UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Form 10-K
for the year ended
December 31, 2012
[X]
[ ]
Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 2012, or
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from____ to____
Commission File Number 001-14039
CALLON PETROLEUM COMPANY
(Exact name of registrant as specified in its charter)
Delaware
(State or other jurisdiction of incorporation or organization)
200 North Canal Street
Natchez, Mississippi
(Address of principal executive offices)
64-0844345
(I.R.S. Employer Identification No.)
39120
(Zip Code)
601-442-1601
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class:
Common Stock, $.01 par value
Name of each exchange on which registered:
New York Stock Exchange
Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Securities registered pursuant to section 12 (g) of the Act: None
Indicate by check mark whether the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes [ ]
No [ X ]
Yes [ ]
No [ X ]
Indicate by check mark whether 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 [ X ]
No [ ]
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be
submitted and posted 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 and post such files).
Yes [ X ]
No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of
registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of
“large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one):
Large accelerated filer [ ]
Non-accelerated filer [ ]
Accelerated filer [ X ]
Smaller reporting company [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
The aggregate market value of the voting and non-voting common equity stock held by non-affiliates of the registrant was
$162.0 million as of June 30, 2012.
As of March 8, 2013, 39,870,136 shares of the Registrant’s common stock, par value $.01 per share, were outstanding.
Yes [ ]
No [ X ]
Portions of the definitive Proxy Statement of Callon Petroleum Company (to be filed no later than 120 days after December 31, 2012) relating to the Annual Meeting
of Stockholders to be held on May 16, 2013, which are incorporated into Part III of this Form 10-K.
Documents Incorporated by Reference
TABLE OF CONTENTS
Special Note Regarding Forward-Looking Statements
Definitions
Part I
Items 1 and 2. Business and Properties
Acquisitions and Divestitures
Crude Oil and Natural Gas Properties
Reserves and Production
Production Wells and Leasehold Acreage
Other
Regulations
Available Information
Risk Factors
Unresolved Staff Comments
Legal Proceedings
Mine Safety Disclosures
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Performance Graph
Selected Financial Data
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 1A.
Item 1B.
Item 3.
Item 4.
Part II
Item 5.
Item 6.
Item 7.
Overview and Outlook
Liquidity and Capital Resources
Results of Operations
Significant Accounting Policies and Critical Accounting Estimates
Subsequent Events
Item 7A.
Item 8.
Quantitative and Qualitative Disclosures About Market Risk
Report of Independent Registered Public Accounting Firm
Financial Statements and Supplementary Data
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Comprehensive Income
Consolidated Statements of Stockholders' Equity
Consolidated Statements of Cash Flows
Note 1 - Description of Business and Basis of Presentation
Note 2 - Summary of Significant Accounting Policies
Note 3 - Global Settlement with Joint Interest Partner
Note 4 - Earnings per Share
Note 5 - Borrowings
Note 6 - Derivative Instruments and Hedging Activities
Note 7 - Fair Value Measurements
Note 8 - Employee Benefit Plans
Note 9 - Share-Based Compensation
Note 10 - Equity Transactions
Note 11 - Income Taxes
Note 12 - Crude Oil and Natural Gas Properties
Note 13 - Asset Retirement Obligations
Note 14 - Supplemental Crude Oil and Natural Gas Reserve Data (Unaudited)
Note 15 - Commitments and Contingencies
Note 16 - Summarized Quarterly Financial Information (Unaudited)
Item 9.
Item 9A.
Item 9B.
Part III
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
Part IV
Item 15.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Controls and Procedures
Other Information
Report of Independent Registered Public Accounting Firm
Directors and Executive Officers and Corporate Governance
Executive Compensation
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Certain Relationships and Related Transactions and Director Independence
Principal Accountant Fees and Services
Exhibits
Table of Contents
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Signatures
88
2
Special Note Regarding Forward Looking Statements
All statements, other than historical fact or present financial information, may be deemed to be forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.
All statements that address activities, outcomes and other matters that should or may occur in the future, including, without limitation,
statements regarding the financial position, business strategy, production and reserve quantities, present value and growth and other plans
and objectives for our future operations, are forward-looking statements. Although we believe the expectations expressed in such forward-
looking statements are based on reasonable assumptions, such statements are not guarantees of future performance. We have no obligation
and make no undertaking to publicly update or revise any forward-looking statements, except as may be required by law.
Forward-looking statements include the items identified in the preceding paragraph, information concerning possible or assumed future
results of operations and other statements in this Form 10-K identified by words such as “anticipate,” “project,” “intend,” “estimate,”
“expect,” “believe,” “predict,” “budget,” “projection,” “goal,” “plan,” “forecast,” “target” or similar expressions.
You should not place undue reliance on forward-looking statements. They are subject to known and unknown risks, uncertainties and other
factors that may affect our operations, markets, products, services and prices and cause our actual results, performance or achievements to
be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. In
addition to any assumptions and other factors referred to specifically in connection with forward-looking statements, risks, uncertainties and
factors that could cause our actual results to differ materially from those indicated in any forward-looking statement include, but are not
limited to:
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
to
fund our planned capital
future property acquisition or divestiture
the timing and extent of changes in market conditions and prices for commodities (including regional basis
differentials),
our ability to transport our production to the most favorable markets or at
all,
the timing and extent of our success in discovering, developing, producing and estimating
reserves,
our ability to respond to low natural gas
prices,
our ability
investments,
the impact of government regulation, including any increase in severance or similar taxes, legislation relating to hydraulic
fracturing, the climate and over-the-counter derivatives,
the costs and availability of oilfield personnel services and drilling supplies, raw materials, and equipment and
services,
our
activities,
the
weather,
increased
competition,
the financial impact of accounting regulations and critical accounting
policies,
the comparative cost of alternative
fuels,
conditions in capital markets, changes in interest rates and the ability of our lenders to provide us with funds as
agreed,
credit risk relating to the risk of loss as a result of non-performance by our counterparties,
and
any other factors listed in the reports we have filed and may file with the Securities and Exchange Commission
(“SEC”).
effects
of
We caution you that the forward-looking statements contained in this Form 10-K are subject to all of the risks and uncertainties, many of
which are beyond our control, incident to the exploration for and development, production and sale of oil and natural gas. These risks
include, but are not limited to, the risks described in Item 1A of this Annual Report on Form 10-K for the year ended December 31, 2012
and all quarterly reports on Form 10-Q filed subsequently thereto (“Form 10-Qs”).
Should one or more of the risks or uncertainties described above or elsewhere in this Form 10-K occur, or should underlying assumptions
prove incorrect, our actual results and plans could differ materially from those expressed in any forward-looking statements. We
specifically disclaim all responsibility to publicly update any information contained in a forward-looking statement or any forward-looking
statement in its entirety and therefore disclaim any resulting liability for potentially related damages.
All forward-looking statements attributable to us are expressly qualified in their entirety by this cautionary statement.
3
All defined terms under Rule 4-10(a) of Regulation S-X shall have their statutorily prescribed meanings when used in this report. As used
in this document:
DEFINITIONS
Table of Contents
•
•
•
•
•
•
three-
Asset
Retirement
Boe per
billion cubic
3-D:
dimensional.
ARO:
Obligation.
Bbl or Bbls: barrel or barrels of oil or natural gas
liquids.
Bcf:
feet.
Boe: barrel of oil equivalent, determined by using the ratio of one Bbl of oil or NGLs to six Mcf of gas. The ratio of one barrel of
oil or NGL to six Mcf of natural gas is commonly used in the industry and represents the approximate energy equivalence of oil or
NGLs to natural gas, and does not represent the economic equivalency of oil and NGLs to natural gas. The sales price of a barrel of
oil or NGLs is considerably higher than the sales price of six Mcf of natural gas.
Boe/d:
day.
BLM:
Management.
BOEM: Bureau of Ocean Energy Management, Regulation and Enforcement; formerly the Minerals Management Service
("MMS").
Btu: a British thermal unit, which is a measure of the amount of energy required to raise the temperature of one pound of water
one degree Fahrenheit.
BSEE: Bureau
Enforcement.
DOI:
Interior.
EPA:
Agency.
• GHG:
and Environmental
Environmental
of Safety
Department
greenhouse
Protection
Bureau
Land
of
of
•
•
•
•
•
•
•
gases.
LIBOR:
Rate.
London Interbank Offered
• Mbbls: thousand barrels of
oil.
• Mboe:
boe.
• Mboe/d:
day.
thousand
Mboe per
• Mcf: thousand cubic feet of natural
gas.
• Mcfe:
thousand cubic
feet of natural gas
equivalents.
• Mcf/d:
day.
Mcf per
• MMbbls: million barrels of
oil.
• MMboe:
boe.
• MMBtu:
Btu.
million
million
• MMcf: million cubic feet of natural
gas.
• MMcf/d:
day.
MMcf per
• MMS: Minerals Management
•
•
Service.
NGL or NGLs: natural gas liquids, such as ethane, propane, butanes and natural gasoline that are extracted from natural gas
production streams.
NYMEX:
Exchange.
New York Mercantile
• OCS:
shelf.
• Oil:
outer
continental
includes
crude
oil
and
condensate.
• ONRR: Office of Natural Resources
•
Revenue.
PDPs:
reserves.
proved developed producing
•
•
•
•
•
proved
proved
developed
undeveloped
non-producing
PDNPs:
reserves.
PUDs:
reserves.
Reserve life: a measurement of the time it will take to produce our proved reserves calculated by dividing our estimate net
equivalent reserves at December 31, 2012 by our total production during 2012 on an equivalent basis.
SEC:
and Exchange
Commission.
US GAAP: Generally Accepted Accounting Principles in the United
States
United States Securities
With respect to information relating to our working interest in wells or acreage, “net” oil and gas wells or acreage is determined by
multiplying gross wells or acreage by our working interest therein. Unless otherwise specified, all references to wells and acres are gross.
4
Table of Contents
PART I.
Items 1 and 2 - Business and Properties
Overview and Business Strategy
Callon Petroleum Company has been engaged in the exploration, development, acquisition and production of oil and natural gas properties
since 1950. The Company was incorporated under the laws of the state of Delaware in 1994 and succeeded to the business of a publicly
traded limited partnership, a joint venture with a consortium of European investors and an independent energy company partially owned by
a member of current management. As used herein, the “Company,” “Callon,” “we,” “us,” and “our” refer to Callon Petroleum Company
and its predecessors and subsidiaries unless the context requires otherwise.
In 2009, the Company began to shift its operational focus from exploration, development and production in the Gulf of Mexico to the
acquisition and development of onshore properties. Currently, our onshore properties located in the Permian Basin in Texas are the
foundation of our onshore strategy. As of December 31, 2012, we had estimated net proved reserves of 10.8 MMbbls and 19.8 Bcf, or 14.1
MMboe. Of these reserves and on an MMboe basis, approximately 68% were located onshore in the Permian Basin, compared with
approximately 61% located onshore at December 31, 2011. Additionally, 77% of our proved reserve volumes were crude oil at year-end
2012 compared to 63% at year-end 2011.
Our Business Strategy
Our goal is to increase stockholder value by:
•
•
•
◦
◦
◦
◦
◦
◦
to build our onshore production base
Continuing
through:
◦
conversion of our existing Permian acreage position
production
leveraging our technical and operational teams across a larger production
base
pursuing opportunistic producing property
acquisitions
leasehold
and
to
on
capital
efficiency
Focusing
through:
◦
through repeatable program
exploiting Permian resources
drilling
continuing
infrastructure
high-grading of capital allocation across our expanded drilling portfolio continuing to refine our vertical and horizontal
completion techniques and target zones
supporting
invest
in
to
Delivering on asset growth potential
through:
◦
focusing on an established production base from vertical Wolfberry
wells
the drilling inventory of horizontal locations identified in 2012 from our evaluation efforts in the southern Midland basin
from horizontal locations developed in 2012
exploration activities on our acreage in the northern Midland
basin
5
Our Strengths
We believe that we are well positioned to achieve our business objectives and to execute our strategy due to the following factors:
Table of Contents
• We have assembled a Permian leasehold position of over 32,900 net acres that are prospective for the exploration, development
and exploitation of multiple oil-bearing intervals through both vertical and horizontal drilling.
•
Our initial horizontal drilling efforts commenced in 2012 have resulted in a large inventory of drillable locations in the southern
Midland basin for future development of two zones of the Wolfcamp shale, complementing our existing vertical drilling program.
We continue to evaluate other intervals prospective for horizontal development that may add to this inventory depending on
evaluation results by us and other industry players.
• We continue to replace high decline-rate, natural gas production from the Gulf of Mexico shelf area with longer reserve life,
liquids-rich production from our Permian drilling programs. As a result, we have increased our reserve life 185% to 8.9 years at
year-end 2012 from 4.8 years at year-end 2008.
•
•
•
Our offshore properties generate substantial cash flow, which we can redeploy in the acquisition, exploration and development of
onshore properties. Since initiating our onshore transition strategy in 2009, we have invested nearly $263 million of offshore cash
flow into our onshore initiatives.
Effective December 28, 2012, we sold our interest in the Habanero field for net cash consideration of $39.4 million, accelerating
our cash flows from this offshore property and monetizing the value of additional undeveloped reserve potential. These proceeds
allowed us to substantially reduce the outstanding balance on our Senior Secured Revolving Credit Facility (the "Credit Facility"),
strengthening our liquidity in 2013 to support our Permian-focused capital development program.
On December 31, 2012, our total liquidity position was approximately $56.1 million, including $1.1 million of available cash and
$55 million of unused borrowing base available under our Credit Facility. The $65 million borrowing base at December 31, 2012
increased by $20 million or 44% over the base at December 31, 2011.
• We have assembled a management team experienced in oil and natural gas acquisitions, exploration, development and production
in the areas in which we focus our operations, with an average of 28 years of experience in their relevant fields of expertise. Our
technical and operational teams continue to benefit from the knowledge gained from our increased level of activity in the Permian
basin and from the addition of new employees with significant industry experience.
Exploration and Development Activities
Our 2012 capital expenditures approximated $147 million, and represented a 39% increase over 2011 actual capital expenditures. Of the
$147 million, approximately 88% was allocated to onshore drilling, development and leasehold acquisition activity in the Permian basin.
During 2012, capital expenditures on an accrual basis for exploration and development costs related to oil and natural gas properties
included the following expenditures (in millions):
Southern Midland basin
Northern Midland basin
Leasehold acquisitions and seismic
Plugging and abandonment costs in the Gulf of Mexico
Capitalized interest
Capitalized general and administrative costs allocated directly to exploration and development projects
Total capital expenditures
$
$
70.3
21.4
37.2
2.3
2.0
13.3
146.5
With our continued operational focus onshore, primarily in the Permian basin, we expect that over 92% of our 2013 capital expenditures
will be focused on the acquisition, exploration, development and operation of onshore properties, with only 8% of capital expenditures
directed towards our offshore properties, excluding the capital required for the subsea development project discussed below. In addition to
the 2013 capital program, which is outlined within Management's Discussion and Analysis (Part II, Item 7), we have received various long-
lead time requests for capital expenditures related to the proposed subsea development of the Medusa field, and we expect to receive
additional requests throughout 2013. The operator plans to begin drilling these
6
wells will begin in the first quarter of 2014. For additional information, please refer to our Offshore - Deepwater discussion, which is also
located within Management's Discussion and Analysis.
Table of Contents
Recent Developments
Acquisitions
During the first quarter of 2012, the Company acquired approximately 16,233 gross (14,653 net) acres in Borden county, Texas, which is
located in the northern Midland basin. The northern Midland basin has had limited drilling activity compared with the southern Midland
basin (where our current production is located), increasing the risk of success for these drilling activities. The purchase price of $14.5
million was funded from existing cash balances. During the third quarter of 2012, we acquired an additional 8,095 gross acres (6,964 net) in
this area for a total consideration of $4.8 million.
During the second quarter of 2012, the Company signed a purchase and sale agreement to acquire 2,319 gross (1,762 net) acres in southern
Reagan county, Texas for a total purchase price of $12.0 million, which was financed with a draw on the Company's Credit Facility. The
transaction had an effective date of May 1, 2012 and closed on July 5, 2012.
Divestitures
On December 28, 2012, we closed the sale of our 11.25% working interest in the Habanero field (Garden Banks Block 341) to Shell
Offshore Inc., a subsidiary of Royal Dutch Shell Plc, for an estimated net cash consideration of $39.4 million after customary purchase
price adjustments. We used the proceeds from the sale to reduce outstanding borrowings on our Credit Facility, providing additional
liquidity to fund our 2013 capital program. The borrowing base under our Credit Facility was revised to $65 million following the
Habanero sale, and was redetermined as scheduled in the first quarter of 2013 based upon the evaluation of year-end proved reserves.
7
Crude Oil and Natural Gas Properties
As of December 31, 2012, our estimated net proved reserves totaled 14.1 MMBoe and included 10.8 MMBbls and 19.8 Bcf, with a pre-tax
present value, discounted at 10%, of $250.1 million. Pre-tax present value is a non-US GAAP financial measure, which we reconcile to the
US GAAP standardized measure of $231.1 million in note (d) to the table below. Oil constitutes approximately 77% of our total estimated
equivalent net proved reserves and approximately 48% of our total estimated equivalent proved developed reserves.
The following table sets forth certain information about our estimated net proved reserves prepared by our independent petroleum reserve
engineers by major field and for all other properties combined at December 31, 2012:
Table of Contents
Estimated Net Proved Reserves
Natural Gas
Oil
(MMcf)
(MBbls)
Total
(MBoe)
(a)
Pre-tax
Discounted
Present
Value
($000)
(b)(c)(d)
7,209
—
7,209
13,242
1,231
14,473
9,416 $
205 $
9,621 $
78,950
666
79,616
Operator
Callon
Callon
Murphy
3,551
3,551
2,083
2,083
3,898 $
3,898 $
179,967
179,967
Apache
Apache
SandRidge Energy
Various
5
5
—
10
20
954
487
1,182
574
3,197
164 $
86
197
106
553 $
1,081
633
(718)
(10,482)
(9,486)
Onshore:
Permian basin
Haynesville shale
Total Onshore
Gulf of Mexico Deepwater:
Mississippi Canyon 538/582
“Medusa”
Total Gulf of Mexico Deepwater
Gulf of Mexico Shelf and Other:
West Cameron Block 295
East Cameron Block 2
East Cameron Block 257
Other (c)
Total Gulf of Mexico Shelf and Other
Total Net Proved Reserves
10,780
19,753
14,072 $
250,097
(a) We convert Mcf to Boe using a conversion ratio of six Mcf to one Bbl. This ratio, which is typical in the industry and represents the
approximate energy equivalent of a Mcf to a Bbl, does not reflect to market price equivalence of an Mcf of natural gas compared with a
Bbl of oil or NGLs. On a market price equivalence basis, a barrel of oil or NGLs has a substantially higher price than six Mcf of natural
gas.
(b) Represents the present value of future net cash flows before deduction of federal income taxes, discounted at 10%, attributable to
estimated net proved reserves as of December 31, 2012, as set forth in the Company’s reserve reports prepared by its independent
petroleum reserve engineers, Huddleston & Co., Inc.
(c)
Includes a reduction for estimated plugging and abandonment costs that is reflected as a liability on our balance sheet at December 31,
2012, in accordance with accounting for asset retirement obligations rules. The negative Pre-Tax Discounted Present Value of the
“Other” reflects plugging and abandonment obligations exceeding the future net cash flows, with most of such obligations estimated to
occur within the next five years.
(d) The Company uses the financial measure “Pre Tax Discounted Present Value” which is a non-US GAAP financial measure. The
Company believes that Pre Tax Discounted Present Value, while not a financial measure in accordance with US GAAP, is an important
financial measure used by investors and independent oil and gas producers for evaluating the relative value of oil and natural gas
properties and acquisitions because the tax characteristics of comparable companies can differ materially. The total standardized measure
calculated in accordance with the guidance issued by the FASB for disclosures about oil and gas producing activities for our proved
reserves as of December 31, 2012 was $231.1 million inclusive of the $18.9 million discounted estimated future income taxes relating to
such future net revenues. The projected per Mcf natural gas price of $4.81 used in the 2012 reserve estimates has been adjusted to reflect
the Btu content, transportation charges and other fees specific to the individual properties. The projected per barrel oil price of $94.68
used in the 2012 reserve estimates has been adjusted to reflect all wellhead deductions and premiums on a property-by-property basis,
including transportation costs, location differentials and crude quality.
8
Onshore Properties
Onshore proved reserves accounted for approximately 68% of year-end 2012 proved reserves on a Boe basis as compared to 61% of 2011
reserves on a Boe basis, consistent with our strategy of using our offshore cash flow to explore and develop our onshore properties and
following the sale of our offshore interest in the Habanero field.
Table of Contents
Permian Basin
As of December 31, 2012, we owned approximately 32,962 net acres in the Permian basin, where we are exclusively focused on the
Midland sub-basin. Our reserves in the Permian basin represent approximately 67% of our total proved reserves at year-end 2012 as
compared to 48% at year-end 2011. Average net production from the Company's Permian basin properties increased 67% to 1,614 Boe/d in
2012 from 967 Boe/d in 2011.
We describe our activities in the Permian basin based on two geographic areas, the southern and northern Midland basin, given their
relative stages of development.
The southern portion of our position (located in Texas counties of Crockett, Upton, Midland, Ector, Reagan and Glasscock) represents the
vast majority of our current Permian production. We have been pursuing a vertical development program in this area since our entry into
the Permian in 2009, drilling 71 gross (63 net) vertical wells over that period. In 2012, we commenced the horizontal drilling of our
properties in Upton and Reagan counties, drilling three net wells targeting the Wolfcamp B shale.
Our northern Midland basin position was established in 2012 with the acquisition of 24,328 gross (21,617 net) acres in Borden and Lynn
counties. We began our exploration program in Borden county during the second half of 2012, drilling one gross (0.8 net) vertical and two
gross (1.8 net) horizontal wells, targeting the Cline and Mississippi lime.
The following table summarizes our wells drilled and completed by area during 2012:
Property
Southern Midland basin vertical wells
Southern Midland basin horizontal wells
Total
Property
Northern Midland basin vertical wells
Northern Midland basin horizontal wells
Total
Other
Drilling
Completion
Gross
Net
Gross
Net
15
3
18
10.7
2.8
13.5
22
2
24
16.0
2.0
18.0
Drilling
Completion
Gross
Net
Gross
Net
1
2
3
0.8
1.8
2.6
—
1
1
—
1.0
1.0
We own a 69% working interest in a 429 net acre unit of the Haynesville shale natural gas unit located in southern Bossier parish,
Louisiana. As of December 31, 2012, our Haynesville shale proved reserves were reduced by 90% compared to year-end 2011 due to low
natural gas prices. During 2012, our one producing well produced 3% of our total production on an equivalent basis. Also during 2012, this
well was shut-in for a combined 112 days during the fourth quarter of 2011 and the first quarter of 2012 due to well interference from an
offsetting well. Production was restored in mid-March 2012 following a successful remediation operation and, as of December 31, 2012,
our Haynesville well was producing approximately 751 Mcf of natural gas per day. We currently have no drilling obligations related to this
lease position and will wait for natural gas prices to return to a level that would justify capital allocation within our portfolio before
recommencing our development of the field.
9
Table of Contents
Gulf of Mexico Deepwater
Medusa, Mississippi Canyon Blocks 538/582
The Medusa field, in which we own a 15% working interest, is located in 2,235 feet of water approximately 50 miles offshore Louisiana,
and currently produces from eight existing wellbores. Murphy Exploration & Production Company (“Murphy”), the operator, owns a 60%
working interest and ENI Deepwater, LLC, owns the remaining 25% working interest. Since the field entered production in 2003,
cumulative gross volumes have approximated 58 MMBoe.
During 2012, the Medusa field produced 464 MBoe net to Callon from eight wells which accounted for 29% of our total production. Six of
the field's wells continue to produce from their initial completions as of December 31, 2012. We project that 1.1 MMBoe of net PDNPs can
be accessed by recompletions in the existing wells. These up-hole recompletions in existing wellbores are expected to occur as existing
completions deplete to a level that is uneconomic to justify continued production. We anticipate the development of our current net 1.3
MMBoe of PUD reserves in conjunction with a subsea development program to be commenced during 2014.
Gulf of Mexico Shelf
Approximately 4% of our year-end 2012 proved reserves were attributable to the shelf area of the Gulf of Mexico and other properties. We
own interests in 14 producing wells in eight oil and natural gas fields in the shelf area of the Gulf of Mexico area. These wells produced
340 MBoe net to our interest in 2012, which accounted for 22% of our total production.
For additional information regarding the Company's properties, including its 2013 capital expenditures program and future development
plans, please refer to the Properties discussion within Management's Discussion and Analysis, which is located in Part II, Item 7 of this
filing.
10
Proved Reserves
Estimates of volumes of proved reserves, net to our interest, at year end are presented in MBbls for oil and in MMcf for natural gas,
including NGLs, at a pressure base of 15.025 pounds per square inch. Total volumes are presented in MBoe. For the MBoe computation,
6,000 cubic feet of gas are the equivalent of one barrel of oil.
The following table sets forth certain information about our estimated net proved reserves. All of our proved reserves are located in the
continental United States and in federal and state waters in the Gulf of Mexico.
Table of Contents
Proved developed:
Oil (MBbls)
Natural gas (MMcf)
MBoe
Proved undeveloped:
Oil (MBbls)
Natural gas (MMcf)
MBoe
Total proved:
Oil (MBbls)
Natural gas (MMcf)
MBoe
Estimated pre-tax future net cash flows (a)
Pre-tax discounted present value (a) (b)
Standardized measure of discounted future net cash flows(a) (b)
Years Ended December 31,
2011
2012
2010
4,955
10,680
6,735
5,825
9,073
7,337
5,069
11,605
7,003
5,006
23,513
8,925
10,780
19,753
14,072
592,424 $
250,097 $
231,148 $
10,075
35,118
15,928
568,798 $
309,890 $
270,357 $
$
$
$
4,503
12,715
6,622
3,645
20,241
7,019
8,149
32,957
13,641
379,448
205,532
198,916
(a)
Includes a reduction for estimated plugging and abandonment costs that is reflected as a liability on our balance sheet at December 31,
2012, in accordance with accounting for asset retirement obligations rules.
(b) The Company uses the financial measure “Pre-tax discounted present value” which is a non-US GAAP financial measure. The Company
believes that Pre-tax discounted present value, while not a financial measure in accordance with US GAAP, is an important financial
measure used by investors and independent oil and gas producers for evaluating the relative value of crude oil and natural gas properties
and acquisitions because the tax characteristics of comparable companies can differ materially. The total standardized measure calculated
in accordance with the guidance issued by the FASB for disclosures about oil and gas producing activities for our proved reserves as of
December 31, 2012 was $231.1 million inclusive of the $18.9 million discounted estimated future income taxes relating to such future net
revenues. The natural gas Mcf prices of $4.81 used in the 2012 reserve estimates have been adjusted to reflect the Btu content,
transportation charges and other fees specific to the individual properties. The projected crude oil prices of $94.68 used in the 2012
reserve estimates have been adjusted to reflect all wellhead deductions and premiums on a property-by-property basis, including
transportation costs, location differentials and crude quality.
See Note 14 of our Consolidated Financial Statements for the additional information regarding the Company’s reserves including its
estimates of proved reserves, PDPs, PUDs and the Company’s estimates of future net cash flows and discounted future net cash flows from
proved reserves.
Estimated net proved reserves at December 31, 2012, represented a 12% decrease over 2011 year-end estimated net proved reserves
primarily due to the sale of the Company's interest in the Habanero field and the downward revision of our Haynesville Shale undeveloped
reserves at year-end 2012, which were reduced due to low natural gas pricing assumptions. These decreases were partially offset by the
Company's development of a portion of its Permian basin, on which it added 7 PDP and 19 PUD wells during 2012.
11
Proved Undeveloped Reserves ("PUDs")
Annually, the Company reviews its PUDs to ensure appropriate plans exist for development. Except as noted below, reserves are
recognized as PUDs only if the Company has plans to convert the PUDs into PDPs within five years of the date they are first recorded as
PUDs. The basis for our development plans include the allocation of capital to projects included within our 2013 capital budget and, in
subsequent years, the allocation of capital within our long-range business plan. Generally, our 2013 capital budget and our long-range
capital plans are governed by our expectations of internally generated cash flow and Credit Facility borrowing availability. Reserve
calculations at any end-of-year period are representative of our development plans at that time. Changes in commodity pricing, oilfield
service costs and availability, and other economic factors may lead to changes in development plans.
The following table summarizes the Company’s recorded PUDs:
Table of Contents
Permian basin
Haynesville shale
Total Onshore PUDs
Medusa
Habanero (a)
Total Deepwater PUDs
Total PUDs
PUDs (MBoe) at December
31,
2011
4,861
1,730
6,591
1,186
1,148
2,334
8,925
2012
6,040
—
6,040
1,297
—
1,297
7,337
2010
2,928
1,757
4,685
1,186
1,148
2,334
7,019
(a) Effective December 28, 2012, we sold our interest in the Habanero field. See Note 12 for additional
information.
The Company's PUDs decreased 18% to 7,337 MBoe from 8,925 MBoe at December 31, 2012 and 2011, respectively. Additions during the
year added 2,344 MBoe to the Company's PUDs, offset by (1) 557 MBoe primarily comprised of transfers to PDPs as a result of our
development program, (2) 1,148 MBoe related to the sale of Habanero, and (3) 2,227 MBoe related to reductions in our PUD reserves,
primarily related to the Haynesville Shale, by amounts no longer deemed to be economic PUDs at year-end. Of our year-end 2011 PUD
reserves, 6% were converted to proved developed producing reserves by year end 2012, at a total cost of approximately $19 million, net.
Our 1,297 MBoe of deepwater PUDs have been classified as PUDs for more than five years, though we expect to develop these PUDs
within the next two years. Our decision to classify these reserves as PUDs was primarily based on (1) our ongoing development planning in
the area, (2) our historical record of completing development of comparable long-term projects, (3) the amount of time which we have
maintained the leases or booked reserves without significant development activities and (4) the extent to which we have followed
previously adopted development plans. Our discussions with the field's operator have resulted in the modification of certain development
plans for Medusa to drill or sidetrack PUDs within a shorter period of time than originally estimated. The Company expects to drill a new
well in 2014 within the Medusa field to access the PUD reserves of 1,297 MBoe. During 2012, the Company did not convert any offshore
PUDs to PDPs.
The Company's plans to develop its onshore, Permian basin PUDs as part of a multi-year drilling program, which is expected to be
completed on existing acreage within five years of the initial recording of any PUD.
Controls Over Reserve Estimates
Compliance as it relates to reporting the Company’s reserves is the responsibility of our Senior Vice President of Operations, who has over
30 years of industry experience including 25 years as a manager and is our principal engineer. In addition to his years of experience, our
principal engineer holds a degree in petroleum engineering and is experienced in asset evaluation and management.
Callon’s controls over reserve estimates included retaining Huddleston & Co., Inc. ("Huddleston"), a Texas registered engineering firm, as
our independent petroleum and geological firm. The Company provided to Huddleston information about our oil and gas properties,
including production profiles, prices and costs, and Huddleston prepared its own estimates of the reserves attributable to the Company’s
properties. All of the information regarding reserves in this annual report is derived from Huddleston’s report. Huddleston's reserve report
letter is included as an Exhibit to this annual report. The principal engineer at Huddleston who is
12
Table of Contents
responsible for preparing the Company’s reserve estimates has over 30 years of experience in the oil and gas industry and is a Texas
Licensed Professional Engineer. Further professional qualifications include a degree in petroleum engineering.
To further enhance the control environment over the reserve estimation process, our Board of Directors includes a Strategic Planning
Committee whose purpose, as stated in the Committee's charter, includes assisting management and the Board with its oversight of the
integrity of the determination of the Company's oil, natural gas and natural gas liquids reserves and work of the Huddleston. The
Committee's charter also specifies that the Committee shall perform, in consultation with the Company's management and senior reserves
and reservoir engineering personnel, the following responsibilities:
•
•
•
•
Oversee the appointment, qualification, independence, compensation and retention of the independent petroleum and geological
firm (the "Firm") engaged by the Company (including resolution of material disagreements between management and the Firm
regarding reserve determination) for the purpose of preparing or issuing an annual reserve report. The Committee shall review any
proposed changes in the appointment of the Firm, determine the reasons for such proposal, and whether there have been any
disputes between the Firm and management.
Review the Company’s significant reserves engineering principles and policies and any material changes thereto, and any proposed
changes in reserves engineering standards and principles which have, or may have, a material impact on the Company’s reserves
disclosure.
Review with management and the Firm the proved reserves of the Company, and, if appropriate, the probable reserves, possible
reserves and the total reserves of the Company, including: (i) reviewing significant changes from prior period reports; (ii)
reviewing key assumptions used or relied upon by the Firm; (iii) evaluating the quality of the reserve estimates prepared by both
the Firm and the Company relative to the Company’s peers in the industry; and (iv) reviewing any material reserves adjustments
and significant differences between the Company’s and Firm’s estimates.
If the Committee deems it necessary, it shall meet in executive session with management and the Firm to discuss the oil and gas
reserve determination process and related public disclosures, and any other matters of concern in respect of the evaluation of the
reserves.
During our last fiscal year, we filed no reports with other federal agencies which contain an estimate of total proved net oil and natural gas
reserves.
13
Production Volumes, Average Sales Prices and Average Operating Costs
The following table sets forth certain information regarding the production volumes and average sales prices received for, and average
production costs associated with, the Company’s sale of crude oil and natural gas for the periods indicated.
Table of Contents
Production
Natural gas and NGLs (Mcf)
Crude oil (MBbl)
Total (MBoe)
Revenues
Natural gas and NGL sales
Crude oil sales
Total revenues
Lease Operating Expenses
Production costs
Severance/production taxes
Gathering
Ad Valorem
Total lease operating expenses
Realized prices
Natural gas ($/Mcf, including realized gains (losses) on derivatives) (a)
Natural gas ($/Mcf, excluding realized gains (losses) on derivatives) (a)
Crude oil ($/Bbl, including realized gains (losses) on derivatives) (b)
Crude oil ($/Bbl, excluding realized gains (losses) on derivatives) (b)
Operating costs per Boe - Total Consolidated
Production costs
Severance/production taxes
Gathering
Ad Valorem
Total operating costs per Boe
Years Ended December 31,
2012
2010
2011
(in thousands, except per unit data)
3,588
977
1,575
5,081
996
1,843
4,892
859
1,674
$
14,149 $
96,584
$ 110,733 $
26,682
100,962
127,644 $
24,639
65,243
89,882
$
$
$
$
$
22,981 $
2,430
349
794
26,554 $
17,693 $
1,826
592
236
20,347 $
15,770
816
802
324
17,712
3.94 $
3.94
98.86
97.41
5.25 $
5.25
101.34
101.72
14.59 $
1.54
0.22
0.50
16.85 $
9.60 $
0.99
0.32
0.13
11.04 $
5.04
4.91
75.97
75.97
9.61
0.49
0.48
0.19
10.77
(a) Natural gas prices exceeded the related NYMEX prices, which are quoted on an MMBtu basis, primarily due to the value of the NGLs in
our liquids-rich natural gas stream, primarily from our Permian basin and deepwater production.
(b) Crude oil prices for production from our two deepwater fields reflect a premium over NYMEX pricing based on Mars WTI differential
for Medusa production and Argus Bonita WTI differential for Habanero production, prior to the sale of Habanero during December 2012.
14
Present Activities and Productive Wells
The following table sets forth the wells drilled and completed during the periods indicated. All such wells were drilled in the continental
United States and in federal and state waters in the Gulf of Mexico. At December 31, 2012, the Company was in the process of drilling one
exploratory well (which is excluded from the table below) and had four wells awaiting fracture stimulation.
Table of Contents
Development:
Crude oil
Natural gas
Non-productive
Total
Exploration:
Crude oil
Natural gas
Non-productive
Total
Years ended December 31,
2012
2011
2010
Gross
Net
Gross
Net
Gross Net
14
—
—
14
7
—
—
7
9.70
—
—
9.70
6.20
—
—
6.20
36
—
—
36
32.77
—
—
32.77
20 19.37
0.69
1
— —
21 20.06
—
—
—
—
—
—
—
—
— —
— —
— —
— —
Wells drilled within the productive boundaries of statistical plays, such as on our southern Midland basin acreage, have been classified as
development wells.
The following table sets forth productive wells as of December 31, 2012:
Working interest
Royalty interest
Total
Crude Oil Wells
Net
Gross
Natural Gas Wells
Gross
Net
103
3
106
84.50
0.10
84.60
10
2
12
4.30
0.08
4.38
A well is categorized as a crude oil well or a natural gas well based upon the ratio of crude oil to natural gas reserves on a Mcfe
basis. However, some of our wells produce both crude oil and natural gas.
