RILEY EXPLORATION PERMIAN, INC. The following discussion and analysis of the Company's financial condition and results of operations should be read in conjunction with the Company's condensed consolidated financial statements and related notes thereto presented in this report as well as the Company's audited consolidated financial statements and related notes included in the Company's Annual Report for the fiscal year endedSeptember 30, 2021 . The following discussion contains "forward-looking statements" that reflect the Company's future plans, estimates, beliefs and expected performance. The Company's actual results could differ materially from those discussed in these forward-looking statements. See "Cautionary Statement Regarding Forward-Looking Statements" and "Part II. Item 1A. Risk Factors" below and the information set forth in the Risk Factors under Part I, Item 1A of the Company's Annual Report for the fiscal year endedSeptember 30, 2021 .
Overview
We operate in the upstream segment of the oil and natural gas industry and are focused on steadily growing conventional reserves, production and cash flow through the acquisition, exploration, development and production of oil, natural gas and NGLs primarily in thePermian Basin inWest Texas . The Company's activities are primarily focused on the San Andres Formation, a shelf margin deposit on the Central Basin Platform and Northwest Shelf. We intend to continue to develop our reserves and increase production through development drilling and exploration activities and through acquisitions that meet our strategic and financial objectives.
Financial and Operating Highlights
Financial and operating results reflect the following:
•Increased total net equivalent production by 12% to 10.2 MBoe/d for the three months endedJune 30, 2022 , as compared to the same period in 2021 and 20% to 10.0 MBoe/d for the nine months endedJune 30, 2022 , as compared to the same period in 2021
•During the three and nine months ended
•Realized average combined price on production sold of$94.80 per Boe, before derivative settlements, during the three months endedJune 30, 2022 , including$108.41 per barrel for oil
•Generated cash flow from operations of
•Total accrued capital expenditures of
•Paid cash dividends on common shares of$6.1 million during the three months endedJune 30, 2022 , and announced latest dividend of$0.31 per share with a record date ofJuly 25, 2022 , which was paid onAugust 8, 2022 , for a total of$6.1 million
•Exited the fiscal third quarter with
Recent Developments
Market Conditions and Commodity Prices
U.S. and global markets are experiencing heightened volatility following impactful geopolitical events, consistent evidence of widespread inflation, as well as increased fears of an economic recession. Though less impactful than during 2021, cases of COVID-19 continue to affect global activity and demand for commodity products. Additionally, the full-scale military invasion ofUkraine by Russian troops has continued unabated sinceFebruary 2022 . Although the length and impact of the ongoing military conflict is highly unpredictable, the conflict inUkraine has led to market disruptions, including significant volatility in commodity prices, credit and capital markets, as well as supply chain interruptions. In addition, global markets are experiencing significant inflation attributable to a number of factors. Certain of our capital expenditures and expenses are affected by general inflation and we expect costs for the remainder of 2022 to continue to be a 29
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function of supply and demand. Specifically, costs for oilfield equipment and services continue to experience significant inflation, which we expect to continue for the foreseeable future.
In response to inflation concerns, theU.S. Federal Reserve initiated a monetary tightening policy in 2022, sharply increasing interest rates in June andJuly 2022 with public estimates of further increases in the future. The Company's floating-rate credit facility will be impacted by such rate increases. The combination of geopolitical events, inflation and the rising rate environment has led to increasing forecasts of aU.S. or global recession. Any such recession could prolong market volatility or cause a decline in commodity prices, among other potential impacts. The Company cannot estimate the length or gravity of the future impact these events will have on the Company's results of operations, financial position, liquidity and the value of oil and natural gas reserves. 30
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Results of Operations
Comparison for the three and nine months ended
The following table sets forth selected operating data for the three and nine
months ended
Three Months Ended June 30, Nine Months Ended June 30,
2022 2021 2022 2021
Revenues (in thousands):
Oil sales $ 82,501
2,850 957 7,344 5,592
Natural gas liquids sales 2,430 1,088 8,232 2,635
Oil and natural gas sales, net $ 87,781 $ 41,549 $ 211,076 $ 100,622
Production Data, net:
Oil (MBbls) 761 612 2,104 1,702
Natural gas (MMcf) 572 732 2,098 1,795
Natural gas liquids (MBbls) 70 94 268 272
Total (MBoe) 926 828 2,722 2,273
Daily combined volumes (Boe/d) 10,176 9,100 9,969 8,325
Daily oil volumes (Bbls/d) 8,363 6,726 7,707 6,234
Average Realized Prices:
Oil ($ per Bbl) $ 108.41 $ 64.55 $ 92.91 $ 54.29
