NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation and Significant Accounting Policies
Basis of Presentation
We prepared this Quarterly Report on Form 10-Q under the rules and regulations of the United States Securities and Exchange Commission (SEC) and in accordance with United States generally accepted accounting principles (U.S. GAAP) as it applies to interim financial statements. Because this is an interim period report presented using a condensed format, it does not include all of the disclosures required by U.S. GAAP and should be read along with our
2018
Annual Report on
Form 10-K. The condensed consolidated financial statements as of
June 30, 2019
and
2018
are unaudited. The consolidated balance sheet as of
December 31, 2018
has been derived from the audited consolidated balance sheet included in our
2018
Annual Report on Form 10-K. In our opinion, all adjustments which are of a normal, recurring nature are reflected to fairly present these interim period results. Our financial statements for prior periods include reclassifications that were made to conform to the current year presentation, none of which impacted our reported net income, stockholder’s equity or cash flows from operating activities. The results for any interim period are not necessarily indicative of the expected results for the entire year.
Liquidity and Ability to Continue as a Going Concern
The accompanying interim consolidated financial statements have been prepared assuming the Company will continue as a going concern. The interim consolidated financial statements do not include any adjustments that might result from the outcome of a going concern uncertainty.
As previously disclosed, in May 2020,
$182 million
of our senior unsecured notes will mature. Based on our forecasted EBITDAX and cash on hand, we anticipate that we will not have sufficient liquidity to repay these notes, meet our working capital needs and/or fund our planned capital expenditures as of one year from the filing date of these financial statements without obtaining additional liquidity through other sources. On August 1, 2019, we borrowed
$268 million
under our Reserve-Based Loan Facility (RBL Facility). Following this drawdown, we have
no
borrowing capacity remaining under the RBL Facility.
In addition, in the next six months, we have the following near-term interest payments due on our indebtedness: (i) an approximately
$40 million
interest payment due under the indenture governing our 8.000% 1.5 Lien Notes due 2025 (the “2025 1.5 Lien Notes”) on August 15, 2019; (ii) an approximately
$7 million
interest payment due under the indenture governing our 7.750% Senior Unsecured Notes due 2022 on September 1, 2019; (iii) an approximately
$9 million
interest payment due under the indenture governing our 9.375% Senior Unsecured Notes due 2020 on November 1, 2019; (iv) an approximately
$51 million
interest payment under the indenture governing our 9.375% 1.5 Lien Notes due 2024 on November 1, 2019; (v) an approximately
$39 million
interest payment due under the indenture governing our 7.750% 1.125 Lien Notes due 2026 on November 15, 2019; (vi) an approximately
$20 million
interest payment due under the indenture governing our 8.000% 1.25 Lien Notes due 2024 on December 2, 2019; and (vii) an approximately
$10 million
interest payment due under the indenture governing our 6.375% Senior Unsecured Notes due 2023 on December 15, 2019. While no decision has been made at this time, we may determine not to pay the interest due on our 2025 1.5 Lien Notes on the August 15, 2019 interest payment due date, and we may decide to utilize the 30-day grace period under the indenture governing the 2025 1.5 Lien Notes, or may not make this interest payment or future interest payments at all. Any failure to make payments of interest and principal on our outstanding indebtedness on a timely basis, including with respect to the 2025 1.5 Lien Notes, would likely result in a default under that indebtedness and likely cause cross-defaults and/or cross-acceleration under our other indebtedness, which in the event of available capacity, could limit our ability to borrow under the RBL Facility.
