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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the quarterly period ended March 31, 2012
For the transition period from to
Commission file number 0-8933
APCO OIL AND GAS INTERNATIONAL INC.
(Exact name of registrant as specified in its charter)
(Former name, Former Address and Former Fiscal Year, if Changed Since Last Report)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes T 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 such shorter period that the registrant was required to submit and post such files).
Yes T No o
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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated Filer T Accelerated Filer £ Non-Accelerated Filer £ Smaller Reporting Company £
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes £ No T
Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date.
APCO OIL AND GAS INTERNATIONAL INC.
PART I. FINANCIAL INFORMATION
Certain matters contained in this report include “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. These forward-looking statements relate to anticipated financial performance, management’s plans and business objectives for future operations, business prospects, outcome of regulatory proceedings, market conditions and other matters. We make these forward-looking statements in reliance on the safe harbor protections provided under the Private Securities Litigation Reform Act of 1995.
All statements, other than statements of historical facts, included in this report that address activities, events or developments that we expect, believe or anticipate will exist or may occur in the future, are forward-looking statements. Forward-looking statements can be identified by various forms of words such as “anticipates,” “believes,” “could,” “may,” “should,” “continues,” “estimates,” “expects,” “forecasts,” “intends,” “might,” “objectives,” “planned,” “potential,” “projects,” “scheduled,” “will” or other similar expressions. These forward-looking statements are based on management’s beliefs and assumptions and on information currently available to management and include, among others, statements regarding:
Forward-looking statements are based on numerous assumptions, uncertainties, and risks that could cause future events or results to be materially different from those stated or implied in this report. Many of the factors that will determine these results are beyond our ability to control or predict. Specific factors that could cause actual results to differ from results contemplated by the forward-looking statements include, among others, the following:
Given the uncertainties and risk factors that could cause our actual results to differ materially from those contained in any forward-looking statement, we caution investors not to unduly rely on our forward-looking statements. We disclaim any obligations to and do not intend to update the above list or to announce publicly the result of any revisions to any of the forward-looking statements to reflect future events or developments.
In addition to causing our actual results to differ, the factors listed above and referred to below may cause our intentions to change from those statements of intention set forth in this report. Such changes in our intentions may also cause our results to differ. We may change our intentions at any time and without notice, based upon changes in such factors, our assumptions, or otherwise.
Because forward-looking statements involve risks and uncertainties, we caution that there are important factors, in addition to those listed above, that may cause actual results to differ materially from those contained in the forward-looking statements. For a detailed discussion of those factors, see Part I, Item 1A. “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2011.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of these consolidated financial statements.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
The accompanying notes are an integral part of these consolidated financial statements.
APCO OIL AND GAS INTERNATIONAL INC.
The accompanying notes are an integral part of these consolidated financial statements.
APCO OIL AND GAS INTERNATIONAL INC.
The accompanying notes are an integral part of these consolidated financial statements.
General Information and Principles of Consolidation
Apco Oil and Gas International Inc. (“Apco”) is an international oil and gas exploration and production company with a focus on South America. Exploration and production will be referred to as “E&P” in this document.
Apco began E&P activities in Argentina in the late 1960s, and as of March 31, 2012, had interests in nine oil and gas producing concessions and two exploration permits in Argentina. E&P activities in Colombia began in 2009 where we have three exploration and production contracts. Our producing operations are located in the Neuquén, Austral, and Northwest basins in Argentina. We also have exploration activities currently ongoing in both Argentina and Colombia. As of March 31, 2012, all of our operating revenues and equity income, and all but $4.8 million of our long-lived assets for which we have carrying values on our balance sheet, were in Argentina.
The consolidated financial statements include the accounts of Apco Oil and Gas International Inc. (a Cayman Islands limited company) and its subsidiaries, Apco Properties Ltd. (a Cayman Islands limited company), Apco Austral S.A. (an Argentine corporation), and Apco Argentina S.A. (an Argentine corporation), which as a group are at times referred to in the first person as “we,” “us,” or “our.” We also sometimes refer to Apco as the “Company.” The Company proportionately consolidates its direct interest of the accounts of its joint ventures into its consolidated financial statements.
WPX Energy, Inc. (“WPX”), an independent exploration and production company with operations primarily in North America, owns 68.96 percent of our aggregate Class A and ordinary shares. We are managed by employees of WPX, and all of our executive officers and three of our directors are employees of WPX. Pursuant to an administrative services agreement between us and WPX, at our corporate headquarters in Tulsa, Oklahoma, WPX provides us with management services, office space, insurance, treasury, accounting, tax, legal, corporate communications, information technology, human resources, internal audit and other administrative corporate services. We have branch offices in Buenos Aires, Argentina and Bogotá, Colombia. These offices are staffed by employees of Apco and/or contractors retained by us.