Natural gas ($ per Mcf) 4.98 1.31 3.50 3.12
Natural gas liquids ($ per Bbl) 34.71 11.57 30.72 9.70
Combined ($ per Boe) $ 94.80 Average Realized Prices, including derivative settlements:(1) Oil ($ per Bbl)$ 77.31 $ 51.84 $ 66.50 $ 51.16 Natural gas ($ per MMBtu) 1.29 1.39 1.31 3.22 Natural gas liquids ($ per Bbl) 34.71 11.57 30.72 9.70 Combined ($ per Boe)$ 66.97 $ 40.86 $ 55.44 $ 42.02 _____________________ (1)The Company's calculation of the effects of derivative settlements includes losses on the settlement of its commodity derivative contracts. These losses are included under other income and expense on the Company's condensed consolidated statements of operations. 31
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Oil and Natural Gas Revenues
Our revenues are derived from the sale of our oil and natural gas production, including the sale of NGLs that are extracted from our natural gas during processing. Revenues from product sales are a function of the volumes produced, product quality, market prices, and gas Btu content. Our revenues from oil, natural gas and NGL sales do not include the effects of derivatives. Our revenues may vary significantly from period to period as a result of changes in volumes of production sold or changes in commodity prices. The Company's total oil and natural gas revenue, net increased$46.2 million and$110.5 million , or 111% and 110%, for the three and nine months endedJune 30, 2022 compared to the same periods in 2021. The Company's realized average combined price on its production for the three and nine months endedJune 30, 2022 increased by$44.62 and$33.27 , or 89% and 75%, respectively, compared to the same periods in 2021.
Oil revenues
•For the three months endedJune 30, 2022 , oil revenues increased by$43.0 million , or 109%, compared to the same period in 2021. Of the increase,$33.4 million was attributable to an increase in our realized price and$9.6 million was attributable to an increase in volume. Volumes increased by 24%, while realized prices increased by 68% compared to the same period in 2021. •For the nine months endedJune 30, 2022 , oil revenues increased by$103.1 million , or 112%, compared to the same period in 2021. Of the increase,$81.3 million was attributable to an increase in our realized price and$21.8 million was attributable to an increase in volume. Volumes increased by 24%, while realized prices increased by 71% compared to the same period in 2021. •Oil volumes increased during the three and nine months endedJune 30, 2022 due to production from new wells and workovers performed on existing wells. During the three and nine months endedJune 30, 2022 , we brought online 5 gross (5.0 net) and 12 gross (10.8 net) horizontal wells, respectively. •The average WTI price increased by$42.65 and$38.12 per Bbl during the three and nine months endedJune 30, 2022 , respectively, compared to the same periods in 2021. Natural gas revenues •For the three months endedJune 30, 2022 , natural gas revenues increased by$1.9 million , compared to the same period in 2021, to$2.9 million from$1.0 million . Volumes decreased by 22%, while realized prices increased by$3.67 per Mcf compared to the same period in 2021. •For the nine months endedJune 30, 2022 , natural gas revenues increased by$1.8 million , compared to the same period in 2021, to$7.3 million from$5.6 million . Volumes increased by 17%, while realized prices increased by$0.38 per Mcf compared to the same period in 2021. •Natural gas sales volumes decreased during the three months endedJune 30, 2022 compared to the same period in 2021 due to curtailed volume capacity by our midstream gas gathering and processing counterparty as a result of their capacity expansion project. For the nine months endedJune 30, 2022 , natural gas sales volumes increased compared to the same period in 2021 due to increased production from new wells and workovers performed on existing wells, partially offset by curtailed volume capacity as seen in during the period. •The averageHenry Hub price increased by$4.55 and$2.65 per Mcf during the three and nine months endedJune 30, 2022 , respectively, compared to the same periods in 2021. Natural gas liquids revenues •For the three months endedJune 30, 2022 , NGL revenues increased by$1.3 million , compared to the same period in 2021, to$2.4 million from$1.1 million . Volumes decreased by 26%, while realized prices increased$23.14 per Bbl compared to the same period in 2021.
•For the nine months ended
•NGL sales volumes decreased during the three months ended
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Contract Services - Related Party Revenue
The following table presents the Company's revenue and costs associated with its related party transactions:
Three Months Ended June 30, Nine Months Ended June 30,
2022 2021 2022 2021
(Inthousands)
Contract services - related parties(1) $ 600$ 600 $ 1,800 $ 1,800 Cost of contract services - related parties(2) 89 91 324 330
Gross profit - related parties $ 511
_____________________
(1)The Company's contract services - related parties revenue is derived from master services agreements with related parties to provide certain administrative support services. (2)The Company's cost of contract services - related parties represents costs specifically attributable to the master service agreements the Company has in place with the respective related parties.