As a result of these issues, there is substantial doubt about the Company’s ability to continue as a going concern. In order to address these issues, our Board of Directors (the “Board”) has appointed a special committee (the “Special Committee”) of the Board consisting of independent members of the Board who are not affiliated with our Sponsors (affiliates of Apollo Global Management LLC, Riverstone Holdings LLC, Access Industries and Korea National Oil Corporation, collectively, the “Sponsors”), and we have engaged financial and legal advisors to consider a number of potential actions we may take in order to address our liquidity and balance sheet issues. We are evaluating certain strategic alternatives including financings, refinancings, amendments, waivers, forbearances, asset sales, debt issuances, exchanges and purchases, out-of-court or in-court restructurings (pursuant to which we may seek relief under the United States Bankruptcy Code, Title 11 (the
“Bankruptcy Code”)) and/or similar transactions involving the Company, none of which have been implemented at this time. The Special Committee is authorized to, among other things, consider, evaluate and approve such strategic alternatives.
However, there is no assurance that our actions will be successful in alleviating these concerns. Should we not be able to execute on one of or a combination of these strategic alternatives, we would be unable to continue as a going concern. In addition, in the absence of any suitable relief through the actions mentioned above, should we be required to include a going concern qualification in our year-end audit report and audited financial statements for 2019, the disclosure would be considered a default under the RBL Facility, and potentially an event of default if not waived within 30 days after receiving notice of the default from the administrative agent under the RBL Facility. An event of default under the RBL Facility could trigger cross-defaults and/or cross acceleration under our other debt agreements, including our senior secured and unsecured notes, which could also result in the acceleration of those obligations by the lenders thereunder.
Furthermore, failure to comply with not only the covenants associated with the indebtedness noted above, but also those under each of our debt agreements would likely result in a default under the indebtedness and likely cause cross-defaults and/or cross-acceleration under our other indebtedness. Any cross-defaults and cross-accelerations of our indebtedness could have a material adverse effect on our business, financial condition, liquidity and results of operations and could require that we take other actions to protect our business, including seeking forbearance agreements from our lenders and investors and/or filing for protection under the Bankruptcy Code.
Significant Accounting Policies
In the first quarter of 2019, we adopted Accounting Standards Update (ASU) No. 2016-02,
Leases,
which requires lessees to recognize lease assets and liabilities on the balance sheet and disclose key information about leasing arrangements. We adopted this standard on a modified retrospective basis, allowing us to account for leases entered into before adoption under prior ASC 840 guidance. The adoption did not have a material impact on our consolidated financial statements, nor did the adoption result in a cumulative-effect adjustment to retained earnings. In addition, we made certain permitted elections upon adoption, the most significant of which were (i) exempting short-term leases (i.e., leases with an initial term of less than 12 months) from balance sheet recognition, (ii) maintaining existing accounting treatment for existing or expired land easements not previously accounted for as leases under prior guidance and (iii) accounting for lease and non-lease components in a contract as a single lease component when not readily determinable. For a further discussion on leases, see Note 7.
2. Income Taxes
Effective Tax Rate.
Interim period income taxes are computed by applying an anticipated annual effective tax rate to year-to-date income or loss, except for significant, unusual or infrequently occurring items, which income tax effects are recorded in the period in which they occur. Changes in tax laws or rates are recorded in the period they are enacted.
For both the quarters and
six
months ended
June 30, 2019
and
2018
, our effective tax rates were approximately
0%
. Our effective tax rates in
2019
and
2018
differed from the statutory rate of 21% primarily as a result of our recognition of a full valuation allowance on our net deferred tax assets. In addition, we recorded adjustments to the valuation allowance on our net deferred tax assets, which offset deferred income tax benefits by
$9 million
and
$13 million
, for the quarters ended
June 30, 2019
and
2018
, respectively, and by
$39 million
and
$8 million
for the
six
months ended
June 30, 2019
and
2018
, respectively.
We evaluate the realization of our deferred tax assets and record any associated valuation allowance after considering cumulative book losses, the reversal of existing temporary differences, the existence of taxable income in prior carryback years, tax planning strategies and future taxable income for each of our taxable jurisdictions. Based upon the evaluation of the available evidence, we maintained a valuation allowance against our net deferred tax assets of
$896 million
as of
June 30, 2019
.
