, LLC, an Oklahoma limited liability company and the owners of all the limited liability company interests in Kaiser-Whiting, LLC (incorporated by reference from Exhibit 2.5 to the Partnership’s Annual Report on Form 10-K filed on March 3, 2017)

2.4

 

Interest Purchase Agreement dated March 8, 2017 among Energy 11 Operating Company, LLC, Kaiser Acquisition and Development – Whiting, LLC, and Kaiser Acquisition and Development, LLC and George B. Kaiser (incorporated by reference from Exhibit 2.1 to the Partnership’s Current Report on Form 8-K filed on March 10, 2017)

3.1

 

Certificate of limited partnership of Energy 11, L.P. (incorporated by reference from Exhibit 3.1 to Amendment No. 4 to the Partnership’s Registration Statement on Form S-1 filed on November 21, 2014)

3.2

 

First Amended and Restated Limited Partnership Agreement of Energy 11, L.P. dated as of August 19, 2015 (incorporated by reference from Exhibit A to the Prospectus included as part of the Amendment No. 6 to the Partnership’s Registration Statement on Form S-1 filed on December 12, 2014)

4.1 Description of Securities Registered Under Section 12 of the Exchange Act*
10.1 Letter Agreement between Energy 11 GP, LLC and Clifford Merritt (incorporated by reference from Exhibit 10.2 to the Partnership’s Current Report on Form 8-K filed on December 21, 2015)

 

 

10.2

 

First Amended and Restated Revolver Loan Agreement dated as of September 30, 2019 between and among Energy 11, L.P. and Energy 11 Operating Company, LLC, collectively as Borrowers, and Simmons Bank, as Administrative Agent and Letter of Credit Issuer and the Lenders Signatory Party Hereto, collectively the Lenders (incorporated by reference from Exhibit 10.7 to the Partnership’s Quarterly Report on Form 10-Q on November 8, 2019)

10.3

 

Letter Agreement dated July 21, 2020 between and among Energy 11, L.P. and Energy 11 Operating Company, LLC, collectively as Borrowers, and Simmons Bank, as Administrative Agent and Letter of Credit Issuer and the Lenders Signatory Party Hereto, collectively the Lenders (incorporated by reference from Exhibit 10.1 to the Partnership’s Current Report on Form 8-K filed on July 23, 2020)

10.4

 

Loan Agreement between GKDML, LLC, as lender, and Energy 11, L.P. and Energy 11 Operating Company, LLC, collectively Borrowers, dated July 21, 2020 (incorporated by reference from Exhibit 10.2 to the Partnership’s Current Report on Form 8-K filed on July 23, 2020)

10.5

 

Administrative Services Agreement, dated December 1, 2020 and effective as of January 1, 2021, by and between Regional Energy Investors, L.P. d/b/a Regional Energy Management, Energy 11, L.P., Energy 11 Operating Company, LLC, Energy Resources 12, L.P. and Energy Resources 12 Operating Company, LLC (incorporated by reference from Exhibit 10.1 to the Partnership’s Current Report on Form 8-K filed on December 3, 2020)

21.1

 

Subsidiaries of the Partnership*

31.1

 

Certification of Chief Executive Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002*

31.2

 

Certification of Chief Financial Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002*

32.1

 

Certification of Chief Executive Officer Pursuant to Section 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*

32.2

 

Certification of Chief Financial Officer Pursuant to Section 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*

99.1

 

Report of Pinnacle Energy Services, LLC, Independent Petroleum Consultants*

101

 

The following materials from Energy 11, L.P.’s Annual Report on Form 10-K for the year ended December 31, 2020 formatted in iXBRL (Inline eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Partners’ Equity, (iv) the Consolidated Statements of Cash Flows, and (v) related notes to these consolidated financial statements, tagged as blocks of text and in detail*

104

 

The cover page from the Partnership’s Annual Report on Form 10-K for the year ended December 31, 2020, formatted in iXBRL and contained in Exhibit 101

 

*Filed herewith.

 

Item 16. Form 10-K Summary

 

None

 

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

ENERGY 11, L.P.

 

By: Energy 11 GP, LLC, its General Partner

 

 

By:

/s/ David S. McKenney

  

David S. McKenney

  

Chief Financial Officer

 

Date: March 12, 2021

 

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

 

Signature

 

Title with General Partner

 

Date

     

/s/ Glade M. Knight

 

Director, Chief Executive Officer

 

March 12, 2021

  

(principal executive officer)

  
     

/s/ David S. McKenney

 

Director, Chief Financial Officer

 

March 12, 2021

  

(principal financial and accounting officer)

  
     

/s/ Anthony F. Keating III

 

Director, Co-Chief Operating Officer

 

March 12, 2021

     
     

/s/ Michael J. Mallick

 

Director, Co-Chief Operating Officer

 

March 12, 2021

     

 

 

 

 

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