For the periods presented, the following table sets forth by major field(s) net production volumes and estimated proved reserves:
Offshore - Gulf of Mexico:
2012
2011
2010
2012
2011
2010
Production Volumes (MBoe)
% of Total Proved Reserves at 12/31/2012
Year ended December 31,
Medusa
Habanero
Shelf and other
Total offshore:
Onshore:
Permian basin
Haynesville shale
Total onshore:
464
134
340
938
591
46
637
641
197
551
1,389
353
101
454
593
233
616
1,442
150
82
232
28%
—%
4 %
32%
67%
1 %
68%
27%
8 %
4 %
39%
48%
13%
61%
33%
10%
7 %
50%
33%
17%
50%
Total
1,575
1,843
1,674
100 %
100 %
100 %
15
Leasehold Acreage
The following table shows our approximate developed and undeveloped (gross and net) leasehold acreage as of December 31, 2012.
Table of Contents
Louisiana
Texas (a)
Federal onshore (b)
Federal waters (c)
Total
Developed
Undeveloped
Total
Gross
Net
Gross
Net
Gross
1,741
10,891
—
44,920
57,552
681
8,914
—
17,136
26,731
233
27,236
64,963
23,715
116,147
167
1,974
24,048
38,127
64,963
64,963
7,599
68,635
96,777 173,699
Net
848
32,962
64,963
24,735
123,508
(a) A portion of our Texas acreage requires continued drilling to hold the acreage for which we have included in our development plans,
though the cost to renew this acreage, if necessary, is not considered material.
(b) The Company's lease of this acreage, located in Nevada, has approximately six years remaining, and had a carrying value at
December 31, 2012 of approximately $2.6 million included in the Company's unevaluated properties balance. The lease requires no
drilling activity to hold the acreage, and we continue to monitor the activity of other operators conducting drilling in the area.
(c) The Company's
production.
federal waters acreage
is held by
Title to Properties
The Company believes that the title to its crude oil and natural gas properties is good and defensible in accordance with standards generally
accepted in the oil and gas industry, subject to such exceptions which, in our opinion, are not so material as to detract substantially from the
use or value of such properties. The Company's properties are typically subject, in one degree or another, to one or more of the following:
•
•
•
•
•
•
•
royalties and other burdens and obligations, express or implied, under oil and natural gas
leases,
overriding royalties and other burdens created by us or our predecessors in
title,
a variety of contractual obligations (including, in some cases, development obligations) arising under operating agreements, farm-
out agreements, production sales contracts and other agreements that may affect the properties or their titles,
back-ins and reversionary
assignments,
liens that arise in the normal course of operations, such as those for unpaid taxes, statutory liens securing obligations to unpaid
suppliers and contractors and contractual liens under operating agreements,
pooling, unitization and communitization agreements, declarations and orders,
and
easements, restrictions, rights-of-way and other matters that commonly affect
property.
interests existing under purchase agreements and
leasehold
To the extent that such burdens and obligations affect the Company's rights to production revenues, these characteristics have been taken
into account in calculating Callon's net revenue interests and in estimating the size and value of its reserves. The Company believes that
the burdens and obligations affecting our properties are typical within the industry for properties of the kind owned by Callon.
Insurance
In accordance with industry practice, the Company maintains insurance against some, but not all, of the operating risks to which its
business is exposed. While not all inclusive, the Company's insurance policies include coverage for general liability insuring both onshore
and offshore operations (including sudden and accidental pollution), physical damage to its offshore oil and natural gas properties, aviation
liability, auto liability, worker's compensation, employer's liability, and maritime employers liability. The company carries control of well
insurance for all offshore wells, though unless contractually bound to do so, the Company does not carry control of well insurance for
onshore operations. At the depths and in the areas in which the Company operates, and in light of the vertical and horizontal drilling that it
undertakes, the Company typically does not encounter high pressures or extreme drilling conditions onshore.
Currently, the Company has general liability insurance coverage up to $1 million per occurrence and $2 million per policy in the aggregate,
which includes sudden and accidental environmental liability coverage for the effects of pollution on third parties
16
Table of Contents
arising from its operations. The Company's insurance policies contain high policy limits, and in most cases, deductibles (generally ranging
from $0 to $1.5 million) that must be met prior to recovery. These insurance policies are subject to certain customary exclusions and
limitations. In addition, the Company maintains up to $100 million in excess liability coverage, which is in addition to and triggered if the
underlying liability limits have been reached.
The Company requires all of its third-party contractors to sign master service agreements in which they agree to indemnify the Company
for injuries and deaths of the service provider's employees as well as contractors and subcontractors hired by the service provider.
Similarly, the Company generally agrees to indemnify each third-party contractor against claims made by employees of the Company and
the Company's other contractors. Additionally, each party generally is responsible for damage to its own property.
The third-party contractors that perform hydraulic fracturing operations for the Company sign master service agreements generally
containing the indemnification provisions noted above. The Company does not currently have any insurance policies in effect that are
intended to provide coverage for losses solely related to hydraulic fracturing operations. However, the Company believes its general
liability and excess liability insurance policies would cover foreseeable third party claims related to hydraulic fracturing operations and
associated legal expenses, in accordance with, and subject to, the terms of such policies.
The Company re-evaluates the purchase of insurance, coverage limits and deductibles annually. Future insurance coverage for the oil and
natural 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. While based on the Company's risk analysis, it
believes that it is properly insured, no assurance can be given that the Company will be able to maintain insurance in the future at rates that
it considers reasonable. In such circumstances, the Company may elect to self-insure or maintain only catastrophic coverage for certain
risks in the future.
Major Customers
Our production is sold generally on month-to-month contracts at prevailing prices. The following table identifies customers to whom we
sold a significant percentage of our total oil and natural gas production, on an equivalent basis, during each of the 12-month periods ended:
Shell Trading Company
Plains Marketing, L.P.
Enterprise Crude Oil, LLC
Louis Dreyfus Energy Services
Other
Total
December 31,
2011
2012
2010
39%
15%
32%
2%
12%
100%
45%
17%
16%
4%
18%
100%
44%
20%
—%
13%
23%
100%
Because alternative purchasers of oil and natural gas are readily available, the Company believes that the loss of any of these purchasers
would not result in a material adverse effect on Callon’s ability to market future oil and natural gas production. We are not currently
committed to provide a fixed and determinable quantity of oil or gas in the near future under our contracts.
Corporate Offices
The Company’s headquarters are located in Natchez, Mississippi, in approximately 51,500 square feet of owned space. We also maintain
leased business offices in Houston and Midland, Texas. Because alternative locations to our leased spaces are readily available, the
replacement of any of our leased offices would not result in material expenditures.
Employees
Callon had 87 employees as of December 31, 2012, which included 13 petroleum engineers and four petroleum geoscientists. None of the
Company’s employees are currently represented by a union, and the Company believes that it has good relations with its employees.
17
Regulations
General. The oil and natural gas industry is subject to regulation at the federal, state and local level, and some of the laws, rules and
regulations that govern our operations carry substantial penalties for non-compliance. 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. This regulatory burden increases our cost of doing business and, consequently, affects our profitability.
Exploration and Production. Our operations are subject to federal, state and local regulations that include requirements for permits to drill
and to conduct other operations and for provision of financial assurances (such as bonds and letters of credit) covering drilling and well
operations. Other activities subject to regulation are:
Table of Contents
•
•
•
•
•
•
•
•
•
•
of
and method
location and spacing of
the
wells,
the method of drilling and completing and operating
wells,
the
rate
production,
the surface use and restoration of properties upon which wells are drilled and other exploration
activities,
notice to surface owners and other third
parties,
the plugging and abandoning of
wells,
the discharge of contaminants into water and the emission of contaminants into
air,
the disposal of fluids used or other wastes obtained in connection with
operations,
the marketing, transportation and reporting of production,
and
the valuation
royalties.
and payment of
For instance, our OCS leases in federal waters are administered by three Bureaus of the Department of Interior "DOI". In response to
concerns that the former MMS revenue-generating and resource development functions were at odds with its safety and environmental
regulatory functions, the DOI reorganized the MMS into three separate agencies: the BOEM, to be the resource manager for conventional
and renewable energy and mineral resources on the OCS; the BSEE, to promote and enforce safety in offshore energy exploration and
production operations; and the ONRR, to collect and distribute royalties, rents, fees and other revenues, including the development of
regulations with respect to revenue valuation and collection and enforcement activities. In this “Exploration and Production” section, we
refer to actions of one or more of the foregoing agencies as actions of “the DOI Bureaus”.
The DOI Bureaus require compliance with detailed regulations and orders. Lessees must obtain DOI Bureau approval for exploration,
exploitation and production plans and applications for permits to drill prior to the commencement of such operations. Since the April 20,
2010 blowout and oil spill at the BP Deepwater Horizon Macondo oil well, the DOI Bureaus have issued numerous rules, Notices to
Lessees and other guidance documents augmenting the existing regulations with more stringent safety, engineering and environmental
requirements. The DOI Bureaus have also issued a rule requiring that all operators in the OCS formulate detailed Safety and Environmental
Management Systems to improve the safety of their operations on the OCS. Current DOI Bureau regulations restrict the flaring or venting
of natural gas, and prohibit the flaring of liquid hydrocarbons and oil without prior authorization. The DOI Bureaus are considering whether
to require flaring rather than venting, where practical, to reduce the potential effect of greenhouse gas emissions.
DOI Bureau policies concerning the volume of production that a lessee must have to maintain an offshore lease beyond its primary term
also are applicable to Callon. Similarly, the DOI Bureaus have promulgated other regulations and Notices to Lessees governing the
plugging and abandonment of wells located offshore and the installation and decommissioning of production facilities. To cover the various
obligations of lessees on the OCS, the DOI Bureaus generally requires that lessees post bonds, letters of credit, or other acceptable
assurances that such obligations will be met. The cost of these bonds or other surety can be substantial, and there is no assurance that bonds
or other surety can be obtained in all cases. Under some circumstances, the DOI Bureaus may require any of our operations on federal
leases to be suspended or terminated. Any such suspension or termination could materially adversely affect our financial conditions and
results of operations.
As stated above, the April 20, 2010 blowout and oil spill at the BP Deepwater Horizon oil rig has prompted the federal government to
impose heightened regulation of oil and natural gas exploration and production on the OCS. Especially with respect to deepwater
operations, the DOI Bureaus have issued rules that are more stringent than the rules issued by the MMS, and have announced their
intention to issue additional safety rules and be more scrupulous in implementing existing environmental requirements in the future.
Legislation has been introduced in the United States Congress to toughen the regulation of oil and natural gas exploration and production
on the OCS. In addition, the National Commission on the BP Deepwater Horizon Oil Spill and Offshore Drilling, whose members were
appointed by President Obama, issued a report proposing, among other things, fundamental reform of the regulation of oil and natural gas
exploration and production on the OCS. The tightening of regulation on the OCS could impose
18
Table of Contents
higher costs on, and render it more difficult to timely obtain regulatory approval of our proposed activities on the OCS, especially as to
deepwater projects.
Operations conducted on federal or state oil and natural gas leases must comply with numerous regulatory restrictions, including various
nondiscrimination 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 the DOI Bureaus or other appropriate federal or state agencies.
Our sales of oil and natural gas are affected by the availability, terms and cost of pipeline transportation. The price and terms for access to
pipeline transportation remain subject to extensive federal and state regulation. If these regulations change, we could face higher
transmission costs for our production and, possibly, reduced access to transmission capacity.
Various proposals and proceedings that might affect the petroleum industry are pending before Congress, the Federal Energy Regulatory
Commission, or FERC, various state legislatures, and the courts. The industry historically has been heavily regulated and we can offer you
no assurance that the less stringent regulatory approach recently pursued by the FERC and Congress will continue nor can we predict what
effect such proposals or proceedings may have on our operations.
We do not currently anticipate that compliance with existing laws and regulations governing exploration and production will have a
significantly adverse effect upon our capital expenditures, earnings or competitive position.
Environmental Regulation. Various federal, state and local laws and regulations concerning the release of contaminants into the
environment, including the discharge of contaminants into water and the emission of contaminants into the air, the generation, storage,
treatment, transportation and disposal of wastes, and the protection of public health, welfare, and safety, and the environment, including
natural resources, affect our exploration, development and production operations, including operations of our processing facilities. We must
take into account the cost of complying with environmental regulations in planning, designing, drilling, constructing, operating and
abandoning wells. Regulatory requirements relate to, among other things, the handling and disposal of drilling and production waste
products, the control of water and air pollution and the removal, investigation, and remediation of petroleum-product contamination. In
addition, our operations may require us to obtain permits for, among other things,
•
•
•
air
emissions,
discharges into surface waters (including wetlands),
and
the construction and operations of underground injection wells or surface pits to treat, re-use or dispose of produced water
and other nonhazardous oilfield wastes.
In the event of an unauthorized discharge (e.g., to land or water), emission (e.g., to air) or other activity, we may be liable for, among other
things, penalties, costs and damages, and subject to injunctive relief, and we could be required to cleanup or mitigate the environmental
impacts of those discharges, emissions or activities. Also, under federal, and certain state, laws, the present and certain past owners and
operators of a site, and persons that treated, disposed of or arranged for the disposal of hazardous substances found at a site, may be liable,
without regard to fault or the legality of the original conduct, for the release of hazardous substances into the environment and damage to
natural resources caused by such release. The Environmental Protection Agency, state environmental agencies and, in some cases third
parties are authorized to take actions in response to threats to human health or the environment and to seek to recover from responsible
classes of persons the costs of such actions. We therefore could be required to remove or remediate previously disposed wastes and
remediate contamination, including contamination in surface water, soil or groundwater, caused by disposal of that waste, irrespective of
whether disposal or release were unlawful. We could be responsible for wastes disposed of or released by us or prior owners or operators at
properties owned or leased by us or at locations where wastes have been taken for disposal also irrespective of whether disposal or release
were authorized. We could also be required to suspend or cease operations in contaminated areas, or to perform remedial well plugging
operations or cleanups to prevent future contamination.
Federal, and certain state, laws also impose duties and liabilities on certain “responsible parties” related specifically 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. These laws
assign liability, which generally is joint and several, without regard to fault, to each liable party for oil removal costs and a variety of public
and private damages. Although defenses and limitations exist to the liability imposed under these laws, they are limited. In the event of an
oil discharge or substantial threat of discharge, we could be liable for costs and damages.
19
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The Environmental Protection Agency and various state agencies have limited the disposal options for hazardous and nonhazardous wastes
thereby increasing the costs of disposal. Furthermore, certain wastes generated by our oil and natural gas operations that are currently
exempt from treatment as hazardous wastes may in the future be designated as hazardous wastes and, therefore, be subject to considerably
more rigorous and costly operating and disposal requirements.
Federal and state occupational safety and health laws require us to organize information about hazardous materials used, released or
produced in our operations. Certain portions of this information must be provided to employees, state and local governmental authorities
and local citizens. We are also subject to the requirements and reporting set forth in federal workplace standards.
There are federal and certain state laws that impose restrictions on activities adversely affecting the habitat of certain plant and animal
species. In the event of an unauthorized impact or taking of a protected species or its habitat, we could be liable for penalties, costs and
damages, and subject to injunctive relief, and we could be required to mitigate those impacts. A critical habitat or suitable habitat
designation also could result in further material restrictions to land use and may materially delay or prohibit land access for oil and natural
gas development.
Oil and natural gas exploration and production activities are being subjected to additional regulatory scrutiny under the Clean Air Act
(“CAA”). On April 17, 2012, the EPA issued final rules to subject oil and gas operations to regulation under the New Source Performance
Standards, or NSPS, and National Emission Standards for Hazardous Air Pollutants, or NESHAPS, programs under the CAA, and to
impose new and amended requirements under both programs. The EPA rules include NSPS standards for completions of hydraulically
fractured natural gas wells. Before January 1, 2015, these standards require owners/operators to reduce 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 new hydraulically
fractured gas wells and also existing gas wells that are refractured. Further, the finalized regulations also establish specific new
requirements, effective in 2012, for emissions from certain compressors, controllers, dehydrators, storage tanks, natural gas processing
plants and other equipment based upon equipment types, locations, and emission thresholds. These rules may require changes to our
operations, including the installation of new equipment to control emissions.
We have made and will continue to make expenditures to comply with environmental regulations and requirements. These are necessary
costs of doing business within the oil and natural gas industry. Although we are not fully insured against all environmental risks, we
maintain insurance coverage which we believe is customary in the industry. Moreover, it is possible that other developments, such as
stricter and more comprehensive environmental laws and regulations, as well as claims for damages to property or persons resulting from
company operations, could result in substantial costs and liabilities. We believe we are in compliance with existing environmental
regulations, and that, absent the occurrence of an extraordinary event the effect of which cannot be predicted, any noncompliance will not
have a material adverse effect on our operations or earnings.
Greenhouse Gas (“GHG”) Regulation. Although federal legislation regarding the control of greenhouse gasses, or GHGs, thus far has
been unsuccessful, the EPA has moved forward with rulemaking to regulate GHGs as pollutants under the CAA. These GHG regulations
may require us to incur increased operating costs and may have an adverse effect on demand for the oil and natural gas we produce.
The EPA, as of January 2, 2011, requires the permitting of GHG emissions from stationary sources under the Prevention of Significant
Deterioration (“PSD”) and Title V permitting programs in a multi-step process, with the largest sources first subject to permitting. Those
permitting provisions, should they become applicable to our operations, could require controls or other measures to reduce GHG emissions
from new or modified sources, and we could incur additional costs to satisfy those requirements. On November 30, 2010, EPA published a
rule establishing GHG reporting requirements for sources in the petroleum and natural gas industry, requiring those sources to monitor,
maintain records on, and annually report their GHG emissions if the total emissions within a basin exceed 25,000 metric tons CO2
equivalent per year. Although this rule does not limit the amount of GHGs that can be emitted, it will require us to incur costs to monitor,
keep records of, and potentially report GHG emissions associated with our operations if the reporting threshold is reached with production
growth.
In addition to federal regulation, a number of states, individually and regionally, also are considering or have implemented GHG regulatory
programs. These potential regional and state 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 our
incurring material expenses to comply, such as by being required to purchase or to surrender allowances for GHGs resulting from our
operations. The federal, regional and local regulatory initiatives also could adversely affect the marketability of the oil and natural gas we
produce. The impact of such future programs cannot be predicted, but we do not expect our operations to be affected any differently than
other similarly situated domestic competitors.
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Application of the Safe Drinking Water Act to Hydraulic Fracturing. Congress has considered but has not passed 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. Hydraulic fracturing involves the injection of water,
sand and chemicals under pressure into rock formations to stimulate oil and natural gas production. Sponsors of these bills have asserted
that chemicals used in the fracturing process could adversely affect drinking water supplies. A number of state, local and regional
regulatory authorities have or are considering hydraulic fracturing regulation. For example, Texas has adopted regulations requiring the
disclosure of hydraulic fracturing chemicals. Potential federal as well as existing and potential state regulation could cause us to incur
substantial compliance costs, and the requirement could negatively affect our ability to conduct fracturing activities on our assets.
In addition, the EPA has recently been taking actions to assert federal regulatory authority over hydraulic fracturing using diesel under the
Safe Drinking Water Act's Underground Injection Control Program. Further, in March 2010, the EPA announced that it would conduct a
wide-ranging study on the effects of hydraulic fracturing on drinking water resources. A progress report was issued in December 2012,
with final results expected in 2014. In addition, in December 2011, the EPA published an unrelated draft report concluding that hydraulic
fracturing caused groundwater pollution in a natural gas field in Wyoming. This study remains subject to review. The agency also
announced that one of its enforcement initiatives for 2011 to 2013 would be to focus on environmental compliance by the energy extraction
sector. This study and enforcement initiative could result in additional regulatory scrutiny that could make it difficult to perform hydraulic
fracturing and increase our costs of compliance and doing business. Consequently, these studies and initiatives could spur further legislative
or regulatory action regarding hydraulic fracturing or other production operations. Further, the BLM has indicated that it will engage in
rulemaking to regulate hydraulic fracturing on federal lands.
Further, EPA has announced an initiative under the Toxic Substances Control Act (“TSCA”) to develop regulations governing the
disclosure and evaluation of hydraulic fracturing chemicals.
All of the acreage and undeveloped reserves within the Permian basin are subject to hydraulic fracturing procedures as the process is
required to economically develop the Wolfberry formation. The hydraulic fracturing process is integral to the Company's overall drilling
and completion costs in the Permian basin and represented approximately 34% or $0.8 million of the total drilling/completion costs per
vertical well drilled during 2012.
The hydraulic fracturing activity is limited to the oil and natural gas bearing formations, which are found at depths ranging between 6,000
and 12,000 feet from the surface in Midland, Ector and Upton counties, Texas. The Railroad Commission of Texas has defined potable
water sources in this area as usable-quality ground water from the surface to a depth of 250 feet for our acreage in Midland and Ector
counties and to a depth of 425 feet for our acreage in Upton counties.
The Company diligently reviews best practices and industry standards, and complies with all regulatory requirements in the protection of
these potable water sources. Protective practices include, but are not limited to, setting multiple strings of protection pipe across the potable
water sources and cementing these pipes from setting depth to surface, continuously monitoring the hydraulic fracturing process in real
time, and disposing of all non-commercially produced fluids in certified disposal wells at depths below the potable water sources.
Based on current drilling techniques, a typical fracturing procedure for a vertical well in the Wolfberry formation uses approximately 1.8
million gallons of fresh water, approximately 1.2 million pounds of sand and other elements including enzymes and guar, a common food
additive. Horizontal wells typically use 9.5 million gallons of water and approximately 6.2 million pounds of sand.
In compliance with the law enacted in Texas in June 2011 and regulations adopted in December 2011, the Company will disclose hydraulic
fracturing data to the Ground Water Protection Council and the Interstate Oil and Gas Compact Commission chemical registry effective
January 2, 2012. This disclosure is required for each chemical ingredient that is subject to the requirements of OSHA regulations, as well as
the total volume of water used in the hydraulic fracturing treatment. A copy of the completed form is uploaded into the Chemical
Disclosure Registry also known as FracFocus, which is a publically accessible website.
There have not been any incidents, citations or suits related to the Company's hydraulic fracturing activities involving environmental
concerns.
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 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.
21
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Army Corps of Engineers. 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, we may be liable for penalties and cleanup and response
costs.
Surface Damage Statutes (“SDAs”). In addition, a number of states and some tribal nations have enacted SDAs. These laws are designed
to compensate for damage caused by oil and gas development operations. Most SDAs contain entry notification and negotiation
requirements to facilitate contact between operators and surface owners/users. Most also contain binding requirements for payments to the
operator in connection with exploration and operating activities. Costs and delays associated with SDAs could impair operational
effectiveness and increase development costs.
Mineral Lease Act of 1920 (“Mineral Act”) . The Mineral Act prohibits direct or indirect ownership of any interest in federal onshore oil
and natural gas leases by a foreign citizen or a foreign corporation except through stock 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 corporations of the United States. If these restrictions are violated, the oil and gas lease or
leases can be canceled in a proceeding instituted by the United States Attorney General. Although the regulations of the Bureau of Land
Management ("BLM") (which administers the Mineral Act) provide for agency designations of non-reciprocal countries, there are presently
no such designations in effect. The Company owns interests in numerous federal onshore oil and natural gas leases. It is possible that
holders of the Company's equity interests may be citizens of foreign countries, which could be determined to be citizens of a non-reciprocal
country under the Mineral Act. In such event, the federal onshore oil and gas leases held by the Company could be subject to cancellation
based on such determination.
Other Regulations. If we conduct operations on federal, state or Indian oil and natural gas leases, these operations must comply with
numerous regulatory restrictions, including various nondiscrimination statutes, royalty and related valuation requirements. Certain of these
operations must be conducted pursuant to certain on-site security regulations and other appropriate permits issued by the BLM, the Bureau
of Ocean Energy Management, the Bureau of Safety and Environmental Enforcement, or other appropriate federal, state, or tribal agencies.
Commitments and Contingencies
The Company's activities are subject to federal, state and local laws and regulations governing environmental quality and pollution
control. Although no assurances can be made, the Company believes that, absent the occurrence of an extraordinary event, compliance
with existing federal, state and local laws, rules and regulations governing the release of materials into the environment or otherwise
relating to the protection of the environment will not have a material effect upon the capital expenditures, earnings or the competitive
position of the Company with respect to its existing assets and operations. The Company cannot predict what effect additional regulation
or legislation, enforcement polices included, and claims for damages to property, employees, other persons, and the environment resulting
from the Company's operations could have on its activities. See Note 15 for additional information.
Available Information
We make available free of charge on our Internet web site (www.callon.com) our Annual Report on Form 10-K, Quarterly Reports on
Form 10-Q, Current Reports on Form 8-K and other filings pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and
amendments to such filings, as soon as reasonably practicable after each are electronically filed with, or furnished to, the SEC. You may
read and copy any materials we file with the SEC at the SEC's Public Reference Room at 100 F Street, NE., Washington, DC 20549. You
may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains
an Internet site (www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers, like
Callon, that file electronically with the SEC.
We also make available within the Investors section of our Internet web site our Code of Business Conduct and Ethics, Corporate
Governance Guidelines, and Audit, Compensation and Nominating and Governance Committee Charters, which have been approved by our
board of directors. We will make timely disclosure by a Current Report on Form 8-K and on our web site of any change to, or waiver from,
the Code of Business Conduct and Ethics for our principal executive and senior financial officers. A copy of our Code of Business Conduct
and Ethics is also available, free of charge by writing us at: Chief Financial Officer, Callon Petroleum Company, P.O. Box 1287, Natchez,
MS 39121.
22
Item 1A. Risk Factors
Risk Factors
Table of Contents
Depressed oil and natural gas prices may adversely affect our results of operations and financial condition . Our success is highly
dependent on prices for oil and natural gas, which are extremely volatile, and the oil and natural gas markets are cyclical. Extended periods
of low prices for oil or natural gas will have a material adverse effect on us. The prices of oil and natural gas depend on factors we cannot
control such as weather, economic conditions, and levels of production, actions by OPEC and other countries and government actions.
Prices of oil and natural gas will affect the following aspects of our business:
flows
revenues,
cash
and
•
our
earnings;
the amount of oil and natural gas that we are economically able to
produce;
our ability to attract capital to finance our operations and the cost of the
capital;
the amount we are allowed to borrow under our Credit
Facility;
the profit or loss we incur in exploring for and developing our reserves;
and
the value of our oil and natural gas
properties.
•
•
•
•
•
Natural gas prices have been depressed recently and have the potential to remain depressed for the next several years, which may
have an adverse effect on our financial condition and results of operations. Natural gas prices have been depressed for the last several
years as a result of over-supply caused by, among other things, increased drilling in unconventional reservoirs, reduced economic activity
associated with a recession and weather conditions. We expect natural gas prices to be depressed during the foreseeable future.
Approximately 23% of our estimated net proved reserves at December 31, 2012 are natural gas, and 38% of our production in 2012 was
natural gas. A sustained reduction in natural gas prices could have an adverse effect on our results of operations and financial condition.
If oil and natural gas prices decrease or remain depressed for extended periods of time, we may be required to take additional
writedowns of the carrying value of our oil and natural gas properties. We may be required to writedown the carrying value of our oil
and natural gas properties when oil and natural gas prices are low or if we have substantial downward adjustments to our estimated net
proved reserves, increases in our estimates of development costs or if we experience deterioration in our exploration results. Under the full-
cost method, which we use to account for our oil and natural gas properties, the net capitalized costs of our oil and natural gas properties
may not exceed the present value, discounted at 10%, of future net cash flows from estimated net proved reserves, using the preceding 12-
months' average oil and natural gas prices based on closing prices on the first day of each month, plus the lower of cost or fair market value
of our unproved properties. If net capitalized costs of our oil and natural gas properties exceed this limit, we must charge the amount of the
excess to earnings. This type of charge will not affect our cash flows, but will reduce the book value of our stockholders' equity. We review
the carrying value of our properties quarterly, based on the pricing noted above. Once incurred, a writedown of oil and natural gas
properties is not reversible at a later date, even if prices increase. See Note 14 to our Consolidated Financial Statements.
Our actual recovery of reserves may substantially differ from our proved reserve estimates. This Form 10-K contains estimates of our
proved oil and natural gas reserves and the estimated future net cash flows from such reserves. These 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 oil and natural gas reserves is complex. This process requires
significant decisions and assumptions in the evaluation of available geological, geophysical, engineering and economic data for each
reservoir and is therefore inherently imprecise. Additionally, our interpretations of the rules governing the estimation of proved reserves
could differ from the interpretation of staff members of regulatory authorities resulting in estimates that could be challenged by these
authorities.
Actual future production, oil and natural gas prices, revenues, taxes, development expenditures, operating expenses and quantities of
recoverable oil and natural gas reserves most likely will vary from the estimates. Any significant variance could materially affect the
estimated quantities and present value of reserves shown in this report. Additionally, reserves and future cash flows may be subject to
material downward or upward revisions, based on production history, development drilling and exploration activities and prices of oil and
natural gas. We incorporate many factors and assumptions into our estimates including:
•
•
•
•
Expected reservoir characteristics based on geological, geophysical and engineering
assessments;
Future production rates based on historical performance and expected future operation investment
activities;
Future oil and natural gas prices and quality and locational differences;
and
Future development and operating
costs.
23
Table of Contents
You should not assume that any present value of future net cash flows from our producing reserves contained in this Form 10-K represents
the market value of our estimated oil and natural gas reserves. We base the estimated discounted future net cash flows from our proved
reserves at December 31, 2012 on average 12-month prices and costs as of the date of the estimate. Actual future prices and costs may be
materially higher or lower. Further, actual future net revenues will be affected by factors such as the amount and timing of actual
development expenditures, the rate and timing of production, and changes in governmental regulations or taxes. At December 31, 2012,
approximately 14% of the discounted present value of our estimated net proved reserves consisted of PUDs. PUDs represented 52% of total
proved reserves by volume, and approximately 18% of our PUDs were attributable to our deepwater property. Recovery of undeveloped
reserves generally requires significant capital expenditures and successful drilling operations. Our reserve estimates include the assumption
that we will make significant capital expenditures to develop these undeveloped reserves and the actual costs, development schedule, and
results associated with these properties may not be as estimated. In addition, the 10% discount factor that we use to calculate the net present
value of future net revenues and cash flows may not necessarily be the most appropriate discount factor based on our cost of capital in
effect from time to time and the risks associated with our business and the oil and gas industry in general.
Information about reserves constitutes forward-looking information. See “Forward-Looking Statements” for information regarding
forward-looking information.
Unless we are able to replace reserves that we have produced, our cash flows and production will decrease over time. The high-rate
production characteristics of our Gulf of Mexico properties subject us to high reserve replacement needs. In general, the volume of
production from oil and natural gas properties declines as reserves are depleted. The decline rates depend on reservoir characteristics. Gulf
of Mexico reservoirs tend to be recovered quickly through production with associated steep declines, while declines in other regions after
initial flush production tend to be relatively low. Our Gulf of Mexico, deepwater properties accounted for approximately 38% of our
production which included the Habanero property during 2012 and 28% of our estimated proved reserves at December 31, 2012 excluding
the Habanero property. Similarly, our Gulf of Mexico shelf properties accounted for approximately 22% of our production during 2012 and
4% of our estimated proved reserves at December 31, 2012. Our reserves will decline as they are produced unless we acquire properties
with proved reserves or conduct successful development and exploration drilling activities. Our future natural gas and oil production is
highly dependent upon our level of success in finding or acquiring additional reserves at a unit cost that is sustainable at prevailing
commodity prices. Without successful exploration or acquisition activities, our reserves, production and revenues will decline.
Exploring for, developing, or acquiring reserves is capital intensive and uncertain. We may not be able to economically find, develop,
or acquire additional reserves, or may not be able to make the necessary capital investments if our cash flows from operations decline or
external sources of capital become limited or unavailable. As part of our exploration and development operations, we have expanded, and
expect to further expand, the application of horizontal drilling and multi-stage hydraulic fracture stimulation techniques. The utilization of
these techniques requires substantially greater capital expenditures, currently expected to be in excess of three times the cost, as compared
to the drilling of a traditional vertical well. The incremental capital expenditures are the result of greater measured depths and additional
hydraulic fracture stages in horizontal wellbores. We cannot assure you that our future exploitation, exploration, development, and
acquisition activities will result in additional proved reserves or that we will be able to drill productive wells at acceptable costs. We cannot
assure you that we will be able to find and develop or acquire additional reserves at an acceptable cost.
The unavailability or high cost of drilling rigs, pressure pumping equipment and crews, other equipment, supplies, water,
personnel and oil field services could adversely affect our ability to execute our exploration and development plans on a timely
basis and within our budget. Our industry is cyclical and, from time to time, there is a shortage of drilling rigs, equipment, supplies, water
or qualified personnel. During these periods, the costs and delivery times of rigs, equipment and supplies are substantially greater. In
addition, the demand for, and wage rates of, qualified drilling rig crews rise as the number of active rigs in service increases. Increasing
levels of exploration and production may increase the demand for oilfield services and equipment, and the costs of these services and
equipment may increase, while the quality of these services and equipment may suffer. The unavailability or high cost of drilling rigs,
pressure pumping equipment, supplies or qualified personnel can materially and adversely affect our operations and profitability.
A significant portion of our production and reserves is concentrated in our deepwater offshore property, and any production
problems or inaccuracies in reserve estimates related to this property would adversely impact our business. During 2012,
approximately 29% of our daily production came from our Medusa field, which is currently our only deepwater property located in the Gulf
of Mexico. In addition, at December 31, 2012, approximately 28% of our total net proved reserves were located within this field. If
mechanical problems, storms or other events curtailed a substantial portion of this production, or if the actual reserves associated with this
producing property are less than our estimated reserves, our results of operations and financial condition could be adversely affected.
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Table of Contents
Our exploration projects increase the risks inherent in our oil and natural gas activities. We may seek to replace reserves through
exploration, where the risks are greater than in acquisitions and development drilling. During 2012, we purchased 24,328 net acres in the
northern portion of the Midland basin, an area that has seen only limited development activity. We expect to conduct substantial
exploration of this acreage over the next several years. Although we have been successful in exploration in the past, we cannot assure you
that we will continue to increase reserves through exploration or at an acceptable cost. Additionally, we are often uncertain as to the future
costs and timing of drilling, completing and producing wells. Our exploration drilling operations may be curtailed, delayed or canceled as a
result of a variety of factors, including:
•
receipt of additional seismic data or other geophysical data or the reprocessing of existing
data;
• material changes in oil or natural gas
•
•
•
•
•
•
•
prices;
the costs and availability of drilling
rigs;
the success or failure of wells drilled in similar formations or which would use the same production
facilities;
availability and cost of
capital;
changes in the estimates of the costs to drill or complete
wells;
our ability to attract other industry partners to acquire a portion of the working interest to reduce exposure to costs and drilling
risks;
decisions of our joint working interest owners;
and
changes to governmental
regulations.
Our exploration and development drilling efforts and the operation of our wells may not be profitable or achieve our targeted
returns. Exploration, development, drilling and production activities are subject to many risks, including the risk that commercially
productive deposits will not be discovered. We may invest in property, including undeveloped leasehold acreage, which we believe will
result in projects that will add value over time. However, we cannot guarantee that any leasehold acreage acquired will be profitably
developed, that new wells drilled will be productive or that we will recover all or any portion of our investment in such leasehold acreage or
wells. Drilling for oil and natural gas may involve unprofitable efforts, not only from dry wells but also from wells that are productive but
do not produce sufficient net reserves to return a profit after deducting operating and other costs. In addition, wells that are profitable may
not achieve our targeted rate of return. Our ability to achieve our target results are dependent upon the current and future market prices for
oil and natural gas, costs associated with producing oil and natural gas and our ability to add reserves at an acceptable cost.
In addition, we may not be successful in controlling our drilling and production costs to improve our overall return. The cost of drilling,
completing and operating a well is often uncertain and cost factors can adversely affect the economics of a project. We cannot predict the
cost of drilling, and we may be forced to limit, delay or cancel drilling operations as a result of a variety of factors, including:
•
•
•
•
or
drilling
irregularities
unexpected
conditions;
pressure
formations;
equipment failures or accidents and shortages or delays in the availability of drilling rigs and the delivery of equipment;
and
compliance
requirements.
governmental
with
in
We may be unable to integrate successfully the operations of future acquisitions with our operations, and we may not realize all the
anticipated benefits of these acquisitions. Our business may include producing property acquisitions that would include undeveloped
acreage. We can offer no assurance that we will achieve the desired profitability from any acquisitions we may complete in the future. In
addition, failure to assimilate recent and future acquisitions successfully could adversely affect our financial condition and results of
operations. Our acquisitions may involve numerous risks, including:
•
•
•
•
•
•
•
larger combined organization and adding
operating a
operations;
difficulties in the assimilation of the assets and operations of the acquired business, especially if the assets acquired are in a new
business segment or geographic area;
risk that oil and natural gas reserves acquired may not be of the anticipated magnitude or may not be developed as
anticipated;
loss of significant key employees from the acquired
business:
diversion of management's attention from other business
concerns;
failure
growth;
failure to realize expected synergies and cost
to realize expected profitability or
•
•
savings;
coordinating geographically disparate organizations, systems and facilities;
and
coordinating or consolidating corporate and administrative
functions.