The Company's and certain subsidiaries' income tax years after 2014 remain open and subject to examination by both federal and state tax authorities, and in 2018 we were notified of an IRS examination of our 2016 U.S. tax return.
3. Earnings Per Share
We exclude potentially dilutive securities from the determination of diluted earnings per share (as well as their related income statement impacts) when their impact on net income per common share is antidilutive. Potentially dilutive securities consist of our stock options, restricted stock and performance share unit awards. For both the quarters and
six
months ended
June 30, 2019
and
2018
, we incurred net losses and accordingly excluded all potentially dilutive securities from the determination of diluted earnings per share as their impact on loss per common share was antidilutive.
4. Fair Value Measurements
We use various methods to determine the fair values of our financial instruments. The fair value of a financial instrument depends on a number of factors, including the availability of observable market data over the contractual term of the underlying instrument. We separate the fair value of our financial instruments into three levels (Levels 1, 2 and 3) based on our assessment of the availability of observable market data and the significance of non-observable data used to determine fair value. As of
June 30, 2019
and
December 31, 2018
, all of our derivative financial instruments were classified as Level 2. Our assessment of the level of an instrument can change over time based on the maturity or liquidity of the instrument.
The following table presents the carrying amounts and estimated fair values of our financial instruments:
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|
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|
|
|
|
|
|
June 30, 2019
|
|
December 31, 2018
|
|
Carrying
Amount
|
|
Fair
Value
|
|
Carrying
Amount
|
|
Fair
Value
|
|
(in millions)
|
Current maturities of long-term debt
|
$
|
182
|
|
|
$
|
7
|
|
|
$
|
58
|
|
|
$
|
44
|
|
|
|
|
|
|
|
|
|
Long-term debt (see Note 6)
|
$
|
4,453
|
|
|
$
|
2,051
|
|
|
$
|
4,380
|
|
|
$
|
2,532
|
|
|
|
|
|
|
|
|
|
Derivative instruments
|
$
|
34
|
|
|
$
|
34
|
|
|
$
|
114
|
|
|
$
|
114
|
|
As of
June 30, 2019
and
December 31, 2018
, the carrying amount of cash and cash equivalents, accounts receivable, owner and royalties payable, and accounts payable represent fair value because of the short-term nature of these instruments. We hold long-term debt obligations with various terms. We estimated the fair value of debt (representing a Level 2 fair value measurement) primarily based on quoted market prices for the same or similar issuances, considering our credit risk.
Oil, Natural Gas and NGLs Derivative Instruments.
We attempt to mitigate a portion of our commodity price risk and stabilize cash flows associated with forecasted sales of oil, natural gas and NGLs through the use of financial derivatives. As of
June 30, 2019
, we had derivative contracts in the form of collars and three-way collars on
19
MMBbls of oil (
7
MMBbls in 2019 and
12
MMBbls in 2020). In addition to our oil derivatives, we had derivative contracts in the form of fixed price swaps and collars on
13
TBtu of natural gas in 2019. As of
December 31, 2018
, we had derivative contracts for
16
MMBbls of oil and
26
TBtu of natural gas. In addition to the contracts above, we have derivative contracts related to locational basis differences on our oil and natural gas production.
None
of our derivative contracts are designated as accounting hedges.
The following table presents the fair value associated with our derivative financial instruments as of
June 30, 2019
and
December 31, 2018
. All of our derivative instruments are subject to master netting arrangements, which provide for the unconditional right of offset for all derivative assets and liabilities with a given counterparty in the event of default. We present assets and liabilities related to these instruments in our consolidated balance sheets as either current or non-current assets or liabilities based on their anticipated settlement date, net of the impact of master netting agreements. On derivative contracts recorded as assets in the table below, we are exposed to the risk that our counterparties may not perform.