Our core operations are located in the Neuquén basin and include our 23 percent working interests in the Entre Lomas, Bajada del Palo and Charco del Palenque concessions and the Agua Amarga exploration permit, and a 40.72 percent equity interest in Petrolera Entre Lomas S.A. (“Petrolera”, a privately owned Argentine corporation), which is accounted for using the equity method (see Note 3). Petrolera is the operator and owns a 73.15 percent working interest in the same properties. Consequently, Apco’s combined direct consolidated and indirect equity interests in the properties underlying the joint ventures total 52.79 percent. The Charco del Palenque concession is the portion of the Agua Amarga exploration permit which was converted to a 25-year exploitation concession in 2009. In the Neuquén basin we also participate in the Coirón Amargo block in which we hold a 45 percent interest. We sometimes refer to these areas in a group as our “Neuquén basin properties.”
The unaudited, consolidated financial statements of Apco included herein do not include all footnote disclosures normally included in annual financial statements and, therefore, should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.
All intercompany balances and transactions between Apco and its subsidiaries have been eliminated in consolidation.
In the opinion of the Company, all normal recurring adjustments have been made to present fairly the results of the three-month periods ended March 31, 2012 and 2011. The results for the periods presented are not necessarily indicative of the results for the respective complete years.
Fair Value Measurements
The carrying amount reported in the balance sheet for cash equivalents, accounts receivable and accounts payable is equivalent to fair value due to the frequency and volume of transactions in and the short-term nature of these accounts. The carrying amount for restricted cash is equivalent to fair value as the funds are invested in a short-term money market account. The fair value of our debt is estimated to approximate the carrying amount as the interest is a floating-rate based on Libor.
The Company recognizes revenues from sales of oil, gas, and plant products at the time the product is delivered to the purchaser and title has been transferred.
Taxes Other Than Income
The Company is subject to multiple taxes in Argentina and Colombia, including provincial production taxes, severance taxes, export taxes, shareholder equity taxes and various transaction taxes.
At March 31, 2012, and December 31, 2011, we had $8.4 million of restricted cash which is collateral for letters of credit related to exploration blocks in Colombia. The letters of credit expire in various dates in 2012 and 2013. We have presented the entire amount as non-current as any letter of credit expirations in 2012 are expected to be renewed and thus will not be available for general corporate purposes.
Our inventory includes hydrocarbons of $1.6 million at March 31, 2012, and $1.1 million at December 31, 2011, which are accounted for at production cost, and spare-parts materials of $3 million at March 31, 2012 and $1.8 million at December 31, 2011, which are accounted for at cost.
Property and Equipment
The Company uses the successful-efforts method of accounting for oil and gas exploration and production operations, whereby costs of acquiring non-producing acreage and costs of drilling successful exploration wells and development costs are capitalized. Geological and geophysical costs, including three dimensional (“3D”) seismic survey costs, and costs of unsuccessful exploratory drilling are expensed as incurred. All of our exploration expense during the three months ended March 31, 2012, is related to the acquisition of 3D seismic information. We had exploratory wells in progress of approximately $4.9 million at March 31, 2012, and $4.2 million as of December 31, 2011.
Oil and gas properties are depreciated over their concession lives using the units of production method based on proved and proved producing reserves. The Company’s proved reserves are limited to the concession life even though a concession’s term may be extended for 10 years based on terms to be agreed on and with the consent of the Argentine government. Non oil and gas property is recorded at cost and is depreciated on a straight-line basis, using estimated useful lives of three to 15 years.
The Company reviews its proved and unproved properties for impairment on a property by property basis and recognizes an impairment whenever events or circumstances, such as declining oil and gas prices, indicate that a property’s carrying value may not be recoverable. The Company records a liability for future asset retirement obligations in accordance with the requirements of FASB ASC 410 (Asset Retirement and Environmental Obligations).
Net Income per Share
Net income per share is calculated by dividing net income attributable to Apco Oil and Gas International Inc. shareholders by the weighted average number of ordinary and Class A shares outstanding. Basic and diluted net income per share is the same because the Company has not issued any potentially dilutive securities such as stock options. The Class A Shares and the ordinary shares have identical rights and preferences with respect to dividends.
The Company accounts for nonmonetary transactions based on the fair values of the assets involved, which is the same basis as that used in monetary transactions. During the first three months of 2012 and 2011, we delivered a volume of our oil production to a third-party refinery to satisfy a portion of our provincial production tax obligation. The crude oil inventory that was transferred to satisfy this obligation was recognized at fair value. We recorded approximately $604 thousand in operating revenues and taxes other than income as a result of this transaction in the first quarter of 2012, and $557 thousand in the first quarter of 2011.
The Company was formed in the Cayman Islands in 1979. Since then, the Company’s income, to the extent that it is derived from sources outside the U.S., has not been subject to U.S. income taxes. Also, the Company has been granted an undertaking from the Cayman Islands government, expiring in 2019, to the effect that the Company will be exempt from tax liabilities resulting from tax laws enacted by the Cayman Islands government subsequent to 1979. The Cayman Islands currently has no applicable income tax or corporation tax. All of the Company’s income during 2012 and 2011 was generated outside the United States.