25
Table of Contents
Further, unexpected costs and challenges may arise whenever businesses with different operations or management are combined, and we
may experience unanticipated delays in realizing the benefits of an acquisition. If we consummate any future acquisition, our capitalization
and results of operation may change significantly, and you may not have the opportunity to evaluate the economic, financial and other
relevant information that we will consider in evaluating future acquisitions.
We may fail to fully identify problems with any properties we acquire, and as such, assets we acquire may prove to be worth less
than we paid because of uncertainties in evaluating recoverable reserves and potential liabilities. We are actively seeking to acquire
additional acreage in Texas or other regions in the future. Successful acquisitions require an assessment of a number of factors, including
estimates of recoverable reserves, exploration potential, future oil and natural gas prices, operating and capital costs and potential
environmental and other liabilities. Although we conduct a review of properties we acquire which we believe is consistent with industry
practices, we can give no assurance that we have identified or will identify all existing or potential problems associated with such
properties or that we will be able to mitigate any problems we do identify. Such assessments are inexact and their accuracy is inherently
uncertain. In addition, our review may not permit us to become sufficiently familiar with the properties to fully assess their deficiencies and
capabilities. We do not inspect every well. Even when we inspect a well, we do not always discover structural, subsurface and
environmental problems that may exist or arise. We are generally not entitled to contractual indemnification for preclosing liabilities,
including environmental liabilities. Normally, we acquire interests in properties on an “as is” basis with limited remedies for breaches of
representations and warranties. As a result of these factors, we may not be able to acquire oil and natural gas properties that contain
economically recoverable reserves or be able to complete such acquisitions on acceptable terms.
There is competition for available oil and natural gas properties. Our competitors include major oil and gas companies, independent
oil and gas companies and financial buyers. Some of our competitors may have greater and more diverse resources than we do. High
commodity prices and stiff competition for acquisitions have in the past, and may in the future, significantly increase the cost of available
properties. The increased competition and rising prices for available properties could limit or impede our ability to identify acquisition
opportunities that are economic for a company our size and that are necessary to grow our reserves or replace reserves produced.
We do not operate and have limited influence over the operations of our deepwater property. Our lack of control could result in the
following:
•
•
•
the operator may initiate exploration or development at a faster or slower pace than we prefer or that we anticipate in preparing
our reserve estimates;
the operator may propose to drill more wells or build more facilities on a project than we have funds for or that we deem
appropriate, which may mean that we are unable to participate in the project or share in the revenues generated by the project even
though we paid our share of exploration costs; and
if an operator refuses to initiate a project, we may be unable to pursue the
project.
Any of these events could materially impact the value of our non-operated properties.
Weather, unexpected subsurface conditions, and other unforeseen operating hazards may adversely impact our ability to conduct
business. There are many operating hazards in exploring for and producing oil and natural gas, including:
•
•
•
•
our drilling operations may encounter unexpected formations or pressures, which could cause damage to equipment or personal
injury;
we may experience equipment failures which curtail or stop
production;
we could experience blowouts or other damages to the productive formations that may require a well to be re-drilled or other
corrective action to be taken;
hurricanes, storms and other weather conditions could cause damages to our production facilities or
wells.
Because of these or other events, we could experience environmental hazards, including release of oil and natural gas from spills, natural
gas-leaks, accidental leakage of toxic or hazardous materials, such as petroleum liquids, drilling fluids or fracturing fluids, including
chemical additives, underground migration, and ruptures.
26
If we experience any of these problems, it could affect well bores, platforms, gathering systems and processing facilities, which could
adversely affect our ability to conduct operations. We could also incur substantial losses in excess of our insurance coverage as a result of:
Table of Contents
•
•
•
•
•
•
•
loss of
injury or
life;
severe damage to and destruction of property, natural resources and
equipment;
pollution and other environmental
damage;
clean-up
responsibilities;
regulatory investigation and
penalties;
suspension of our operations;
and
repairs to resume
operations.
Offshore operations are also subject to a variety of additional operating risks peculiar to the marine environment, such as capsizing,
collisions and damage or loss from hurricanes or other adverse weather conditions. These conditions can cause substantial damage to
facilities and interrupt production. As a result, we could incur substantial liabilities that could reduce or eliminate the funds available for
development or leasehold acquisitions, or result in loss of equipment and properties.
We engage third parties to provide hydraulic fracturing or other well stimulation services to us in connection with the wells for which we
are the operator. Contamination of groundwater by oil and natural gas drilling, production, and related operations may result in fines,
penalties, and remediation costs, among other sanctions and liabilities under federal and state laws. In addition, third party claims may be
filed by landowners and other parties claiming damages for alternative water supplies, property damages, and bodily injury. In March 2010,
the EPA announced that it would conduct a wide-ranging study on the effects of hydraulic fracturing on drinking water resources. A
progress report was issued in December 2012, with final results expected in 2014. The agency also announced that one of its enforcement
initiatives for 2011 to 2013 would be to focus on environmental compliance by the energy extraction sector. This study and enforcement
initiative, could result in additional regulatory scrutiny that could make it difficult to perform hydraulic fracturing and increase our costs of
compliance and doing business.
We cannot assure you that we will be able to maintain adequate insurance at rates we consider reasonable to cover our possible losses from
operating hazards. The occurrence of a significant event not fully insured or indemnified against could materially and adversely affect our
financial condition and results of operations.
Factors beyond our control affect our ability to market production and our financial results. The ability to market oil and natural gas
from our wells depends upon numerous factors beyond our control. These factors could negatively affect our ability to market all of the oil
or natural gas we produce. In addition, we may be unable to obtain favorable prices for the oil and natural gas we produce. These factors
include:
•
•
•
•
•
•
•
•
of
pipeline
availability
the extent of domestic production and imports of oil and natural
gas;
the proximity of the natural gas production to natural gas and NGL
pipelines;
the
capacity;
the demand for oil and natural gas by utilities and other end
users;
the availability of alternative
sources;
the
weather;
state and federal regulation of oil and natural gas marketing;
and
federal regulation of natural gas sold or transported in interstate
commerce.
inclement
effects
fuel
of
In particular, in areas with increasing non-conventional shale drilling activity, capacity may be limited and it may be necessary for new
interstate and intrastate pipelines and gathering systems to be built.
Part of our strategy involves drilling in new or emerging shale formations using horizontal drilling and completion techniques. The
results of our planned drilling program in these formations may be subject to more uncertainties than conventional drilling
programs in more established formations and may not meet our expectations for reserves or production. The results of our recent
horizontal drilling efforts in new or emerging formations, including the Wolfcamp shale, Cline shale, and Mississippian lime in the Permian
basin, are generally more uncertain than drilling results in areas that are developed and have established production. Because new or
emerging formations have limited or no production history, we are less able to rely on past drilling results in those areas as a basis predict
our future drilling results. The ultimate success of these drilling and completion strategies and techniques will be better evaluated over time
as more wells are drilled and production profiles are better established. Further, access to adequate gathering systems or pipeline takeaway
capacity and the availability of drilling rigs and other services may be more challenging in new or emerging areas. If our drilling results are
less than anticipated
27
Table of Contents
or we are unable to execute our drilling program because of capital constraints, access to gathering systems and takeaway capacity or
otherwise, and/or natural gas and oil prices decline, our investment in these areas may not be as economic as we anticipate, we could incur
material writedowns of unevaluated properties and the value of our undeveloped acreage could decline in the future.
The loss of key personnel could adversely affect our ability to operate. We depend, and will continue to depend in the foreseeable
future, on the services of our senior officers and other key employees, as well as other third-party consultants with extensive experience
and expertise in evaluating and analyzing drilling prospects and producing oil and natural gas from proved properties and maximizing
production from oil and natural gas properties. Our ability to retain our senior officers, other key employees and our third party consultants,
none of whom are subject to employment agreements, is important to our future success and growth. The unexpected loss of the services of
one or more of these individuals could have a detrimental effect on our business.
We may not be insured against all of the operating risks to which our business in exposed. In accordance with industry practice, we
maintain insurance against some, but not all, of the operating risks to which our business is exposed. We cannot assure you that our
insurance will be adequate to cover losses or liabilities. We experienced Gulf of Mexico production interruption in 2005, 2006, 2007, and
2012 from Hurricanes Katrina, Rita, and Isaac and in 2008 and 2009 from Hurricanes Gustav and Ike for which we had no production
interruption insurance. Also, we cannot predict the continued availability of insurance at premium levels that justify its purchase. No
assurance can be given that we will be able to maintain insurance in the future at rates we consider reasonable and may elect none or
minimal insurance coverage. The occurrence of a significant event, not fully insured or indemnified against, could have a material adverse
affect on our financial condition and operations.
Competitive industry conditions may negatively affect our ability to conduct operations. We compete with numerous other companies
in virtually all facets of our business. Our competitors in development, exploration, acquisitions and production include major integrated oil
and gas companies as well as numerous independents, including many that have significantly greater resources. Therefore, competitors may
be able to pay more for desirable leases and evaluate, bid for and purchase a greater number of properties or prospects than our financial or
personnel resources permit. We also compete for the materials, equipment and services that are necessary for the exploration, development
and operation of our properties. Our ability to increase reserves in the future will be dependent on our ability to select and acquire suitable
prospects for future exploration and development. Factors that affect our ability to compete in the marketplace include:
•
•
•
•
•
our access to the capital necessary to drill wells and acquire
properties;
our ability to acquire and analyze seismic, geological and other information relating to a
property;
our ability to retain the personnel necessary to properly evaluate seismic and other information relating to a
property;
our ability to procure materials, equipment and services required to explore, develop and operate our properties, including the
ability to procure fracture stimulation services on wells drilled; and
our ability to access pipelines, and the location of facilities used to produce and transport oil and natural gas
production.
Current or proposed financial legislation and rulemaking could have an adverse effect on our ability to use derivative instruments
to reduce the effect of commodity price, interest rate and other risks associated with our business.
During 2010, the President signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”). Among other
things, the Act requires the Commodity Futures Trading Commission (the “CFTC”) and the SEC to enact regulations affecting derivative
contracts, including the derivative contracts we use to hedge our exposure to price volatility through the over-the-counter market.
In its rulemaking under the new legislation, the CFTC has issued a final rule on position limits for certain futures and option contracts in
the major energy markets and for swaps that are their economic equivalents (with exemptions for certain bona fide hedging transactions);
the CFTC's final rule was set aside by the U.S. District Court for the District of Columbia on September 28, 2012 and remanded to the
CFTC to resolve ambiguity as to whether statutory requirements for such limits to be determined necessary and appropriate were satisfied.
As a result, the rule has not yet taken effect, although the CFTC has indicated that it intends to appeal the court's decision and that it
believes the Dodd-Frank Act requires it to impose position limits. The impact of such regulations upon our business is not yet clear. Certain
of our hedging and trading activities and those of our counterparties may be subject to the position limits, which may reduce our ability to
enter into hedging transactions.
In addition, the Act does not explicitly exempt end users (such as us) from the requirement to use cleared exchanges, rather than hedging
over-the-counter, and the requirements to post margin in connection with hedging activities. While it is not possible at this time to predict
when the CFTC will finalize certain other related rules and regulations, the Act and related regulations may require us to comply with
margin requirements and with certain clearing and trade-execution requirements in connection with our derivative activities, although
whether these requirements will apply to our business is uncertain at this time. If the regulations ultimately adopted require that we post
margin for our hedging activities or require our counterparties to hold margin or maintain
28
Table of Contents
capital levels, the cost of which could be passed through to us, or impose other requirements that are more burdensome than current
regulations, our hedging would become more expensive and we may decide to alter our hedging strategy.
The financial reform legislation may also require the counterparties to derivative instruments to spin off some of their derivative activities
to separate entities, which may not be as creditworthy as the current counterparties. The new legislation and any new regulations could
significantly increase the cost of derivative contracts (including through requirements to post collateral which could adversely affect our
available liquidity), materially alter the terms of derivative contracts reduce the availability of derivatives to protect against risks we
encounter, restrict our flexibility in conducting trading and hedging activity and increase our exposure to less creditworthy counterparties.
If we reduce our use of derivative contracts as a result of the new requirements, our results of operations may become more volatile and
cash flows less predictable, which could adversely affect our ability to plan for and fund capital expenditures. Finally, the legislation was
intended, in part, to reduce the volatility of oil and natural-gas prices, which some legislators attributed to speculative trading in derivatives
and commodity instruments related to oil and natural gas. Our revenues could therefore be adversely affected if a consequence of the
legislation and regulations is to lower commodity prices. Any of these consequences could have a material adverse effect on our
consolidated financial position, results of operations, or cash flows.
We may not have production to offset hedges; by hedging, we may not benefit from price increases. Part of our business strategy is to
reduce our exposure to the volatility of oil and natural gas prices by hedging a portion of our production. In a typical hedge transaction, we
will have the right to receive from the other parties to the hedge the excess of the fixed price specified in the hedge over a floating price
based on a market index, multiplied by the quantity hedged. If the floating price exceeds the fixed price, we are required to pay the other
parties this difference multiplied by the quantity hedged. Additionally, we are required to pay the difference between the floating price and
the fixed price when the floating price exceeds the fixed price regardless of whether we have sufficient production to cover the quantities
specified in the hedge. Significant reductions in production at times when the floating price exceeds the fixed price could require us to
make payments under the hedge agreements even though such payments are not offset by sales of production. Hedging will also prevent us
from receiving the full advantage of increases in oil or natural gas prices above the fixed amount specified in the hedge.
We also enter into price “collars” to reduce the risk of changes in oil and natural gas prices. Under a collar, no payments are due by either
party so long as the market price is above a floor set in the collar and below a ceiling. If the price falls below the floor, the counter-party to
the collar pays the difference to us and if the price is above the ceiling, we pay the counter-party the difference. Another type of hedging
contract we have entered into is a put contract. Under a put, if the price falls below the set floor price, the counter-party to the contract pays
the difference to us. See “Quantitative and Qualitative Disclosures About Market Risks” for a discussion of our hedging practices.
Compliance with environmental and other government regulations could be costly and could negatively impact production. Our
operations are subject to numerous laws and regulations governing the operation and maintenance of our facilities and the discharge of
materials into the environment or otherwise relating to environmental protection. For a discussion of the material regulations applicable to
us, see “Regulations.” These laws and regulations may:
•
•
•
•
•
require that we acquire permits before commencing
drilling;
impose operational, emissions control and other conditions on our
activities;
restrict the substances that can be released into the environment in connection with drilling and production
activities;
limit or prohibit drilling activities on protected areas such as wetlands, wilderness areas or coral reefs;
and
require measures to remediate or mitigate pollution and environmental impacts from current and former operations, such as
cleaning up spills or dismantling abandoned production facilities.
Under these laws and regulations, we could be liable for costs of investigation, removal and remediation, damages to and loss of use of
natural resources, loss of profits or impairment of earning capacity, property damages, costs of and increased public services, as well as
administrative, civil and criminal fines and penalties, and injunctive relief. We could also be affected by more stringent laws and
regulations adopted in the future, including any related climate change, greenhouse gases and hydraulic fracturing. Under the common law,
we could be liable for injuries to people and property. We maintain limited insurance coverage for sudden and accidental environmental
damages. We do not believe that insurance coverage for environmental damages that occur over time is available at a reasonable cost. Also,
we do not believe that insurance coverage for the full potential liability that could be caused by sudden and accidental environmental
damages is available at a reasonable cost. Accordingly, we may be subject to liability or we may be required to cease production from
properties in the event of environmental incidents.
29
Table of Contents
Climate change legislation or regulations restricting emissions of “greenhouse gasses” could result in increased operating costs and
reduced demand for the oil and natural gas we produce. The EPA has adopted its so-called "GHG tailoring rule" that will phase in
federal PSD permit requirements for greenhouse gas emissions from new sources and modification of existing sources, federal Title V
operating permit requirements for all sources, based upon their potential to emit specific quantities of GHGs. These permitting provisions to
the extent applicable to our operations could require us to implement emission controls or other measures to reduce GHG emissions and we
could incur additional costs to satisfy those requirements.
In addition, on October 30, 2009, the EPA published a final rule requiring the reporting of greenhouse gas emissions from specified large
greenhouse gas emission sources in the United States beginning in 2011 for emissions occurring in 2010. On November 30, 2010, the EPA
published its amendments to the greenhouse gas reporting rule to include 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 we operate. Reporting
of greenhouse gas emissions from such facilities is required on an annual basis if the total emissions within a basin exceed 25,000 metric
tons CO2 equivalent per year. We will have to incur costs associated with this monitoring obligation and potentially additional reporting
costs if production growth triggers the emission threshold.
In addition, the United States Congress has considered legislation to reduce emissions of GHGs and many states have already taken or have
considered legal measures to reduce or measure GHG emissions, often involving the planned development of GHG emission inventories
and/or cap and trade programs. Most of these cap and trade programs would require major sources of emissions or major producers of fuels
to acquire and surrender emission allowances. The number of allowances available for purchase is reduced each year in an effort to achieve
the overall GHG emission reduction goal. These allowances would be expected to escalate significantly in cost over time. The adoption and
implementation of any legislation or regulatory programs imposing GHG reporting obligations on, or limiting emissions of GHGs from, our
equipment and operations could require us to incur costs to reduce emissions of GHGS associated with our operations or could adversely
affect demand for the oil and natural gas that we produce.
Significant physical effects of climatic change have the potential to damage our facilities, disrupt our production activities and
cause us 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, our exploration and production operations
have the potential to be adversely affected. Potential adverse effects could include damages to our facilities from powerful winds or rising
waters in low-lying areas, disruption of our production activities either because of climate-related damages to our facilities in our 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 affect on our financing and operations by disrupting the transportation or process-related services provided by midstream
companies, service companies or suppliers with whom we have a business relationship. We 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. In addition, our hydraulic
fracturing operations require large amounts of water. Should drought conditions occur, our ability to obtain water in sufficient quality and
quantity could be impacted and in turn, our ability to perform hydraulic fracturing operations could be restricted or made more costly.
Federal legislation and state legislative and regulatory initiatives relating to hydraulic fracturing could result in increased costs and
additional operating restrictions or delays. Hydraulic fracturing is used to stimulate production of hydrocarbons, particularly natural gas,
from tight formations. The process involves the injection of water, sand and chemicals under pressure into formations to fracture the
surrounding rock and stimulate production. The process is typically regulated by state oil and gas commissions but is not subject to
regulation at the federal level (except for fracturing activity involving the use of diesel). The EPA has commenced a study of the potential
environmental impacts of hydraulic fracturing activities. A progress report was issued in December 2012, and final results anticipated in
2014. In addition, in December 2011, the EPA published an unrelated draft report concluding that hydraulic fracturing caused groundwater
pollution in a natural gas field in Wyoming; this study remains subject to review. A committee of the U.S. House of Representatives
conducted an investigation of hydraulic fracturing practices. Legislation was introduced before Congress to provide for federal regulation
of hydraulic fracturing and to require disclosure of the chemicals used in the fracturing process. In addition, some states and local or
regional regulatory authorities have adopted or are considering adopting, regulations that could restrict hydraulic fracturing in certain
circumstances. For example, New York has imposed a de facto moratorium on the issuance of permits for high-volume, horizontal
hydraulic fracturing until state-administered environmental studies are finalized. Further, Pennsylvania has adopted a variety of regulations
limiting how and where fracturing can be performed. While we have no operations in either New York or Pennsylvania, any other new laws
or regulations that significantly restrict hydraulic fracturing in areas in which we do operate could make it more difficult or costly for us to
perform hydraulic fracturing activities and thereby affect the determination of whether a well is commercially viable. Further, EPA has
announced an initiative under TSCA to develop regulations governing the disclosure and evaluation of hydraulic fracturing chemicals, and
the BLM has indicated that it will continue with rulemaking to regulate hydraulic fracturing on federal lands. In addition, if hydraulic
fracturing is regulated at the federal level, our fracturing activities could become subject to additional
30
Table of Contents
permit requirements or operational restrictions and also to associated permitting delays and potential increases in costs. Such federal or state
legislation could require the disclosure of chemical constituents used in the fracturing process to state or federal regulatory authorities who
could then make such information publicly available. In addition, restrictions on hydraulic fracturing could reduce the amount of oil and
natural gas that we are ultimately able to produce in commercial quantities.
Certain U.S. federal income tax preferences currently available with respect to oil and natural gas production may be eliminated as
a result of future legislation. In recent years, the Obama administration's budget proposals and other proposed legislation have included
the elimination of certain key U.S. federal income tax incentives currently available to oil and gas exploration and production. If enacted
into law, these proposals would eliminate certain tax preferences applicable to taxpayers engaged in the exploration or production of
natural resources. These changes include, but are not limited to (1) the repeal of the percentage depletion allowance for oil and gas
properties, (2) the elimination of current deductions for intangible drilling and development costs, (3) the elimination of the deduction for
U.S. production activities and (4) the increase in the amortization period from two years to seven years for geophysical costs paid or
incurred in connection with the exploration for or development of, oil and gas within the United States. It is unclear whether any such
changes will be enacted or how soon any such changes would become effective. The passage of any legislation as a result of these
proposals or any other similar changes in U.S. federal income tax laws could negatively affect the Company's financial condition and results
of operations.
There are inherent limitations in all control systems, and misstatements due to error or fraud that could seriously harm our
business may occur and not be detected. Our management, including our Chief Executive Officer and Chief Financial Officer, do not
expect that our internal controls and disclosure controls will prevent all possible error and all fraud. A control system, no matter how well
conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. In addition,
the design of a control system must reflect the fact that there are resource constraints and the benefit of controls must be relative to their
costs. Because of the inherent limitations in all control systems, an evaluation of controls can only provide reasonable assurance that all
material control issues and instances of fraud, if any, in our company have been detected. These inherent limitations include the realities
that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Further, controls can be
circumvented by the individual acts of some persons or by collusion of two or more persons. The design of any system of controls is based
in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in
achieving its stated goals under all potential future conditions. Because of inherent limitations in a cost-effective control system,
misstatements due to error or fraud may occur and not be detected. A failure of our controls and procedures to detect error or fraud could
seriously harm our business and results of operations.
ITEM 1B. Unresolved Staff Comments
None.
ITEM 3. Legal Proceedings
We are a defendant in various legal proceedings and claims, which arise in the ordinary course of our business. We do not believe the
ultimate resolution of any such actions will have a material effect on our financial position or results of operations.
ITEM 4. Mine Safety Disclosures
Not applicable.
31
PART II.
Table of Contents
ITEM 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
The Company’s common stock trades on the New York Stock Exchange under the symbol "CPE". The following table sets forth the high
and low sale prices per share as reported for the periods indicated.
First quarter
Second quarter
Third quarter
Fourth quarter
First quarter
Second quarter
Third quarter
Fourth quarter
2012
ended
ended
ended
ended
2011
ended
ended
ended
ended
March 31, 2012
June 30, 2012
September 30, 2012
December 31, 2012
March 31, 2011
June 30, 2011
September 30, 2011
December 31, 2011
Stock Price
High Low
$ 7.95 $ 5.09
3.80
4.11
4.05
6.45
6.55
6.36
$ 9.36 $ 5.81
5.93
3.79
3.02
8.04
7.73
5.99
As of March 1, 2013 the Company had approximately 3,229 common stockholders of record.
The Company has never paid dividends on its common stock, and intends to retain its cash flow from operations for the future operation
and development of its business. In addition, the Company’s Credit Facility and the terms of our outstanding debt prohibit the payment of
cash dividends on our common stock.
During the fourth quarter of 2012, neither the Company nor any affiliated purchasers made repurchases of Callon’s equity securities.
Equity Compensation Plan Information
The following table summarizes information regarding the number of shares of our common stock that are available for issuance under all
of our existing equity compensation plans as of December 31, 2012 (securities amounts are presented in thousands).
Plan Category
Equity compensation plans approved by security holders
Equity compensation plans not approved by security holders
Total
Outstanding Options
Number of
securities to be
issued upon
exercise of
outstanding
options
Weighted-average
exercise price of
outstanding
options
37 $
30
67
13.51
7.90
11.82
Number of securities
remaining available
for future issuance
under equity
compensation plans
1,669
—
1,669
For additional information regarding the Company’s benefit plans and share-based compensation expense, see Notes 8 and 9 to the
Consolidated Financial Statements.
32
Performance Graph
Table of Contents
The following stock price performance graph is intended to allow review of stockholder returns, expressed in terms of the performance of
the Company’s common stock relative to two broad-based stock performance indices. The information is included for historical
comparative purposes only and should not be considered indicative of future stock performance. The graph compares the yearly percentage
change in the cumulative total stockholder return on the Company’s common stock with the cumulative total return of the New York Stock
Exchange Market Index and of the Morningstar Group Index (consisting of independent oil and gas drilling and exploration companies)
from December 31, 2007, through December 31, 2012. The stock performance graph and related information shall not be deemed
“soliciting material” or to be “filed” with the SEC, nor shall information be incorporated by reference into any future filing under the
Securities Act of 1933 or Securities Exchange Act of 1934, each as amended, except to the extent that the Company specifically
incorporates it by reference into such filing.
Company/Market/Peer Group
Callon Petroleum Company
NYSE Composite Index
Morningstar Group Index
2007
2008
2009
2010
2011
2012
$
100.00 $
100.00
100.00
15.81 $
60.86
39.51
9.12 $
78.25
71.28
35.99 $
88.89
74.52
30.21 $
85.63
64.64
28.57
99.47
71.97
For the Year Ended December 31,
33
ITEM 6. Selected Financial Data
The following table sets forth, as of the dates and for the periods indicated, selected financial information about us. The financial
information for each of the five years in the period ended December 31, 2012 has been derived from our audited Consolidated Financial
Statements for such periods. The information should be read in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the Consolidated Financial Statements and Notes thereto. The following information is not
necessarily indicative of our future results. The information included in this table for the year ended December 31, 2011 include the effects
of corrections on the previously reported financial statements, as further discussed in Note 1 to the Consolidated Financial Statements
included in Part II, Item 8 of this filing.
Table of Contents
Statement of Operations Data:
Operating revenues:
Oil and natural gas sales
Medusa BOEM royalty recoupment (a)
Total operating revenues
Operating expenses:
Non-impairment related operating expenses
Impairment of oil and gas properties (b)
Total operating expenses
Income (loss) from continuing operations
Net income (loss) (c)
Earnings (loss) per share ("EPS"):
Basic
Diluted
Weighted average number of shares outstanding for Basic EPS
Weighted average number of shares outstanding for Diluted EPS
Statement of Cash Flows Data:
Net cash provided by operating activities
Net cash used in investing activities
Net cash provided by (used in) financing activities
Balance Sheet Data:
Oil and natural gas properties, net
Total assets
Long-term debt (d)
Stockholder' equity (deficit)
Proved Reserves Data:
Total oil (MMBbls)
Total natural gas (MMcf)
Total proved reserves (MBoe)
Standardized measure
2012
For the year ended December 31,
2011
2009
2010
(In thousands, except per share amounts)
2008
$
$
$
$
$
$
$
$
$
110,733 $
127,644 $
—
—
110,733 $
127,644 $
89,882 $
—
89,882 $
101,259 $
40,886
142,145 $
141,312
—
141,312
100,043 $
—
100,043 $
10,690
2,747
88,022 $
—
88,022 $
39,622
106,396
0.07 $
0.07 $
39,522
40,337
2.81 $
2.76 $
37,908
38,582
68,703 $
—
68,703 $
21,179
8,386
0.29 $
0.28 $
28,817
29,476
68,692 $
—
68,692 $
73,453
46,796
2.12 $
2.11 $
22,072
22,200
97,497
485,498
582,995
(441,683)
(438,893)
(20.68)
(20.68)
21,222
21,222
51,290 $
(93,703 )
(243)
79,167 $
(91,511 )
38,703
100,102 $
(59,738 )
(26,252 )
19,698 $
(43,189 )
10,000
89,054
(4,511)
(120,667)
269,521 $
378,173
120,668
205,971
215,912 $
369,707
125,345
201,202
168,868 $
218,326
165,504
15,810
130,608 $
227,991
179,174
(80,854 )
159,252
266,090
272,855
(129,804)
10,780
19,753
14,072
231,148 $
10,075
35,118
15,928
270,357 $
8,149
32,957
13,641
198,916 $
6,479
19,103
9,663
135,921 $
6,027
18,652
9,136
86,305
(a) Following the decisions resulting from several court cases brought by another oil and gas company, the court ruled that the BOEM was
not entitled to receive these royalty payments. The amount above reflects royalty recoupments for production from the fields 2003
inception through December 31, 2008, which were accrued at December 31, 2009 and paid by the BOEM during 2010.
(b)
In 2008, the Company recorded a $485.5 million impairment of oil and gas properties as a result of the ceiling test. See Notes 2 and 12 to
the Consolidated Financial Statements for a description of the relevant accounting policy and the Company’s oil and gas properties
disclosures, respectively.
(c) Net income for 2011 includes $69.3 million of income tax benefit related to the reversal of the Company's deferred tax asset valuation
allowance. See Note 11 for additional information.
(d) 2012 and 2011 long-term debt includes a non-cash deferred credit of $13,707 and $18,384, respectively that will be amortized into
earnings as a reduction to interest expense over the life of the 13% Senior Notes due 2016. See Note 5 for additional information.
34
Table of Contents
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
General
The following management's discussion and analysis is intended to assist in understanding the principal factors affecting the Company's
results of operations, liquidity, capital resources and contractual cash obligations. This discussion should be read in conjunction with the
accompanying audited consolidated financial statements, information about our business practices, significant accounting policies, risk
factors, and the transactions that underlie our financial results, which are included in various parts of this filing.
We have been engaged in the exploration, development, acquisition and production of oil and gas properties since 1950. In 2009, we began
to shift our operational focus from exploration in the Gulf of Mexico to building an onshore asset portfolio in order to provide a multi-year,
low-risk drilling program in both oil and natural gas basins. This onshore transition has been, and is expected to continue to be, primarily
funded by reinvesting the cash flows from our Gulf of Mexico properties including, as previously discussed, the proceeds from the
monetization of our interest in the deepwater Habanero field in the fourth quarter of 2012.
Well count information is presented gross unless otherwise indicated.
Overview and Outlook
During 2012, Callon realized net income and fully diluted earnings per share of $2.7 million and $0.07, respectively, compared to net
income of $106.4 million and fully diluted earnings per share of $2.76, respectively for 2011. Net income during 2011 benefited
significantly from an income tax benefit of $69.3 million, that related primarily to the full reversal of a valuation allowance we previously
recorded against our deferred tax assets (see Note 11 for additional information). The Company’s earnings, and the drivers of these
earnings, are discussed in greater detail within the “Results of Operations” section included below.
During 2012, the Company continued to transition its asset base from primarily offshore to primarily onshore, seeking to replace high
volume offshore production with long-lived onshore crude oil production. In addition to building upon its portfolio of unconventional
drilling opportunities with a crude oil focus, the Company continued to expand upon its expertise as an onshore operator in the Permian
basin while maintaining a strong financial position to facilitate future growth. Significant accomplishments for 2012 include:
•
•
•
•
•
Increased 2012 Permian basin production by 67% to 591 Mboe as compared to
2011,
Increased 2012 Permian basin proved reserves by 24% to 9.4 MMboe as compared to
2011,
Increased 2012 Permian basin leasehold position by 246% to 32,962 net acres as compared to
2011,
Commenced the horizontal development of our East Bloxom field in the southern portion of the Midland basin, with the
drilling of two horizontal wells targeting the Wolfcamp B shale. The average initial (24-hour) production rate from these two
wells was 801 Boe per day, with an oil composition of 83%,
Commenced the evaluation of our newly acquired northern Midland acreage position, testing numerous vertical and
horizontal development concepts,
• Accelerated offshore cash flows for onshore redeployment with the sale of our interest in the Habanero field for $39.4 million,
and
•
Expanded our lending bank group to five institutions and increased our Credit Facility size by $20.0 million or 44% as
compared to December 31, 2011.
35
Callon Petroleum
Company
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Table of Contents
Highlights of our onshore activity and Gulf of Mexico operations include:
Onshore - Permian Basin
We expect that our production and reserve growth initiatives will continue to focus primarily on the Permian basin, in which we own
approximately 38,127 gross (32,962 net) acres as of December 31, 2012.
Southern Portion: We currently own approximately 11,345 net acres in the southern portion of the Permian basin, an increase of 19% since
year-end 2011. Our current production in the southern Midland basin (Crockett, Ector, Glasscock, Midland, and Upton counties in Texas) is
primarily from the Wolfberry play, although we added production volumes from the horizontal development of the Wolfcamp B shale
during 2012.
During 2012, we drilled 15 vertical wells and completed 22 vertical wells. As part of this program, we tested deeper target zones below the
Atoka in the fourth quarter of 2012. Based on the results of this test, we are currently planning to add these deeper zones to our ongoing
vertical Wolfberry-type drilling and completion program at our Pecan Acres and Carpe Diem fields.
In addition to this vertical drilling program, we commenced a horizontal oil shale drilling program at our East Bloxom field in the second
quarter of 2012, initially targeting the Wolfcamp B formation. In 2012, we drilled and completed two horizontal wells on this acreage
position, each with a lateral length of over 7,100 feet. In the first quarter of 2013, we drilled an additional three horizontal Wolfcamp shale
wells at East Bloxom, with two wells targeting the Wolfcamp B shale and one targeting the Wolfcamp A shale.
In order to increase our exposure to horizontal development of the Wolfcamp B shale, we acquired 2,319 gross (1,762 net) acres in southern
Reagan county, Texas, which closed on July 5, 2012, and is now referred to as our Taylor Draw field. We finished the drilling of our initial
horizontal well, targeting the Wolfcamp B shale, in December 2012, completed the well in February 2013, and are currently evaluating the
well results that include some positive indications.
Based on our initial results and the results of other industry participants, we are planning to increase our level of horizontal drilling activity
in 2013 in this portion of the basin, drilling a total of 14 wells. Given this level of sustained activity, we are planning on executing these
wells from drilling pads using batch completions in an effort to maximize capital efficiency. These development plans are currently
expected to be focused on our East Bloxom and Taylor Draw fields.
Northern Portion: We currently own approximately 21,617 net acres in the northern portion of the Permian basin, which includes the
14,653 net acres in Borden county, Texas and an additional 6,964 net acres in Lynn county, Texas. These leasehold positions were acquired
during the course of 2012 for a total consideration of $19.4 million, or $896 per net acre. These positions represent our effort to expand our
drilling inventory in the Midland basin with exploration upside potential at a reasonable cost of entry.
After completing a 3-D seismic survey on our acreage position, we commenced the drilling of an exploratory vertical well in July 2012,
followed by the drilling of two horizontal wells. The first horizontal well was drilled in the Cline shale and was completed in December
2012. The hydrocarbons from this well did not produce in economic quantities and the well was temporarily abandoned in February 2013.
We drilled the second horizontal well, targeting the Mississippian lime interval, in November 2012, completed the well in February 2013
and are currently evaluating the well results.
Although the area has experienced a recent increase in drilling activity, the northern Midland basin has had limited drilling activity
compared with the southern basin (where our current production is located), which significantly increases the risk associated with
successful drilling activities in this area.
In addition to the $29.6 million consideration paid for each of the above referenced leasehold additions, the Company's unevaluated
property balance of $68.8 million at December 31, 2012 includes $29.7 million of exploration and facility costs incurred in 2012 on these
properties and $9.5 million of other related items. See Note 12 for additional information. Based on the Company's present development
plans, the Company expects the majority of the exploration and facility costs will be transferred to evaluated properties during 2013.
36
Callon Petroleum
Company
Offshore - Deepwater
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Table of Contents
Our net interest in the Habanero field produced an average of 366 Boe per day for 2012. The field was shut-in for approximately 50 days
during the year for scheduled maintenance, and hurricane-related issues. On December 28, 2012, we completed the sale of our interest in
the Habanero field to Shell Offshore Inc., a subsidiary of Royal Dutch Shell Plc, for net cash consideration of $39.4 million.
Our remaining deepwater property, our 15% interest in the Medusa field, continues to play a key role in our portfolio. Our net interest in
the Medusa field produced an average of 1,268 Boe per day during 2012, approximately 87% being crude oil that receives pricing based on
Mars WTI crude. The Medusa platform was shut-in for 28 days during the second quarter of 2012 for planned construction activities on the
West Delta 143 oil pipeline through which Medusa's production is transported. Due to Hurricane Isaac, the platform was once again shut-in
from August 27, 2012 to September 4, 2012.
We anticipate that the future cash flows from Medusa will continue to contribute to the funding of our onshore activity. In addition, we
believe that additional reserve potential exists as part of this project. The operator of the field, Murphy Oil Corporation, has sanctioned a
two well subsea development for the Medusa field. One of these wells will be targeting the development of reserves associated with our
existing PUD reserves in the T-4B sand with an uphole recomplete to the T-0A and T-0B sand. The remaining well will target probable
reserves. We anticipate that the drilling of these wells will begin in the first quarter of 2014.
Offshore – Shelf & Other Properties
We own interests in 14 producing wells in eight crude oil and natural gas fields in the shelf area of the Gulf of Mexico. These wells
produced 340 MBoe net to our interest in 2012, which accounted for 22% of our total production. Production from the East Cameron Block
257 field, which contributed an average of 175 Boe per day of production prior to being shut-in in November 2011, is expected to
recommence once the Stingray Pipeline is brought back online. The restart of flows on the pipeline is currently anticipated to occur in the
second quarter of 2013.