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Level 2
|
|
Derivative Assets
|
|
Derivative Liabilities
|
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Gross
Fair Value
|
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|
|
Balance Sheet Location
|
|
Gross
Fair Value
|
|
|
|
Balance Sheet Location
|
|
|
Impact of
Netting
|
|
Current
|
|
Non-
current
|
|
|
Impact of
Netting
|
|
Current
|
|
Non-
current
|
|
(in millions)
|
|
(in millions)
|
June 30, 2019
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|
|
|
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative instruments
|
$
|
38
|
|
|
$
|
(4
|
)
|
|
$
|
24
|
|
|
$
|
10
|
|
|
$
|
(4
|
)
|
|
$
|
4
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2018
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative instruments
|
$
|
116
|
|
|
$
|
(2
|
)
|
|
$
|
101
|
|
|
$
|
13
|
|
|
$
|
(2
|
)
|
|
$
|
2
|
|
|
$
|
—
|
|
|
$
|
—
|
|
For the quarters ended
June 30, 2019
and
2018
, we recorded derivative gains and losses of
$29 million
and
$64 million
, respectively. For the six months ended
June 30, 2019
and
2018
, we recorded derivative losses of
$66 million
and
$78
million
, respectively. Derivative gains and losses on our oil, natural gas and NGLs financial derivative instruments are recorded in operating revenues in our consolidated income statements.
5. Property, Plant and Equipment
Oil and Natural Gas Properties
. As of
June 30, 2019
and
December 31, 2018
, we had approximately
$3.9 billion
and
$3.8 billion
, respectively, of total property, plant, and equipment, net of accumulated depreciation, depletion and amortization on our consolidated balance sheets, substantially all of which relates to proved oil and natural gas properties.
Our capitalized costs related to proved oil and natural gas properties by area were as follows:
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|
|
|
June 30, 2019
|
|
December 31, 2018
|
|
(in millions)
|
Proved
|
|
|
|
Eagle Ford
|
$
|
4,132
|
|
|
$
|
3,898
|
|
Permian
|
1,789
|
|
|
1,787
|
|
Northeastern Utah
|
1,704
|
|
|
1,659
|
|
Total Proved
|
7,625
|
|
|
7,344
|
|
Less accumulated depletion
|
(3,772
|
)
|
|
(3,607
|
)
|
Net capitalized costs for oil and natural gas properties
|
$
|
3,853
|
|
|
$
|
3,737
|
|
Suspended well costs were not material as of
June 30, 2019
or
December 31, 2018
.
We evaluate capitalized costs related to proved properties upon a triggering event (e.g., a significant continued decline in forward commodity prices) to determine if an impairment of such properties has occurred. Commodity price declines may cause changes to our capital spending levels, production rates, levels of proved reserves and development plans, which may result in an impairment of the carrying value of our proved properties in the future.
Asset Retirement Obligations.
We have legal asset retirement obligations associated with the retirement of our oil and natural gas wells and related infrastructure. We settle these obligations when production on those wells is exhausted, when we no longer plan to use them or when we abandon them. We accrue these obligations when we can estimate the timing and amount of their settlement.
Changes in estimates represent changes to the expected amount and timing of payments to settle our asset retirement obligations. Typically, these changes primarily result from obtaining new information about the timing of our obligations to plug and abandon oil and natural gas wells and the costs to do so, or reassessing our assumptions in light of changing market conditions. The net asset retirement liability as of
June 30, 2019
on our consolidated balance sheet in other current and non-current liabilities and the changes in the net liability from January 1 through
June 30, 2019
were as follows:
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|
|
|
2019
|
|
(in millions)
|
Net asset retirement liability at January 1
|
$
|
42
|
|
Accretion expense
|
2
|
|
Net asset retirement liability at June 30
|
$
|
44
|
|
Capitalized Interest.
Interest expense is reflected in our consolidated financial statements net of capitalized interest. We capitalize interest primarily on the costs associated with drilling and completing wells until production begins using a weighted average interest rate on our outstanding borrowings. Capitalized interest for both the quarters and
six
months ended
June 30, 2019
and
2018
were approximately
$2 million
and
$3 million
, respectively.