The following table presents the Company's operating costs and expenses and other (income) expenses:
Three Months Ended June 30, Nine Months Ended June 30,
2022 2021 2022 2021
Costs and Expenses: (In thousands)
Lease operating expenses $ 8,062 $ 5,766 $ 22,311 $ 16,289
Production and ad valorem taxes $ 5,526 $ 2,017 $ 12,033 $ 6,061
Exploration costs $ 22 $ 2,785 $ 2,131 $ 8,682
Depletion, depreciation, amortization
and accretion $ 7,188 $ 7,082 $ 20,688 $ 19,323
Administrative costs $ 4,399 $ 4,030 $ 12,046 $ 9,176
Equity-based compensation 553 779 2,521 6,042
General and administrative expense
$ 14,567 $ 15,218 Transaction costs $ -$ 321 $ 3,896 $ 3,534 Interest expense, net $ 697$ 1,171 $ 2,271 $ 3,571 Loss on derivatives$ 12,363 $ 35,396 $ 67,188 $ 74,208 Income tax expense$ 10,927 $ 3,245 $ 14,682 $ 16,953 Lease Operating Expenses Lease operating expenses ("LOE") are the costs incurred in the operation and maintenance of producing properties. Expenses for compression, direct labor, saltwater disposal and materials and supplies comprise the most significant portion of our lease operating expenses. Certain operating cost components, such as direct labor and materials and supplies, generally remain relatively fixed across broad production volume ranges, but can fluctuate depending on activities performed during a specific period. For instance, repairs to our pumping equipment or surface facilities or subsurface maintenance result in increased production expenses in periods during which they are performed. Certain operating cost components, such as compression and saltwater disposal associated with completion water, are variable and increase or decrease as hydrocarbon production levels and the volume of completion water disposal increases or decreases. The Company's LOE increased by$2.3 million for the three months endedJune 30, 2022 compared to the same period in 2021. For the three months endedJune 30, 2022 ,$2.1 million of the increase was due to higher workover expense as additional workovers were performed in the 2022 period and$1.6 million of the increase was attributable to costs associated with new wells and additional production volumes, partially offset by a$1.4 million decrease attributable to efficiencies on existing wells. 33
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The Company's LOE increased by$6.0 million for the nine months endedJune 30, 2022 compared to the same period in 2021. For the nine months endedJune 30, 2022 ,$4.7 million of the increase was attributable to costs associated with new wells and additional production volume and$3.4 million of the increase was due to higher workover expense as additional workovers were performed in the 2022 period, partially offset by a$2.1 million decrease attributable to efficiencies on existing wells.
Production and Ad Valorem Tax Expense
Production taxes are paid on produced oil, natural gas and NGLs based on a percentage of revenues at fixed rates established by federal, state or local taxing authorities. In general, the production taxes we pay correlate to changes in our oil, natural gas and NGL revenues. We are also subject to ad valorem taxes in the counties where our production is located. Ad valorem taxes are generally based on the valuation of our oil and natural gas properties, which also trend with oil and natural gas prices and vary across the different counties in which we operate. Production and ad valorem taxes increased by$3.5 million and$6.0 million for the three and nine months endedJune 30, 2022 , respectively, compared to the same periods in 2021. Production taxes increased primarily due to increases in our oil and natural gas sales, net, as discussed above. Ad valorem taxes increased for the three and nine months endedJune 30, 2022 based on higher estimated property values for the current taxable period.
Exploration Expense
Exploration expense consists of expiration of unproved leasehold and geological and geophysical costs which include seismic survey costs. The following table presents exploration expense by area for the three and nine months endedJune 30, 2022 and 2021: Three Months Ended June 30, Nine Months Ended June 30, 2022 2021 2022 2021 (In thousands, except acreage data) Exploration expense(1) $ -$ 2,785 $ 2,053 $ 8,615 Geological and geophysical costs 22 - 78 67 Total exploration expense $ 22$ 2,785 $ 2,131 $ 8,682 Expired net acres - Texas - 159 717 1,626 Expired net acres - New Mexico - 6,867 1,664 14,068 Net acres renewed after expiration(2) 9 - 106 486
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(1)For the nine months endedJune 30, 2022 , exploration expense includes$1.5 million and$0.6 million related to expiration of unproved leasehold costs inTexas andNew Mexico , respectively. (2)The Company did not renew any net acreage after expiration inNew Mexico during the three and nine months endedJune 30, 2022 and 2021.