Provision is made for deferred Argentine income taxes applicable to temporary differences between the financial statement and tax basis of the assets and liabilities. The table below summarizes the income tax expense for the periods shown.
We are domiciled in the Cayman Islands where the income tax rate is zero. However, we are required to pay income taxes in Argentina. Our effective income tax rate reflected in the Consolidated Statements of Income differs from Argentina’s statutory rate of 35 percent. This is primarily because the Company also generates income and incurs expenses outside of Argentina that are not subject to income taxes in Argentina or in any other jurisdiction. Therefore these amounts do not affect the amount of income taxes paid by the Company. Such items include interest income resulting from the Company’s cash and cash equivalents deposited in its Cayman Island and Bahamas bank accounts, general and administrative expenses incurred by the Company in its headquarters office in Tulsa, Oklahoma, and foreign exchange gains and losses resulting from changes in the value of the peso, which do not affect taxable income in Argentina. The Company also incurred expenses related to exploration activity in Colombia that provide no benefit to income tax expense until these activities generate sufficient taxable income in Colombia. Additionally, equity income from its Argentine investment is recorded by the Company on an after tax basis and income generated from production in Tierra del Fuego in Argentina is not subject to Argentine income tax.
The effective income tax rate is higher for the three months ended March 31, 2012, compared with the same period of 2011 primarily due to larger expenses in Colombia during 2012 which are providing no tax benefit.
As of March 31, 2012 and December 31, 2011, the Company had no unrecognized tax benefits or reserve for uncertain tax positions.
The Company’s policy is to recognize tax related interest and penalties as a component of income tax expense. The statute of limitations for income tax audits in Argentina is six years, and begins on December 31 in the year in which the tax return is filed, therefore the tax years 2005 through 2011 remain open to examination.
The Company uses the equity method to account for its 40.72 percent investment in Petrolera. Petrolera’s principal business is its operatorship and 73.15 percent interest in the Entre Lomas, Bajada del Palo and Charco del Palenque concessions and the Agua Amarga exploration permit.
Under the equity method of accounting, the Company's share of net income from Petrolera is reflected as an increase in its investment account and is also recorded as equity income from Argentine investment. Dividends received from Petrolera are recorded as reductions of the Company’s investment.
The Company’s carrying amount of its investment in Petrolera is greater than its proportionate share of Petrolera’s net equity by $717 thousand. The reasons for this basis difference are: (i) goodwill recognized on its acquisition of additional Petrolera shares in 2002 and 2003; (ii) certain costs expensed by Petrolera but capitalized by the Company; (iii) recognition of a provision for doubtful account associated with a receivable held by Petrolera; and (iv) a difference from periods prior to 1991 when the Company accounted for its interest in Petrolera under the cost recovery method, which will be recognized upon full recovery of the Company’s investment.
Summarized unaudited financial position and results of operations of Petrolera are presented in the following tables.
Petrolera’s financial position at March 31, 2012 and December 31, 2011 is as follows. Amounts are stated in thousands:
Petrolera’s results of operations for the three months ended March 31, 2012 and 2011 are as follows. Amounts are stated in thousands:
The balance of accrued liabilities consisted of the following:
We have a loan agreement with a financial institution for a $10 million bank line of credit. The funds can be borrowed during a one-year period which ended in March 2012. As of March 31, 2012, we borrowed $8 million under this banking agreement. Borrowings under this facility are unsecured and bear interest at the six-month Libor rate plus three percent per annum plus a one percent arrangement fee per borrowing and a commitment fee for the unused portion of the loan amount. Principal amounts will be repaid in four equal semi-annual installments from each borrowing date after a two and a half year grace period. This debt agreement contains covenants that restrict or limit, among other things, our ability to create liens supporting indebtedness, purchase or sell assets outside the ordinary course of business, and incur additional debt. Aggregate minimum maturities of our long-term debt are as follows:
In November 2004, the Company received a formal notice from the Banco Central de la Republica Argentina (the Central Bank of Argentina or the “BCRA”), of certain proceedings based upon alleged violation of foreign currency regulations. Specifically, the BCRA claimed that between December of 2001 and November of 2002 the Company failed to bring into the country 100 percent of the foreign currency proceeds from its Argentine oil exports. In 1989, the government established guidelines that required most oil companies to bring into Argentina 30 percent of foreign currency proceeds from exports instead of 100 percent of such proceeds as was generally required of exporters in other industries. In 1991, all foreign exchange controls were lifted by the government.
In response to Argentina’s economic crisis of 2001 and 2002, the government reintroduced foreign exchange controls in 2002, and as a result the Company repatriated 30 percent of its proceeds from oil exports during 2002 following the 1989 guidelines. An opinion from Argentina’s Attorney General, however, declared that the benefits granted to the oil and gas industry in 1989 were no longer effective and, therefore, 100 percent of such funds had to be repatriated. This opinion supported the position taken by the Argentine government during 2002. The government then revised its position in 2003 and expressly clarified that oil companies are required to only repatriate 30 percent of such proceeds. The government’s departure from its 2002 position was effective January 1, 2003, leaving some uncertainty in the law with regard to 2002.