Liquidity and Capital Resources
Historically, our primary sources of capital have been cash flows from operations, borrowings from financial institutions and the sale of
debt and equity securities. Cash and cash equivalents decreased by $42.7 million during 2012 to $1.1 million compared to $43.8 million at
December 31, 2011. The decrease in our cash balance is primarily attributable to 2012 capital expenditures of $133.3 million, representing
a $33.1 million or 33% increase over the amount spent during the same period in 2011. While at December 31, 2012, our Balance Sheet
reflects a working capital deficiency of $18.6 million, which is reflective of our current capital investment-driven growth strategy within
our Permian properties, we believe that as discussed below our operating cash flows combined with the borrowing availability under our
Credit Facility provides the liquidity necessary to meet our operational cashflow needs.
Senior Secured Credit Facility (the "Credit Facility")
On June 20, 2012, Regions Bank increased the Company's Credit Facility to $200 million with an associated borrowing base under the
Credit Facility of $60 million and a maturity of July 31, 2014. Subsequently and in October 2012, the Credit Facility was further amended
to increase the borrowing base to $80 million, extend the maturity to March 15, 2016 and add Citibank, NA, IberiaBank, Whitney Bank and
OneWest Bank, FSB as participating lenders. Regions Bank continues to serve as Administrative Agent for the Credit Facility.
As of December 31, 2012 the borrowing base was revised to $65 million following the sale of our interest in the deepwater Habanero field.
Proceeds from the sale, net cash consideration of $39.4 million after customary purchase price adjustments, were used to reduce
outstanding borrowings on our Credit Facility. The borrowing base will be redetermined as scheduled in the first quarter of 2013 based
upon the evaluation of year-end proved reserves.
Amounts borrowed under the Credit Facility may not exceed a borrowing base, which is generally reviewed on a semi-annual basis and is
then eligible for re-determination. The Credit Facility is secured by mortgages covering the Company's major producing fields.
As of December 31, 2012, the balance outstanding under the Credit Facility was $10.0 million with a weighted average interest rate on the
Credit Facility of 2.72% , calculated as the London Interbank Offered Rate (“LIBOR”) plus a tiered rate ranging from 2.5% to 3.0%, which
is based on utilization of the Credit Facility. In addition, the Credit Facility carries a commitment fee of 0.5% per annum on the unused
portion of the borrowing base, which is payable quarterly. As of March 13, 2013 , the balance outstanding
37
Callon Petroleum
Company
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Table of Contents
on the Credit Facility was $25 million as the Company drew an additional $15 million in support of the Company's ongoing capital
development program.
Senior Notes due 2016
At December 31, 2012, following a $10 million principal redemption in June 2012, we had approximately $97 million principal amount of
13% Senior Notes due 2016 outstanding with interest payable quarterly.
2013 Capital Expenditures
For 2013, we designed a flexible capital spending program, which we plan to fund from cash on hand and cash flows from operations in
addition to borrowings under our Credit Facility. However, depending on macroeconomic conditions or the Company's operational results,
our capital budget may be adjusted up or down during the year.
Our 2013 capital budget has been established at $125.0 million with over 90% of our budgeted operating expenditures (including drilling,
completion, infrastructure, and plugging and abandonment) allocated to our Midland basin operations.. The 15% decrease in total capital
from 2011 reflects our primary focus on drilling and completion activities in the Permian basin and reduced emphasis on acreage
acquisitions that were budgeted in 2012 to expand the Company's presence in the basin. Our budget includes further exploration and
development of our Permian basin properties with plans to complete approximately 26 gross wells including 14 horizontal wells and 12
vertical wells. Components of the 2013 capital budget include (in millions):
Midland basin
Gulf of Mexico
Total projected operations budget
Capitalized general and administrative costs
Capitalized interest and other
Total projected capital expenditures budget
$
$
97
10
107
14
4
125
Our total liquidity at December 31, 2012 was $56.1 million, including $1.1 million of cash available and $55.0 million of availability under
our Credit Facility. We believe that this liquidity position, combined with our expected operating cash flow based on current commodity
prices and forecasted production, will be adequate to meet our forecasted capital expenditures, interest payments, and operating
requirements for 2013.
38
Callon Petroleum
Company
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Table of Contents
The following table includes the Company’s contractual obligations and purchase commitments as of December 31, 2012, at which date the
Company had no product delivery commitments:
(amounts in thousands)
Payments due by Period
13% Senior Notes
Office space lease commitments
Drilling rig leases and related (a)
Other
Total
$
96,961 $
3,012
11,512
40
$
111,525 $
— $
384
9,235
13
9,632 $
785
2,277
27
3,089 $
Total
< 1 Year
Years 2 - 3 Years 4 - 5
— $
96,961 $
719
—
—
97,680 $
>5 Years
—
1,124
—
—
1,124
(a) The agreement includes early termination provisions that would reduce the minimum rentals under the agreement, assuming the lessor is
unable to re-charter the rig and staffing personnel to another lessee, as follows: <1 year of $5.8 million and 2-3 years of $1.4 million.
Summary cash flow information is provided as follows:
Operating Activities. For the year ended December 31, 2012, net cash provided by operating activities was $51.3 million, compared to
$79.2 million for the same period in 2011. The decrease relates primarily to lower revenues from a 2% decrease in crude oil production, a
29% decrease in natural gas production and a 31% increase in lease operating expenses, partially offset by a 2% increase in the average sales
price on an equivalent basis. Production and realized prices are discussed below in Results of Operations.
Investing Activities. For the year ended December 31, 2012, net cash used in investing activities was $93.7 million as compared to $91.5
million for the same period in 2011. The net $2.2 million increase in cash used in investing activities is primarily attributable to a $33.1
million increase in capital expenditures related to development activity on our Permian basin acreage and $2.1 million for producing
property acquisitions. These expenditures were largely offset by a $32.3 million year-over-year increase in proceeds received for the sale of
certain mineral interests including the late 2012 sale of our interest in the deepwater Habanero field discussed below and in Note 12 to the
financial statements. The $33.1 million increase in capital expenditures includes the acquisition of additional acreage in Borden and Lynn
counties located in the northern Midland basin, additional acreage in Reagan county in the southern Midland basin and costs associated
with the horizontal drilling activity.
Financing Activities . For the year ended December 31, 2012, net cash used in financing activities was $0.2 million compared to cash
provided by financing activities of $38.7 million during the same period of 2011. Net cash used for 2012 financing activities included a net
$10 million draw on our Credit Facility offset by the $10.2 million redemption of Senior Notes. Net cash provided by 2011 financing
activities included $73.8 million of net proceeds from an equity offering offset by approximately $35.1 million used to redeem a $31
million principal portion of our outstanding 13% Senior Notes and to pay the $4.0 million call premium and other redemption expenses.
Income Taxes
Prior to 2012, we carried a full valuation allowance against our net deferred tax asset. The income tax benefit of $69.3 million in 2011
resulted primarily from the reversal of the valuation allowance established in 2008 against our net deferred tax assets. As a result of
reporting net income from 2009 to 2011, we achieved income on an aggregate basis for the three-year period ended December 31, 2011.
Additionally we expect to generate sufficient taxable income necessary to fully utilize all of the deferred tax assets prior to their expiration.
Consequently, we reversed the $69.3 million valuation allowance at December 31, 2011. For additional information, see Note 11 to the
Consolidated Financial Statements.
Global Settlement with Joint Interest Partner
During the second quarter of 2011, we entered into a final project wind-down agreement with a former joint interest partner in a deepwater
project. The agreement provided for the extinguishment of all existing agreements and commitments between the parties as it relates to the
past development of the deepwater project. The agreement also included a formal extinguishment of the non-recourse credit agreement
between the parties and the assignment to us of the joint interest partner's 50% rights to the remaining project assets, which included
primarily the unsold, residual equipment and all engineering data. For additional information regarding the settlement, please refer to Note
3 included in Item II, Part 8 of this filing.
39
Callon Petroleum
Company
Results of Operations
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Table of Contents
The following table sets forth certain unaudited operating information with respect to the Company's oil and natural gas operations for the
periods indicated:
2012
2011
Change
% Change
2010
Change
% Change
For the year ended December 31,
Net production:
Crude oil (MBbls)
Natural gas (MMcf)
Total production (MBoe)
Average daily production (Boe)
Average realized sales price (see below):
Crude oil (Bbl)
Natural gas (Mcf)
Total (Boe)
Crude oil and natural gas revenues (in
thousands):
Crude oil revenue
Natural gas revenue
Total
Additional per Boe data:
Sales price
Lease operating expense
Operating margin
977
3,588
1,575
4,303
996
5,081
1,843
5,049
(19 )
(1,493)
(268)
(746)
(2)%
(29 )%
(15 )%
(15 )%
859
4,892
1,674
4,587
137
189
169
462
$
98.86 $
3.94
70.31
101.34 $
5.25
69.26
(2.48 )
(1.31 )
1.05
(2)% $
(25 )%
2 %
75.97 $
5.04
53.69
25.37
0.21
15.57
$ 96,584 $ 100,962 $
14,149
26,682
$ 110,733 $ 127,644 $
(4,378)
(12,533 )
(16,911 )
(4)% $
(47 )%
(13 )% $
65,243 $
24,639
89,882 $
35,719
2,043
37,762
$
$
70.31 $
(16.86)
53.45 $
69.26 $
(11.04)
58.22 $
1.05
(5.82 )
(4.77 )
2 % $
(53 )%
(8)% $
53.69 $
(10.58)
43.11 $
15.57
(0.46 )
15.11
16 %
4 %
10 %
10 %
33 %
4 %
29 %
55 %
8 %
42 %
29 %
4 %
35 %
Below is a reconciliation of the average NYMEX price to the average realized sales price per barrel of oil and Mcf of natural gas:
Average NYMEX oil price ($/Bbl)
$
94.19 $
95.14 $
(0.95 )
(1)% $
79.52 $
15.62
20 %
Basis differential and quality adjustments
(a)
Transportation
Hedging (b)
Average realized oil price ($/Bbl)
$
Average NYMEX natural gas price ($/Mcf) $
Basis differential and quality adjustments
(c)
Hedging (b)
Average realized natural gas price ($/Mcf)
$
3.97
(0.75 )
1.45
98.86 $
7.58
(1.00 )
(0.38 )
101.34 $
(3.61 )
0.25
1.83
(2.48 )
(48 )%
25 %
482 %
(2)% $
(2.39 )
(1.16 )
—
75.97 $
9.97
0.16
(0.38 )
25.37
(417)%
(14 )%
100 %
33 %
2.82 $
4.03 $
(1.21 )
(30 )% $
4.40 $
(0.37 )
(8)%
1.12
—
3.94 $
1.22
—
5.25 $
(0.10 )
—
(1.31 )
(8)%
n/a
(25 )% $
0.51
0.13
5.04 $
0.71
(0.13 )
0.21
139 %
(100)%
4 %
(a) Crude oil prices for production from our two deepwater fields include a premium over NYMEX pricing based on Mars WTI differential
for Medusa production and Argus Bonita WTI differential for Habanero production.
(b) As discussed in Note 6, the Company discontinued hedge accounting beginning with derivative contracts executed on January 1, 2012.
Consequently, the realized portion of derivative contracts is now included in the statement of operations within Gain on derivative
contracts. The amounts reported above reflect the realized portion of derivative contracts designated as cash flow hedges.
(c) Natural gas prices exceeded the related NYMEX prices, which are quoted on an MMBtu basis, primarily due to the value of the NGLs in
our liquids-rich natural gas stream, primarily from our Permian basin and deepwater production.
40
Callon Petroleum
Company
Revenues
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Table of Contents
The following tables are intended to reconcile the change in oil, natural gas and total revenue by reflecting the effect of changes in volume,
changes in the underlying commodity prices and the impact of our hedge program (in thousands):
Revenues for the year ended December 31, 2009
$
Oil
73,842 $
Natural Gas
27,417 $
Volume decrease
Price increase
Impact of hedges increase
Net decrease during the year
(11,164)
2,556
9
(8,599)
(4,050)
649
623
(2,778)
Total
101,259
(15,214)
3,205
632
(11,377)
Revenues for the year ended December 31, 2010
$
65,243 $
24,639 $
89,882
Volume increase
Price increase
Impact of hedges decrease
Net increase during the year
10,406
25,688
(375)
35,719
952
1,091
—
2,043
11,358
26,779
(375)
37,762
Revenues for the year ended December 31, 2011
$
100,962 $
26,682 $
127,644
Volume decrease
Price decrease
Impact of hedges increase
Net decrease during the year
(1,926)
(3,872)
1,420
(4,378)
(7,840)
(4,693)
—
(12,533)
(9,766)
(8,565)
1,420
(16,911)
Revenues for the year ended December 31, 2012
$
96,584 $
14,149 $
110,733
Crude Oil Revenue
For the year ended December 31, 2012, crude oil revenues of $96.6 million decreased $4.4 million or 4% compared to revenues of $101.0
million for the year ended December 31, 2011. A decrease in commodity prices and production resulted in decreased oil revenue. The
average price realized decreased 2% to $98.86 per barrel compared to $101.34 for the same period of 2011. Similarly, production
decreased by 2% to 977 MBbls compared to 996 MBbls during the same period in 2011. Crude oil prices for production from our two
deepwater fields are adjusted and reflect a premium over NYMEX pricing based on Mars WTI differential for Medusa production and
Bonita WTI differential for Habanero production. Production decreases relate primarily to the down-time at the Habanero and Medusa
fields and the normal and expected declines from our other offshore properties. These production declines were offset by production from
our new Permian wells, 22 vertical and two horizontal, brought onto production during 2012.
For the year ended December 31, 2011, crude oil revenues of $101.0 million increased $35.7 million or 55% compared to revenues of
$65.2 million for the year ended December 31, 2010. An increase in commodity prices and production resulted in increased crude oil
revenue. The average price realized increased 33% to $101.34 per barrel compared to $75.97 for the same period of 2010. Similarly,
production increased by 16% to 996 MBbls compared to 859 MBbls during the same period in 2010. Crude oil prices for production from
our two deepwater fields are adjusted and reflect a premium over NYMEX pricing based on Mars WTI differential for Medusa production
and Bonita WTI differential for Habanero production. Production increases relate primarily to progress in developing our Permian basin
properties and a successful recompletion at our Medusa field, partially offset by the downtime experienced at our deepwater fields and due
to normal and expected declines in our other properties.
41
Callon Petroleum
Company
Natural Gas Revenue
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Table of Contents
For the year ended December 31, 2012, natural gas revenues of $14.1 million represented a decrease of 47% or $12.5 million when
compared to natural gas revenues of $26.7 million for the year ended December 31, 2011. Natural gas production decreased 29%, driven
primarily by down time at our Haynesville well, which was shut-in for 70 days during the first quarter of 2012 due to well interference from
an offsetting well, and due to down time at our East Cameron 257 well, which was suspended in the fourth quarter of 2011 due to a natural
gas leak in an upstream section of the Stingray Pipeline that transports production volumes from the field. Production from our East
Cameron 257 well is expected to resume once the pipeline is brought back online during the second quarter of 2013. Also contributing to
the decline was the previously discussed down-time at our Habanero and Medusa fields and normal and expected declines in natural gas
production from our offshore and Haynesville wells. In addition to production decreases, the average realized price decreased 25% to $3.94
per Mcf compared to an average realized price of $5.25 per Mcf in 2011. Our natural gas prices on an MMBtu equivalent basis exceeded
the related NYMEX prices primarily due to the value of the NGLs in our natural gas stream, primarily from our Permian basin and
deepwater production.
For the year ended December 31, 2011, natural gas revenues of $26.7 million represented an increase of 8% or $2.0 million when
compared to natural gas revenues of $24.6 million for the year ended December 31, 2010. Natural gas production increased 4%, primarily
driven by production from our Haynesville Shale natural gas well, which was placed on production during September 2010, and due to
down time at our East Cameron #2 field, which was shut-in during the first quarter of 2010 for repairs to the host facility and did not return
to production until December 2010. In addition to production increases, the average realized price increased 4% to $5.25 per Mcf compared
to an average realized price of $5.04 per Mcf in 2010. Our natural gas prices on an MMBtu equivalent basis exceeded the related NYMEX
prices primarily due to the value of the NGLs in our natural gas stream, primarily from our Permian basin and deepwater production.
Offsetting the increases in production are normal and expected declines in production from our other natural gas properties and a 35-day
shut-in, as of December 31, 2011, of our Haynesville well due to interference caused by an offsetting well. The Haynesville well returned to
production in mid-March 2012.
42
Callon Petroleum
Company
Operating Expenses
Lease operating expenses
Depreciation, depletion and
amortization
General and administrative
Accretion expense
Impairment of other property and
equipment (See Note 3)
Total operating expenses
Lease operating expenses
Depreciation, depletion and
amortization
General and administrative
Accretion expense
Acquisition expense
Total operating expenses
Lease Operating Expenses
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Table of Contents
2012
$ 26,554 $
Per Boe
2011
16.86 $ 20,347 $
For the year ended December 31,
Total Change
$
%
6,207
Per Boe
11.04 $
Boe Change
%
$
5.82
31 % $
49,701
20,358
2,253
31.56
12.93
1.43
48,701
16,636
2,338
26.42
9.03
1.27
1,000
3,722
(85 )
2 %
22 %
(4)%
5.14
3.9
0.16
53 %
19 %
43 %
13 %
1,177
$ 100,043
0.75
—
$ 88,022
—
1,177
100 %
0.75
100 %
2011
$ 20,347 $
Per Boe
2010
11.04 $ 17,712 $
For the year ended December 31,
Total Change
$
%
2,635
Per Boe
10.58
Boe Change
%
$
0.46
4 %
15 % $
48,701
16,636
2,338
—
$ 88,022
26.42
9.03
1.27
—
31,805
16,507
2,446
233
$ 68,703
19.00
9.86
1.46
0.14
16,896
129
(108)
(233)
53 %
1 %
(4)%
(100)%
7.42
(0.83 )
(0.19 )
(0.14 )
39 %
(8)%
(13 )%
(100)%
For the year ended December 31, 2012, lease operating expenses ("LOE") of $26.6 million increased 31% or $6.2 million compared to
$20.3 million for the year ended December 31, 2011. The increase was primarily due to $4.2 million in costs related to significant growth
in the number of wells now producing in our Permian basin properties and $3.3 million associated with the remediation work on the
Haynesville well. These increases were partially offset by a $1.3 million decline in LOE for our deepwater properties due to lower
throughput charges as a result of reduced production volumes discussed previously.
For the year ended December 31, 2011, lease operating expenses ("LOE") of $20.3 million increased by 15% or $2.6 million compared to
$17.7 million for the year ended December 31, 2010. The significant growth in the number of wells now producing in our Permian basin
properties and our Haynesville Shale well increased total LOE approximately $3.6 million , or $1.95 on a per Boe basis, compared to the
corresponding period of 2010. Additionally, total LOE increased approximately $0.5 million related to Medusa Spar maintenance work,
the increased production from the Medusa A6 well following the well recompletion, and increased $0.8 million due to processing fees at
our East Cameron #2 well, which resumed production in December 2010 after being shut-in for repairs on the host facility during the first
quarter of 2010. Partially offsetting these increases was a mix of lower LOE related primarily to our shelf properties.
Depreciation, Depletion and Amortization
Depreciation, depletion and amortization (“DD&A”) for the year ended December 31, 2012 increased 19% per Boe to $31.56 per Boe
compared to $26.42 per Boe for the year ended December 31, 2011. The prior period DD&A rates were effectively reduced by the impact
of a $486 million 2008 impairment charge following a ceiling test writedown. This significant oil and natural gas property impairment
charge resulted in a lower, prospective DD&A rate for the then existing reserves. Increases in the DD&A rate subsequent to that impairment
are attributable to our planned exploration and development expenditures related to our onshore reserve development including the ongoing
onshore development cost increases in the Permian basin area. We currently estimate that a normalized DD&A rate for our properties will
approximate $36.00 per Boe.
43
Callon Petroleum
Company
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Table of Contents
Depreciation, depletion and amortization (“DD&A”) for the year ended December 31, 2011 increased 39% per Boe to $26.42 per Boe
compared to $19.00 per Boe for the year ended December 31, 2010. Onshore development cost increases account for nearly all of the
increase.
General and Administrative, net of amounts capitalized
For the year ended December 31, 2012, general and administrative (“G&A”) expenses, net of amounts capitalized, increased $3.7 million
or 22% to $20.4 million from $16.6 million for the same period of 2011. The increase is due mainly to $1.6 million in costs for non-
recurring employee-related expenses including early retirement and severance expense for which we had no expense during the same
period of 2011. Additionally, we incurred an increase in non-cash charges of $1.2 million related to incentive compensation share-based
instruments awarded during 2012. The remaining increase relates primarily to higher compensation-related expenses including the costs
associated with employing staff to support our onshore growth and 100% operated Permian production, as well as relocation and related
costs.
For the year ended December 31, 2011, G&A expenses of $16.6 million, net of amounts capitalized, was relatively flat compared to $16.5
million for the year ended 2010.
Accretion Expense
Accretion expense related to our asset retirement obligation decreased 4% for the year ended December 31, 2012 compared to the same
periods of 2011. Accretion expense correlates directionally with the Company's asset retirement obligation (“ARO”). At December 31,
2012, our ARO of $13.3 million was lower than the $13.9 million ARO at December 31, 2011. See Note 13 for additional information
regarding the Company's ARO.
For the year ended December 31, 2011, accretion expense decreased 4% for the year ended December 31, 2011 compared to the same
periods of 2010. The Company's accretion expense decreases as its ARO decreases. At December 31, 2011, our ARO of $13.9 million was
lower than the $15.9 million ARO at December 31, 2010. See Note 13 for additional information regarding the Company's ARO.
Impairment of Other Property and Equipment
During 2012, the Company recorded a write-down of the value of certain assets acquired in 2011 as part of a settlement reached with a
former joint interest partner on a deepwater project. For information concerning the impairment of these assets, which are currently
classified as available for sale, please see Note 3 to the Consolidated Financial Statements.
44
Callon Petroleum
Company
Other (Income) Expense
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Table of Contents
For the year ended December 31,
Interest expense
(Gain) loss on early extinguishment of debt
Gain on acquired assets (See Note 3)
Gain on derivative contracts
Other (income) expense
Total other expenses,net
Income tax expense (benefit)
Equity in earnings of Medusa Spar LLC
Interest Expense
$
$
$
$ Change % Change
2011
2012
9,108 $ 11,717 $ (2,609)
576
(1,942)
(1,366)
5,041
(5,041)
—
(1,717)
—
(1,717)
(1,426)
(79 )
1,347
3,308
5,946 $
2010
$ Change % Change
(12 )%
(673)%
(100)%
— %
(455)%
(22 )% $ 13,312 $ (1,595)
(2,281)
339
30 %
(5,041)
—
100 %
—
—
(100)%
(257)
(1,169)
94 %
$ 13,394
2,223 $ (69,283 ) $ 71,506
(573)
799
226
103 % $
(72 )%
(174) $ (69,109 )
372
427
(39,718 )%
87 %
Interest expense on Callon's debt obligations decreased 22% to $9.1 million for the year ended December 31, 2012 compared to $11.7
million for the same period of 2011. The decrease relates primarily to the redemption of $10 million principal of 13% Senior Notes during
June 2012 in addition to a $1.5 million increase in capitalized interest compared to 2011, partially offset by interest expense related to
increased borrowings under our Credit Facility and decreases in the deferred credit amortization. The increase in capitalized interest relates
to a higher balance year-over-year in average unevaluated oil and natural gas properties following the purchase of additional unevaluated
acreage with exploration costs in the Permian basin.
Interest expense on Callon's debt obligations decreased 12% to $11.7 million for the year ended December 31, 2011 compared to $13.3
million for the same period of 2010. The decrease relates primarily to the redemption of $31 million principal of 13% Senior Notes during
March 2011. This early redemption reduced interest expense by approximately $3.2 million for the current year compared to
2010. Additionally, 2010 interest expense included approximately $0.5 million related to the remaining outstanding $16.1 million of
9.75% Senior Notes, which were redeemed on April 30, 2010 and were therefore not included in 2011 interest expense. Offsetting these
declines in interest expense is a $1.4 million drop in capitalized interest in 2011 compared to 2010, and relates to a lower balance year-over-
year in average unevaluated oil and natural gas properties following the transfer to evaluated earlier in 2011 of certain leases, primarily
offshore, that the Company elected not to renew. Further offsetting the declines discussed above are slight decreases in the deferred credit
amortization recorded in 2011 compared to 2010.
(Gain) Loss on Early Extinguishment of Debt
During June 2012, the Company redeemed $10 million of its Senior Notes with a carrying value of $11.6 million , including $1.6 million of
the Notes’ deferred credit, in exchange for $10.2 million , comprised of the $10 million principal of the Notes and $0.2 million of
redemption expenses, which resulted in a $1.4 million net gain on the early extinguishment of debt.
During March 2011, using a portion of the proceeds from the Company's February 2011 equity offering, the Company redeemed 13%
Senior Notes with a carrying value of $37 million, including $6.0 million of the Notes' deferred credit, in exchange for $35.1 million,
comprised of the $31 million principal of the notes, the $4.0 million call premium and miscellaneous redemption expenses, which resulted
in a $1.9 million net gain on the early extinguishment of debt.
Gain on Acquired Assets
During 2011 and related to the 2012 activity mentioned above, we entered into a settlement with a former deepwater joint interest partner,
which included the transfer of certain assets and liabilities to Callon with estimated net fair values of $8.7 million. The assets acquired
consisted primarily of the surplus project equipment while the liabilities assumed consisted of deferred tax liabilities associated with the
basis difference of the equipment. The adjusted fair market value of the net assets acquired was recorded during 2011 as a $5.0 million
gain and a $3.7 million adjustment to our full cost pool of oil and gas properties. The gain recognition was required as a result of our
acquiring the joint interest partner's former share of the assets, and the full cost pool adjustment was required to reflect our share of the
assets held prior to the deconsolidation of a related subsidiary in 2010. See Note 3 for additional information concerning the gain on
acquired assets.
45
Callon Petroleum
Company
Gain on Derivative Contracts
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Table of Contents
As discussed in Note 6 and beginning with derivative contracts executed in 2012, the Company elected to no longer designate its derivative
contracts as accounting hedges. For the year ended December 31, 2012, unrealized losses and gains on mark-to-market derivative
instruments, net were $1.7 million gain, compared to none in 2011 when all derivative contracts were designated as hedges for accounting
purposes. See Notes 6 and 7 for disclosures related to derivative instruments including their composition and valuation.
Income Tax Expense (Benefit)
The income tax expense of $2.2 million in 2012 resulted primarily from pre-tax income earnings of $4.7 million. See Note 11 for a
discussion of our effective tax rate.
Prior to 2012, we carried a full valuation allowance against our net deferred tax asset. The income tax benefit of $69.3 million in 2011
resulted primarily from the reversal of the valuation allowance established in 2008 against our net deferred tax assets. As a result of
reporting net income from 2009 to 2011, we achieved income on an aggregate basis for the three-year period ended December 31, 2011.
Additionally we expect to generate sufficient taxable income necessary to fully utilize all of the deferred tax assets prior to their expiration.
Consequently, we reversed the $69.3 million valuation allowance at December 31, 2011. For additional information, see Note 11 to the
Consolidated Financial Statements.
Off-Balance Sheet Arrangements
The Company holds a 10% ownership interest in Medusa Spar LLC (“LLC”), which is accounted for under the equity method of
accounting for investments. The LLC owns a 75% undivided ownership interest in the deepwater spar production facilities at the
Company’s Medusa field in the Gulf of Mexico. The LLC earns a tariff based upon production volume throughput from the Medusa area.
Callon is obligated to process through the spar production facilities its share of production from the Medusa field and any future discoveries
in the area. The balance of Medusa Spar LLC is owned by Oceaneering International, Inc. and Murphy Oil Corporation.
46
Callon Petroleum
Company
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Table of Contents
Summary of Significant Accounting Policies and Critical Accounting Estimates
Property and Equipment
The Company utilizes the full-cost method of accounting for its oil and natural gas properties whereby all costs incurred in connection with
the acquisition, exploration and development of oil and natural gas reserves, including certain overhead costs, are capitalized into the “full-
cost pool.” The amounts capitalized into the full-cost pool are depleted (charged against earnings) using the unit-of-production
method. The full-cost method of accounting for our proved oil and natural gas properties requires that the Company makes estimates based
on its assumptions of future events that could change. These estimates are described below.
Depreciation, Depletion and Amortization (DD&A) of Oil and Natural Gas Properties
The Company calculates depletion by using the depletable base, equal to the net capitalized costs in our full-cost pool plus estimated future
development costs, and the estimated net proved reserve quantities. Capitalized costs added to the full-cost pool include the following:
•
•
•
•
•
•
costs of drilling and equipping productive wells, dry hole costs, acquisition costs of properties with proved reserves, delay rentals
and other costs related to exploration and development of our crude oil and natural gas properties;
payroll costs including the related fringe benefits paid to employees directly engaged in the acquisition, exploration and/or
development of crude oil and natural gas properties as well as other directly identifiable general and administrative costs
associated with such activities. Such capitalized costs do not include any costs related to the production of crude oil and natural
gas or general corporate overhead;
costs associated with unevaluated properties, those lacking proved reserves, are excluded from the depletable base. These
unevaluated property costs are added to the depletable base at such time as wells are completed on the properties, the properties
are sold or the Company determines these costs have been impaired. The Company’s determination that a property has or has not
been impaired (which is discussed below) requires assumptions about future events;
estimated costs to dismantle, abandon and restore properties that are capitalized to the full-cost pool when the related liabilities are
incurred (see also the discussion below regarding Asset Retirement Obligations);
estimated future costs to develop proved properties are added to the full-cost pool for purposes of the DD&A computation. The
Company uses assumptions based on the latest geologic, engineering, regulatory and cost data available to it to estimate these
amounts. However, the estimates made are subjective and may change over time. The Company’s estimates of future
development costs are reviewed at least annually and as additional information becomes available; and
capitalized costs included in the full-cost pool plus estimated future development costs are depleted and charged against earnings
using the unit-of-production method. Under this method, the Company estimates the proved reserves quantities at the beginning
of each accounting period. For each Mcfe produced during the period, the Company records a depletion charge equal to the
amount included in the depletable base (net of accumulated depreciation, depletion and amortization) divided by our estimated net
proved reserve quantities.
Because the Company uses estimates and assumptions to calculate proved reserves (as discussed below) and the amounts included in the
depletable base, our depletion rates may materially change if actual results differ from these estimates.
Ceiling Test
Under the full cost method of accounting, the Company compares, at the end of each financial reporting period, the present value of
estimated future net cash flows from proved reserves (excluding cash flows related to estimated abandonment costs), to the net capitalized
costs of proved crude oil and natural gas properties net of related deferred taxes. The Company refers to this comparison as a “ceiling test.”
If the net capitalized costs of proved crude oil and natural gas properties exceed the estimated discounted (at 10%) future net cash flows
from proved reserves, the Company is required to write-down the value of its crude oil and natural gas properties to the value of the
discounted cash flows. Estimated future net cash flows from proved reserves are based on a twelve-month average pricing assumption and
include consideration of existing cash flow hedges. Given the volatility of crude oil and natural gas prices, it is reasonably possible that the
Company’s estimates of discounted future net cash flows from proved
47
Callon Petroleum
Company
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Table of Contents
crude oil and natural gas reserves could change in the near term. If crude oil and natural gas prices decline significantly, even if only for a
short period of time, it is possible that write-downs of crude oil and natural gas properties could occur in the future. See Notes 2 and 12 for
additional information regarding the Company’s crude oil and natural gas properties.
Estimating Reserves and Present Value of Estimated Future Net Cash Flows
Estimates of quantities of proved crude oil and natural gas reserves, including the discounted present value of estimated future net cash
flows from such reserves at the end of each quarter, are based on numerous assumptions, which are likely to change over time. These
assumptions include:
•
•
the prices at which the Company can sell its crude oil and natural gas production in the future. Crude oil and natural gas prices
are volatile, but we are required to assume that they remain constant. In general, higher crude oil and natural gas prices will
increase quantities of proved reserves and the present value of estimated future net cash flows from such reserves, while lower
prices will decrease these amounts; and
the costs to develop and produce the Company’s reserves and the costs to dismantle its production facilities when reserves are
depleted. These costs are likely to change over time. Increases in costs will reduce estimated crude oil and natural gas quantities
and the present value of estimated future net cash flows, while decreases in costs will increase such amounts.
Changes in these prices and/or costs will affect the present value of estimated future net cash flows more than the estimated quantities of
oil and natural gas reserves for the Company’s properties that have relatively short productive lives.
In addition, the process of estimating proved crude oil and natural gas reserves requires that the Company’s independent and internal
reserve engineers exercise judgment based on available geological, geophysical and technical information. We have described the risks
associated with reserve estimation and the volatility of crude oil and natural gas prices under “Risk Factors.”
Sales of crude oil and natural gas properties are accounted for as adjustments to the net full cost pool with no gain or loss recognized unless
the adjustment would significantly alter the relationship between capitalized costs and proved reserves.
Unproved Properties
Costs, including capitalized interest, associated with properties that do not have proved reserves are excluded from the depletable base, and
are included in the line item “Unevaluated properties excluded from amortization.” Unproved property costs are transferred to the
depletable base when wells are completed on the properties or the properties are sold. In addition, the Company is required to determine
whether its unproved properties are impaired and, if so, include the costs of such properties in the depletable base. The Company
determines whether an unproved property is impaired by periodically reviewing its exploration program on a property-by-property
basis. This determination may require the exercise of substantial judgment by management.
Asset Retirement Obligations
We are required to record its estimate of the fair value of liabilities for obligations associated with the retirement of tangible long-life assets
and the associated asset retirement costs. Interest is accreted on the present value of the asset retirement obligation and reported as
accretion expense within operating expenses in the Consolidated Statements of Operations. See Note 13 for additional information.
Derivatives
To manage crude oil and natural gas price risk on a portion of our planned future production, we have historically utilized commodity
derivative instruments (including collars, swaps, puts, and other structures) on approximately 50% of our projected production volumes in
any given year. We do not use these instruments for trading purposes. Settlement of derivative contracts are generally based on the
difference between the contract price and prices specified in the derivative instrument and a NYMEX price or other cash or futures index
price.
Beginning in 2012, we elected to no longer designate derivative contracts executed after January 1, 2012 as accounting hedges under FASB
ASC 815-20-25. As such and beginning with derivative contracts executed during 2012, all derivative positions are carried at their fair
value on the balance sheet and are marked-to-market through earnings at the end of each period. Realized gains (losses) related to cash
settlements on these contracts are recorded in the Statement of Operations as an increase or decrease in crude oil and natural gas sales.
Unrealized gains (losses) related to our derivative contracts not designated as accounting hedges
48
Callon Petroleum
Company
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Table of Contents
are recorded in the Statement of Operations as an increase or decrease in Unrealized gains (losses) on mark-to-market derivative
instruments.
Derivative contracts that existed at and prior to December 31, 2011 were accounted for as cash flow hedges, and were recorded at fair
market value on its consolidated balance sheet. Changes in fair value were recorded through other comprehensive income (loss), net of tax,
in stockholders’ equity. The changes in fair value related to ineffective derivative contracts are recognized as derivative expense (income).
The estimated fair value of our derivative contracts is based upon closing exchange prices on NYMEX and in the case of collars and floors,
the time value of options. For additional information regarding derivatives and their fair values, see Notes 6 and 7 to the Consolidated
Financial Statements and Part II, Item 7A Commodity Price Risk.
Income Taxes
The amount of income taxes recorded requires interpretations of complex rules and regulations of federal and state tax jurisdictions. We
recognize current tax expense based on estimated taxable income for the current period and the applicable statutory tax rates. We routinely
assess potential uncertain tax positions and, if required, estimate and establish accruals for such amounts. We have recognized deferred tax
assets and liabilities for temporary differences, operating losses and other tax carryforwards. We routinely assess our deferred tax assets and
reduce such assets by a valuation allowance if we deem it is more likely than not that some portion or all of the deferred tax assets will not
be realized. Numerous judgments and assumptions are inherent in the determination of future taxable income, including factors such as
future operating conditions (particularly as related to prevailing crude oil and natural gas prices). See Note 11 for additional information
regarding Income Taxes.
Recent Accounting Standards
Various accounting standards and interpretations were issued in 2012 with effective dates subsequent to December 31, 2012. We have
evaluated the recently issued accounting pronouncements that are effective in 2013 and believe that none of them will have a material
effect on our financial position, results of operations or cash flows when adopted. For a discussion of recently issued accounting standards,
see Note 2 to the Consolidated Financial Statements.