Depletion, Depreciation, Amortization and Accretion Expense
Depletion, depreciation and amortization is the systematic expensing of the capitalized costs incurred to acquire, explore and develop oil, natural gas and NGLs. All costs incurred in the acquisition, exploration and development of properties (excluding costs of surrendered and abandoned leaseholds, delay lease rentals, dry holes and overhead related to exploration activities) are capitalized. Capitalized costs are depleted using the units of production method. Accretion expense relates to ARO. We record the fair value of the liability for ARO in the period in which the liability is incurred (at the time the wells are drilled or acquired) with the offset to property cost. The liability accretes each period until it is settled or the well is sold, at which time the liability is removed. Depletion, depreciation, amortization and accretion expense increased by$0.1 million and$1.4 million for the three and nine months endedJune 30, 2022 , respectively, compared to the same periods for 2021. The increase for the three and nine months endedJune 30, 2022 was primarily due to higher production, partially offset by a lower depletion rate. The depletion rate is a function of capitalized cost and related underlying reserves. The lower depletion rate was primarily driven by an increase in reserves as a result of the Company's drilling activity and improved commodity prices. 34
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General and Administrative Expense ("G&A")
G&A expenses include corporate overhead such as payroll and benefits for our corporate staff, equity-based compensation expense, office rent for our headquarters, audit and other fees for professional services and legal compliance. G&A expenses are reported net of overhead recoveries from other owners in properties operated by us.
Total G&A expense increased by$0.1 million and decreased by$0.7 million for the three and nine months endedJune 30, 2022 , respectively, compared to the same periods for 2021. Administrative costs, which includes payroll, benefits and non-payroll costs, increased by$0.4 million and$2.9 million , respectively, for the three and nine months endedJune 30, 2022 , compared to the same periods for 2021. The increase in administrative costs was primarily attributable to increased professional services, insurance, technology and investor relations costs. Equity-based compensation expense decreased by$3.5 million for the nine months endedJune 30, 2022 , respectively, compared to the same periods in 2021. The higher equity-based compensation during the nine months endedJune 30, 2021 relates to restricted shares awarded to certain employees following completion of the Merger that immediately vested.
Transaction Costs
Transaction costs represent costs incurred on successful or unsuccessful business combinations or unsuccessful property acquisitions. During the three and nine months endedJune 30, 2021 , the transaction costs of$0.3 million and$3.5 million , respectively, primarily relates to costs incurred on the Merger withTengasco inFebruary 2021 . The Company did not incur any transaction costs during the three months endedJune 30, 2022 . The transaction costs of$3.9 million for the nine months endedJune 30, 2022 primarily relate to a potential business combination and related financing that the Company pursued but ultimately chose not to consummate due to changing market conditions.
Interest Expense
Interest expense decreased by$0.5 million and$1.3 million during the three and nine months endedJune 30, 2022 , respectively, when compared to the same periods for 2021. Interest expense decreased due to a lower outstanding average balance on the Company's revolving credit facility as well as the capitalized interest related to the Company's EOR project during the three and nine months endedJune 30, 2022 , respectively, when compared to the same periods for 2021.
Gain/Loss on Derivatives
The Company recognizes settlements and changes in the fair value of its derivative contracts as a single component within other income (expense) on its condensed consolidated statements of operations. We have oil and natural gas derivative contracts, including fixed price swaps, basis swaps and collars, that settle against various indices. The following table presents the components of the Company's loss on derivatives for the three and nine months endedJune 30, 2022 and 2021: Three Months Ended June 30, Nine Months Ended June 30, 2022 2021 2022 2021 (In
thousands)
Settlements on derivative contracts
$ (60,172) $ (5,133) Non-cash gain (loss) on derivatives 13,420 (27,684) (7,016) (69,075) Loss on derivatives$ (12,363) $ (35,396) $ (67,188) $ (74,208) Our earnings are affected by the changes in value of our derivative portfolio between periods and the related cash received or paid upon settlement of our derivatives. To the extent the future commodity price outlook declines between periods, we will have mark-to-market gains; while future commodity price increases between measurement periods result in mark-to-market losses. 35
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The decrease in the loss on derivatives for the three and nine months endedJune 30, 2022 compared to the same periods in 2021 is due to the change in non-cash gain (loss) on derivatives of$41.1 million and$62.1 million , partially offset by the increase in the loss on settlements of$18.1 million and$55.0 million . The change in non-cash gain (loss) on derivatives for the three and nine months endedJune 30, 2022 is due to the decrease in total contract volumes for our open derivative contracts with volumes on our fixed price oil swaps decreasing by 55% as ofJune 30, 2022 when compared to the same period in 2021. Additionally, the change in the non-cash gain (loss) on derivatives was impacted by the change in the estimated forward-looking oil and natural gas prices used at the end of the period to calculate the fair value of the open derivative contracts. The increase in the loss on settlements on derivatives was due to the increase in oil and natural gas prices for the three and nine months endedJune 30, 2022 compared to the same periods in 2021. For example, the average WTI price was$108.83 per Bbl for the three months endedJune 30, 2022 compared to$66.19 per Bbl for the same period in 2021.