The BCRA audited the Company in 2004 and took the position that 100 percent of its foreign currency proceeds from its 2002 exports were required to be returned to the country rather than only 30 percent, as had been returned to the country by the Company in 2002. The difference for the Company totals $6.2 million. In December 2004, the Company filed a formal response disagreeing with the position taken by the BCRA. In addition, without admitting any wrongdoing, the Company brought into the country $6.2 million and exchanged this amount for Argentine pesos using the applicable exchange rates required by the regulation.
In May 2011, the BCRA sent the case file to the National Justice for Economic Crimes. The Company anticipates that this matter will remain open for some time. Under the pertinent foreign exchange regulations, the BCRA may impose significant fines on the Company; however, historically few fines have been made effective in those cases where the foreign currency proceeds were brought into the country and traded in the exchange market at the adequate exchange rate and the exporters had reasonable grounds to support their behavior. As a result, a conclusion cannot be made at this time as to the probability of an outcome or the amount of any loss to the Company that might result from this proceeding.
In the third quarter of 2011, we received a claim from the Dirección General de Rentas (the “DGR,” or provincial taxation authority) in the province of Chubut, Argentina, for alleged deficiencies in exploitation canon payments applicable to the Cañadón Ramírez concession during the years 2009, 2010 and 2011. The DGR has claimed that we owe an additional $4.3 million pesos (approximately $1 million U.S. dollars). In making this assessment, the DGR has failed to acknowledge that we relinquished portions of the original surface area of the concession during those periods. Therefore, we believe this claim has no merit and that the exploitation canon payments made are correct. We initiated an administrative proceeding with the province to challenge the DGR claim in the fourth quarter of 2011. In February 2012, the province rejected our motion for reconsideration. We filed an administrative appeal with the Provincial Ministry of Economy in March 2012. We sold our interest in Cañadón Ramírez at the end of 2010.
The following discussion and analysis explains the significant factors that have affected our results of operations for the three-month period ended March 31, 2012, compared with the three-month period ended March 31, 2011, and our financial condition since December 31, 2011. This discussion and analysis should be read in conjunction with the Consolidated Financial Statements and notes thereto included in Item 1 of this document and our 2011 Annual Report on Form 10-K.
Overview of Three Months Ended March 31, 2012
During the first quarter of 2012, net income attributable to Apco Oil and Gas International Inc. was $10.1 million compared with $8.2 million for the first quarter of 2011. Net income increased quarter-to-quarter due to higher operating revenues and greater equity income which was partially offset by higher costs and operating expenses, including significantly higher exploration expense. During first quarter 2012, we incurred $4.6 million more exploration expense than in 2011 due to significant 3D seismic acquisition investments as a result of our prospecting efforts both in Colombia and Argentina.
Net cash provided by operating activities during the first three months of 2012 was $6.9 million, a decrease of $1.8 million compared with the first three months of 2011. We ended the first quarter with a cash and cash equivalents balance of $39.8 million, or 13 percent of total assets. We believe we have sufficient liquidity and capital resources to fund our ongoing operations and planned capital expenditures during 2012.
See additional discussion in “Results of Operations” and “Financial Condition” below.
On April 16, 2012, President Cristina Kirchner announced that she was submitting to Argentina’s congress a draft law that provides for the expropriation of almost all of Repsol’s shareholding in YPF S.A. (“YPF”). We do not expect negative repercussions to our operations in Argentina as a result of this action. For further discussion, see “Quantitative and Qualitative Disclosures about Market Risk – Economic and Political Environment” in Item 3 of this report.
Neuquén Basin Properties
During the first three months of 2012, we completed and put on production four development wells and one exploration well that commenced drilling in 2011. The successful exploration well is a natural gas discovery in our Charco del Palenque concession. For our 2012 drilling program, ten development wells were spudded during the quarter. Five of these wells were completed and put on production during the quarter and five wells were in various stages of drilling or completion at the end of the quarter.
In April, we performed a fracture stimulation of the Vaca Muerta shale in an existing well in the Bajada del Palo concession. This two stage fracture is significantly larger than the single stage fractures we executed in our three- well pilot program in the Bajada del Palo and Entre Lomas concessions in 2011. We expect to have final results from this fracture of the Vaca Muerta in the second quarter.
In December 2011, we commenced a three stage fracture stimulation of the Vaca Muerta formation in the CAS x-1 well drilled earlier in 2011. During the production test in the first quarter 2012 which lasted 48 days, the well flowed intermittently for the equivalent of 20 days at an average rate of 173 barrels of oil per day (“bopd”). The well was put on production in April. Although this result is encouraging, it is not conclusive as exploration of the Vaca Muerta in this basin is in the very early stages and the productive behavior of the Vaca Muerta formation is not well understood.