6. Long-Term Debt
Listed below are our debt obligations as of the periods presented:
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Interest Rate
|
|
June 30, 2019
|
|
December 31, 2018
|
|
|
|
(in millions)
|
RBL credit facility - due November 23, 2021
(1)
|
Variable
|
|
$
|
355
|
|
|
$
|
100
|
|
Senior secured term loans:
|
|
|
|
|
|
2.0 Lien due April 30, 2019
(2)
|
Variable
|
|
—
|
|
|
8
|
|
Senior secured notes:
|
|
|
|
|
|
1.5 Lien due May 1, 2024
|
9.375%
|
|
1,092
|
|
|
1,092
|
|
1.25 Lien due November 29, 2024
|
8.000%
|
|
500
|
|
|
500
|
|
1.5 Lien due February 15, 2025
|
8.000%
|
|
1,000
|
|
|
1,000
|
|
1.125 Lien due May 15, 2026
|
7.750%
|
|
1,000
|
|
|
1,000
|
|
Senior unsecured notes:
|
|
|
|
|
|
Due May 1, 2020
|
9.375%
|
|
182
|
|
|
232
|
|
Due September 1, 2022
|
7.75%
|
|
182
|
|
|
182
|
|
Due June 15, 2023
|
6.375%
|
|
324
|
|
|
324
|
|
Total debt
|
|
|
4,635
|
|
|
4,438
|
|
Current maturities of long-term debt, net of debt issue costs of less than $1 million
|
|
|
(182
|
)
|
|
(58
|
)
|
Total long-term debt
|
|
|
4,453
|
|
|
4,380
|
|
Less debt discount and non-current portion of unamortized debt issue costs
(3)
|
|
|
(88
|
)
|
|
(95
|
)
|
Total long-term debt, net
|
|
|
$
|
4,365
|
|
|
$
|
4,285
|
|
|
|
(1)
|
Carries interest at a specified margin over
LIBOR
of
2.50%
to
3.50%
, based on borrowing utilization.
|
(2)
Carries interest at a specified margin over the
LIBOR
of
3.50%
, with a minimum
LIBOR
floor of
1.00%
. As of April 30, 2019 and
December 31, 2018
, the effective interest rates for the term loan were
6.08%
and
6.21%
. In April 2019, we retired the note in full.
|
|
(3)
|
Includes debt discount of
$39 million
and
$42 million
as of
June 30, 2019
and
December 31, 2018
, respectively, associated with our 1.5 Lien Notes maturing in 2024 and unamortized debt issue costs of
$49 million
and
$53 million
as of
June 30, 2019
and
December 31, 2018
, respectively.
|
Gain on extinguishment/modification of debt
. During 2018, we completed an exchange of approximately
$1.1 billion
of certain senior unsecured notes for new 1.5 Lien Notes maturing in 2024. The exchange transaction was accounted for as a modification of debt and an extinguishment of debt depending on the senior unsecured notes exchanged. In conjunction with the exchange, we recorded a
$12 million
loss on debt considered modified for accounting purposes and a net gain of
$53 million
on debt considered extinguished for accounting purposes.
Additionally, in 2019 and 2018, we also recorded gains and losses on extinguishment/modification of debt primarily related to repurchased debt as follows:
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|
Quarter ended June 30,
|
|
Six months ended June 30,
|
|
|
2019
|
|
2018
|
|
2019
|
|
2018
|
|
|
(in millions)
|
Debt repurchased- face value
(1)
|
|
—
|
|
|
19
|
|
|
50
|
|
|
19
|
|
Cash paid
|
|
—
|
|
|
10
|
|
|
40
|
|
|
10
|
|
Gain on extinguishment of debt
|
|
—
|
|
|
9
|
|
|
10
|
|
|
9
|
|
Other losses on extinguishment of debt
(2)
|
|
—
|
|
|
(2
|
)
|
|
—
|
|
|
(2
|
)
|
(1) In 2019 and 2018, repurchases were associated with our 2020 senior unsecured notes and 2022 and 2023 senior unsecured notes, respectively.