49
Table of Contents
ITEM 7A. Quantitative and Qualitative Disclosures about Market Risks
Commodity Price Risk
The Company’s revenues, earnings, cash flow, capital investments and, ultimately, future rate of growth are highly dependent on the prices
we receive for our crude oil and natural gas, which have historically been very volatile due to unpredictable events such as economical
growth or retraction, weather and climate, changes in supply and government actions. Crude oil and natural gas price declines and volatility
could adversely affect the Company’s revenues, cash flows and profitability. Price volatility is expected to continue. Using the Company's
annual sales volumes for 2012, excluding the effects of the Company’s hedging program, a 10% decline in the NYMEX price of crude oil
and natural gas would have reduced our revenues by approximately $9.1 million and $1.3 million, respectively.
While the Company does not enter into derivative transactions for speculative purposes, in order to limit its exposure to this risk, the
Company sometimes utilizes price "collars," swaps, puts and other structures to reduce the risk of changes in crude oil and natural gas
prices. Under a collar arrangements, no payments are due by either party as long as the market price is above the floor price and below the
ceiling price set in the collar. If the price falls below the floor, the counterparty to the collar pays the difference to Callon, and if the price
rises above the ceiling, Callon pays the difference to the counterparty. Fixed price “swaps” reduce the Company's exposure to decreases in
commodity prices, while simultaneously limiting the benefit the Company might otherwise have received from any increases in
commodity prices. The Company’s derivatives policy also allows Callon to, at its discretion, purchase or sale “puts.” Purchased "puts"
reduce the Company's exposure to decreases in prices of the hedged commodity while allowing realization of the full benefit from any
increases those prices. If the commodity price falls below the "put" price, the counter-party pays the difference to Callon. Conversely, sold
"puts" expose the Company to risk whereby Callon would pay its counter-party if prices fall below the "put" price. See Note 6 to the
Consolidated Financial Statements for a description of our hedged position at December 31, 2012.
Interest Rate Risk
On December 31, 2012, the majority of the Company's debt consisted of its fixed-rate 13% Senior Notes. However, the Company’s Credit
Facility with Regions Bank includes a variable interest rate, and as such fluctuates based on short-term interest rates. Although the
Company had $10 million borrowings outstanding at December 31, 2012 under its Credit Facility, were the Company to fully draw its
available $65 million borrowing base at the beginning of the year, a 100 basis point change in the variable interest rate would increase the
Company’s annual interest expense by $0.65 million. For additional information, see Note 5 to the Consolidated Financial Statements
additional information regarding the Company’s Credit Facility and other borrowings at December 31, 2012.
50
ITEM 8. Financial Statements and Supplementary Data
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2012 and 2011
Consolidated Statements of Operations for Each of the Three Years in the Period Ended December 31, 2012
Consolidated Statements of Comprehensive Income (Loss) for the Three Years in the Period Ended December 31, 2012
Consolidated Statements of Stockholders' Equity (Deficit) for Each of the Three Years in the Period Ended December 31, 2012
Consolidated Statements of Cash Flows for Each of the Three Years in the Period Ended December 31, 2012
Notes to Consolidated Financial Statements
Page
52
53
54
55
56
57
58
Table of Contents
51
Report of Independent Registered Public Accounting Firm
Table of Contents
The Board of Directors and Stockholders of
Callon Petroleum Company
We have audited the accompanying consolidated balance sheets of Callon Petroleum Company as of December 31, 2012 and 2011, and the
related consolidated statements of operations, comprehensive income, stockholders' equity (deficit) and cash flows for each of the three
years in the period ended December 31, 2012. These financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of
Callon Petroleum Company as of December 31, 2012 and 2011, and the consolidated results of its operations and its cash flows for each of
the three years in the period ended December 31, 2012, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Callon
Petroleum Company’s internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control—
Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 14,
2013, expressed an unqualified opinion thereon.
New Orleans, Louisiana
March 14, 2013
/s/Ernst & Young LLP
52
CALLON PETROLEUM COMPANY
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
Table of Contents
December, 31
2012
2011
ASSETS
Current assets:
Cash and cash equivalents
Accounts receivable
Fair market value of derivatives
Other current assets
Total current assets
Crude oil and natural gas properties, full-cost accounting method:
Evaluated properties
Less accumulated depreciation, depletion and amortization
Net oil and natural gas properties
Unevaluated properties excluded from amortization
Total oil and natural gas properties
Other property and equipment, net
Restricted investments
Investment in Medusa Spar LLC
Deferred tax asset
Other assets, net
Total assets
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities
Asset retirement obligations
Fair market value of derivatives
Total current liabilities
13% Senior Notes:
Principal outstanding
Deferred credit, net of accumulated amortization of $17,800 and $13,123, respectively
Total 13% Senior Notes
Senior secured revolving credit facility
Asset retirement obligations
Other long-term liabilities
Total liabilities
Stockholders' equity:
Preferred Stock, $.01 par value, 2,500,000 shares authorized;
Common Stock, $.01 par value, 60,000,000 shares authorized; 39,800,548 and 39,398,416
shares outstanding at December 31, 2012 and 2011, respectively
Capital in excess of par value
Other comprehensive income
Retained deficit
Total stockholders' equity
Total liabilities and stockholders' equity
$
$
$
$
1,139 $
15,608
1,674
1,502
19,923
1,497,010
(1,296,265 )
200,745
68,776
269,521
10,058
3,798
8,568
64,383
1,922
378,173 $
36,016 $
2,336
125
38,477
96,961
13,707
110,668
10,000
10,965
2,092
172,202
—
398
328,116
—
(122,543 )
205,971
378,173 $
43,795
15,181
2,499
1,601
63,076
1,421,640
(1,208,331 )
213,309
2,603
215,912
10,512
3,790
9,956
65,743
718
369,707
26,057
1,260
—
27,317
106,961
18,384
125,345
—
12,678
3,165
168,505
—
394
324,474
1,624
(125,290 )
201,202
369,707
The accompanying notes are an integral part of these financial statements.
53
CALLON PETROLEUM COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
Table of Contents
Operating revenues:
Crude oil sales
Natural gas sales
Total operating revenues
Operating expenses:
Lease operating expenses
Depreciation, depletion and amortization
General and administrative
Accretion expense
Acquisition expense
Impairment of other property and equipment (See Note 3)
Total operating expenses
Income from operations
Other (income) expenses:
Interest expense
(Gain) loss on early extinguishment of debt
Gain on acquired assets (See Note 3)
Gain on derivative contracts
Other income, net
Total other expenses, net
Income before income taxes
Income tax expense (benefit)
Income before equity in earnings of Medusa Spar LLC
Equity in earnings of Medusa Spar LLC
Net income available to common shares
Net income per common share:
Basic
Diluted
Shares used in computing net income per common share:
Basic
Diluted
For the year ended December 31,
2011
2012
2010
$
96,584 $
14,149
110,733
100,962 $
26,682
127,644
26,554
49,701
20,358
2,253
—
1,177
100,043
10,690
9,108
(1,366)
—
(1,717)
(79)
5,946
4,744
2,223
2,521
20,347
48,701
16,636
2,338
—
—
88,022
39,622
11,717
(1,942)
(5,041)
—
(1,426)
3,308
36,314
(69,283)
105,597
226
2,747 $
799
106,396 $
0.07 $
0.07 $
2.81 $
2.76 $
$
$
$
65,243
24,639
89,882
17,712
31,805
16,507
2,446
233
—
68,703
21,179
13,312
339
—
—
(257)
13,394
7,785
(174)
7,959
427
8,386
0.29
0.28
39,522
40,337
37,908
38,582
28,817
29,476
The accompanying notes are an integral part of these financial statements.
54
CALLON PETROLEUM COMPANY
CONSOLIDATE STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
Table of Contents
For the year ended December 31,
2011
2012
2010
Net income
Other comprehensive income (loss):
Change in fair value of derivatives designated as accounting hedges
Total other comprehensive income
$
$
2,747 $
106,396 $
8,386
(1,624)
1,123 $
2,561
108,957 $
(1,082)
7,304
The accompanying notes are an integral part of these financial statements.
55
CALLON PETROLEUM COMPANY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(In thousands)
Table of Contents
Preferred
Stock
Common
Stock
Capital in
Excess of
Par
287 $ 243,898 $
Accumulated Other
Comprehensive
Income (Loss)
145
Retained
Earnings
(Deficit)
$ (325,184) $
Total
Stockholders'
Equity (Deficit)
(80,854 )
85,095
Balance at December 31, 2009
Deconsolidation of subsidiary
Comprehensive income:
Net income
Other comprehensive loss
Total comprehensive income
Shares issued pursuant to employee benefit
plans
Restricted stock
Balance at December 31, 2010
Comprehensive income:
Net income
Other comprehensive income
Total comprehensive income
Shares issued pursuant to employee benefit
plans
Restricted stock
Common stock issued
Reconsolidate subsidiary
Balance at December 31, 2011
Comprehensive income:
Net income
Other comprehensive loss
Total comprehensive income
Shares issued pursuant to employee benefit
plans
Restricted stock
Balance at December 31, 2012
$
$
$
$
— $
—
—
—
—
—
— $
—
—
—
—
—
—
— $
—
—
—
—
— $
—
—
—
1
2
—
—
—
192
4,070
—
85,095
—
(1,082)
8,386
—
—
—
—
—
290 $ 248,160 $
(937)
$ (231,703) $
—
—
—
—
—
2,561
106,396
—
—
207
3
101
—
394 $ 324,474 $
2,446
73,661
—
—
—
—
—
—
—
—
17
1,624
$ (125,290) $
201,202
—
—
—
—
—
(1,624)
2,747
—
—
235
—
—
4
3,407
398 $ 328,116 $
—
— $ (122,543) $
—
1,123
235
3,411
205,971
7,304
193
4,072
15,810
108,957
207
2,449
73,762
17
The accompanying notes are an integral part of these financial statements.
56
CALLON PETROLEUM COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Table of Contents
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to
cash provided by operating activities:
Depreciation, depletion and amortization
Accretion expense
Amortization of non-cash debt related items
Amortization of deferred credit
Equity in earnings of Medusa Spar LLC
Deferred income tax expense
Valuation allowance
Unrealized gain on derivative contracts
Impairment of other property and equipment
Gain on acquired assets
Non-cash gain for early debt extinguishment
Non-cash expense related to equity share-based awards
Change in the fair value of liability share-based awards
Payments to settle asset retirement obligations
Changes in current assets and liabilities:
Accounts receivable
Other current assets
Current liabilities
Payments to settle vested liability share-based awards
Change in natural gas balancing receivable
Change in natural gas balancing payable
Change in other long-term liabilities
Change in other assets, net
Cash provided by operating activities
Cash flows from investing activities:
Capital expenditures
Acquisitions
Proceeds from sale of mineral interests and equipment
Investment in restricted assets related to plugging and abandonment
Distribution from Medusa Spar LLC
Cash used in investing activities
Cash flows from financing activities:
Borrowings on senior secured revolving credit facility
Payments on senior secured revolving credit facility
Redemption of remaining 9.75% senior notes
Redemption of 13% senior notes
Issuance of common stock
Taxes paid related to exercise of employee stock options
Cash (used in) provided by financing activities
Net change in cash and cash equivalents
Cash and cash equivalents:
For the year ended December 31,
2010
2011
2012
$
2,747 $
106,396 $
8,386
51,043
2,253
402
(3,086)
(226)
2,223
—
(1,683)
1,176
—
(1,366)
1,697
1,620
(1,314)
(883)
100
1,753
(3,383)
51
(102)
205
(1,937)
51,290
49,753
2,338
461
(3,155)
(799)
10,928
(80,211)
—
—
(4,995)
(1,942)
1,337
761
(2,563)
(3,734)
180
4,695
—
252
(115)
100
(520)
79,167
(133,299)
(2,075)
39,936
—
1,735
(93,703)
(100,243)
—
7,615
(150)
1,267
(91,511)
53,000
(43,000)
—
(10,225)
—
(18)
(243)
(42,656)
—
—
—
(35,062)
73,765
—
38,703
26,359
32,629
2,446
397
(3,670)
(427)
1,503
(1,503)
—
—
—
339
2,347
760
(2,486)
59,527
(209)
907
—
347
(300)
(115)
(776)
100,102
(59,908)
(995)
—
(375)
1,540
(59,738)
—
(10,000)
(16,212)
—
—
(40)
(26,252)
14,112
Balance, beginning of period
Less: Cash held by subsidiary deconsolidated at January 1, 2010
Balance, end of period
43,795
—
1,139 $
17,436
—
43,795 $
3,635
(311)
17,436
$
The accompanying notes are an integral part of these financial statements.
57
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except share, per-share and per-hedge data)
Table of Contents
Note
1.
2.
3.
4.
5.
6.
7.
8.
Description
Description of Business and Basis of Presentation
Summary of Significant Accounting Policies
Global Settlement with Joint Interest Partner
Earnings per Share
Borrowings
Derivative Instruments and Hedging Activities
Fair Value Measurements
Employee Benefit Plans
Note
9.
10.
11.
12.
13.
14.
15.
16.
Description
Share-Based Compensation
Equity Transactions
Income Taxes
Crude Oil and Natural Gas Properties
Asset Retirement Obligations
Supplemental Crude Oil and Natural Gas Reserve Data (unaudited)
Other
Summarized Quarterly Financial Information (unaudited)
NOTE 1 – Description of Business and Basis of Presentation
Callon Petroleum Company is an independent crude oil and natural gas company, which since 1950 has been focused on building reserves
and production both onshore and offshore through efficient operations and low finding and development costs. Today, the Company's
principal development operations are in the Permian basin in West Texas. The Company's producing assets in the Gulf of Mexico provide
significant cash flow to execute Callon's current onshore development operations. Following the December 2012 sale of our deepwater
Gulf of Mexico property, discussed later within Note 12, the Company has one remaining deepwater Gulf of Mexico property, along with
several Gulf of Mexico shelf properties, providing cash flow to support Callon's onshore development operations.
The Company was incorporated under the laws of the state of Delaware in 1994 and succeeded to the business of a publicly traded limited
partnership, a joint venture with a consortium of European investors and an independent energy company partially owned by a member of
current management. As used herein, the “Company,” “Callon,” “we,” “us,” and “our” refer to Callon Petroleum Company and its
predecessors and subsidiaries unless the context requires otherwise.
The Consolidated Financial Statements include the accounts of the Company, and its subsidiary, Callon Petroleum Operating Company
(“CPOC”). CPOC also includes the subsidiaries Callon Offshore Production, Inc. and Mississippi Marketing, Inc. All intercompany
accounts and transactions have been eliminated. Certain prior year amounts have been reclassified to conform to presentation in the
current year. To the extent these amounts are material, we have either footnoted them within the Company's disclosures or have noted the
items within this footnote.
Unless otherwise indicated, all amounts included within the footnotes to the financial statements are presented in thousands, except for
share, per-share and per-hedge data.
58
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except share, per-share and per-hedge data)
Table of Contents
Correction of an Immaterial Error
During the second quarter of 2012, the Company determined that its December 31, 2011 financial statements reflected a misstatement
caused by an error in adjusting the Company's deferred tax position at December 31, 2011. Management concluded that the impact of this
error was immaterial on the prior reporting period. However, because the adjustment to correct the error in 2012 would have had a material
impact on the 2012 financial statements, we corrected the prior period financial statements in the second quarter 2012 Form 10-Q and
within the December 31, 2012 Form 10-K in accordance with SEC guidance. The adjustment had no effect on the Company's cash flow,
and the information included in this Form 10-K sets forth the effects of this correction on the previously reported Balance Sheet and
Income Statement as of and for the year ended December 31, 2011 as follows:
Balance Sheet:
Deferred tax asset
Total assets
Retained deficit
Total stockholders' equity
Total liabilities and stockholders' equity
Income Statement:
Income tax benefit
Net income available to common shares
Net income per common share - Basic
Net income per common share - Diluted
NOTE 2 – Summary of Significant Accounting Policies
A. Use of
Estimates
Year ended December 31, 2011
As Reported Adjustment
As Adjusted
$
63,496 $
367,460
(127,537)
198,955
367,460
2,247 $
2,247
2,247
2,247
2,247
65,743
369,707
(125,290)
201,202
369,707
$
(67,036) $
104,149
2.75
2.70
(2,247) $
2,247
0.06
0.06
(69,283)
106,396
2.81
2.76
The preparation of financial statements in conformity with United States generally accepted accounting principles (“US GAAP”) requires
management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
B. Cash
and
Cash
Equivalents
The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents.
C. Accounts
Receivable
Accounts receivable consists primarily of accrued crude oil and natural gas production receivables. The balance in the reserve for doubtful
accounts netted within accounts receivable was $34 and $36 at December 31, 2012 and 2011, respectively. During 2012, 2011, and 2010
the Company recorded $0, $(281) and $281, respectively of bad debt expense in general and administrative expenses. The negative bad
debt expense in 2011 relates to the collection of an amount charged to bad debt expense during 2010.
D. Revenue Recognition
and Natural Gas
Balancing
The Company recognizes revenue under the entitlement method of accounting. Under this method, revenue is deferred for deliveries in
excess of the Company’s net revenue interest, while revenue is accrued for the undelivered volumes. Production imbalances are generally
recorded at the lower of cost or market. The revenue we receive from the sale of natural gas liquids is included in natural gas sales. Natural
gas balancing receivables were $93 and $144 as of 2012 and 2011, respectively. Natural gas balancing payables were $653 and $756 as of
2012 and 2011, respectively.
59
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except share, per-share and per-hedge data)
Table of Contents
E. Major
Customers
The Company’s production is generally sold on month-to-month contracts at prevailing prices. The following table identifies customers to
whom it sold a significant percentage (>10%) of its total crude oil and natural gas production during each of the years ended:
Shell Trading Company
Plains Marketing, L.P.
Enterprise Crude Oil, LLC
Louis Dreyfus Energy Services
Other
Total
December 31,
2011
2012
2010
39%
15%
32%
2%
12%
100%
45%
17%
16%
4%
18%
100%
44%
20%
—%
13%
23%
100%
Because alternative purchasers of crude oil and natural gas are readily available, the Company believes that the loss of any of these
purchasers would not result in a material adverse effect on its ability to market future crude oil and natural gas production.
F. Crude Oil and Natural Gas
Properties
The Company uses the full-cost method of accounting for its exploration and development activities. Under this method of accounting, the
cost of both successful and unsuccessful exploration and development activities are capitalized as property and equipment. Such amounts
include the cost of drilling and equipping productive wells, dry hole costs, lease acquisition costs, delay rentals, interest capitalized on
unevaluated leases, other costs related to exploration and development activities, and site restoration, dismantlement and abandonment
costs capitalized in accordance with asset retirement obligation accounting guidance. Costs capitalized also include any internal costs that
are directly related to exploration and development activities, including salaries and benefits, but do not include any costs related to
production, general corporate overhead or similar activities. The Company capitalized $13,331, $11,857 and $11,829 of these internal
costs during 2012, 2011 and 2010, respectively.
When applicable, proceeds from the sale or disposition of crude oil and natural gas properties are accounted for as a reduction to
capitalized costs unless the sale would significantly alter the relationship between capitalized costs and proved reserves, in which case a
gain or loss is recognized in income.
Costs of crude oil and natural gas properties, including future development costs, which have proved reserves and properties which have
been determined to be worthless, are depleted using the unit-of-production method based on proved reserves. Excluded from this
amortization are costs associated with unevaluated properties, including capitalized interest on such costs. Unevaluated property costs are
transferred to evaluated property costs at such time as wells are completed on the properties or management determines that these costs
have been impaired.
Under the SEC's full cost accounting rules, we review the carrying value of our crude oil and natural gas properties each quarter. Under
these rules, we compare the present value, discounted at 10%, of estimated future net cash flows from proved crude oil and natural gas
reserves to the capitalized costs of crude oil and natural gas properties (net of accumulated depreciation, depletion and amortization and
related deferred income taxes) which may not exceed a “ceiling”.
These rules generally require that we price our future crude oil and natural gas production at the twelve-month average of the first-day-of-
the-month reference prices as adjusted for location and quality differentials. Our reference prices are the West Texas Intermediate, or WTI,
for crude oil and the Henry Hub spot price for natural gas. Such prices are utilized except where different prices are fixed and determinable
from applicable contracts for the remaining term of those contracts. The reserve estimates exclude the effect of any derivatives we have in
place. The rules require an impairment if our capitalized costs exceed this “ceiling”. See Notes 12 and 14 for additional information
regarding the Company’s crude oil and natural gas properties.
Upon the acquisition or discovery of crude oil and natural gas properties, the Company estimates by using available geological,
engineering and regulatory data the future net costs to dismantle, abandon and restore the property. Such cost estimates are periodically
updated for changes in conditions and requirements. In accordance with asset retirement obligation guidance issued by the FASB, such
costs are capitalized to the full-cost pool when the related liabilities are incurred. In accordance with SEC's rules, assets recorded in
connection with the recognition of an asset retirement obligation are included as part of the costs subject
60
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except share, per-share and per-hedge data)
Table of Contents
to the full-cost ceiling limitation. The future cash outflows associated with settling the recorded asset retirement obligations are excluded
from the computation of the present value of estimated future net revenues used in determining the full-cost ceiling amount.
G. Other Property and
Equipment
The Company depreciates its other property and equipment of $6,424 and $3,998 at December 31, 2012 and 2011, respectively, using the
straight-line method over estimated useful lives of three to 20 years. Depreciation expense of $760, $645 and $446 relating to other
property and equipment was included in general and administrative expenses in the Company’s consolidated statements of operations for
the years ended December 31, 2012, 2011 and 2010, respectively. The accumulated depreciation on other property and equipment was
$13,238 and $12,688 as of December 31, 2012 and 2011, respectively. Included within the Company's other property and equipment, and
excluded from depreciation, are certain assets held for sale, which were valued at $3,634 and $6,514 as of December 31, 2012 and 2011,
respectively. The Company reviews its other property and equipment for impairment when indicators of impairment exist. See Note 7 for
additional information regarding the assets held for sale and their fair values.
H. Asset Retirement
Obligations
The Company is required to record its estimate of the fair value of liabilities for obligations associated with the retirement of tangible long-
lived assets and the associated asset retirement costs. Interest is accreted on the present value of the asset retirement obligations and
reported as accretion expense within operating expenses in the consolidated statements of operations. See Note 13 for additional
information.
I. Derivatives
The Company’s derivative contracts executed prior to 2012 were designated as cash flow hedges, and were recorded at fair market value
with the changes in fair value recorded net of tax through other comprehensive income (loss) (“OCI”) in stockholders’ equity. Ineffective
derivative contracts or portions of contract designated as cash flow hedges are recognized as derivative expense (income). The last of the
Company's derivative contracts designated as cash flow hedges expired on December 31, 2012. Derivative contracts executed during 2012
and outstanding as of December 31, 2012 are not designated as accounting hedges, and are also carried on the balance sheet at their fair
market value. Changes in the fair value of derivative contracts not designated as accounting hedges are reflected in earnings as a gain or
loss on derivative contracts. See Notes 6 and 7 for additional information regarding the Company's derivative contracts.
J.
Income
Taxes
Provisions for income taxes include deferred taxes resulting primarily from temporary differences due to different reporting methods for
crude oil and natural gas properties for financial reporting purposes and income tax purposes. US GAAP requires the recognition of a
deferred tax asset for net operating loss carryforwards, statutory depletion carryforward and tax credit carryforwards, net of a valuation
allowance. A valuation allowance is provided for that portion of the asset for which it is deemed more likely than not will not be realized.
See Note 11 for additional information.
K. Share-Based
Compensation
The Company grants to directors and employees stock options, restricted stock awards ("RS awards"), and restricted stock unit awards
("RSU awards") that may be settled in cash or common stock at the option of the Company and RSU awards that may only be settled in
cash (“Cash-settleable RSU awards”).
Stock Options. For stock options the Company expects to settle in common stock, share-based compensation expense is based on the
grant-date fair value and recognized straight-line over the vesting period (generally three years).
RS awards, RSU awards and Cash-settleable RSU awards. For RS and RSU awards that the Company expects to settle in common
stock, share-based compensation expense is based on the grant-date fair value and recognized straight-line over the vesting period
(generally three years). For Cash-settleable RSU awards that the Company expects or is required to settle in cash, share-based
compensation expense is based on the fair value remeasured at each reporting period, recognized over the vesting period (generally
three years) and classified as Accounts payable and accrued liabilities for the portion of the awards that are vested or are expected to vest
within the next 12 months, with the remainder classified as Other long-term liabilities.
61
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except share, per-share and per-hedge data)
Table of Contents
L. Statements of Cash
Flows
During the three year period ended 2012, the Company paid no federal income taxes. During the years ended December 31, 2012, 2011
and 2010, the company made cash interest payments of $13,920, $14,922 and $18,579, respectively.
M. Off-Balance Sheet Investment in Medusa Spar
LLC
The Company holds a 10% ownership interest in Medusa Spar LLC (“LLC”), which is accounted for under the equity method of
accounting for investments. The LLC owns a 75% undivided ownership interest in the deepwater spar production facilities at the
Company’s Medusa field in the Gulf of Mexico. The LLC earns a tariff based upon production volume throughput from the Medusa area.
Callon is obligated to process through the spar production facilities its share of production from the Medusa field and any future discoveries
in the area. The balance of Medusa Spar LLC is owned by Oceaneering International, Inc. and Murphy Oil Corporation.
N. Consolidation of Variable Interest
Entities
In June 2009, the FASB issued an accounting standard which became effective for the Company on January 1, 2010, and which amended
US GAAP as follows:
•
•
•
•
•
•
•
to require an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a
controlling financial interest in a Variable Interest Entity (“VIE”), identifying the primary beneficiary of a VIE;
to require ongoing reassessment of whether an enterprise is the primary beneficiary of a VIE, rather than only when specific events
occur;
to eliminate the quantitative approach previously required for determining the primary beneficiary of a
VIE;
to amend certain guidance for determining whether an entity is a
VIE;
to add an additional reconsideration event when changes in facts and circumstances pertinent to a VIE
occur;
to
the
eliminate
reconsideration; and
to require advanced disclosures that will provide users of financial statements with more transparent information about an
enterprise’s involvement in a VIE.
regarding VIE
troubled debt
restructuring
exception
for
The Company adopted the pronouncement for consolidation of variable interest entities on January 1, 2010. Upon adoption, and as
discussed in Note 3, the Company reevaluated its interest in its subsidiary, Callon Entrada. Based on the evaluation performed,
management concluded that a VIE reconsideration event had taken place resulting in the determination that Callon Entrada is a VIE, for
which the Company is not the primary beneficiary. Therefore, effective January 1, 2010, Callon Entrada was deconsolidated from the
consolidated financial statements of the Company. During the second quarter of 2011 and through the formal execution of a wind-down
agreement with its former joint interest partner in the Entrada deepwater project, the Company became the primary beneficiary of Callon
Entrada. Consequently, effective April 29, 2011, Callon Entrada was reconsolidated in the Company's financial statements. For additional
information, see Note 3.
O. Earnings
("EPS")
per
Share
The Company’s basic EPS amounts have been computed based on the weighted-average number of shares of common stock outstanding
for the period. Diluted EPS reflects the potential dilution, using the treasury-stock method, which assumes that options were exercised and
restricted stock was fully vested. Diluted EPS also includes the impact of unvested share appreciation plans. For awards in which the
share price goals have already been achieved, shares are included in diluted EPS using the treasury-stock method. For those awards in
which the share price goals have not been achieved, the number of contingently issuable shares included in the diluted EPS is based on the
number of shares, if any, using the treasury-stock method, that would be issuable if the market price of the Company’s stock at the end of
the reporting period exceeded the share price goals under the terms of the plan.
P. Treasury
Stock
The Company applies the weighted-average-cost method of accounting for treasury stock transactions and held 29 treasury shares as of
December 31, 2012.
62
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except share, per-share and per-hedge data)
Table of Contents
Q. Recent
Pronouncements
Accounting
From time to time, new accounting pronouncements are issued by FASB that are adopted by the Company as of the specified effective
date. If not discussed, management believes that the impact of recently issued standards, which are not yet effective, will not have a
material impact on the Company’s financial statements upon adoption.
NOTE 3 - Global Settlement with Joint Interest Partner
During May 2011, the Company entered into a final project wind-down agreement (the "Agreement") with CIECO. As a result of this
Agreement, which included both the assignment of the rights to the Entrada assets (including the rights to 50% of the assets previously held
by CIECO and the rights to 50% of the assets held by Callon Entrada) and the proceeds from the ultimate sale of such assets, the Company
gained the power to direct the activities related to the sale of the remaining assets, and therefore became the primary beneficiary of Callon
Entrada. Therefore, Callon Entrada was consolidated in the Company's consolidated financial statements, effective April 29, 2011. Upon
consolidating Callon Entrada, the Company estimated the fair values of the assets acquired to be $11,349 and liabilities assumed, primarily
deferred tax liabilities associated with the tax basis difference in the assets, of Callon Entrada to be $2,681as a result of this Agreement.
Also in connection with this Agreement, Callon Entrada agreed to pay to CIECO approximately $438, which represented the net balance of
joint interest billings due to CIECO and which had been previously accrued. The agreement also included joint releases of each party from
any further liabilities or obligations to the other party in connection with the Entrada project. The adjusted fair market value of the net
assets acquired of approximately $8,759 were recorded during 2011 as a $5,041 gain and $3,718 as an adjustment to the Company's full
cost pool of crude oil and natural gas properties.
While the Company continues to actively market these assets, its inability to complete a transaction over the past several quarters
constituted an impairment indicator, which prompted the Company to reevaluate the remaining value of the assets. As of December 31,
2012, the remaining unsold assets, which are included in the Company's balance sheet as a component of Other property and equipment,
net had carrying values of $3,634. During the year ended December 31, 2012, the Company sold assets valued at $527, and recorded an
impairment charge of $1,177 to its Statement of Operations as a result of the Company's December 31, 2012 impairment analysis. The
Company continues to actively market these assets, and will continue to monitor the assets for additional impairment. See Note 7 for
additional information regarding the determination of the assets' fair values.
NOTE 4 - Earnings per Share
Basic net income per common share was computed by dividing net income by the weighted average number of shares of common stock
outstanding during the year. Diluted net income per common share was determined on a weighted average basis using common shares
issued and outstanding adjusted for the effect of stock options and restricted stock considered common stock equivalents computed using
the treasury stock method.
A reconciliation of the basic and diluted net income per share computation is as follows (in thousands, except per share amounts):
(a) Net income
(b) Weighted average shares outstanding
Dilutive impact of stock options
Dilutive impact of restricted stock
(c) Weighted average shares outstanding
for diluted net income per share
Basic net income per share (a/b)
Diluted net income per share (a/c)
$
$
$
The following were excluded from the diluted EPS calculation because their effect would be anti-dilutive:
52
Stock options
123
Restricted stock
67
816
63
For the year ended December 31,
2011
2012
106,396 $
2,747 $
2010
8,386
39,522
8
807
37,908
18
656
28,817
108
551
40,337
38,582
29,476
0.07 $
0.07 $
2.81 $
2.76 $
0.29
0.28
122
5
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except share, per-share and per-hedge data)
Table of Contents
NOTE 5 - Borrowings
Principal components:
Credit Facility
13% Senior Notes due 2016, principal
Total principal outstanding
Non-cash components:
13% Senior Notes due 2016 unamortized deferred credit
Total carrying value of borrowings
Senior Secured Revolving Credit Facility (the “Credit Facility”)
For the year ended December 31,
2012
2011
$
$
$
10,000 $
96,961
106,961 $
—
106,961
106,961
13,707
120,668 $
18,384
125,345
On June 20, 2012, Regions Bank increased the Company's Credit Facility to $200,000 with an associated borrowing base under the Credit
Facility of $60,000 and a maturity of July 31, 2014. In October 2012, the Credit Facility was further amended to increase the borrowing
base to $80,000, extend the maturity to March 15, 2016 and add Citibank, NA, IberiaBank, Whitney Bank and OneWest Bank, FSB as
participating lenders. Regions Bank continues to serve as Administrative Agent for the Credit Facility.
Following the sale of our interest in the deepwater Habanero field and as of December 31, 2012, the borrowing base was revised to
$65,000, representing a 44% increase over the $45,000 borrowing base at December 31, 2011. The $39,410 proceeds from this sale, net of
customary purchase price adjustments, were used to reduce outstanding borrowings on the Credit Facility to the $10,000 reflected on the
Company's Consolidated Balance Sheet as of December 31, 2012.
Amounts borrowed under the Credit Facility may not exceed a borrowing base, which is generally reviewed on a semi-annual basis and is
then eligible for re-determination. The next redetermination is scheduled for the first quarter of 2013, and will be based upon year-end 2012
proved reserves. The Credit Facility is secured by mortgages covering the Company's major producing fields.
As of December 31, 2012, the balance outstanding on the Credit Facility was $10,000 with an interest rate on the Credit Facility of 2.72%,
calculated as the London Interbank Offered Rate ("LIBOR"), plus a tiered rate ranging from 2.5% to 3.0%, which is based on the amount
drawn on the Credit Facility. In addition, the Credit Facility carries a commitment fee of 0.5% per annum on the unused portion of the
borrowing base, which is payable quarterly. As of March 13, 2013, the balance outstanding on the Credit Facility was $25,000 as the
Company drew an additional $15,000 in support of the Company's ongoing capital development program.
13% Senior Notes due 2016 (“Senior Notes”) and Deferred Credit
As of December 31, 2012, the Company had principal outstanding of $96,961 related to its 13% Senior Notes due 2016. The interest
coupon is payable on the last day of each quarter.
Upon issuing the Senior Notes during November 2009, the Company reduced the carrying amount of the Old Notes by the fair value of the
common and preferred stock issued in the amount of $11,527. The $31,507 difference between the adjusted carrying amount of the Old
Notes and the face value of the Senior Notes was recorded as a deferred credit, which is being amortized as a reduction in interest expense
over the life of the Senior Notes at an 8.5% effective interest rate.
64
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except share, per-share and per-hedge data)
Table of Contents
The following table summarizes the Company’s deferred credit balance at December 31, 2012:
Gross Carrying
Amount
$31,507
Accumulated
Amortization
$17,800
Carrying Value
$13,707
Amortization Recorded
during Current Year
(a)
$4,677
Estimated Annual
Amortization Expense
Expected to be
Recognized in 2013 (b)
$3,300
(a) Of the amount recorded as amortization during the current year, $3,086 was recorded as a reduction of interest expense and $1,591 (discussed
below) was recorded as a component of the gain on early extinguishment of debt.
(b) Deferred credit amortization expected to be recorded as a reduction in interest expense during, 2014, 2015 and 2016 is $3,592, $3,910, and
$2,905, respectively.
In June 2012, the Company redeemed $10,000 of its Senior Notes, which resulted in a net $1,366 gain on the early extinguishment of debt.
The gain represents the difference between the $10,225 paid (inclusive of $225 of redemption expenses) for Notes with a carrying value of
$11,591 (inclusive of the $1,591 of accelerated deferred credit amortization).
Following the completion of an equity offering during February 2011, the Company redeemed $31,000 of the Notes. This redemption was
completed in March 2011, and resulted in a gain on the early extinguishment of debt of $1,974. The gain represents the difference between
the $35,062 paid for $37,004 (including $31,000 principal amount of the notes plus $6,004 of accelerated deferred credit amortization)
carrying value of the Notes, offset by the $4,030 charge related to the 13% call premium required by the terms of the call option and $32 of
redemption expenses.
Certain of the Company’s subsidiaries guarantee the Company’s obligations under the Senior Notes. The subsidiary guarantors are 100%
owned, all of the guarantees are full and unconditional and joint and several, the parent company has no independent assets or operations
and any subsidiaries of the parent company other than the subsidiary guarantors are minor.
Restrictive Covenants
The Indenture governing our Senior Notes and the Company’s Credit Facility contains various covenants including restrictions on
additional indebtedness and payment of cash dividends. In addition, Callon’s Credit Facility contains covenants for maintenance of certain
financial ratios. The Company was in compliance with these covenants at December 31, 2012.
NOTE 6 – Derivative Instruments and Hedging Activities
Objectives and Strategies for Using Derivative Instruments
The Company is exposed to fluctuations in crude oil and natural gas prices on the majority of its production. Consequently, the Company
believes it is prudent to manage the variability in cash flows on a portion of its crude oil and natural gas production. The Company utilizes
primarily collars and swap derivative financial instruments to manage fluctuations in cash flows resulting from changes in commodity
prices. The Company does not use these instruments for trading purposes.
Counterparty Risk
The use of derivative transactions exposes the Company to counterparty credit risk, or the risk that a counterparty will be unable to meet its
commitments. To reduce the Company’s risk in this area, counterparties to the Company’s commodity derivative instruments
predominantly include a large, well-known financial institution and/or a large, well-known oil and gas company. The Company monitors
counterparty creditworthiness on an ongoing basis; however, it cannot predict sudden changes in counterparties’ creditworthiness. In
addition, even if such changes are not sudden, the Company may be limited in its ability to mitigate an increase in counterparty credit risk.
Should one of these counterparties not perform, the Company may not realize the benefit of some of its derivative instruments under lower
commodity prices.
The Company executes commodity derivative transactions under master agreements that have netting provisions that provide for offsetting
payables against receivables. In general, if a party to a derivative transaction incurs an event of default, as defined in the applicable
agreement, the other party will have the right to demand the posting of collateral, demand a transfer or terminate the arrangement.