Additional activities in the first quarter included drilling of the CAS x-4 well that spud in December 2011 in the southeastern portion of the area. A 453- foot core sample of the Vaca Muerta formation was taken from the CAS x-4 for laboratory analysis. We plan to perform a multi-stage fracture of this well after the core analysis is completed and we have finished evaluating production results from the CAS x-1 well. We have also drilled the CAS x-2 well that discovered oil in the Tordillo formation. The well also encountered a 433- foot section of the Vaca Muerta shale. At quarter’s end, the well was being put into production from the Tordillo. In March, we spudded the CAN 5 well, our first development well in the northern sector of the block.
In March 2012, we received formal approval to convert approximately 26,700 acres into an exploitation concession with a term of 25 years. The exploration permit for the remaining portion of the block was extended for two years and has been deemed a “high-risk exploration area” that will require exploration drilling and seismic commitments of approximately $18 million net to Apco during 2012 and 2013 to continue our investigation of the Tordillo formation and unconventional potential from the Vaca Muerta and Molles formations in the block. After the two-year exploration period, we will determine how much of the area will be converted to an exploitation concession and how much acreage, if any, will have to be relinquished.
During the first quarter of 2012, we spud our first exploration well in Colombia. Drilling of the Maniceño-1 well on the Llanos 32 block began in March. The well reached a measured depth of 11,027 feet in April. The well encountered approximately 50 feet of oil column at the top of the Mirador formation. It was then perforated across a 14-foot section, and over a period of four hours the well flowed oil, on jet pump, at a rate of 7,558 barrels of oil per day. In addition, the well flowed naturally at a rate of 3,036 barrels of oil per day over a subsequent six-hour period. After installing a high volume electric submersible pump in the Maniceño-1 well, the drilling rig will move to a second Llanos 32 exploration drilling location, the Samaria Norte-1 prospect. It is expected to spud in May. We have a 20 percent interest in the Llanos 32 block.
Also during the quarter, we received the first of two drilling permits required for the Turpial block. The approval of the second permit was received in April and we expect to drill our first well on the block by the third quarter. In the Llanos 40 block we began the acquisition of 305 square kilometers of 3D seismic.
Oil prices have a significant impact on our ability to generate earnings, fund capital projects, and pay shareholder dividends. In general, oil prices are affected by many factors, including changes in market demands, global economic activity, political events, weather, and OPEC production quotas. More importantly to Apco, oil sales price realizations for oil produced and sold in Argentina are significantly influenced by Argentine governmental actions.
In Argentina, politically driven mechanisms significantly influence the sale price of oil produced and sold in the country. To alleviate the impact of higher crude oil prices on Argentina’s economy and slow the rate of inflation, the Argentine government created an oil export tax and enacted price controls over gasoline prices to force producers and refiners to negotiate oil sales prices significantly below international market levels.
For the first quarter of 2012, our average realized price for our direct working interests consolidated in our operating revenues was $74.37 per barrel, compared with $56.66 in the first quarter of 2011. The average oil sales price for our equity interests was $74.81 per barrel for the first quarter of 2012 compared with $56.83 for the same period in 2011. Our oil price netbacks have been increasing since 2009 when we received approximately $43 per barrel. Gradual increases in gasoline prices in Argentina have enabled producers to negotiate higher oil sales prices with refiners. The combination of declining production in Argentina, increasing gasoline prices and tighter demand for our high-quality crude oil has resulted in higher oil price realizations. Nevertheless, as our oil price realizations continue to be negotiated on a short-term basis, and because policies regarding export taxes and price controls may change, we cannot accurately predict if the gradual trend of increasing prices we have experienced will continue throughout the year.
Results of Operations
The following table and discussion is a summary of our consolidated results of operations for the three-months ended March 31, 2012, compared with the three-months ended March 31, 2011. Please read this information in conjunction with the Consolidated Statements of Income.
Total revenues for the first quarter of 2012 increased by $7.0 million, or 30 percent compared with first quarter 2011. The following tables and discussion explain the components and variances in operating revenues.
The three-month comparisons of our oil, natural gas, and LPG sales volumes and average sales prices for our consolidated interests accounted for as operating revenues are shown in the following tables.
The volume and price changes in the table above caused the following changes to our oil, natural gas and LPG revenues between the three months ended March 31, 2012 and 2011.
The increase in Oil revenues during the first quarter of 2012 is primarily due to higher average oil sales prices. Our average oil sales prices increased by 31 percent compared with first quarter of 2011 due to the factors previously discussed in “Oil Prices” in this report.
Total Costs and Operating Expenses
During the first quarter of 2012, Total costs and operating expenses increased by $7.8 million compared with first quarter 2011 primarily due to greater exploration expense. Notable variances for the comparable quarters include the following:
Depreciation, Depletion and Amortization Expenses (“DD&A”)
The changes in our total volumes, DD&A average rates per unit and DD&A expense of oil and gas properties between the three-months ended March 31, 2012 and 2011 are shown in the following table:
The following table details the changes in DD&A expense of oil and gas properties due to changes in volumes and average rates between the three-months ended March 31, 2012 and 2011.