(2) Reflects the elimination of associated unamortized debt issue costs related to the reduction of our RBL Facility commitments in 2018.
Reserve-based Loan Facility.
We have a RBL Facility which allows us to borrow funds or issue letters of credit (LCs) up to
$629 million
. The RBL Facility matures in November 2021. As of
June 30, 2019
, we had
$247 million
of capacity
remaining with approximately
$27 million
of LCs issued and
$355 million
outstanding under the RBL Facility. On August 1, 2019, we borrowed
$268 million
under our RBL Facility. Following this drawdown, we have
no
borrowing capacity remaining under the RBL Facility.
The RBL Facility is collateralized by certain of our oil and natural gas properties and has a borrowing base subject to semi-annual redetermination. In April 2019, our RBL borrowing base was reaffirmed at
$1.36 billion
and total commitments remained at
$629 million
. Our next redetermination date is in November 2019. Downward revisions of our oil and natural gas reserves volume and value due to declines in commodity prices, the impact of lower estimated capital spending in response to lower prices, performance revisions, or sales of assets or the incurrence of certain types of additional debt, among other items, could cause a reduction of our borrowing base in the future, and these reductions could be significant.
Restrictive Provisions/Covenants.
The availability of borrowings under our RBL Facility and our ability to incur additional indebtedness is subject to various financial and non-financial covenants and restrictions, including first lien debt to EBITDAX and current ratio financial covenants. First lien debt for purposes of the covenant only includes amounts borrowed under our RBL Facility. Our current financial covenants require us to maintain a ratio of first lien debt to EBITDAX not exceeding
2.25
to 1.00 and a current ratio (as defined in the RBL Facility) of not less than
1.00
to 1.00. As of
June 30, 2019
, we were in compliance with our debt covenants.
Under our various debt agreements, we are limited in our ability to repurchase certain tranches of non-RBL Facility debt. Certain other covenants and restrictions, among other things, also limit or place certain conditions on our ability to incur or guarantee additional indebtedness, make restricted payments, pay dividends on equity interests, redeem, repurchase or retire equity interests or subordinated indebtedness, sell assets, make investments, create certain liens, prepay debt obligations, engage in certain transactions with affiliates, and enter into certain hedging agreements. We are also subject to cross-defaults and/or cross-acceleration under our debt agreements which are further described in Note 1.
7. Commitments and Contingencies
Legal Matters
We and our subsidiaries and affiliates are parties to various legal actions and claims that arise in the ordinary course of our business. For each matter, we evaluate the merits of the case or claim, our exposure to the matter, possible legal or settlement strategies and the likelihood of an unfavorable outcome. If we determine that an unfavorable outcome is probable and can be estimated, we establish the necessary accruals. While the outcome of our current matters cannot be predicted with certainty and there are still uncertainties related to the costs we may incur, based upon our evaluation and experience to date, we believe we have established appropriate reserves for these matters. It is possible, however, that new information or future developments could require us to reassess our potential exposure and adjust our accruals accordingly, and these adjustments could be material. As of
June 30, 2019
, we had approximately
$29 million
accrued for all outstanding legal matters.
FairfieldNodal v. EP Energy E&P Company
,
L.P.