65
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except share, per-share and per-hedge data)
Table of Contents
Financial statement presentation and settlements
Settlements of the Company's derivative instruments are based on the difference between the contract price or prices specified in the
derivative instrument and a New York Mercantile Exchange ("NYMEX") price. The fair value of the Company's derivative instruments,
depending on the type of instruments, was determined by the use of present value methods or standard option valuation models with
assumptions about commodity prices based on those observed in underlying markets. See Note 7 for additional information regarding fair
value.
During 2012, the Company elected not to designate its derivative contracts, nor does it expect to designate future derivative contracts, as an
accounting hedge under FASB ASC 815. Consequently, any derivative contract not designated as an accounting hedge will be carried at its
fair value on the balance sheet and marked-to-market at the end of each period, with the change in value reflected as a gain or loss on the
statement of operations.
Prior to 2012, the Company's derivative contracts recorded on the Consolidated Balance Sheets were designated as cash flow hedges, and
were recorded at fair market value with the changes in fair value recorded net of tax through OCI in stockholders' equity. The future cash
settlements on effective derivative contracts were recorded as an increase or decrease in crude oil and natural gas sales. Both changes in fair
value and cash settlements on effective derivative contracts were recognized as derivative expense (income).
The following table reflects the fair values of the Company's derivative instruments for the periods indicated:
Commodity Classification
Line Description
Balance Sheet Presentation
Asset Fair Value
12/31/12 12/31/11
Liability Fair Value
Net Derivative Fair Value
12/31/12
12/31/11
12/31/12
12/31/11
Derivatives not designated as Hedging Instruments under ASC 815
Natural gas
Natural gas
Crude oil
Crude oil
Current
Non-current
Current
Non-current
Fair market value of derivatives
Other long-term liabilities
Fair market value of derivatives
Other long-term assets
$
— $
—
1,674
250
$
—
—
—
—
$
(125)
(116)
—
—
—
—
—
—
$
(125) $
(116)
1,674
250
Subtotals
$ 1,924 $
—
$
(241)
$
—
$
1,683 $
—
—
—
—
—
Derivatives designated as Hedging Instruments under ASC 815
Natural gas
Natural gas
Crude oil
Crude oil
Current
Non-current
Current
Non-current
Fair market value of derivatives
Other long-term assets
Fair market value of derivatives
Other long-term liabilities
$
— $
—
—
—
—
—
—
—
Subtotals
Totals
$
— $
—
$ 1,924 $
—
66
$
$
$
—
—
—
—
$
—
—
2,499
—
—
$ 2,499
(241)
$ 2,499
$
$
$
— $
—
—
—
—
—
2,499
—
— $
2,499
1,683 $
2,499
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except share, per-share and per-hedge data)
Table of Contents
Derivatives not designated as hedging instruments under ASC 815
For the periods indicated, the Company recorded the following related to its derivative instruments that were not designated as accounting
hedges and are recorded in the Statement of Operations as the gain or loss on derivative contracts:
For the year ended December 31,
2012
2011
2010
Natural gas derivatives
Realized gain, net
Unrealized loss, net
Subtotal loss, net
Crude oil derivatives
Realized gain, net
Unrealized gain, net
Subtotal gain, net
$
$
$
$
34 $
(241)
(207) $
— $
1,924
1,924 $
— $
—
— $
— $
—
— $
Total gain on derivative instruments, net
$
1,717 $
— $
Derivatives designated as hedging instruments under ASC 815
—
—
—
—
—
—
—
The tables below present the effect of the Company’s derivative financial instruments on the consolidated statements of operations as an
increase (decrease) to crude oil and natural gas sales:
Amount of gain (loss) reclassified from OCI into income (effective portion)
Amount of gain (loss) recognized in income (ineffective portion and amount excluded from effectiveness testing)
Derivative positions
For the year ended
December 31,
$
2010
2011
2012
1,420 $ (375) $ 632
— —
—
Listed in the table below are the outstanding oil and natural gas derivative contracts as of December 31, 2012:
Product
Crude oil (a) (b)
Instrument
Collar
Product
Natural gas (c)
Natural gas (c)
Natural gas (c)
Instrument
Swap
Put Option
Call Option
Average
Volumes per
Month
40
Average
Volumes per
Month
91
91
38
Quantity
Type
Bbls
Average Floor Price
per Hedge
Average Ceiling
Price per Hedge
$
90.00 $
116.00
Period
Jan13 - Dec13
Quantity
Type
MMbtu
MMbtu
MMbtu
$
$
Put/Call Price
Fixed-Price Swap
n/a $
3.00
4.75
3.52
n/a
n/a
Period
Jan13 - Dec13
Jan13 - Dec13
Jan14 - Dec14
(a) See "Subsequent Event" discussion below regarding the replacement of this crude oil derivative contract in January
2013.
(b) A collar is a combination of a sold call option (ceiling) and a purchased put option
(floor).
(c) The natural gas swap, put and call option were executed contemporaneously. The "above market" $3.52/MMbtu swap price the Company
received was offset by the value of the two options sold by the Company. The short natural gas put option, when combined with the swap,
creates the potential for a reduction in the effective swap price if NYMEX natural gas prices are below $3.00/MMbtu in 2013. The short
natural gas call option, when combined with the Company's long production position, represents a "covered call," and creates a
$4.75/MMbtu ceiling during the covered period.
67
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except share, per-share and per-hedge data)
Table of Contents
Subsequent Event:
Derivative contracts executed subsequent to December 31, 2012 include the following:
Product
Crude oil (a)
Crude oil
Crude oil (a)
Instrument
Swap
Swap
Put
Average
Volumes per
Month
40
30
30
Quantity
Type
Bbls
Bbls
Bbls
$
Put Price
Fixed-Price Swap
Period
n/a $
n/a $
70.00
101.30 Feb13 - Dec13
Jan14 - Dec14
93.35
Jan14 - Dec14
n/a
(a) During January 2013, the Company monetized the remaining portion (Feb13-Dec13) of its 2013 crude oil collar positions of 40 Bbls per
month reflected in previous table. The proceeds from this transaction, combined with the proceeds from the sale of the listed put for 30
Bbls per month, were used to finance the uplift in the crude oil swap for the period Feb13-Dec13.
NOTE 7 – Fair Value Measurements
Fair value is defined within the accounting rules as the price that would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the measurement date. The rules established a fair value hierarchy that prioritizes the
inputs to valuation techniques used to measure fair value. As presented in the tables below, this hierarchy consists of three broad levels:
Level 1 Valuations consist of unadjusted quoted prices in active markets for identical assets and liabilities and has the highest priority.
Level 2 Valuations rely on quoted prices in markets that are not active or observable inputs over the full term of the asset or liability.
Level 3 Valuations are based on prices or third party or internal valuation models that require inputs that are significant to the fair
value measurement and are less observable and thus have the lowest priority.
Fair Value of Financial Instruments
Cash, Cash Equivalents, and Short-Term Investments. The carrying amounts for these instruments approximate fair value due to the short-
term nature or maturity of the instruments.
Debt. The Company’s debt is recorded at the carrying amount on its Consolidated Balance Sheet. The fair value of Callon’s fixed-rate
debt, which is valued using Level 2 inputs, is based upon estimates provided by an independent investment banking firm. The carrying
amount of floating-rate debt approximates fair value because the interest rates are variable and reflective of market rates.
The following table summarizes the respective carrying and fair values at:
For the year ended December 31,
2012
2011
Credit Facility
13% Senior Notes due 2016 (a)
Total
$
$
10,000 $
110,668
120,668 $
10,000 $
100,112
110,112 $
Carrying
Value
Fair Value
Carrying
Value
Fair Value
—
110,571
110,571
— $
125,345
125,345 $
(a) 2012 and 2011 Fair value is calculated only in relation to the $96,961 and $106,961 face value outstanding of the 13% Senior Notes,
respectively. The remaining $13,707 and $18,384, respectively represents the Company's deferred credits and have been excluded from
the fair value calculation. See Note 5 for additional information.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
Certain assets and liabilities are reported at fair value on a recurring basis (unless otherwise noted below) in Callon’s Consolidated Balance
Sheet. The following methods and assumptions were used to estimate the fair values:
68
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except share, per-share and per-hedge data)
Table of Contents
Commodity Derivative Instruments. Callon’s derivative policy allows for commodity derivative instruments to consist of collars, natural
gas and crude oil basis swaps, and similar commodity instrument structures. The fair value of these derivatives is derived using a
valuation model that utilizes market-corroborated inputs that are observable over the term of the derivative contract, and the values are
corroborated by quotes obtained from counterparties to the agreements. The Company’s fair value calculations also incorporate an estimate
of the counterparties’ default risk for derivative assets and an estimate of the Company’s default risk for derivative liabilities. The
Company believes that the majority of the inputs used to calculate the commodity derivative instruments fall within Level 2 of the fair-
value hierarchy based on the wide availability of quoted market prices for similar commodity derivative contracts. See Note 6 for additional
information regarding the Company’s derivative instruments.
The following tables present the Company’s assets and liabilities measured at fair value on a recurring basis for each hierarchy level:
December 31, 2012
Balance Sheet Presentation
Level 1 Level 2 Level 3 Total
Assets
Derivative financial instruments - current Portion
Derivative financial instruments - non-current
Sub-total assets
Liabilities
Derivative financial instruments - current portion
Derivative financial instruments - non-current
Sub-total liabilities
Fair market value of derivatives
Other assets, net
$ — $ 1,674 $
—
250
$ — $ 1,924 $
— $ 1,674
250
—
— $ 1,924
Fair market value of derivatives
Other long-term liabilities
$ — $
—
$ — $
125 $
116
241 $
— $
—
— $
125
116
241
Total
$ — $ 1,683 $
— $ 1,683
December 31, 2011
Balance Sheet Presentation
Level 1 Level 2 Level 3 Total
Assets
Derivative financial instruments - current Portion
Derivative financial instruments - non-current
Total
Fair market value of derivatives
Other assets, net
$ — $ 2,499 $
—
—
$ — $ 2,499 $
— $ 2,499
—
—
— $ 2,499
The derivative fair values above are based on analysis of each contract. Derivative assets and liabilities with the same counterparty are
presented here on a gross basis, even where the legal right of offset exists. See Note 6 for a discussion of net amounts recorded in the
Consolidated Balance Sheet at December 31, 2012.
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
Certain assets and liabilities are reported at fair value on a nonrecurring basis in Callon’s Consolidated Balance Sheet. The following
methods and assumptions were used to estimate the fair values:
Asset Retirement Obligations Incurred in Current Period. Callon estimates the fair value of AROs based on discounted cash flow
projections using numerous estimates, assumptions and judgments regarding such factors as (1) the existence of a legal obligation for an
ARO, (2) amounts and timing of settlements, (3) the credit-adjusted risk-free rate to be used and (4) inflation rates. AROs incurred for the
year ended December 31, 2012 and resulting in fair value measurement, including upward revisions to ARO liabilities of $81, were Level 3
fair value measurements. See Note 13 for a summary of changes in the Company’s ARO liability.
Other Property and Equipment. See Note 3 for additional information regarding the global settlement with Callon’s former joint interest
partner on the project. During the second quarter of 2011, Callon acquired 100% of the rights to all remaining assets related to one of the
Company's deepwater projects, which primarily consisted of surplus equipment.
As Callon is required to measure the assets acquired at fair value, Callon estimated each asset’s fair value based on several factors
including (1) historical prices received for assets sold, (2) the similarity of unsold assets to those previously sold and the sales prices for
those similar assets, (3) the number of market participants expected to have an interest in the assets, (4) the degree to which the asset has
been customized and would require modification by a purchaser for use, and (5) the nature of the asset being
69
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except share, per-share and per-hedge data)
Table of Contents
held for sale (i.e. whether the asset is highly specialized, built-for-purpose, etc.). We also obtained certain information that was considered
in the valuation of this equipment from an independent firm that is in the business of manufacturing and selling this equipment.
Values assigned to equipment sold prior to the June 30, 2011 reporting date and for which the exit price, as defined by US GAAP, became
readily determinable, represented Level 2 fair value measurements equal to $3,954 of the total $11,349 acquired through the agreement.
The remaining $7,395 of acquired assets represented Level 3 fair value measurements based on the limited ability of market pricing
information for either identical or similar items. Certain assets were assigned no value in instances where the fair value was indeterminable
due to the built-for-purpose or highly specialized nature of the assets. Also as a result of this settlement agreement, the Company assumed
$2,681 of liabilities, which consisted entirely of a deferred tax liability associated with the basis difference of the equipment.
At December 31, 2012, the Company evaluated for impairment the unsold surplus equipment, noting the passage of time without
significant sales activity, as an indicator of impairment. The Company followed the process described above to reevaluate the assets fair
values. As a result of this analysis, the Company recorded an impairment charge of $1,177 , which was recorded as a loss on the Statement
of Operations. The carrying value of the remaining unsold equipment is $3,634, at December 31, 2012, is recorded on the Consolidated
Balance Sheet within Other Property and Equipment, net and represents a Level 3 fair value measurement. See Note 3 for additional
information.
NOTE 8 – Employee Benefit Plans
The Company utilizes various forms of incentive compensation designed to align the interest of the executives and employees with those of
its stockholders. Tabular disclosures related to the share-based awards are presented in Note 9. The narrative that follows provides a brief
description of each plan, summarizes the overall status of each plan and discusses current year awards under each plan:
Savings and Protection Plan
The Savings and Protection Plan (“401-K Plan”) provides employees with the option to defer receipt of a portion of their compensation,
and the Company may, at its discretion, match a portion of the employee's deferral with cash. The Company may also elect, at its
discretion, to contribute a non-matching amount in cash and Company Common Stock to employees. The amounts held under the 401-K
Plan are invested in various funds maintained by a third party in accordance with the directions of each employee. An employee is fully
vested, including Company discretionary contributions, immediately upon participation in the 401-K Plan. The total amounts contributed
by the Company, including the value of the common stock contributed, were $918, $811 and $690 in the years 2012, 2011 and 2010,
respectively.
2011 Omnibus Incentive Plan (the “2011 Plan”)
The 2011 Plan, which became effective May 12, 2011 following shareholder approval, authorized and reserved for issuance 2,300 shares of
common stock, which may be issued upon exercise of vested stock options and/or the vesting of any other share-based equity award that is
granted under this plan. The 2011 Plan is the Company's only active plan, and included a provision at inception whereby all remaining, un-
issued and authorized shares from the Company's previous share-based incentive plans became issuable under the 2011 Plan. This transfer
provision resulted in the transfer of an additional 841 shares into the plan, increasing the quantity authorized and reserved for issuance
under the Plan to 3,141 at the inception of the plan. Another provision provided that shares which would otherwise become available for
issue under the previous plans as a result of vesting and/or forfeiture of any equity awards existing as of May 12, 2012, would also increase
the authorized shares available to the 2011 Plan. As of December 31, 2012, the 2011 Plan had 1,669 shares remaining and eligible for
future issuance.
Equity awards issued under this plan may be subject to various vesting, accelerated vesting, and forfeiture provisions upon the occurrence
of certain events. Any vested but unexercised options contractually expire 10 years from the date of grant. Equity awards under the 2011
Plan generally vest over time but may also be subject to attaining a specified performance metrics and may be immediate or cliff vest at a
specified date. The Company will recognize expense on the grant date for all immediately vesting awards, while it will recognize expense
ratably over the requisite service (i.e. vesting) period for both cliff and ratably vesting awards. For performance-based awards, the
Company recognizes expense based on its analysis of the performance criteria, and records or reverses expense as necessary based on its
analysis. For market-based awards, the Company recognizes expense based on its analysis of the market criteria, and records expense as
necessary based on its analysis. Awards with a market-based provision do not allow for the reversal of previously recognized expense,
even if the market metric is not achieved and no shares ultimately vest or are awarded.
70
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except share, per-share and per-hedge data)
Table of Contents
Stock Incentive Award for Inducement of Employment
In April 2012 and as an inducement of employment, the Company awarded 100 restricted stock units to its Senior Vice President of
Finance. The restricted stock units vest in one-third increments on each award anniversary date beginning July 1, 2013, and are being
expensed ratably over the vesting period.
Following the Chief Operating Officer's ("COO") September 2010 departure from the Company, the COO forfeited his previously awarded
200 restricted and performance-based shares and 333 of his unvested performance-based stock options. Prior to his departure in 2010, the
Company achieved the first of three performance metrics specified in the performance-based stock options agreement resulting in the COO
vesting in 167 options, for which the Company recorded approximately $180 of compensation expense.
In April 2010 and as an inducement of employment, the Company awarded 50 restricted stock units to its Senior Vice President of
Operations. The restricted stock units cliff vested on January 1, 2011, and were fully expensed as of December 31, 2010.
Cash-Settleable RSU Awards
Certain of the Company's RSUs awarded require cash-settlement. Cash-settleable RSU awards are accounted for as liabilities as the
Company is contractually obligated to settle these awards in cash, and are recorded in the Company's consolidated balance sheet for the
ratable portion of their fair values. Changes in the fair value of cash-settleable awards are recorded as adjustments to compensation
expense. See Note 7 for additional information regarding fair value of cash-settleable awards.
A portion of the Company's cash-settleable RSU awards include a market-based vesting condition and may ultimately vest at a quantity
different than the base RSUs awarded. The number of RSUs that cliff-vest is based on a calculation that compares the Company's total
shareholder return to the same calculated return of a group of peer companies as selected by the Company, and the number of units that
will vest can range between 0% and 200% of the base units awarded. As of December 31, 2012, the Company had the following cash-
settleable RSU awards outstanding:
Vesting in 2013
Vesting in 2014
Vesting in 2015
Other
Total cash-settleable RSU awards
Base Units
Outstanding at
December 31, 2012
Potential Minimum Potential Maximum
Units at Vesting at
Units at Vesting at
December 31, 2012
December 31, 2012
348
569
72
—
989
79
62
72
—
213
483
1,077
72
—
1,632
For the year ended December 31, 2012, 364 cash-settleable RSUs subject to the peer market-based vesting described above vested at their
maximum potential unit vesting of 546 units, resulting in a cash payment of $2,626. Additionally, 144 cash-settleable RSUs vested during
2012, resulting in a cash payment of $757. See Note 9 for additional information regarding cash-settleable RSUs.
NOTE 9 - Share-Based Compensation
As discussed in Note 8, the Company grants various forms of share-based compensation awards to employees of the Company and its
subsidiaries and to non-employee members of the Board of Directors. At December 31, 2012, shares available for future share-based
awards, including stock options or restricted stock grants, under the Company's only active plan, the 2011 Plan, were 1,669.
71
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except share, per-share and per-hedge data)
Table of Contents
The following table presents share-based compensation expense for each respective period:
For the year ended December 31,
Share-based compensation expense for:
Options
RSU equity awards
Cash-settleable RSU awards
401(k) contributions in shares
Total share-based compensation expense (a)
$
$
2012
— $
2011
Equity-based Liability-based Equity-based Liability-based Equity-based Liability-based
—
—
1,396
—
206 $
24 $
2010
— $
—
2,916
—
2,916 $
2,832
—
202
3,058 $
— $
—
1,335
—
1,335 $
4,210
—
218
4,428 $
3,898
—
201
4,305 $
1,396
(a) The portion of this share-based compensation expense that was included in general and administrative expense totaled $4,081, $2,502
and $3,107 for the same years respectively, and the portion capitalized to oil and gas properties was $3,263, $1,891 and $2,594,
respectively.
The following table presents the specified share-based compensation expense for the indicated periods:
Unrecognized compensation costs related to:
Unvested options
Unvested RSU equity awards
Unvested cash-settleable RSU awards
As of December 31,
2012
2011
$ —
6,320
2,826
$ —
5,748
2,498
2010
$
57
3,353
2,676
Future expected share-based compensation expense for:
RSU equity awards
Cash-settleable RSU awards
2013
3,565
1,862
2014
2,182
937
The following table summarizes the Company's cash-settleable RSU awards for the periods indicated:
2015
Thereafter Total
6,320
—
2,826
—
573
27
Consolidated Balance Sheets Classification
Accounts payable and accrued liabilities - current portion
Other long-term liabilities - non-current portion
Total cash-settleable RSU awards
2012
2011
2010
$
$
1,429 $
1,017
2,446 $
604 $
2,309
2,913 $
—
1,578
1,578
Stock Options
The Company uses the Black-Scholes option pricing model to estimate the fair value of stock option awards with the following weighted-
average assumptions for the indicated periods. However, the Company issued no stock options for the past three years and no options
vested during 2012. As of December 31, 2012, the Company had 67 options outstanding and exercisable at a weighted average exercise
price per option of $11.82, with no aggregate intrinsic value and with a weighted-average remaining contract life per unit of 2.7 years.
During 2012, 31 options were exercised at a weighted average exercise price per option of $3.72 and with an aggregate intrinsic value of
$56. Also During 2012, 60 options expired unexercised and 15 options were forfeited. As of December 31, 2011, the Company had 173
options outstanding and exercisable at a weighted average exercise price per option of $8.66, with no aggregate intrinsic value and with a
weighted-average remaining contract life per unit of 2.0 years. The Company net-share settles option exercises and therefore receives no
cash proceeds from the exercise of stock options.
72
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except share, per-share and per-hedge data)
Table of Contents
Restricted Stock Units
The following table represents unvested restricted stock activity for the year ended December 31, 2012:
Outstanding at the beginning of the period
Granted
Vested (a)
Forfeited
Outstanding at the end of the period
a.
The fair value of shares vested was
$2,817.
NOTE 10 – Equity Transactions
Weighted average
Number of
Shares
Grant-Date
Fair Value
per Share
Period over which expense is
expected to be recognized
1,918 $
1,008
(530)
(101)
2,295 $
5.16
5.22
3.29
5.88
5.58
1.5
During February, 2011, the Company received $73,720 in net proceeds from the public offering of 10.1 million shares of its common
stock, which included the issuance of 1.1 million shares pursuant to the underwriters' over-allotment option. The Company used $35,062 of
the proceeds to repurchase $31,000 principal amount of its Senior Notes, with the remaining proceeds intended for general corporate
purposes including the planned development of the Company's Permian basin and other onshore assets. The Company completed the
redemption in March 2011, which resulted in a gain on the early extinguishment of debt of $1,974. The gain represents the difference
between the $35,062 paid for the $37,004 (including the $31,000 principal amount of the notes plus $6,004 of accelerated deferred credit
amortization) carrying value of the Notes, offset by the $4,030 charge related to the 13% call premium required by the terms of the call
option and $32 of redemption expenses.
NOTE 11 – Income Taxes
The following table presents Callon’s net tax benefits relating to its reported net losses and other temporary differences from operations:
Deferred tax asset:
Federal net operating loss carryforward
Statutory depletion carryforward
Alternative minimum tax credit carryforward
Asset retirement obligations
Other
Total deferred tax asset
Deferred tax liability:
Crude oil and natural gas properties
Other
Total deferred tax liability
Net deferred tax asset
For the year ended December 31
2012
2011
$
$
87,774 $
8,184
208
3,357
9,571
109,094
41,336
3,375
44,711
64,383 $
89,457
7,032
208
3,552
9,182
109,431
40,782
2,906
43,688
65,743
Prior to 2012, the Company carried a full valuation allowance against its net deferred tax assets. The Company considered both the positive
and negative evidence in determining whether it was more likely than not that its deferred tax assets were recoverable. The Company
incurred a loss in 2008, primarily as a result of a write-down of its crude oil and natural gas properties following the ceiling test, which
created a loss on an aggregate basis for the three-year period ended December 31, 2008. Primarily as a result of recent cumulative losses,
the Company established a full valuation allowance as of December 31, 2008, and continued to carry the full valuation allowance each
reporting period until December 31, 2011.
73
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except share, per-share and per-hedge data)
Table of Contents
The Company reported profitable operations from 2009 to 2012, and had income on an aggregate basis for the three-year periods ended
December 31, 2011 and 2012. After considering all available positive and negative evidence, the Company believed that it was more likely
than not that it would fully utilize its deferred tax assets recorded at December 31, 2011 and 2012. Among other factors, the Company
believed its recent cumulative income, together with its future operating results using current proved reserves, provided sufficient positive
evidence to reach this conclusion. Based upon this analysis, the Company reversed its related valuation allowance at December 31, 2011.
If not utilized, the Company’s federal operating loss ("NOL") carryforwards will expire as follows:
Federal NOL carryforwards
$
Total
250,783 $
Year Expiring
2013-2018 2019-2021 2022-2024 2025-2027 2028-2031
52,645
101,495 $
39,714 $
56,929 $
— $
The Company has limited state taxable income. Accordingly, the Company has established a full valuation allowance on the tax benefit
associated with the state net operating loss carryforwards of approximately $169,672 which expire in years through 2032, as the Company
does not anticipate generating taxable state income in the states in which these carryforwards apply. These amounts are not included in the
deferred tax summary table above.
In 2009, the Company began to shift its operational focus from exploration, development and production in the Gulf of Mexico to the
acquisition and development of onshore properties. This shift in exploration and development activity resulted in an increase in Texas
income from production by the end of 2012. This, coupled with the sale of one of the Company's primary federal offshore producing
properties, the Habanero field, in December 2012, results in a change in the projected future Texas state tax rate beyond 2012 as a
component of overall anticipated future taxes.
The Company had no significant unrecognized tax benefits at December 31, 2012. Accordingly, the Company does not have any interest
or penalties related to uncertain tax positions. However, if interest or penalties were to be incurred related to uncertain tax positions, such
amounts would be recognized in income tax expense. Tax periods for years 2000 through 2012 remain open to examination by the federal
and state taxing jurisdictions to which the Company is subject.
In addition, the NOL carryback provision of the Internal Revenue Code was amended on November 6, 2009, as part of The Worker,
Homeownership and Business Assistance Act of 2009 (the “WHB Act”). The WHB Act allows businesses with NOLs for 2008 and 2009 to
carry back losses for up to five years and suspends the 90% limitation on the use of any alternative minimum tax NOL deduction
attributable to carrybacks of the applicable NOL. There would be no limit on the NOL carrybacks for the first four preceding years of the
carryback period, but for the fifth preceding year, the NOL carryback would be limited to fifty percent of a company’s taxable income in
that year. In applying the new five-year NOL carryback rule, the Company was able to file during 2010 for a refund claim to recover
approximately $174.
74
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except share, per-share and per-hedge data)
Table of Contents
Below is a reconciliation of the reported amount of income tax expense attributable to continuing operations to the amount of income tax
expense that would result from applying domestic federal statutory tax rates to pretax income from continuing operations.
Component of Income Tax Rate Reconciliation
Income tax expense computed at the statutory federal income tax rate
Change in valuation allowance
Percentage depletion carryforward
State taxes net of federal benefit
Section 162m
Restricted stock and stock options
Other
Effective income tax rate
Components of Income Tax Expense
Current federal income tax benefit
Current state income tax expense
Deferred federal income tax expense
Change in deferred rate
Valuation allowance
Total income tax expense (benefit)
NOTE 12 – Crude Oil and Natural Gas Properties
For the years ended December 31,
2012
2011
2010
35 %
— %
(22 )%
6 %
22 %
2 %
4 %
47 %
35 %
(227)%
(3)%
— %
— %
— %
4 %
(191)%
35 %
(18 )%
(15 )%
— %
— %
— %
— %
2 %
For the years ended December 31,
2012
2011
2010
— $
110
1,777
336
—
2,223
$
— $
—
13,176
—
(82,459 )
(69,283 )
$
(174)
—
1,503
—
(1,503)
(174)
$
$
The following table discloses certain financial data relating to the Company's crude oil and natural gas activities, all of which are located in
the United States.
For the year ended December 31,
2011
2012
2010
Capitalized costs incurred:
Evaluated Properties-
Beginning of period balance
Deconsolidation of Subsidiary January 1, 2010
Capitalized G&A
Property acquisition costs
Exploration costs
Development costs
End of period balance
Unevaluated Properties (excluded from amortization):
Beginning of period balance
Acquisitions
Exploration
Capitalized interest
Transfers to evaluated
End of period balance
Accumulated depreciation, depletion and amortization:
Beginning of period balance
Provision charged to expense
Deconsolidation of Subsidiary January 1, 2010
Sale of mineral interests
End of period balance
75
$
$
$
$
$
$
1,421,640 $ 1,316,677 $ 1,593,884
(364,589)
10,676
—
14,739
61,967
1,497,010 $ 1,421,640 $ 1,316,677
—
12,148
2,075
22,703
38,444
—
11,205
—
5,473
88,285
2,603 $
29,590
34,674
2,109
(200)
68,776 $
8,106 $
2,422
1,372
573
(9,870)
2,603 $
25,442
1,374
2,187
2,000
(22,897)
8,106
1,208,331 $ 1,155,915 $ 1,488,718
31,786
(364,589)
—
1,296,265 $ 1,208,331 $ 1,155,915
48,524
—
39,410
52,416
—
—
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except share, per-share and per-hedge data)
Table of Contents
Unevaluated property costs primarily include lease acquisition costs incurred at federal and state lease sales, unevaluated drilling costs,
seismic, capitalized interest and certain overhead costs related to exploration and development. Collectively, these costs are excluded from
the amortizable evaluated property base, and consisted of $66,173 incurred in 2012, $841 in 2011, and $1,762 in 2010 . These costs are
directly related to the acquisition and evaluation of unproved properties and major development projects. The excluded costs and related
reserves are included in the amortization base as the properties are evaluated and proved reserves are established or impairment is
determined. The Company expects that the majority of these costs will be evaluated over the next three but within five years. The
Company’s unevaluated property balance increased by $66,173 to $68,776 at December 31, 2012 compared to December 31, 2011. A
significant portion of this increase relates to the purchase of leases, primarily in the Midland basin and exploration costs associated with
evaluating our new acreage.
Subsequent to December 31, 2012 and through March 8, 2013, the Company completed two horizontal exploration wells and two vertical
exploration wells and is evaluating the results. The Company also drilled three horizontal wells and had one in progress.
Depletion per unit-of-production (Boe) amounted to $31.56, $26.42 and $19.00 for the years ended December 31, 2012, 2011, and 2010,
respectively. Lease operating expense, or production costs, per unit-of-production (Boe) amounted to $16.86, $11.04, and $10.58 for the
years ended December 31, 2012, 2011, and 2010, respectively.
Under the full-cost accounting rules of the SEC, the Company reviews the carrying value of its proved crude oil and natural gas properties
each quarter. Under these rules, capitalized costs of crude oil and natural gas properties, net of accumulated depreciation, depletion and
amortization and deferred income taxes, may not exceed the present value of estimated future net cash flows from proved crude oil and
natural gas reserves, discounted at 10%, plus the lower of cost or fair value of unevaluated properties, net of related tax effects (the full-
cost ceiling amount). These rules generally require pricing based on the preceding 12-months’ average crude oil and natural gas prices
based on closing prices on the first day of each month and require a write-down if the “ceiling” is exceeded. Given the volatility of crude
oil and natural gas prices, it is reasonably possible that the Company’s estimate of discounted future net cash flows from proved crude oil
and natural gas reserves could change in the near term. If crude oil and natural gas prices decline significantly, even if only for a short
period of time, it is possible that write-downs of crude oil and natural gas properties could occur in the future. For the years ended
December 31, 2012, 2011, and 2010, the Company recorded no impairment charges related to its crude oil and natural gas properties as a
result of this calculation.
Property Acquisitions and Dispositions
Acquisitions:
During the first quarter of 2012, the Company acquired approximately 16,233 gross (14,653 net) acres in Borden county, which is located
in the northern Midland basin. The northern Midland basin has had limited drilling activity compared with the southern Midland basin
(where our current production is located), increasing the economic risk related to these drilling activities. The purchase price of $14,538
was funded from existing cash balances. During the third quarter of 2012, we acquired an additional 8,095 gross acres (6,964 net) in this
area for a total consideration of $4,835.
During the second quarter of 2012, the Company signed a purchase and sale agreement to acquire 2,319 gross (1,762 net) acres in southern
Reagan county, Texas for a total purchase price of $12,012, which was financed with a draw on the Credit Facility. The transaction had an
effective date of May 1, 2012 and closed on July 5, 2012.
Dispositions:
Effective December 28, 2012, the Company closed on the sale of its 11.25% working interest in the Habanero field (Garden Banks Block
341). The Company sold its interest in Habanero to Shell Offshore Inc., a subsidiary of Royal Dutch Shell Plc, for an estimated net cash
consideration of USD $39,410 after customary purchase price adjustments. As discussed in Note 2, the proceeds from the sale were
accounted for as a reduction to capitalized costs as the sale did not significantly alter the relationship between capitalized costs and proved
reserves.
76
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except share, per-share and per-hedge data)
Table of Contents
NOTE 13 – Asset Retirement Obligations
The following table summarizes the activity for the Company’s asset retirement obligations:
Asset retirement obligations at beginning of the period
Accretion expense
Liabilities incurred
Liabilities settled
Revisions to estimate
Asset retirement obligations at end of period
Less: current asset retirement obligations
Long-term asset retirement obligations at the end of the period
For the year ended
December 31,
2012
2011
13,938 $
2,253
205
(1,950)
(1,145)
13,301
(2,336)
10,965 $
15,925
2,338
36
(3,797)
(564)
13,938
(1,260)
12,678
$
$
Certain of the Company's operating agreements require that assets be restricted for future abandonment obligations. Amounts recorded on
the Consolidated Balance Sheets at December 31, 2012 as long-term restricted investments were $3,798. These assets, which primarily
include short-term U.S. Government securities, are held in abandonment trusts dedicated to pay future abandonment costs for several of the
Company’s oil and natural gas properties.
NOTE 14 – Supplemental Crude Oil and Natural Gas Reserve Data (unaudited) )
The Company's proved oil and natural gas reserves at December 31, 2012, 2011 and 2010 have been estimated by Huddleston & Co., Inc.,
the Company’s independent petroleum engineers. The reserves were prepared in accordance with guidelines established by the
SEC. Accordingly, the following reserve estimates are based upon existing economic and operating conditions.
There are numerous uncertainties inherent in establishing quantities of proved reserves. The following reserve data represents estimates
only, and should not be deemed exact. In addition, the standardized measure of discounted future net cash flows should not be construed as
the current market value of the Company's oil and natural gas properties or the cost that would be incurred to obtain equivalent reserves.
77
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except share, per-share and per-hedge data)
Table of Contents
Estimated Reserves
Changes in the estimated net quantities of crude oil and natural gas reserves, all of which are located onshore within the continental United
States and offshore within the Gulf of Mexico, are as follows:
Reserve Quantities
For the year ended December 31,
2011
2010
2012
Proved developed and undeveloped reserves:
Crude Oil (MBbls):
Beginning of period
Revisions to previous estimates
Change in ownership
Purchase of reserves in place
Sale of reserves in place
Extensions and discoveries
Production
End of period
Natural Gas (MMcf):
Beginning of period
Revisions to previous estimates
Change in ownership
Purchase of reserves in place
Sale of reserves in place
Extensions and discoveries
Production
End of period
Proved developed reserves:
Crude Oil (MBbls):
Beginning of period
End of period
Natural Gas (MMcf):
Beginning of period
End of period
MBoe:
Beginning of period
End of period
Proved undeveloped reserves:
Crude Oil (MBbls):
Beginning of period
End of period
Natural Gas (MMcf):
Beginning of period
End of period
MBoe
Beginning of period
End of period
10,075
(488)
—
38
(504)
2,636
(977)
10,780
35,118
(10,838 )
—
115
(4,404)
3,350
(3,588)
19,753
5,069
4,955
11,605
10,680
7,003
6,735
5,006
5,825
23,513
9,073
8,925
7,337
8,149
(110)
—
—
(30 )
3,062
(996)
10,075
32,957
486
—
—
(308)
7,064
(5,081)
35,118
4,503
5,069
12,715
11,605
6,622
7,003
3,645
5,006
20,241
23,513
7,019
8,925
6,479
423
—
—
—
2,106
(859)
8,149
19,103
354
—
—
—
18,392
(4,892)
32,957
4,346
4,503
12,301
12,715
6,396
6,622
2,133
3,645
6,802
20,241
3,267
7,019
Total Proved Reserves: The Company ended 2012 with estimated net proved reserves of 14,072 MBoe, representing a 12% decrease over
2011 year-end estimated net proved reserves of 15,928 MBoe. The decrease is primarily due to the sale of the Company's interest in the
Habanero field and the downward revision of our Haynesville Shale undeveloped reserves at year-end 2012, which were reduced due to
low natural gas prices. These decreases were partially offset by the Company’s development of a portion of its Permian basin, on which it
drilled a total of 27 oil wells during 2012.
Extrapolation of performance history and material balance estimates were utilized by the Company's independent petroleum and geological
firm to project future recoverable reserves for the producing properties where sufficient history existed to suggest performance trends and
where these methods were applicable to the subject reservoirs. The projections for the remaining producing
78
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except share, per-share and per-hedge data)
Table of Contents
properties were necessarily based on volumetric calculations and/or analogy to nearby producing completions. Reserves assigned to
nonproducing zones and undeveloped locations were projected on the basis of volumetric calculations and analogy to nearby production.