Our DD&A rate increased in the first quarter of 2012 compared with the same period in 2011 because in the Río Negro province, where our largest producing field with the largest proved reserves is located, we have been adding less proved reserves per well drilled for calculating DD&A with each year that passes without obtaining the remaining ten-year extension as our proved reserves are limited to the current concession life. Furthermore, as we develop our most mature fields, proved reserves added per well decrease over time. Additionally, our weighted average DD&A rate increased in 2012 due to a greater proportion of sales volumes on a barrel of oil equivalent basis from properties with DD&A rates that are higher than the weighted average rate experienced in the first quarter of 2011.
We are working to obtain the ten-year concession extensions for our properties in Río Negro and Tierra del Fuego which currently have concession terms ending in 2016. If any extensions are obtained, we expect to experience a favorable effect on future DD&A rates as wells whose productive lives extend beyond 2016 will result in the addition of proved developed reserves.
Total investment income increased by $3.5 million for the first quarter of 2012 compared with first quarter 2011 due to greater Equity income from Argentine investment. The increase in our equity income for the periods is due to higher net income of our equity investee, Petrolera. The comparative increase in Petrolera’s net income is primarily a result of greater revenues driven by higher oil sales prices and volumes.
Summary of Total Volumes, Sales Prices and Production Costs
The following table reflects our total sales volumes, average sales prices, and our average production costs per unit sold for the periods presented:
Oil price realizations in Argentina have continued to gradually increase, reaching approximately $75 per barrel in March 2012. Higher oil prices also benefit Petrolera’s cash flows from operations and its ability to pay dividends. Petrolera’s ability to pay dividends is dependent upon numerous factors, including its cash flows provided by operating activities, levels of capital spending, changes in crude oil and natural gas prices, and debt and interest payments. Oil price realizations in Argentina continue to be negotiated on a short-term basis, and as such, we cannot accurately predict how they will evolve in the remainder of 2012.
Inflation in Argentina has been a persistent problem for some time. The annual inflation rate was 20 percent or higher in 2011; economists in Argentina are predicting similar levels of inflation for 2012. In contrast, the Argentine peso has not experienced a commensurate level of devaluation thereby causing considerable increases in our U.S. dollar cost of operations and capital expenditures. Consequently, there is no assurance that operating income will increase in line with the upward trend of our oil price realizations.
We will continue to monitor our capital programs and the quarterly shareholder dividend as necessary to provide Apco with the financial resources and liquidity needed to continue development drilling in its core properties over the long term, fund new investment opportunities, meet future working capital needs and fund any further cash bonus payments that may be negotiated to obtain concession extensions, if any, while maintaining sufficient liquidity to reasonably protect against unforeseen circumstances requiring the use of funds. To that end, in May 2012, our Board of Directors decided to suspend paying a regular quarterly dividend. Most recently, we had been paying a regular quarterly dividend of two cents per share on our shares. The reduction in the dividend compared with prior periods is designed to provide additional resources for potential investment opportunities and capital for expected development of recent exploration successes.
Although we have interests in several oil and gas properties in Argentina, our direct participation in those Neuquén basin properties in which we are partners with Petrolera and dividends from our equity interest in Petrolera are the largest contributors to our net cash provided by operating activities.
We have historically funded capital programs and past property acquisitions with internally generated cash flow. We have generally not relied on debt or equity as sources of capital due to the turmoil that periodically affects Argentina’s economy which has made financing difficult to obtain on reasonable terms. Although we have not typically relied on debt or equity as sources of capital, successful exploration efforts in Argentina or Colombia could lead to development capital needs that are currently beyond our ability to fund from operations. Consequently, we may have to consider additional bank financing or some form of equity financing in the future. Such financing may not be available or available on acceptable terms.
With a cash and cash equivalents balance at March 31, 2012, of $39.8 million, or 13 percent of total assets, and the ability to adjust capital spending as necessary, we believe we have sufficient liquidity and capital resources to effectively manage our business throughout the remainder of 2012.
Our liquidity is affected by restricted cash balances that are pledged as collateral for letters of credit for exploration activities in Colombia. One of our letters of credit for $2.9 million expires in September of 2012. We expect to renew this upon expiration as our drilling efforts continue. A second letter of credit for $5.5 million collateralized with cash expires in 2013. Consequently, $8.4 million of cash is considered restricted as of March 31, 2012. The restricted cash is invested in a short-term money market account with a financial institution.
Cash Flow Analysis
The following table summarizes the change in cash and cash equivalents for the periods shown.
Our net cash provided by operating activities totaled $6.9 million for the first three months of 2012, compared with $8.7 million during the same period in 2011. The change in cash provided by operating activities was primarily a result of lower dividends from our Argentine investment.
During the first three months of 2012, capital expenditures totaled $9.4 million, most of which was invested in drilling in our Neuquén basin properties and Coirón Amargo, compared with $5 million in 2011.