On March 3, 2014, Fairfield filed suit against one of our subsidiaries in the 157th District Court of Harris County, Texas, claiming we were contractually obligated to pay a transfer fee of approximately
$21 million
for seismic licensing, triggered by a change in control with the Sponsors’ (affiliates of Apollo Global Management LLC, Riverstone Holdings LLC, Access Industries and Korea National Oil Corporation, collectively, the Sponsors) acquisition of our predecessor entity in 2012. Prior to the change in control, we had unilaterally terminated the seismic licensing agreements, and we returned the applicable seismic data. Fairfield also claimed EP Energy did not properly maintain the confidentiality of the seismic data and interpretations made from it. In April 2015, the district court granted summary judgment to EP Energy, and Fairfield then appealed. On July 6, 2017, an intermediate court of appeals in Texas reversed the judgment related to the transfer fee and denied rehearing on October 5, 2017. We filed a petition for review in the Texas Supreme Court, which denied review in June 2019. We filed a motion for rehearing in the Texas Supreme Court on July 31, 2019. If denied, the case will be remanded to the trial court for further proceedings. As of
June 30, 2019
, we had accrued
$21 million
related to this matter.
Weyerhaeuser Company v. Pardee Minerals LLC, et al.
On July 5, 2017, Weyerhaeuser filed suit against one of our subsidiaries, among other defendants, in the United States District Court for the Western District of Louisiana. Weyerhaeuser seeks to recoup the value of production after November 2006 (approximately
$15.6 million
) plus judicial interest (approximately
$7.8 million
at this time) from certain wells drilled by EP Energy between 2002 and 2013 on leases Weyerhaeuser claims were invalid. Weyerhaeuser alleges that lessees prior to EP Energy had not drilled wells in good faith to perpetuate the associated mineral servitude (rights conveyed to produce minerals), rendering EP Energy’s subsequent lease invalid. As of
June 30, 2019
, we had accrued
$3 million
related to this matter, which was subsequently settled in July 2019.
Storey Minerals, Ltd., et al. v. EP Energy E&P Company, L.P.
On May 29, 2018, Storey Minerals, Ltd., Maltsberger/Storey Ranch, LLC, and Rene R. Barrientos, Ltd. (collectively, “MSB”) filed suit against EP Energy in the 81
st
Judicial District Court of La Salle County, Texas. MSB alleged that by acquiring certain oil and gas leases within the perimeter of the Storey Altito Ranch, EP Energy triggered the most favored nation clause (“MFN clause”) in the leases. After investigation, EP Energy agreed that the MFN clause had been triggered and tendered a lease amendment with a check for
$4 million
for increased lease bonus. EP Energy's calculation confirmed that no delay rentals were due. MSB, however, did not accept the tender and asserts that the MFN clause operates retroactively to the date of the lease and applies to all of the acreage leased at that time. EP Energy maintains that the unambiguous language in the MFN clause operates prospectively and supports its tendered amendment and calculation. The parties filed cross-motions for summary judgment. In June 2019, the court entered an order agreeing with EP Energy on delay rentals, but with MSB on lease bonus. The court entered a final judgment in July 2019 ordering EP Energy to pay MSB
$43.8 million
in increased lease bonus, attorney’s fees, expenses and interest to date. EP Energy filed an appeal to the Fourth Circuit Court of Appeals in San Antonio on July 17, 2019 and intends to pursue fully its appeal. As of
June 30, 2019
, EP Energy's accrual of
$4 million
related to this matter reflects the amount tendered to MSB with the lease amendment noted above, which EP Energy believes is the appropriate amount of increased bonus due to MSB.
Environmental Matters
We are subject to existing federal, state and local laws and regulations governing environmental quality, pollution control and greenhouse gas (GHG) emissions. Numerous governmental agencies, such as the Environmental Protection Agency (EPA), issue regulations which often require difficult and costly compliance measures that carry substantial administrative, civil and criminal penalties and may result in injunctive obligations for non-compliance. Our management believes that we are in substantial compliance with applicable environmental laws and regulations, and we have not experienced any material adverse effect from compliance with these environmental requirements. For additional details on certain environmental matters, including matters related to climate change, air quality and other emissions, hydraulic fracturing regulations and waste handling, refer to the Risk Factors section of our
2018
Annual Report on Form 10-K.