Income Tax Expense
The Company became a taxable entity as a result of its Merger withTengasco onFebruary 26, 2021 . See further discussion in Note 4 - Acquisitions to the Company's condensed consolidated financial statements included herein. WhileREP LLC was organized as a limited liability company, taxable income passed through to its unit holders. Accordingly, a provision for federal and state corporate income taxes has been made for the operations of the Company only fromFebruary 27, 2021 throughJune 30, 2022 in the accompanying condensed consolidated financial statements. Deferred income taxes are provided to reflect the future tax consequences or benefits of differences between the tax basis of assets and liabilities and their reported amounts in the financial statements using enacted tax rates. Upon consummation of the Merger inFebruary 2021 , the Company established a$13.6 million provision for deferred income taxes with the conversion to a C-corporation. The majority of this deferred tax liability was established by a change in tax status which primarily was attributable to the oil and natural gas properties. See Note 11 - Income Taxes to the Company's condensed consolidated financial statements included herein for further discussion of income taxes. Three Months Ended June 30, Nine Months Ended June 30, 2022 2021 2022 2021 (In thousands) Current income tax expense (benefit) $ 715$ (1,009) $ 1,608 $ (232) Deferred income tax expense 10,212 4,254 13,074 17,185 Total income tax expense$ 10,927 $ 3,245 $ 14,682 $ 16,953 Effective income tax rate 22.0 % (18.8) % 21.8 % (38.0) %
Liquidity and Capital Resources
The business of exploring for, developing and producing oil and natural gas is capital intensive. Because oil, natural gas and NGL reserves are a depleting resource, like all upstream operators, we must make capital investments to grow and even sustain production. The Company's principal liquidity requirements are to finance its operations, fund capital expenditures and acquisitions, make cash distributions and satisfy any indebtedness obligations. Cash flows are subject to a number of variables, including the level of oil and natural gas production and prices, and the significant capital expenditures required to more fully develop the Company's oil and natural gas properties. Historically, our primary sources of capital funding and liquidity have been our cash on hand, cash flow from operations and borrowings under our revolving credit facility. At times and as needed, we may also issue debt or equity securities, including through transactions under our shelf registration statement filed with theSEC . We estimate the combination of the sources of capital discussed above will continue to be adequate to meet our short and long-term liquidity needs. Cash on hand and operating cash flow can be subject to fluctuations due to trends and uncertainties that are beyond our control. Likewise, our ability to issue equity and obtain credit facilities on favorable terms may be impacted by a variety of market factors as well as fluctuations in our results of operations. During the fiscal third quarter of 2022, the Company's natural gas and NGL sales were negatively impacted due to its primary midstream gas gathering and processing counterparty curtailing volume capacity as work continued on their overall capacity expansion project. With the expansion project being fully commissioned in July, the Company expects to benefit from an increase in production capacity. The Company is not currently aware of additional scheduled curtailments; however, the Company may continue to experience periodic curtailments on natural 36
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gas produced in excess of our contractual processing capacity. For further discussion of risks related to our liquidity and capital resources, see "Item 1A. Risk Factors."
Working Capital Working capital is the difference in our current assets and our current liabilities. Working capital is an indication of liquidity and potential need for short-term funding. The change in our working capital requirements is driven generally by changes in accounts receivable, accounts payable, commodity prices, credit extended to, and the timing of collections from customers, the level and timing of spending for expansion activity, and the timing of debt maturities. As ofJune 30, 2022 , we had a working capital deficit of$55.6 million compared to a deficit of$46.9 million as ofSeptember 30, 2021 . The working capital deficit atJune 30, 2022 reflects$50.3 million in current derivative liabilities compared to$42.1 million in current derivative liabilities atSeptember 30, 2021 . Additionally, we had$8.8 million payable to our counterparties forJune 2022 derivative contract settlements, which is included in accounts payable atJune 30, 2022 . We utilize our revolving credit facility and cash on hand to manage the timing of cash flows and fund short-term working capital deficits. Our current derivative assets and liabilities represent the mark-to-market value as ofJune 30, 2022 of future commodity production which will settle on a monthly basis through the end of their contractual terms. This aligns with the receipt of oil and natural gas revenues on a monthly basis.
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