During the first three months of 2012, we paid $591 thousand of dividends to shareholders and non-controlling interests, and we received $6 million in borrowings from our banking agreement to fund capital expenditures.
Our contractual obligations have decreased by approximately $9 million from our total obligations as reported in our Annual Report on Form 10-K for the year ended December 31, 2011, as a result of drilling and exploration activities during the first three months of 2012. Additionally, our obligations increased due to our borrowing $6 million under our banking agreement.
Off-Balance Sheet Arrangements
We do not currently use any off-balance sheet arrangements to enhance liquidity and capital resources.
Our operations are exposed to market risks as a result of changes in commodity prices and foreign currency exchange rates.
Commodity Price Risk
We have historically not used derivatives to hedge price volatility. As previously mentioned in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” oil sales price realizations for oil produced and sold in Argentina are significantly influenced by Argentine governmental actions. In the current regulatory environment, the combination of hydrocarbon export taxes and strict government controls over Argentine gasoline prices directly impacts net backs for the sale of crude oil in the domestic Argentine market. As a result, our price is impacted more by government controls than changes in world oil prices. Because our oil prices are negotiated on a short-term basis, we cannot accurately predict our future sales prices, and it is difficult for us to determine what effect increases or decreases in world oil prices may have on our results of operations.
Inflation, Foreign Currency and Operations Risk
The majority of our operations and all of our current production is located in Argentina which has had a history of high levels of inflation and resulting currency devaluation. Therefore, our financial results may be affected by factors such as changes in foreign currency exchange rates, weak economic conditions, or changes in Argentina’s political climate. During 2002 and 2003, we recorded sizeable foreign currency exchange losses due to the significant devaluation of the Argentine peso that occurred as a consequence of Argentina’s economic problems during 2001 and 2002. From 2003 to mid-2008, the Argentine government used monetary policies to keep the peso to U.S. dollar exchange rate stable at approximately 3.00:1. Although government policies such as regulated gasoline prices and strict controls over natural gas prices have attempted to reduce inflationary pressures in Argentina, inflation has averaged approximately 20 percent annually for several years. Since 2007, the peso to US dollar exchange rate has not changed in proportion to these levels of inflation, resulting in significant year-over-year cost increases when measured in US dollars. At December 31, 2011, the peso to US dollar exchange rate was 4.30:1. At March 31, 2012, the exchange rate was 4.38:1.
Economic and Political Environment
Argentina has a history of economic and political instability. Because our operations are predominately located in Argentina, our operations and financial results have been, and could be in the future, adversely affected by economic, market, currency, and political instability in Argentina, as well as measures taken by its government in response to such instability. Argentina’s economic and political situation continues to evolve, and the Argentine government may enact future regulations or policies that may materially impact, among other items, (i) the realized prices we receive for the commodities we produce and sell; (ii) the timing of repatriations of cash to the Cayman Islands; (iii) our asset valuations; (iv) the dollar value of peso-denominated monetary assets and liabilities; and (v) restrictions on imports of materials necessary for our operations.
In October 2011, President Cristina Kirchner was re-elected for a second term. Her first term was highlighted by energy policies that controlled prices of hydrocarbons, in particular natural gas prices, subsidies for the import of natural gas at prices far higher than those permitted for the sale of natural gas produced in Argentina, close alliances with labor unions, and a monetary policy designed to support the value of the peso. Additionally, the government has taken various measures to assert greater state control over different areas of the country’s economy, including nationalizing an airline and private pension funds. Since the president’s re-election, the government has tightened foreign exchange controls and forced oil and gas companies to repatriate export proceeds.
On April 16, 2012, President Cristina Kirchner announced that she was submitting to Argentina’s congress a draft law that provides for the expropriation of almost all of Repsol’s S.A. (“Repsol”) shareholding in YPF. Repsol owned 57 percent of YPF and it will be left with six percent. Over recent months the Argentine government has asserted that exploration and production companies operating in Argentina had not invested sufficiently to overcome domestic production declines, thereby leading to reduced levels of oil and natural gas production as well as reductions in oil and natural gas proved reserves. As described elsewhere in this document, politically driven price controls implemented by the government over the past decade have kept oil price net backs in Argentina far below world market levels and prices of natural gas produced in country far below the price of imported natural gas. These low prices have created disincentives for exploration drilling. The result has been that Argentina has become an importer of natural gas with the government subsidizing this at a cost of billions of dollars per year.
In February 2012, the Argentine federal government and the hydrocarbon producing provinces, which have dominion over the subsurface minerals, issued a statement declaring their intention to increase oil and gas investment and hydrocarbon production in the country. YPF, as the largest oil and gas producing company in Argentina, and the previous state owned energy company, was the primary target of this criticism. Previous to Argentina’s energy deregulation in the early 1990s, YPF was 100 percent owned by the Argentine government. YPF was subsequently sold off and became a publicly owned company of which Repsol acquired a majority shareholder interest.