Proved Undeveloped Reserves: The Company annually reviews its proved undeveloped reserves (“PUDs”) to ensure an appropriate plan
for development exists. Generally, reserves for the Company’s onshore properties are booked as PUDs only if the Company has plans to
convert the PUDs into proved developed reserves within five years of the date they are first booked as PUDs. The Company's PUDs
decreased 18% to 7,337 MBoe from 8,925 MBoe at December 31, 2012 and 2011, respectively. Additions during the year added 2,344
MBoe to the Company's PUDs, offset by (1) 557 MBoe primarily comprised of transfers to PDPs as a result of our development program,
(2) 1,148 MBoe related to the sale of Habanero, and (3) 2,227 MBoe related to reductions in our PUD reserves, primarily related to the
Haynesville Shale, by amounts no longer deemed to be economic PUDs at year-end. Of the Company's year-end 2011 PUD reserves, 6%
were converted to proved developed producing reserves by year end 2012, at a total cost of approximately $19 million, net.
Of the Company's 2012 PUDs, 1,297 MBoe are attributable to the Company’s offshore properties in the Medusa fields in the Gulf of
Mexico. The Company's deepwater PUDs have been classified as PUDs for more than five years, though we expect to develop these PUDs
within the next two years. Callon's decision to classify these reserves as PUDs was primarily based on (1) its ongoing development
activities in the area, (2) its historical record of completing development of comparable long-term projects, (3) the amount of time which
Callon have maintained the leases or booked reserves without significant development activities and (4) the extent to which Callon have
followed previously adopted development plans. Callon's discussions with the field's operator have resulted in the modification of certain
development plans for Medusa to drill or sidetrack PUDs within a shorter period of time than originally estimated. The Company expects to
develop its Medusa PUDs by drilling a new well by the first quarter of 2014. The Company did not convert any offshore, deepwater PUDs
to proved developed in 2012.
Standardized Measure
The following tables present the standardized measure of future net cash flows related to estimated proved oil and natural gas reserves
together with changes therein, including a reduction for estimated plugging and abandonment costs that are also reflected as a liability on
the balance sheet at December 31, 2012. You should not assume that the future net cash flows or the discounted future net cash flows,
referred to in the tables below, represent the fair value of our estimated oil and natural gas reserves. Prices based on either the preceding 12-
months’ average price based on closing prices on the first day of each month, or prices defined by existing contractual arrangements. The
following table summarizes the average 12-month oil and natural gas prices net of differentials for the respective periods:
Average 12-month price, net of differentials, per Mcf of natural gas
Average 12-month price, net of differentials, per barrel of crude oil
2012
2011
2010
$
4.81 $
94.68
5.60 $
98.98
5.10
78.07
Future production and development costs are based on current costs with no escalations. Estimated future cash flows net of future income
taxes have been discounted to their present values based on a 10% annual discount rate.
Natural gas production from our deepwater and Permian basin properties has a high BTU content of separator natural gas. The natural gas
Mcf prices of $4.81 and $5.60 used in the 2012 and 2011 reserve estimates include adjustments to reflect the Btu content, transportation
charges and other fees specific to the individual properties. The projected oil prices of $94.68 and $98.98 used in the 2012 and 2011
reserve estimates have been adjusted to reflect all wellhead deductions and premiums on a property-by-property basis, including
transportation costs, location differentials and crude quality.
79
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except share, per-share and per-hedge data)
Table of Contents
Future cash inflows
Future costs -
Production
Development and net abandonment
Future net inflows before income taxes
Future income taxes
Future net cash flows
10% discount factor
Standardized measure of discounted future net cash flows
Standardized measure at the beginning of the period
Sales and transfers, net of production costs
Net change in sales and transfer prices, net of production costs
Net change due to purchases and sales of in place reserves
Extensions, discoveries, and improved recovery, net of future production and
development costs incurred
Changes in future development cost
Revisions of quantity estimates
Accretion of discount
Net change in income taxes
Changes in production rates, timing and other
Aggregate change
Standardized measure at the end of period
NOTE 15 – Other
Standardized Measure
For the year ended December 31,
2011
2012
$
1,115,570 $ 1,194,079 $
2010
804,111
(249,329)
(273,817)
592,424
(55,772)
536,652
(305,504)
231,148 $
(356,653)
(268,628)
568,798
(78,813)
489,985
(219,628)
270,357 $
(277,793)
(146,870)
379,448
(24,719)
354,729
(155,813)
198,916
Changes in Standardized Measure
For the year ended December 31,
2011
2012
198,916 $
270,357 $
(107,297)
(84,044)
125,518
47,261
1,275
(35,665)
2010
135,921
(72,171)
126,571
621
53,446
39,815
(77,322)
30,989
13,969
(27,658)
(39,209)
231,148 $
22,598
(83,110)
(949)
68,384
(32,918)
77,940
71,441
270,357 $
23,739
(68,960)
23,295
10,597
(5,170)
24,473
62,995
198,916
$
$
$
Commitments and Contingencies: The Company is involved in various claims and lawsuits incidental to its business. In the opinion of
management, the ultimate liability hereunder, if any, will not have a material adverse effect on the financial position or results of operations
of the Company.
The Company’s activities are subject to federal, state and local laws and regulations governing environmental quality and pollution
control. Although no assurances can be made, the Company believes that, absent the occurrence of an extraordinary event, compliance
with existing federal, state and local laws, rules and regulations governing the release of materials into the environment or otherwise
relating to the protection of the environment are not expected to have a material effect upon the capital expenditures, earnings or the
competitive position of the Company with respect to its existing assets and operations. The Company cannot predict what effect additional
regulation or legislation, enforcement polices hereunder, and claims for damages to property, employees, other persons and the
environment resulting from the Company’s operations could have on its activities.
Operating Leases: In February 2012, we contracted a drilling rig for a term of two years to support our horizontal drilling program in the
Permian basin. The drilling rig was delivered in April 2012, and lease costs recorded during 2012 was $6,609. Lease payments will
approximate $9,235 in 2013 and $2,277 in 2014. The agreement includes early termination provisions that would reduce the minimum
rentals under the agreement, assuming the lessor is unable to re-charter the rig and staffing personnel to another lessee, to $5,784 in 2013
and $1,350 in 2014. Should the lessor be able to re-charter the rig, these minimum rentals would be further reduced by the re-chartered
lease payments.
80
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except share, per-share and per-hedge data)
Table of Contents
NOTE 16 – Summarized Quarterly Financial Information (unaudited)
2012
Total revenues
Income from operations
Net income (loss)
Net income (loss) per common share - basic
Net income (loss) per common share - diluted
2011
Total revenues
Income from operations
Net income (loss)
Net income (loss) per common share - basic
Net income (loss) per common share - diluted
First Quarter
$
29,294 $
2,716
488
0.01
0.01
Second
Quarter
Third
Quarter
Fourth
Quarter
25,360 $
2,759
3,799
0.10
0.09
27,402 $
2,563
(1,105)
(0.03)
(0.03)
28,677
2,652
(435)
(0.01)
(0.01)
First Quarter
$
25,449 $
5,789
4,164
0.12
0.12
Second
Quarter
Third
Quarter
Fourth
Quarter
36,834 $
14,201
19,877
0.51
0.50
33,550 $
10,524
8,406
0.21
0.21
31,811
9,108
73,949
1.88
1.85
The amounts reported in the table for 2011 have been amended to adjust for the matter discussed in Note 1.
ITEM 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure
There have been no disagreements with the independent auditors on any matters of accounting principles or practices, financial statement
disclosure, or auditing scope or procedures.
ITEM 9A. Controls and Procedures
Disclosure Controls and Procedures. Disclosure controls and procedures include, without limitation, controls and procedures designed to
ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Securities Exchange Act of
1934, as amended (the “Exchange Act”), is accumulated and communicated to the issuer's management, including its principal executive
and financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. The
Company's principal executive and principal financial officers have concluded that the Company's disclosure controls and procedures (as
defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) were effective as of December 31, 2012.
Management’s Report on Internal Control over Financial Reporting . Management is responsible for establishing and maintaining
adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Our internal
control structure is designed to provide reasonable assurance to our management and Board of Directors regarding the reliability of
financial reporting and the preparation and fair presentation of our financial statements prepared for external purposes in accordance with
U.S. generally accepted accounting principles. Under the supervision and with the participation of our management, including our CEO and
CFO, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2012 based on the
framework in Internal Control – Integrated Framework published by the Committee of Sponsoring Organizations (COSO) of the
Treadway Commission. Based on that evaluation, management concluded that our internal control over financial reporting was effective as
of December 31, 2012.
Because of its inherent limitations, internal control over financial reporting can provide only reasonable assurance that the objectives of the
control system are met and may not prevent or detect misstatements. In addition, any evaluation of the effectiveness of internal controls
over financial reporting in future periods is subject to risk that those internal controls may become inadequate because of changes in
conditions, or that the degree of compliance with the policies or procedures may deteriorate.
The Company's independent registered public accounting firm has issued an attestation report regarding its assessment of the Company's
internal control over financial reporting as of December 31, 2012, which follows Part II, Item 9B of this filing. Additionally, the financial
statements for each of the years covered in this Annual Report on Form 10-K have been audited by an independent registered public
accounting firm, Ernst & Young LLP whose report is presented immediately preceding the Company's financial statements included in Part
II, Item 8 of this Annual Report on Form 10-K.
81
Changes in Internal Control over Financial Reporting. There were no changes to our internal control over financial reporting during our
last fiscal quarter that have materially affected, or are reasonable likely to materially affect, our internal control over financial reporting.
Table of Contents
ITEM 9A (T). Controls and Procedures
See Item 9A.
ITEM 9B. Other Information
Submissions of Matters to a Vote of the Security Holders
None.
82
Report of Independent Registered Public Accounting Firm
Table of Contents
The Board of Directors and Stockholders of
Callon Petroleum Company
We have audited Callon Petroleum Company's internal control over financial reporting as of December 31, 2012 based on criteria
established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission
(the COSO criteria). Callon Petroleum Company's management is responsible for maintaining effective internal control over financial
reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying
Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal
control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial
reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting,
assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on
the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit
provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting
principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide
reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of
management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of
any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in
conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Callon Petroleum Company maintained, in all material respects, effective internal control over financial reporting as of
December 31, 2012, based on the COSO criteria.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the
consolidated balance sheets of Callon Petroleum Company as of December 31, 2012 and 2011, and the related statements of operations,
comprehensive income, cash flow, and changes in stockholders' equity (deficit) for each of the three years in the period ended December
31, 2012, and our report dated March 14, 2013 expressed an unqualified opinion thereon.
/s/Ernst & Young LLP
New Orleans, Louisiana
March 14, 2013
83
Table of Contents
ITEM 10. Directors, Executive Officers and Corporate Governance
PART III.
For information concerning Item 10, see the definitive proxy statement of Callon Petroleum Company relating to the Annual Meeting of
Stockholders to be held on May 16, 2013 which will be filed with the Securities and Exchange Commission and is incorporated herein by
reference.
The Company has adopted a code of ethics that applies to the Company’s chief executive officer, chief financial officer and chief
accounting officer. The full text of such code of ethics has been posted on the Company’s website at www.callon.com, and is available
free of charge in print to any shareholder who requests it. Request for copies should be addressed to the Secretary at 200 North Canal
Street, Natchez, Mississippi 39120.
ITEM 11. Executive Compensation
For information concerning Item 11, see the definitive proxy statement of Callon Petroleum Company relating to the Annual Meeting of
Stockholders to be held on May 16, 2013 which will be filed with the Securities and Exchange Commission and is incorporated herein by
reference.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
For information concerning the security ownership of certain beneficial owners and management, see the definitive proxy statement of
Callon Petroleum Company relating to the Annual Meeting of Stockholders to be held on May 16, 2013 which will be filed with the
Securities and Exchange Commission and is incorporated herein by reference.
ITEM 13. Certain Relationships and Related Transactions and Director Independence
For information concerning Item 13, see the definitive proxy statement of Callon Petroleum Company relating to the Annual Meeting of
Stockholders to be held on May 16, 2013 which will be filed with the Securities and Exchange Commission and is incorporated herein by
reference.
ITEM 14. Principal Accountant Fees and Services
For information concerning Item 14, see the definitive proxy statement of Callon Petroleum Company relating to the Annual Meeting of
Stockholders to be held on May 16, 2013 which will be filed with the Securities and Exchange Commission and is incorporated herein by
reference.
84
ITEM 15. Exhibits
Exhibit
1
2
3
Exhibits
2
3
4
9
10
3.1
3.2
3.3
3.4
4.1
4.2
4.3
10.1
10.2
10.3
PART IV.
Table of Contents
Description
The following is an index to the financial statements and financial statement schedules that are filed as part
of this Form 10-K on pages 51 through 80.
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2012 and 2011
Consolidated Statements of Operations for each of the three years in the period ended December 31,
2012
Consolidated Statements of Stockholders' Equity (Deficit) for each of the three years in the Period Ended
December 31, 2012
Consolidated Statements of Cash Flows for each of the three years in the period ended December 31,
2012
Notes to Consolidated Financial Statements
Schedules other than those listed above are omitted because they are not required, not applicable or the
required information is included in the financial statements or notes thereto.
Plan of acquisition, reorganization, arrangement, liquidation or succession*
Articles of Incorporation and Bylaws
Certificate of Incorporation of the Company, as amended (incorporated by reference to Exhibit 3.1 of
the Company’s Annual Report on Form 10-K for the year ended December 31, 2003, File No. 001-
14039)
Bylaws of the Company (incorporated by reference from Exhibit 3.2 of the Company's Registration
Statement on Form S-4, filed August 4, 1994, Reg. No. 33-82408)
Certificate of Amendment to Certificate of Incorporation of the Company (incorporated by reference
to Exhibit 3.3 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2003,
File No. 001-14039)
Certificate of Amendment to the Certificate of Incorporation of the Company
(incorporated by reference to Exhibit 3.4 of the Company's Annual Report on Form 10-K for the year
ended December 31, 2010, File No. 001-14039)
Instruments defining the rights of security holders, including indentures
Specimen Common Stock Certificate (incorporated by reference from Exhibit 4.1 of the Company's
Registration Statement on Form S-4, filed August 4, 1994, Reg. No. 33-82408)
Rights Agreement between Callon Petroleum Company and American Stock Transfer & Trust
Company, Rights Agent, dated March 30, 2000 (incorporated by reference from Exhibit 99.1 of the
Company’s Registration Statement on Form 8-A, filed April 6, 2000, File No. 001-14039)
Indenture for the Company’s 13.00% Senior Notes due 2016, dated November 24, 2009, between
Callon Petroleum Company, the subsidiary guarantors described therein, Regions Bank and American
Stock Transfer & Trust Company (incorporated by reference to Exhibit T3C to the Company’s Form
T3, filed November 19, 2009, File No. 022-28916)
Voting trust agreement
None
Material contracts
Callon Petroleum Company 1994 Stock Incentive Plan (incorporated by reference from Exhibit 10.5
of the Company's Registration Statement on Form 8-B, filed October 3, 1994)
Callon Petroleum Company 1996 Stock Incentive Plan as amended on May 9, 2000 (incorporated by
reference from Appendix I of the Company’s Definitive Proxy Statement on Schedule 14A, filed
March 28, 2000, File No. 001-14039)
Callon Petroleum Company 2002 Stock Incentive Plan (incorporated by reference to Exhibit 10.13 of
the Company’s Annual Report on Form 10-K for the year ended December 31, 2001, File No. 001-
14039)
85
10.4
10.5
10.6
10.7
10.8
10.9
10.10
10.11
10.12
10.13
10.14
10.15
10.16
10.17
10.18
10.19
10.20
10.21
10.22
10.23
11
Table of Contents
Medusa Spar Agreement dated as of August 8, 2003, among Callon Petroleum Operating Company,
Murphy Exploration & Production Company-USA and Oceaneering International, Inc. (incorporated
by reference to Exhibit 10.19 of the Company’s Annual Report on Form 10-K for the year ended
December 31, 2003, File No. 001-14039)
Amendment No. 3 to the Callon Petroleum Company 1996 Stock Incentive Plan (incorporated by
reference from Exhibit 10.1 of the Company’s Current Report on Form 8-K, filed January 5, 2009, File
No. 001-14039)
Amendment No. 1 to the Callon Petroleum Company 2002 Stock Incentive Plan (incorporated by
reference from Exhibit 10.2 of the Company’s Current Report on Form 8-K, filed January 5, 2009, File
No. 001-14039)
Callon Petroleum Company Amended and Restated 2006 Stock Incentive Plan (incorporated by
reference from Exhibit 10.3 of the Company’s Current Report on Form 8-K, filed January 5, 2009, File
No. 001-14039)
Callon Petroleum Company 2009 Stock Incentive Plan effective as of April 30, 2009 (incorporated by
reference from Exhibit A to the Company’s Definitive Proxy Statement on Schedule 14A, filed March
30, 2009, File No. 001-14039)
Amendment to the Callon Petroleum Company 1996 Stock Incentive Plan effective as of August 7,
2009 (incorporated by reference from Exhibit 10.1 of the Company’s Quarterly Report on Form 10-Q
for the period ended September 30, 2009, File No. 001-14039)
Callon Petroleum Company 2010 Phantom Share Plan, adopted May 4, 2010 (incorporated by
reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed on May 7, 2010)
Form of Callon Petroleum Company Phantom Share Award Agreement, adopted May 4, 2010
(incorporated by reference to Exhibit 10.2 of the Company’s current Report on Form 8-K filed on May
7 , 2010)
Deferred Compensation Plan for Outside Directors; Callon Petroleum Company (effective as of January
1, 2011) (incorporated by reference to Exhibit 10.17 of the Company's Annual Report on Form 10-K for
the year ended December 31, 2010, File No. 001-14039)
Amended and Restated Severance Compensation Agreement, dated as of March 15, 2011 and effective
as of January 1, 2011, by and between Fred L. Callon and Callon Petroleum Company (incorporated by
reference to Exhibit 10.1 of the Company's Current Report on Form 8-K filed on March 18, 2011)
Form of Amended and Restated Severance Compensation Agreement, dated as of March 15, 2011 and
effective as of January 1, 2011, by and between Callon Petroleum Company and its executive officers
(incorporated by reference to Exhibit 10.2 of the Company's Current Report on Form 8-K filed on
March 18, 2011)
Severance Compensation Agreement, dated as of September 21, 2011, by and between Gary A.
Newberry and Callon Petroleum Company (incorporated by reference to Exhibit 10.1 of the Company's
Current Report on Form 8-K filed on September 21, 2011)
Severance Compensation Agreement, dated as of September 21, 2011, by and between Vince Borrello
and Callon Petroleum Company
Fourth Amended and Restated Credit Agreement dated as of June 20, 2012, by and among the
Company, the "Lenders" described therein, and Regions Bank as the sole arranger and administrative
agent (incorporated by reference from Exhibit 10.1 on Form 8-K, filed June 25, 2012, File No. 001-
14039)
Fourth Amended and Restated Revolving Promissory Note dated June 20, 2012 (incorporated by
reference from Exhibit 10.1 on Form 8-K, filed June 25, 2012, File No. 001-14039)
Fourth Amended and Restated Guaranty Agreement dated June 20, 2012 (incorporated by reference
from Exhibit 10.1 on Form 8-K, filed June 25, 2012, File No. 001-14039)
Master Assignment, Agreement and Amendment No. 1 to the Fourth Amended and Restated Credit
Agreement (incorporated by reference from Exhibit 10.1 on Form 8-K, filed October 16, 2012, File No.
001-14039)
Purchase and Sale Agreement by and between Shell Offshore Inc. and Callon Petroleum Operating
Company dated as of November 27, 2012.
Resignation/Retirement Agreement and Release between Stephen Woodcock and Callon Petroleum
Company dated September 7, 2012 (incorporated by reference from Exhibit 10.1 on Form 8-K, filed
September 12, 2012, File No. 14039)
Callon Petroleum Company 2011 Omnibus Incentive Plan (incorporated by reference from Exhibit A of
the Company's Definitive Proxy Statement on Schedule 14A filed March 21, 2011, File No. 14039)
Statement re computation of per share earnings*
86
Statements re computation of ratios*
Annual Report to security holders, Form 10-Q or quarterly reports*
Code of Ethics
14.1
Code of Ethics for Chief Executive Officers and Senior Financial Officers (incorporated by reference
to Exhibit 14.1 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2003,
File No. 001-14039)
Table of Contents
Letter re change in certifying accountant*
Letter re change in accounting principles*
Subsidiaries of the Company
21.1
Subsidiaries of the Company
23.1
23.2
31.1
31.2
Published report regarding matters submitted to vote of security holders*
Consents of experts and counsel
Consent of Ernst & Young LLP
Consent of Huddleston & Co., Inc.
Power of attorney*
Rule 13a-14(a) Certifications
Certification of Chief Executive Officer pursuant to Rule 13(a)-14(a)
Certification of Chief Financial Officer pursuant to Rule 13(a)-14(a)
Section 1350 Certifications of Chief Executive and Financial Officers pursuant to
Rule 13(a)-14(b)
Additional Exhibits
12
13
14
16
18
21
22
23
24
31
32
99
99.1
Reserve Report Summary prepared by Huddleston and Co. as of December 31, 2012.
101
Interactive Data Files **
*
**
Not applicable to this filing
Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a
registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or
Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability.
87
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.
SIGNATURES
Table of Contents
Date:
March 14, 2013
Date:
March 14, 2013
Date:
March 14, 2013
Date:
March 14, 2013
Date:
March 14, 2013
/s/ Fred L. Callon
Fred L. Callon (principal executive officer, director)
/s/ B. F. Weatherly
B. F. Weatherly (principal financial officer, director)
/s/ Rodger W. Smith
Rodger W. Smith (principal accounting officer)
/s/ L. Richard Flury
L. Richard Flury (director)
/s/ John C. Wallace
John C. Wallace (director)
Date:
March 14, 2013
/s/ Anthony J. Nocchiero
Anthony J. Nocchiero (director)
Date:
March 14, 2013
/s/ Larry D. McVay
Larry McVay (director)
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.
Date:
March 14, 2013
/s/ B. F. Weatherly
B. F. Weatherly, Executive Vice President and
Chief Financial Officer (Principal Financial Officer)
88
Exhibit 21.1
Subsidiaries of Callon Petroleum Company
Name
State of Incorporation
Callon Offshore Production, Inc.
Callon Petroleum Operating Company
Mississippi Marketing, Inc.
Mississippi
Delaware
Mississippi
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Exhibit 23.1
We consent to the incorporation by reference in the following Registration Statements:
Registration Statement (Form S-8 No. 33-90410) of Callon Petroleum Company;
Registration Statement (Form S-8 No. 333-100646) of Callon Petroleum Company;
Registration Statement (Form S-8 No. 333-47784) of Callon Petroleum Company;
Registration Statement (Form S-8 No. 333-29537) of Callon Petroleum Company;
Registration Statement (Form S-8 No. 333-29529) of Callon Petroleum Company;
Registration Statement (Form S-8 No. 333-109744) of Callon Petroleum Company;
Registration Statement (Form S-8 No. 333-135703) of Callon Petroleum Company;
Registration Statement (Form S-8 No. 333-160223) of Callon Petroleum Company;
Registration Statement (Form S-8 No. 333-176061) of Callon Petroleum Company;
Registration Statement (Form S-3 No. 333-176811) of Callon Petroleum Company;
of our reports dated March 14, 2013, with respect to the consolidated financial statements of Callon Petroleum Company and the
effectiveness of internal control over financial reporting of Callon Petroleum Company, included in this Annual Report (Form 10-
K) of Callon Petroleum Company for the year ended December 31, 2012.
/s/Ernst & Young LLP
New Orleans, Louisiana
March 14, 2013
EXHIBIT 23.2
Huddleston & Co., Inc.
Petroleum and Geological Engineers
1 Houston Center
1221 McKinney, Suite 3700
Houston, Texas 77010
PHONE (713) 209-1100 FAX (713) 752-0828
CONSENT OF HUDDLESTON & CO., INC.
As independent oil and gas consultants, we hereby consent to the references to us and our reserve reports for the years ended December 31,
2012, 2011, and 2010 in Callon's Annual Report on Form 10-K for the year ended December 31, 2012 and the incorporation by reference
of our reports in the following Registration Statements:
Registration Statement (Form S-8 No. 33-90410) of Callon Petroleum Company;
Registration Statement (Form S-8 No. 333-100646) of Callon Petroleum Company;
Registration Statement (Form S-8 No. 333-47784) of Callon Petroleum Company;
Registration Statement (Form S-8 No. 333-29537) of Callon Petroleum Company;
Registration Statement (Form S-8 No. 333-29529) of Callon Petroleum Company;
Registration Statement (Form S-8 No. 333-109744) of Callon Petroleum Company;
Registration Statement (Form S-8 No. 333-135703) of Callon Petroleum Company;
Registration Statement (Form S-8 No. 333-160223) of Callon Petroleum Company;
Registration Statement (Form S-8 No. 333-176061) of Callon Petroleum Company;
Registration Statement (Form S-3 No. 333-176811) of Callon Petroleum Company.
HUDDLESTON & CO., INC.
Texas Registered Engineering Firm F-1024
/s/Peter D. Huddleston
Peter D. Huddleston, P.E.
President
Houston, Texas
March 14, 2013
Exhibit 31.1
I, Fred L. Callon, certify that:
CERTIFICATIONS
1.
2.
I have reviewed this Annual Report on Form 10-K of Callon Petroleum Company;
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect
to the period covered by this report;
3.
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all
material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this
report;
4.
The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in
Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed
under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during the period in which this report is being prepared;
(b)
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be
designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted accounting principles;
(c)
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on
such evaluation; and
(d)
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the
registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or
is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.
The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over
financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the
equivalent function):
(a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information;
and
(b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the
registrant’s internal controls over financial reporting;
Date:
March 14, 2013
/s/ Fred L. Callon
Fred L. Callon, President and Chief Executive Officer
(Principal executive officer)
Exhibit 31.2
CERTIFICATIONS
I, B. F. Weatherly, certify that:
1.
I have reviewed this Annual Report on Form 10-K of Callon Petroleum
Company;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with
respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all
material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented
in this report;
4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures
(as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange
Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a.
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed
under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during the period in which this report is being prepared;
b.
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be
designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted accounting principles;
c.
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on
such evaluation; and
d.
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the
registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or
is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over
financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing
the equivalent function):
a.
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information;
and
b.
Any fraud, whether or not material, that involves management or other employees who have a significant role in the
registrant’s internal controls over financial reporting;
Date:
March 14, 2013
/s/ B. F. Weatherly
B. F. Weatherly, Executive Vice President and
Chief Financial Officer (Principal Financial Officer)
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
EXHIBIT 32
In connection with the Annual Report on Form 10-K of Callon Petroleum Company. (the “Company”) for the year ended December 31,
2012 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), the undersigned, in the capacities and on the
dates indicated below, each hereby certify pursuant to 18 U.S.C. section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002, that the Report fully complies with requirements of Section 13(a) of 15(d) of the Securities Exchange Act of 1934 and the
information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the
Company.
Date:
March 14, 2013
Date:
March 14, 2013
/s/ Fred L. Callon
Fred L. Callon (principal executive officer, director)
/s/ B. F. Weatherly
B. F. Weatherly (principal financial officer, director)
The foregoing certification is being furnished as an exhibit to the Report pursuant to Item 601(b)(32) of Regulation S-K and Section 906 of
the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United States Code) and, accordingly, is
not being filed as part of the Report for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and is not incorporated
by reference into any filing of the Company, whether made before or after the date hereof, regardless of any general incorporation
language in such filing.
Exhibit 99.1
Huddleston & Co., Inc.
Petroleum and Geological Engineers
1 Houston Center
1221 McKinney, Suite 3700
Houston, Texas 77010
PHONE (713) 209-1100 FAX (713) 752-0828
Huddleston & Co., Inc.
Huddleston & Co., Inc.
Petroleum and Geological Engineers
1 Houston Center
1221 McKinney, Suite 3700
Houston, Texas 77010
PHONE (713) 209-1100 FAX (713) 752-0828
February 4, 2013
Re: Callon Petroleum Company
Estimated Future Reserves and Revenues
As of December 31, 2012
Callon Petroleum Company
February 4, 2013
Page Seven
Callon Petroleum Company
200 North Canal Street
Natchez, Mississippi 39120
Gentlemen:
Pursuant to your request, we have estimated oil, condensate, and natural gas reserves and projected revenues for all
properties owned by Callon Petroleum Company. It is our understanding that the Proved reserves estimates shown herein
constitute all of the Proved reserves owned by Callon. The properties are located in Louisiana, Texas, and in the federal
waters of the Gulf of Mexico.
Our conclusions, as of December 31, 2012, follow:
Constant Product Prices
Estimated Future Net Oil/Cond., Mbbl
Estimated Future Net (Sales) Gas, MMcf
Estimated Future Gross Revenue, $M
Estimated Future Operating Expenses, $M
Estimated Future Production Taxes, $M
Estimated Future Capital Costs, $M
Estimated Future Net Revenue (“FNR”), $M
Estimated FNR Discounted at 10%, $M
Projected Revenues by Year - Constant Product Prices, $M**
2013
2014
2015
Thereafter
Total
Estimated 2013 Production
Oil/Cond., Mbbl
Gas (Sales), MMcf
Net to Callon Petroleum Company*
Proved Developed
Proved
Producing
Nonproducing Undeveloped
Total
Proved
3,768.9
8,825.5
1,186.2
1,853.8
5,824.5
9,072.6
10,779.6
19,751.9
397,451.8
100,058.7
12,253.6
10,935.8
274,203.6
167,484.7
128,535.1
29,877.0
625.5
20,484.8
77,547.9
48,602.7
589,583.2 1,115,569.9
59,137.6
189,073.4
22,818.4
35,697.4
266,954.3
298,374.9
240,672.8
592,424.3
34,009.2
250,096.5
53,390.9
35,399.4
29,608.5
155,804.8
274,203.6
(2,655.1)
10,096.5
9,148.2
60,958.3
77,547.9
(49,223.2)
(55,337.2)
(11,124.5)
356,357.7
240,672.8
1,512.5
(9,841.2)
27,632.2
573,120.8
592,424.3
672.6
2,513.3
21.2
544.0
22.2
30.6
716.0
3,087.8
*Numbers subject to rounding.
**Certain negative values are attributable to operating cost allocation for the producing and nonproducing categories.
Report Preparation
Purpose of Report - The purpose of this report is to provide the management of Callon with a projection of future reserves
and revenues for an assessment of oil and gas properties owned by Callon for inclusion in their public filings. The Proved
reserve and revenue projections shown herein have been prepared in accordance with Securities and Exchange Commission
(“SEC”) requirements for reporting purposes as described below.
Reporting Requirements - SEC Regulation S‑K, Item 102, and Regulation S‑X, Rule 4‑10, require oil and gas reserve
information to be reported by publicly held companies as supplemental financial data. These regulations were revised by the
SEC effective for filings beginning January 1, 2010. The revised regulations provide for certain changes in Proved reserve
definitions, add definitions for Probable and Possible reserves, and require that revenues associated with Proved reserves be
reported on the basis of the average of the preceding 12‑month, first-of-month product prices. Revenues are to be discounted
at 10%, consistent with that required in prior years.
The Proved reserves included herein under "Constant Product Prices" have been prepared in accordance with the
methodologies specified under SEC and Financial Accounting Standards Board guidelines.
Standards of Practice - This report has been prepared in accordance with our understanding of the Standards Pertaining to
the Estimating and Auditing of Oil and Gas Reserve Information as promulgated by the Society of Petroleum Engineers and the
Guidelines for Application of the Definitions for Oil and Gas Reserves prepared by the Society of Petroleum Evaluation
Engineers. However, the projected reserves have been prepared with consideration for reserve
classification definitions specified by the SEC that do not necessarily conform to definitions promulgated by the Society of
Petroleum Engineers and the World Petroleum Congress.
Economic Limits - In some cases the projections have been prepared with consideration for overall field production, resulting
in negative cash flow projections for certain properties. In our opinion, the projections shown herein properly reflect the
expected operations. The projections include consideration for abandonment costs, resulting in negative future revenues and
discounted revenues.
Cash Flow Projections - The cash flow projections were run on the aries computer program utilizing Callon's computer
facilities. However, Huddleston & Co., Inc., supplied all of the input parameters for the reserve projections.
Cash Flow Presentation - The gross and net reserve volume columns in the cash flow projections have been separated into
three different columns: oil (Mbbl), produced gas (MMcf), and sales gas (MMcf). Product prices, net revenues before taxes,
and severance taxes are shown separately for each product.
Reserve Estimates
Extrapolation of performance history and material balance estimates were utilized for projecting future recoverable reserves for
the producing properties where sufficient history was available to suggest performance trends and where these methods were
applicable to the subject reservoirs. The projections for the remaining producing properties were necessarily based on
volumetric calculations and/or analogy to nearby producing completions. Reserves assigned to nonproducing zones and
undeveloped locations were projected on the basis of volumetric calculations and analogy to nearby production.
Approximately 67% of the future net revenues discounted at 10% are included in the Proved Developed Producing category.
The remaining 33% of discounted net revenues are included in the Nonproducing and Undeveloped classifications. However,
only 37.2% of estimated future reserves (on an equivalent barrel basis) were included in the Producing category. Reserve
estimates for those properties in the Nonproducing and Undeveloped categories will be subject to a significantly greater level
of variation than estimates for producing properties exhibiting established decline trends.
We have utilized certain geologic and engineering data furnished by Callon. However, in all cases we have exercised the final
judgments for the estimated reserves and future schedules of production.
In our opinion the assumptions, data, methodologies and analytical procedures used in this report are appropriate for SEC
reporting purposes. We have used the methods and procedures that we consider necessary and appropriate to prepare the
estimates of reserves herein.
Gas Volumes - Gas volumes are reported at the prevailing pressure base of the state in which the reserves are located and at
60 degrees Fahrenheit. The projections reflect gas streams for production gas and sales gas. The difference between the two
is intended to reflect fuel and lease usage.
Property Descriptions
Mississippi Canyon 538/582 - The Medusa Prospect, drilled by Murphy on Mississippi Canyon Blocks 538 and 582 during
1999 and more fully delineated as a result of drilling conducted in 2000 and 2001, successfully tested a number of horizons in
two separate fault blocks. Drilling operations conducted during 2002 resulted in certain minor revisions in geological
interpretations and reserves were adjusted to reflect a revised study of geological and petrophysical characteristics. Reserve
estimates for a total of 17 reservoirs, representing 11 horizons, have been based on volumetric calculations utilizing 3‑D
seismic data and subsurface control for mapping, as well as petrophysical calculations derived from well logs and sidewall
cores.
Production operations for this property were initiated in November 2003 and there were 8 wellbores producing at the time of
report preparation. The estimated reserves for those reservoirs completed in the existing wells have been revised from our
original projections to reflect the performance of the wells to date. In some cases Nonproducing and Undeveloped reserve
assignments have been adjusted to conform with the performance of the existing completions. On an overall basis the
estimated ultimate oil reserves have been increased 2.0% and gas reserves have been decreased 2.1% in comparison to our
previous report. The Medusa Prospect represents 32.9% and 10.5% of the remaining oil and gas reserves, respectively, net to
Callon.
Undeveloped reserves have been projected for a new wellbore (No. 6, previously No. 7) to be drilled in 2014 with production to
be initiated January 1, 2015. We have been informed that the scheduling of development operations is the result of facilities
limitations and cost considerations and other factors associated with overall platform operations.
Garden Banks 341 - We have been informed that the Habanero Prospect was divested by Callon during 2012; therefore this
property is no longer included in the Callon reserve report. This property previously represented 6.0% of the estimated Proved
net oil and 13.0% of the Proved net gas reserves for Callon as shown in the December 31, 2011 reserve report.
Wolfberry Properties - In 2009 Callon acquired ownership in four West Texas fields: Block 5, Carpe Diem, East Bloxom, and
Kayleigh, located in Crockett, Midland, Upton, and Ector Counties, respectively. The subject properties are located within the
Wolfberry trend. During 2011, the Pecan Acres Tract was acquired and in 2012 the Taylor Draw property was acquired. On an
overall basis the properties include 92 producing wells, 10 nonproducing wells and recompletions, and 89 undeveloped
locations.
Reserve assignments for the producing completions were assigned on the basis of the extrapolation of performance data.
Analogy was considered in determining hyperbolic exponents for the estimation of future reserves for those completions that
did not have sufficient production history to definitively project the proper decline profile. Reserves for the undeveloped
locations were projected on the basis of analogy to existing completions. In all cases, the undeveloped locations are direct
offsets to existing completions.
At year end 2012, ten undeveloped locations shown in previous reports have been excluded as a result of offset performance
and declining product prices (based on SEC parameters). In addition a number of locations are shown which have positive
future net revenue, but negative revenue discounted at 10%. Callon has informed us that it intends to drill the subject locations
and that they have re-bid drilling and completion costs which are expected to significantly reduce total development costs.
Since the cost reductions were not actually realized during 2012, the projections reflect historical costs and expenditures.
In aggregate, these properties represent 46.6% and 53.6% of oil and gas reserves, respectively, net to Callon. Approximately
60% of the estimated reserves, on an equivalent barrel basis, are in the Undeveloped category. Development operations
conducted by Callon during 2012 resulted in 15 wells being drilled (14 producing and 1 awaiting completion).
Wolfcamp Horizontal Properties - During 2012, Callon drilled 2 horizontal wells with lateral lengths of approximately 7000' in
East Bloxum Field, Upton County, Texas to test the Wolfcamp section. We have assigned reserves for these completions and
6 undeveloped locations on the basis of preliminary performance data and an existing well offset to the Callon properties. The
reserves attributable to these wells are separate and apart from the conventional completions in East Bloxum Field. The
estimated reserves for these properties represent 20.2% and 18.9% of oil and gas reserves, respectively, net to Callon.
Swan Lake - During 2010 Callon drilled the Mills No. 1, a Haynesville completion located in Bossier Parish, Louisiana, which
had produced approximately 2.67 Bcf by year end 2012. All 3 associated development wells have been removed from this
year's report since they are no longer economic with consideration for the product prices utilized herein. We will re-consider
inclusion of such reserves if prices recover and Callon provides information indicating that the locations will actually be drilled.
Reserve assignments for the producing completion were assigned on the basis of the extrapolation of performance data.
Reserves for undeveloped locations were considered on the basis of analogy to existing completions, but excluded as a result
of current economic conditions.
In aggregate, this property represents 6.2% of gas reserves net to Callon. All of the estimated reserves are included in the
Producing category.
West Cameron Block 295 - West Cameron Block 295, discovered in 2005, is defined by two separate gas accumulations that
are productive from similar geologic intervals. However, there is some evidence that the M-1 sands in the two existing wells
have some degree of pressure communication though produced fluids vary somewhat in composition. The No. A‑1 (formerly
No. 2) wellbore encountered productive sands in the Rob M‑1 horizon (15,370' MD) and the Rob L horizon (13,100' MD). The
well was completed in the Rob M‑1 and is currently on production. A development well, designed to effectively drain the M‑1
reservoir (No. A‑2), was drilled during 2006
and encountered the target horizon. The initial completion in the Rob M-1 Lower depleted during 2007 and the well has been
recompleted to the Rob M-1.
Reserve estimates for the property were increased to reflect the performance of the existing completions. Ultimate gross
recovery for the field is estimated to be approximately 43.7 Bcf. The property represents 4.8% of remaining gas reserves net to
Callon.
Product Prices
As we understand the SEC requirements issued on January 14, 2009, oil and gas prices utilized to determine the Standardized
Measure of discounted cash flows should be based on the trailing twelve-month average of the first-of-the-month prices. The
estimated revenues shown herein reflect the actual average of first-of-the-month prices received by Callon on a property by
property basis which conform with benchmark prices of $94.74 per barrel for West Texas Intermediate, $111.03 per barrel for
Louisiana Light Sweet, and $2.76 per MMBtu. All prices were held constant over the producing life of the properties. The
projected prices for both oil and gas were based on our understanding of SEC requirements.
Gas prices have been adjusted to reflect the Btu content, transportation charges, and other fees specific to the individual
properties. Gas prices for certain properties (most notably in West Texas) include consideration for processing arrangements
and the price shown herein has been adjusted to reflect such arrangements in comparison to produced gas volumes. On an
overall basis, the wellhead gas prices utilized herein are approximately 14% lower than the values utilized as of
December 31, 2011. Market level gas prices are subject to a significant level of variation depending on location and marketing
considerations specific to the individual properties. In our opinion, it is likely that there will be a substantial degree of variation
in prices in the future. Spot prices for natural gas have experienced a large degree of volatility during recent years, which can
be attributed to seasonal demands and other market considerations.
The projected oil prices for individual properties have been adjusted to reflect all wellhead deductions and premiums on a
property by property basis, including transportation costs, location differentials, and crude quality. The weighted average
wellhead prices shown herein are approximately 4.3% lower than those utilized for our report prepared as of
December 31, 2011, which has had a material impact on estimated future revenues and in some cases has marginally
affected economically recoverable reserves. Variations in oil prices are the result of changes in market conditions and future
prices are likely to be affected by a variety of factors including OPEC actions, political and market considerations, and overall
economic conditions.
All deductions and premiums to individual oil and gas prices were held constant over the life of the properties. Variations in
future product prices may materially affect actual revenues in comparison to the projections shown herein.
Product price hedges, if any, were not considered for the purposes of this report.
A comparison of the average product prices, weighted as a composite for all Proved properties, follows:
Oil, $/bbl
Gas, $/Mcf
2013
Maximum
97.09
3.65
97.79
6.00
Average Over Life
94.68
4.81
Operating Expenses
Operating expenses, generally shown as dollars per well per month for onshore properties, were provided by Callon and
adjusted for nonrecurring costs where applicable. Operating costs for the Wolfberry properties include a component of variable
costs projected on a unit of production basis to reflect declining expenses associated with decreasing producing levels. In
some cases, particularly for the offshore properties, operating costs were projected on a total-unit or platform basis and the
projections were continued until the unit or facility reached the economic limit. Severance and ad valorem taxes were
calculated at the rates applicable to each property and have been deducted from the cash flow. Operating costs were held
constant over the economic life of the properties.
The projections exclude consideration for COPAS overhead charges for those properties operated by Callon.
Capital Costs
Capital costs necessary to perform recompletions and to drill new wells were supplied by Callon. We have generally reviewed
the projected expenditures and they are consistent with our perception of current costs necessary to perform the intended
operations. Capital costs were held constant over the life of the properties. As previously noted the capital expenditures have
been based on 2012 levels and exclude anticipated savings until such time that such savings are actually realized.
Other Considerations
Additional Costs - Costs were not deducted for depletion, depreciation, and/or amortization. Consideration has also been
excluded for federal and/or state income taxes, if any.
Abandonment costs for all properties were included in the projections where Callon has determined the total cost associated
with abandoning the wells, facilities and platforms will exceed salvage value. In some cases, funds have been escrowed to
cover anticipated future abandonment costs. The projections reflect a total of $28.955 million in abandonment costs.
Additional Potential Values - Values were not assigned to nonproducing acreage or to acreage held by production, if any.
Context - The estimated reserves and revenues shown herein should be considered on an overall basis and estimates for
individual properties should not be taken out of context with the total or overall projections.
Development - Callon has assured us of its intent and ability to proceed with the development activities included in this report
and that they are not aware of any legal, regulatory, political or economic obstacles that would significantly alter these plans.
Data Sources - Essentially all data were furnished by Callon, including production statistics, product prices, operating costs,
ownership, and basic well information. In some cases we have considered information from our files or data from publically
available sources. We have accepted the data as represented. Production statistics for the significant Callon-operated
properties and for several of the other more significant properties were available through December 2012.
We retain in our files plotted production histories for all properties and certain other information that we believe pertinent. We
have not inspected the properties evaluated in this report nor have we conducted independent well tests.
Report Qualifications
THE REVENUES AND PRESENT WORTH OF FUTURE NET REVENUES ARE NOT REPRESENTED TO BE MARKET
VALUES EITHER FOR INDIVIDUAL PROPERTIES OR ON A TOTAL PROPERTY BASIS.
Reserve estimates are inherently uncertain. The reserves shown in this report are estimates only and should not be construed
as exact quantities. Proved reserves are those quantities of oil and gas which, by analysis of engineering and geoscience data,
can be estimated with reasonable certainty to be economically producible. If the reserves are recovered, the resulting
revenues and the related costs could be more or less than the estimated amounts. As a result of governmental regulations and
policies and uncertainties in supply and demand, the sales rates, the prices received for produced reserves, the ability to
recover the reserves, and the costs incurred in recovering such reserves may vary from the assumptions made in the
preparation of this report. Estimates of reserves may increase or decrease as a result of future operations, market conditions,
and/or changes in governmental regulations or policies.
PDH:klh
Respectfully submitted,
Peter D. Huddleston, P.E.
Texas Registered Engineering Firm F-1024
PURCHASE AND SALE AGREEMENT
Exhibit 99.2
This Purchase and Sale Agreement (this “ Agreement”) is entered into as of the [27th] day of November, 2012
(the “Execution Date”), by and between Shell Offshore Inc., a corporation organized under the laws of the State of
Delaware (“Shell”), as the successor-in-interest by merger to Shell Deepwater Development Inc., and Callon Petroleum
Operating Company, a corporation organized under the laws of the State of Delaware (“Callon”). In this Agreement,
Shell and Callon are each referred to as a “Party” and collectively as the “ Parties.”
A. Callon owns an eleven and twenty-five one hundredths percent (11.25%) right, title and interest in that
certain Oil and Gas Lease (Federal Serial No. OCS-G 15879), dated effective February 1, 1996, by and between the
United States of America and Shell, covering all of Block 341, Garden Banks on the Outer Continental Shelf of the
Gulf of Mexico off the coast of Louisiana, together with a like undivided eleven and twenty-five one hundredths
percent (11.25%) interest in all wells, fixtures, flowlines, facilities and other equipment associated therewith
(collectively, the “Conveyed Interest”).
B. The Conveyed Interest is subject to that certain Joint Operating Agreement, dated effective November 1,
1998, by and among Callon, Shell, and Murphy Exploration & Production Company, a corporation organized under the
laws of the State of Delaware (“Murphy”), as amended (the “ JOA”).
C. In accordance with the terms and conditions of this Agreement, Shell desires to acquire from Callon, and
Callon desires to sell to Shell, the Conveyed Interest in exchange for the Purchase Price (as defined below) (the
“Transaction”).
D. Excluded Conveyed Interest . Notwithstanding anything to the contrary in Sections A and C herein above,
the Conveyed Interest does not include the following (collectively, the “Excluded Assets”):
i)
ii)
iii)
iv)
all trade credits and all accounts, instruments and general intangibles attributable to the
Conveyed Interest with respect to any period of time prior to the Effective Time;
all claims and causes of action of Callon (i) arising from acts, omissions or events related to, or
damage to or destruction of, the Conveyed Interest, occurring prior to the Effective Time, (ii)
arising under or with respect to any contracts that are attributable to periods of time prior to the
Effective Time (including claims for adjustments or refunds), or (iii) with respect to any of the
Excluded Assets;
all rights and interest of Callon (i) under any policy or agreement of insurance or indemnity, (ii)
under any bond, or (iii) to any insurance or condemnation proceeds or awards arising, in each
case, from acts, omissions or events related to, or damage to or destruction of, the Conveyed
Interest, occurring prior to the Effective Time;
claims of Callon for refunds of or loss carry forwards with respect to (i) production, severance or
any other taxes attributable to the Conveyed Interest for any period prior to the Effective Time,
(ii)
v)
vi)
vii)
income or franchise taxes for any period prior to the Effective Time, or (iii) any taxes attributable
to the Excluded Assets;
all amounts due or payable to Callon as adjustments to insurance premiums related to the
Conveyed Interest with respect to any period prior to the Effective Time;
any of Callon's corporate, limited liability company, partnership, corporate financial and
corporate tax records, except for any records and information related to Code sections 614 and
29 and Forms 1065 U.S. Partnership Return of Income relating to the Conveyed Interest;
any of Callon's proprietary computer software, patents, trade secrets, copyrights, names,
trademarks, logos and other intellectual property, including Callon's proprietary seismic data and
licenses related to the Conveyed Interest;
viii)
any documents and instruments of Callon relating to the Conveyed Interest that may be protected
by an attorney‑client privilege, excluding title opinions related to the Conveyed Interest;
ix)
x)
data in respect of the Conveyed Interest that cannot be disclosed or assigned to Shell without
breaching confidentiality arrangements under agreements with persons unaffiliated with Callon
after Callon has used its reasonable best efforts to procure a waiver of such prohibitions; and
audit rights arising under any contracts or otherwise with respect to any period prior to the
Effective Time or to any of the Excluded Assets.
In consideration of the above and of the mutual covenants and promises contained in this Agreement, the
Parties agree as follows:
1.
a.
b.
Term and Termination.
If Closing has not occurred, this Agreement may be terminated by either Party by giving the other
Party ten (10) days' prior written notice of such termination at any time after the one hundred and
twentieth (120th) day following the Execution Date (such one hundred and twenty day period from
and after the Execution Date is hereafter referred to as the “Subject Period”), for any reason,
including, without limitation, the failure to satisfy, or the failure to waive, the conditions precedent
to Closing (as defined herein) set forth in Section 5(b).
If this Agreement is terminated pursuant to Section 1(a), it will become void and of no further force
or effect (except for the provisions of paragraphs 10, 11, 12, 13, 14, 15, 16, 17, 18, 19 and 20);
provided, however, that such termination will not affect the liability of any Party for any breach
prior to such termination of any of the provisions of this Agreement.
2.
Preferential Purchase Right.
a. Callon's conveyance of the Conveyed Interest to Shell is subject to the preferential right to purchase
held by the parties to the JOA as set forth in Section 24.2 of the JOA (“ Preferential Purchase
Right”). Contemporaneously with the execution hereof, but no later than the Execution Date, Callon
shall send written notice to Murphy, in accordance with Section 24.2 of the JOA, notifying Murphy
of the proposed Transaction and seeking the waiver of Murphy's Preferential Purchase Right of its
proportionate share of Callon's Conveyed Interest.
b. Notwithstanding any other provision contained herein, if, Murphy provides timely written notice to
Callon of its election to exercise its Preferential Purchase Right of its proportionate share of Callon's
Conveyed Interest, this Agreement and the attached exhibits hereto, and any other documents,
certificates, instruments or agreements which are entered into by the Parties in furtherance of this
Transaction, shall be amended, but only for the limited purpose of reflecting that, upon Closing,
Shell will acquire its proportionate share of Callon's Conveyed Interest for a reduced Base Purchase
Price, such Base Purchase Price being reduced to reflect Shell's purchase of its proportionate share
of Callon's Conveyed Interest; provided, however, that all such other provisions of this Agreement,
the attached exhibits hereto, and any other documents, certificates, instruments or agreements
entered into by the Parties in furtherance of this Transaction, shall remain in force and effect as
agreed to by the Parties as of the Execution Date.
3.
Purchase Price.
a. As used in this Agreement, the term “ Purchase Price” means (i) Forty-Two Million Dollars
($42,000,000.00) (the “Base Purchase Price”) plus or minus (ii) the adjustments to the Base Purchase Price set
forth in Section 3(b) (the “Purchase Price Adjustments ”). The Parties agree that the Purchase Price (after taking
into consideration the Purchase Price Adjustments) will be allocated, for federal income tax purposes, fifty
percent (50%) to leasehold and fifty percent (50%) to facilities.
b. The Base Purchase Price shall be adjusted by the following Purchase Price Adjustments:
i. decreased by the amount of all outstanding joint interest billings attributable to the Conveyed
Interest, and remaining unpaid by Callon as of the Closing Date, to the extent they relate to the
period prior to the Effective Time;
ii.decreased by the amount of all operating revenues attributable to the Conveyed Interest and
increased by the amount of all operating expenses and capital expenses paid by Callon
attributable to the Conveyed Interest, in each case to the extent they relate to the period on and
after the Effective Time; and
iii.
increased or decreased as appropriate by the estimated net production imbalance between
Shell and Callon as of the Effective Time, which shall be calculated in accordance with
the procedures set forth in the Gas Balancing Agreement, as attached as Exhibit “D” to
the JOA.
c. Pursuant to this Agreement, Shell will also reimburse Callon for Callon's share of paid Hab2 ST2
Long Lead AFE costs and the Hab2 STI TA AFE, in the sum of $500,000.00 (“AFE Cost”).
4.
a.
Closing.
The closing of the sale and transfer of the Conveyed Interest to Shell (the “ Closing”) will take
place at Callon's offices, 200 North Canal Street, Natchez, Mississippi,
39120, on December 28, 2012 or such other date or location as the Parties may mutually determine (the “ Closing
Date”).
b.
Notwithstanding the foregoing, Callon or Shell, as applicable, will not be obligated to close the
transactions evidenced by this Agreement unless each of the conditions to its performance set forth below are
satisfied on the Closing Date or such Party waives the satisfaction of such conditions.
i. Neither Party will be obligated to close if, as of the Closing Date, any suit or other proceeding is
pending or threatened before any court or governmental agency seeking to restrain, prohibit, or
declare illegal, or seeking substantial damages in connection with, the Transaction.
ii.Callon will not be obligated to close if any matter represented or warranted in this Agreement by
Shell is untrue, inaccurate or is misleading as of the Closing Date as though made on and as of
the Closing Date.
iii.
Shell will not be obligated to close if any matter represented or warranted in this
Agreement by Callon is untrue, inaccurate or is misleading as of the Closing Date as
though made on and as of the Closing Date.
c.
On the Closing Date, at the Closing:
i. Shell shall deliver an amount equal to $39,500,000.00, being the Base Purchase Price less
$3,000,000.00, which is an estimated amount of the Purchase Price Adjustment, plus the amount
of the AFE Cost, in immediately available funds to Callon by wire transfer to an account
designated in writing by Callon at least five (5) business days prior to the Closing.
ii.the Parties shall exchange duly executed counterparts of the form of Assignment of Record Title
Interest attached hereto as Exhibit A and the Bill of Sale attached hereto as Exhibit B (the
“Conveyance”), accompanied by the appropriate forms of assignment to effect the transfer of the
Conveyed Interest to Shell under the then-current regulations of the Bureau of Ocean Energy
Management of the United States Department of the Interior, or such successor governmental
authority with jurisdiction over the subject matter hereof as of the Closing Date (the “BOEM”).
The Parties shall execute and deliver the Conveyance and the accompanying forms of
assignment in sufficient duplicate originals to allow recording and/or filing in all appropriate
offices. Following the Closing, Shell shall record the transfer of the Conveyed Interest in the
appropriate local jurisdiction and effect the transfer of the Conveyed Interest with the BOEM.
iii.
iv.
Callon will deliver to Shell its Certificate of Non-Foreign Status in the form attached
hereto as Exhibit C.
Shell and Callon shall execute such other remaining documents, certificates, instruments
or agreements which are contemplated by the Transaction or deemed necessary or
appropriate by the Parties.
On or before ninety (90) days after the Closing, Shell will prepare and deliver to Callon a written
draft final accounting of the Purchase Price Adjustment (the “Draft Final Accounting ”). Callon
will timely provide any accounting information and records that Shell may reasonably request in
order to complete the Draft Final Accounting. Within thirty (30) days of the receipt of the Draft
Final Accounting, Callon may deliver written statement asserting its right to audit the Draft Final
Accounting (an “Audit Notice”). If Callon fails to do so, then the Draft Final Accounting will be
deemed to be accepted by Callon as the final accounting of the Purchase Price Adjustment (the
“Final Accounting ” ) . If Callon does elect to audit the Draft Final Accounting, Callon shall
complete such audit and deliver a
d.
statement of objections, if any, within sixty (60) days following delivery of the Audit Notice. Shell
will timely provide any accounting information and records that Callon may reasonably request in
order to complete its audit of the Draft Final Accounting. After Callon completes its audit and
delivers its statement of written objections, if any, to the Draft Final Accounting, during the next
following thirty (30) days, the Parties shall attempt to resolve Callon's objections. Upon doing so,
Shell will prepare the Final Accounting which shall set forth the resolution agreed by the Parties. If
the Parties cannot resolve Callon's objections, the Parties will submit the dispute to an accounting
firm, experienced in accounting for oil and gas operations, not regularly engaged by either of the
Parties, to resolve the dispute. The decision of such accounting firm shall be final and binding upon
the Parties, and upon such decision Shell shall prepare and deliver to Callon a Final Accounting that
incorporates such decision. Whichever Party owes money to the other Party as shown on the Final
Accounting shall pay the other Party within thirty (30) days of Shell's delivery of the Final
Accounting.
If a Party receives any proceeds or pays any additional expenses for or on behalf of the other Party,
it shall promptly invoice the other Party for such expenses (who shall promptly pay such invoice)
or remit to the other Party the proceeds received (to the extent such amounts had not been
previously accounted for in the Final Accounting).
Promptly following Closing, Shell shall notify all purchasers of production, other contract parties
and government agencies that Shell has acquired the Conveyed Interest. Shell and Callon shall
execute all transfer orders, division orders, letters-in-lieu, and joinders and ratifications necessary
to assign contracts listed on the exhibits to Exhibit A and Exhibit B hereto, and to transfer
payment of proceeds from the sale of production from the Conveyed Interest as of the Effective
Time from Callon to Shell. After such notice is given to the remitters of proceeds of production, to
the extent that any remitter pays revenues to the incorrect Party, that Party shall promptly remit
such revenues (without interest) to the correct Party.
e.
f.
5.
a.
Representations.
Shell represents and warrants to Callon as follows:
i. Shell and the person executing this Agreement on behalf of Shell are fully authorized to execute
and deliver this Agreement on behalf of Shell and all of the obligations and covenants of Shell
contained herein are and shall be the legal, valid and binding obligations and covenants of Shell
in accordance with the terms of this Agreement.
ii.At the Closing, Shell is purchasing the Conveyed Interest for its own account as an investment
without the present intent to sell, transfer or otherwise distribute such interests to any other
person, and, together with its partners, officers and advisors, is familiar with investments of the
nature of the Conveyed Interest, understands that this investment involves certain risks, and
believes that it has adequately investigated the Conveyed Interest, and has substantial knowledge
and experience in financial and business matters such that it is capable of evaluating, and has
evaluated, the merits and risks inherent in purchasing the Conveyed Interest, and is able to bear
the economic risks of such investment.
b.
Callon represents and warrants to Shell as follows:
i. Callon and the person executing this Agreement on behalf of Callon are fully authorized to
execute and deliver this Agreement on behalf of Callon and all of the obligations and covenants
of Callon contained herein are and shall be the legal, valid and binding obligations and
covenants of Callon in accordance with the terms of this Agreement.
ii.Callon owns (and at the Closing will own) the Conveyed Interest, subject to the other agreements
and instruments listed on Exhibit “A” to the form of Assignment of Record Title Interest
attached hereto as Exhibit A and to the other agreements and instruments listed on Exhibit “A-1”
to Exhibit “A” to the form of Bill of Sale attached hereto as Exhibit B (collectively, the
“Permitted Encumbrances”), free and clear of any liens (other than the security rights established
under the JOA), charges, lease royalty burdens (other than lessor's royalty), overriding royalty
interests, payments out of production, dedications or commitments of reserves or production
(other than as provided in the Permitted Encumbrances), mortgages, area of mutual interest
obligations or any other encumbrances created by, through or under Callon.
6.
Effective Time. If the Closing occurs, Shell's acquisition of the Conveyed Interest will be effective at
12:01 a.m. (Central Time) on October 1, 2012 (the “Effective Time”), and Shell shall be entitled to all of the right of
ownership attributable to the Conveyed Interest and shall be responsible for all costs, expenses and/or other liabilities
attributable to the Conveyed Interest from and after the Effective Time.
Conduct of Business; Access to Records . During the Subject Period, Callon will:
7.
8.
a. only conduct business with respect to the Conveyed Interest in accordance with the ordinary course of
business and consistent with past practices; and
b. grant Shell access, at reasonable times during business hours after reasonable notice, to all of Callon's
land, lease, title and regulatory files with respect to the Conveyed Interest.
Assumption of P&A Obligation; Indemnification .
a. From and after the Closing, Shell shall assume in accordance with applicable law all obligations to
abandon, restore and remediate the Conveyed Interest, whether arising before or after the Effective
Time, including all obligations to (i) plug and abandon each well on the Conveyed Interest, (ii) remove
all equipment and facilities, and (iii) restore and remediate the surface and subsurface sites associated
with the Conveyed Interest (the “P&A Obligation”).
b. From and after the Closing, Shell shall indemnify, defend and hold harmless Callon, its affiliates and
their respective officers, directors, employees, agents, representatives, successors and permitted assigns
from and against any and all losses, damages or claims actually suffered or incurred by them arising out
of or related to the Conveyed Interest, including the P&A Obligation, or the failure of Shell's
representations and warranties in Section 5(a) to be true and correct in all material respects as of the
Closing.
c. The indemnification provided for in Section 8(b) above does not extend to losses, damages, or claims for
taxes, lessor's royalty, any overriding royalty payable with respect to hydrocarbon production
attributable to the Conveyed Interest prior to the Effective Time, or any other obligations attributable to
the Conveyed Interest prior to the Effective Time (other than the P&A Obligation), the liability for
which shall be retained by Callon.
d. From and after the Closing, Callon shall indemnify, defend and hold harmless Shell, its affiliates and
their respective officers, directors, employees, agents, representatives, successors and permitted assigns
from and against any and all losses, damages or claims actually suffered or incurred by them arising out
of (i) the failure of Callon's representations and warranties in Section 5(b) to be true and correct in all
material
9.
a.
respects as of the Closing, or (ii) obligations attributable to the Conveyed Interest prior to the Effective
Time (other than the P&A Obligation) including any taxes, lessor's royalty, or any overriding royalty
payable with respect to hydrocarbon production attributable to the Conveyed Interest prior to the
Effective Time.
DISCLAIMER OF REPRESENTATIONS AND WARRANTIES .
IN CONSUMMATING THE PURCHASE AND THE SALE OF THE CONVEYED INTEREST
CONTEMPLATED HEREUNDER, SHELL ACKNOWLEDGES THAT IT WILL BECOME THE
OWNER OF THE CONVEYED INTEREST, AND THAT, SHELL ACCEPTS SUCH CONVEYED
INTEREST IN THEIR AS-IS, WHERE-IS, CONDITION, WITH ALL FAULTS, WITHOUT ANY
EXPRESS OR
IMPLIED COVENANT, WARRANTY AS TO TITLE, CONDITION,
MERCHANTABILITY, PERFORMANCE, FITNESS (BOTH GENERALLY AND FOR ANY
PARTICULAR PURPOSE) OR OTHERWISE (WHICH WARRANTIES CALLON HEREBY
EXPRESSLY DISCLAIMS), OR RECOURSE, OTHER THAN AS EXPRESSLY SET FORTH
HEREIN. SHELL EXPRESSLY WAIVES ANY GUARANTEE AGAINST HIDDEN OR LATENT
REDHIBITORY VICES, INCLUDING LOUISIANA CIVIL CODE ARTICLES 2520 THROUGH
2548.
b. EXCEPT FOR THE REPRESENTATIONS AND WARRANTIES EXPRESSLY MADE BY CALLON
IN THIS AGREEMENT AND THE SPECIAL WARRANTY OF TITLE IN THE CONVEYANCE,
SHELL ACKNOWLEDGES AND AGREES THAT: (A) THERE ARE NO REPRESENTATIONS,
WARRANTIES, STATEMENTS, ASSURANCES OR GUARANTEES MADE BY CALLON,
EXPRESS OR IMPLIED, AS TO (i) THE CONVEYED INTEREST, (ii) THE HYDROCARBON
RESERVES UNDERLYING THE CONVEYED INTEREST, (iii) OR THE PROSPECTS RELATING
TO THE EXPLORATION OF THE CONVEYED INTEREST, AND THAT IN MAKING ITS
DECISION TO ENTER INTO THIS AGREEMENT AND TO CONSUMMATE THE PURCHASE OF
THE CONVEYED INTEREST, SHELL HAS RELIED AND WILL RELY SOLELY UPON ITS OWN
INDEPENDENT INVESTIGATION, VERIFICATION, ANALYSIS AND EVALUATION; (B)
CALLON DISCLAIMS ALL LIABILITY AND RESPONSIBILITY FOR ANY OTHER
REPRESENTATION, WARRANTY, STATEMENT OR INFORMATION ORALLY OR IN
WRITING MADE OR COMMUNICATED TO SHELL
INCLUDING ANY OPINION,
INFORMATION OR ADVICE WHICH MAY HAVE BEEN PROVIDED TO SHELL BY OR ON
BEHALF OF CALLON OR ANY AFFILIATES OF CALLON.
10.
Confidentiality.
a. Each Party agrees to keep the terms of this Agreement and any information related to the Transaction
confidential and not disclose the same to any other persons, firms or entities without the prior written
consent of the other Party, except (a) disclosures compelled by law, court order or stock exchange
requirements applicable to such Party, and (b) disclosures to such Party's affiliates or such Party's or its
affiliates' officers, employees, financial advisors, attorneys, accountants or other advisors that need to
know such information in connection with performance of such Party's obligations under this
Agreement, provided those persons, firms or entities likewise agree to keep this Agreement confidential.
Except as may be required under applicable law or stock exchange requirements, no press releases or
other public disclosure relating to the Transaction will be issued without the mutual consent of both
Parties, which consent will not be unreasonably withheld, delayed or conditioned. All necessary press
releases and other public disclosures required must be submitted by the disclosing Party to the
other Party a reasonable time prior to the dissemination thereof in order to permit such other Party a
reasonable opportunity to comment on any such disclosure prior to its dissemination. The confidentiality
obligations set forth in this paragraph will survive termination of this Agreement for a period of one (1)
year.
b. Callon agrees that, from and after the Closing Date, Callon will keep any non-public geological,
geophysical, seismic, commercial and financial information related to the Conveyed Interest confidential
pursuant to the terms and conditions of the JOA.
11.
Expenses. Each Party will be responsible for its respective fees and expenses incurred in connection
with the negotiation, documentation and execution of the Transaction, regardless of whether the Transaction is
consummated.
12.
Assignment.
a.
Except as otherwise provided in Section 12(b), no assignment of this Agreement or of any rights
or obligations under this Agreement may be made by either Party (by operation of law or otherwise) without the
prior written consent of the other Party, and any attempted assignment without such required consent will be
void.
b.
Each of the Parties reserves the right to structure the Transaction contemplated under the terms
of this Agreement as a like-kind exchange pursuant to §1031 of the Internal Revenue Code of 1986, as amended
(the “Code”), and regulations promulgated thereunder, with respect to any or all of the Conveyed Interest at any
time prior to the Closing Date (a “Like-Kind Exchange”). In order to effect a Like-Kind Exchange, the non-
electing Party shall cooperate and do all acts as may be reasonably required or requested by the Party electing for
a Like-Kind Exchange with regard to effecting such Like-Kind Exchange, including, but not limited to,
permitting such Party to assign any or all its rights under this Agreement to a Qualified Intermediary (“QI”) of
such party's choice in accordance with Treasury Regulation § 1.1031(k)-1(g)(4) or executing additional escrow
instructions, documents, agreements or instruments to effect an exchange; provided, however, that Shell's
ownership of the Conveyed Interest will not be delayed by reason of any such Like-Kind Exchange. Shell
reserves the right, at or prior to Closing, to assign its rights or a portion thereof under this Agreement with
respect to any or all of the Conveyed Interest to Shell's Qualified Exchange Accommodation Titleholder (as that
term is defined in Revenue Procedure 2000-37, 2000-2 C.B. 308) (“QEAT”) in connection with effecting a Like-
Kind Exchange. Callon and Shell acknowledge and agree that a whole or partial assignment of this Agreement to
a QI or QEAT shall not release either Callon or Shell from, or expand, any of their respective liabilities and
obligations to each other under this Agreement. Any Party not participating in the Like-Kind Exchange shall not
be obligated to pay any additional costs or incur any additional obligations in its sale or purchase, as applicable,
of the Conveyed Interest if such costs are the result of the another Party's Like-Kind Exchange, and the Party
electing to consummate the sale as a Like-Kind Exchange agrees to hold harmless and indemnify the other
Parties from and against all claims, losses and liabilities, if any, resulting from the Like-Kind Exchange.
13.
Choice of Law; Jurisdiction . THE VALIDITY, CONSTRUCTION, INTERPRETATION AND
EFFECT OF THIS Agreement SHALL BE GOVERNED BY AND INTERPRETED IN ACCORDANCE WITH THE
LAWS OF THE STATE OF TEXAS WITHOUT REGARD TO CONFLICTS RULES THAT WOULD OTHERWISE
REFER THE MATTER TO THE LAWS OF ANOTHER JURISDICTION. EACH PARTY CONSENTS TO
PERSONAL JURISDICTION IN ANY ACTION BROUGHT IN THE UNITED STATES FEDERAL COURTS
LOCATED IN HOUSTON, TEXAS (OR, IF JURISDICTION IS NOT AVAILABLE THE UNITED STATES
FEDERAL COURTS LOCATED IN HOUSTON, TEXAS, TO PERSONAL JURISDICTION IN ANY ACTION
BROUGHT IN THE STATE COURTS LOCATED IN HOUSTON, TEXAS) WITH RESPECT TO ANY DISPUTE,
CLAIM OR CONTROVERSY ARISING OUT OF OR IN RELATION
TO OR IN CONNECTION WITH THIS Agreement, AND EACH OF THE PARTIES AGREES THAT ANY
ACTION INSTITUTED BY IT AGAINST THE OTHER WITH RESPECT TO ANY SUCH DISPUTE,
CONTROVERSY OR CLAIM WILL BE INSTITUTED EXCLUSIVELY IN THE UNITED STATES DISTRICT
COURT FOR THE SOUTHERN DISTRICT OF TEXAS (OR, IF JURISDICTION IS NOT AVAILABLE IN THE
UNITED STATES DISTRICT COURT FOR THE SOTHERN DISTRICT OF TEXAS, THEN EXCLUSIVELY IN
THE STATE COURTS LOCATED IN HOUSTON, TEXAS). EACH OF SHELL AND CALLON WAIVE ANY
OBJECTION TO LAYING VENUE IN ANY SUCH ACTION, SUIT OR PROCEEDING IN SUCH COURTS AND
WAIVES ANY OBJECTION THAT SUCH COURTS ARE AN INCONVENIENT FORUM OR DO NOT HAVE
JURISDICTION OVER IT.
14.
Equitable Relief. The Parties agree that irreparable damage may occur if any of the provisions of this
Agreement were not performed in accordance with their specific terms or were otherwise breached. The Parties
acknowledge and agree that either Party's breach of this Agreement may result in irreparable injury to the other Party
and that monetary damages and other forms of legal damages may be inadequate or impossible to ascertain in the event
of a breach of such provisions of this Agreement. In the event of any breach or threatened breach by a Party of the
provisions of this Agreement, without prejudice to any other right and remedy available to it, the other Party may be
entitled to injunctive and other equitable relief, including enforcing specifically the terms and provision of this
Agreement. Injunctive and other equitable relief will be cumulative and in addition to all other remedies available.
15.
Limitation of Liability. Neither Party will be liable to the other for any indirect, incidental,
PUNITIVE, EXEMPLARY, special or consequential loss or damage (including, but not limited to, loss of use, loss of
profit, LOSS OF interest or business interruption) incurred by the other Party, whether based on contract, negligence or
other tort, statute, strict liability or otherwise arising out of this Agreement.
16.
No Relationship. It is not the intention of either Party and nothing contained in this Agreement will
be deemed or construed as creating a relationship of partnership, association, principal and agent or joint venture by or
between either Party.
17.
Entire Agreement. This Agreement and the Conveyance, and the other documents delivered pursuant
to this Agreement, including the exhibits hereto, constitutes the entire and only agreement between these Parties at the
time of its execution with respect to the subject matter hereof and supersede all prior agreements and merge all prior
discussions, negotiations, proposals and offers (written or oral) between them with respect to the Transaction
contemplated herein, including, but not limited to, the Letter of Deal Points, executed by Callon on November 15,
2012. There are no undertakings or representations of any kind, expressed, implied, oral, written, statutory or otherwise
not expressly set forth herein. No alteration or modification of the Agreement will be binding unless agreed in writing.
18.
Notices. All notices to be given to a Party hereunder will be in writing and will be deemed to have
been duly given if delivered in person or by an express courier service to the relevant party hereunder at their respective
addresses below or if sent by facsimile to the following addresses:
If to Shell:
If to Callon:
Shell Offshore Inc.
One Shell Square
701 Poydras Street
New Orleans, Louisiana 70139
Attention: Mark Thompson
Fax: 504-728-0399
Callon Petroleum Operating Company
200 North Canal Street
P.O. Box 1287
Natchez, Mississippi 39121
Attention: Dee Newman
Land Manager
Fax: 601-446-1434
19.
Construction. Each of the Parties has had the opportunity to exercise business discretion in relation to
the negotiation of the details of the Transaction, and this Agreement is the result of arm's-length negotiations from
equal bargaining positions. It is expressly agreed that this Agreement will not be construed against any Party, and no
consideration will be given or presumption made, on the basis of who drafted this Agreement or any particular
provision of this Agreement.
20.
Counterparts. This Agreement may be executed by the Parties in separate counterparts, each of which
when so executed and delivered will be an original, but all such counterparts will together constitute one and the same
instrument. Each counterpart may consist of a number of copies hereof each signed by less than all, but together signed
by all of the Parties.
[SIGNATURE PAGE FOLLOWS]
Signature Page to the Purchase and Sale Agreement
IN WITNESS WHEREOF, Shell and Callon have duly executed this Agreement as of the Execution Date.
SHELL OFFSHORE INC.
CALLON PETROLEUM OPERATING COMPANY
By:/s/ S.M.King
Name:S. M. King
Title:Attorney-in-Fact
By:/s/ Fred Callon
Name:Fred Callon
Title:President and CEO