During the first quarter of 2012, provincial governments began rescinding certain of YPF’s concessions. The province of Neuquén, however, also rescinded one non-producing concession each from two other companies including Petrobras Energía, our partner in our core properties. During the quarter, YPF publicly announced a very significant upward revision to 22.8 billion barrels of oil resource potential in their Neuquén basin properties certified by the engineering consulting firm Ryder Scott Company.
As a result of these actions and events, and in spite of the YPF announcement, the share price of YPF and many other public companies with oil and gas interests in Argentina have fallen off precipitously as have the shares of Apco.
The law enabling the expropriation was approved by both chambers of Argentina’s congress in May. These events could act to discourage the influx of needed capital in Argentina for oil and gas exploration and development, especially the continued exploration of Argentina’s unconventional potential.
However, in spite of these actions and events, we do not expect negative repercussions to our operations in Argentina. We have historically reinvested most of our earnings into the exploration and development of our properties in Argentina with positive results to both oil and natural gas production and proved reserves. We are currently working with our partners to obtain concession extensions in the provinces of Río Negro and Tierra del Fuego and have recently received approvals to convert Charco del Palenque and the northern portion of the Coirón Amargo block to 25-year concessions.
Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-(e) of the Securities Exchange Act of 1934) (Disclosure Controls) or our internal controls over financial reporting (Internal Controls) will prevent all errors 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. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the 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 a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also 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 the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. We monitor our Disclosure Controls and Internal Controls and make modifications as necessary; our intent in this regard is that the Disclosure Controls and Internal Controls will be modified as systems change and conditions warrant.
Evaluation of Disclosure Controls and Procedures
An evaluation of the effectiveness of the design and operation of our Disclosure Controls was performed as of the end of the period covered by this report. This evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that these Disclosure Controls were not effective at a reasonable assurance level at the end of the period covered by this report.
First Quarter 2012 Changes in Internal Controls
As previously reported in Management’s Report on Internal Control Over Financial Reporting in our Form 10-K, in the third quarter of 2011, we identified a material weakness related to the lack of technical accounting resources. Although we believe the steps taken to date, including the retention of additional technical personnel in the first quarter of 2012, have improved our internal controls over financial reporting, we have not completely remediated our internal control deficiencies. Therefore, the material weakness still existed at the end of the period covered by this report.
Other than described above, there have been no changes during the first quarter of 2012 that have materially affected, or are reasonably likely to materially affect, our Internal Controls over financial reporting.
PART II. OTHER INFORMATION
The additional information called for by this item is provided in Note 6 Contingencies in the Notes to the Consolidated Financial Statements included under Part I, Item 1. Financial Statements of this report, which information is incorporated by reference into this item.
Part I, Item 1A. “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2011, includes certain risk factors that could materially affect our business, financial condition or future results. Those risk factors have not materially changed, except as set forth below.
The Argentine government could take action with regard to our concessions before their contract terms expire.
During the first quarter of 2012, the Argentine government asserted that exploration and production companies operating in Argentina had not invested sufficiently to overcome domestic production declines, thereby leading to reduced levels of oil and natural gas production as well as reductions in oil and natural proved reserves. On that basis, several provinces rescinded certain of YPF’s and other producer’s concessions. In addition, the federal government expropriated a majority interest in YPF, the largest oil producing company in Argentina. If the government subjectively determines that we have not sufficiently invested in our properties, they could take action with regard to our concessions before their contract terms expire. See “Quantitative and Qualitative Disclosures about Market Risk – Economic and Political Environment” in Item 3 of this report.
3.1 – Memorandum of Association of Apco Oil and Gas International Inc., as amended, (incorporated by reference to Exhibit 3.2 to our Quarterly Report on Form 10-Q filed with the SEC on August 7, 2007).
3.2 – Articles of Association of Apco Oil and Gas International Inc. as amended, (incorporated by reference to Exhibit 3.2 to our Quarterly Report on Form 10-Q filed with the SEC on August 8, 2011).
4.1 – Specimen Ordinary Share Certificate of Apco Oil and Gas International Inc. (incorporated by reference to Exhibit 4.1 to our Quarterly Report on Form 10-Q filed with the SEC on August 7, 2009).
31.1 – Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer.*
31.2 – Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.*
32 – Section 1350 Certifications of Chief Executive Officer and Chief Financial Officer.**
101 .INS – XBRL Instance Document**
101 .SCH – XBRL Schema Document**
101 .CAL – XBRL Calculation Linkbase Document**
101 .LAB – XBRL Label Linkbase Document**
101 .PRE – XBRL Presentation Linkbase Document**
101 .DEF – XBRL Definition Linkbase Document**
* Filed herewith.
Pursuant to the requirements 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.
APCO OIL AND GAS INTERNATIONAL INC.
By: /s/ Landy L. Fullmer
Chief Financial Officer,
Chief Accounting Officer and Controller
(Duly Authorized Officer
and Principal Accounting Officer)
May 8, 2012
INDEX TO EXHIBITS
* Filed herewith.
** Furnished herewith.