While our reserves for environmental matters are currently not material, there are still uncertainties related to the ultimate costs we may incur in the future in order to comply with increasingly strict environmental laws, regulations, and orders of regulatory agencies, as well as claims for damages to property and the environment or injuries to employees and other persons resulting from our current or past operations. Based upon our evaluation and experience to date, however, we believe our accruals for these matters are adequate. It is possible that new information or future developments could result in substantial additional costs and liabilities which could require us to reassess our potential exposure related to these matters and to adjust our accruals accordingly, and these adjustments could be material.
Other Matters
As of
June 30, 2019
, we had approximately
$15 million
accrued (in other accrued liabilities in our consolidated balance sheet) related to other contingent matters including, but not limited to, a number of examinations by taxing authorities on non-income matters and indemnifications that we periodically enter into as part of the divestiture of assets or businesses. These arrangements include, but are not limited to, indemnifications for income taxes, the resolution of existing disputes and other contingent matters. In addition, the decline in commodity prices has created an environment where there is an increased risk that owners and/or operators of assets previously purchased from us may no longer be able to satisfy plugging and abandonment obligations that attach to such assets. In that event, under various laws or regulations, we could be required to assume all, or a portion of the plugging or abandonment obligations on assets we no longer own or operate.
Lease Obligations
Our noncancellable leases classified as finance leases for accounting purposes include certain compressors under long-term arrangements which were capitalized upon commencement of the lease term at the fair value of the leased asset, which was lower than the present value of the minimum lease payments. The discount rate used for our finance leases was the incremental borrowing rate adjusted so that the present value of the corresponding lease payments did not exceed the fair value of the leased asset. For the quarter ended
June 30, 2019
, both interest and depreciation expense associated with our finance leases was approximately
$1 million
and related cash payments were approximately
$2 million
. For the
six
months ended
June 30, 2019
, both interest and depreciation expense associated with our finance leases were approximately
$2 million
and related cash payments were approximately
$4 million
.
Our noncancellable leases classified as operating leases and capitalized upon commencement of the lease term for accounting purposes include those for office space, drilling rigs and field equipment. The discount rate used for our operating leases is either the discount rate implicit in the contract, or the applicable interest rate on a collateralized basis if not determinable. Operating lease costs for minimum lease payments are recognized as capital or expense on a straight-line basis
over the lease term depending on the nature of the payment. For the quarter ended
June 30, 2019
, operating lease costs and related cash payments were approximately
$3 million
and
$2 million
, respectively, and
$5 million
and
$3 million
, respectively, for the six months ended
June 30, 2019
. These were primarily capitalized as part of our oil and natural gas properties. Variable lease costs (amounts incurred beyond minimum lease payments such as utilities, usage, maintenance, mobilization fees, etc.) are recognized in the period incurred. For both the
quarter and six
months ended
June 30, 2019
, variable lease costs were approximately
$1 million
.
Short-term lease costs for the
quarter and six
months ended
June 30, 2019
were approximately
$7 million
and
$16 million
, respectively, and were primarily capitalized as part of our oil and natural gas properties.
Supplemental balance sheet information related to leases was as follows:
|
|
|
|
|
|
|
|
June 30, 2019
|
|
|
(in millions)
|
Operating lease assets
(1)(4)
|
|
$
|
23
|
|
Finance lease assets
(2)
|
|
11
|
|
Total lease assets
|
|
$
|
34
|
|
|
|
|
Operating leases
(3)(4)
|
|
|
Current liability
|
|
$
|
10
|
|
Noncurrent liability
|
|
13
|
|
Total operating lease liability
|
|
$
|
23
|
|
Finance leases
(3)
|
|
|
Current liability
|
|
$
|
2
|
|
Noncurrent liability
|
|
9
|
|
Total finance lease liability
|
|
$
|
11
|
|
|
|
|
Weighted average remaining lease term
|
|
|
Operating leases
|
|
4 years
|
|
Finance leases
|
|
4 years
|
|
Weighted average discount rate
|
|
|
Operating leases
|
|
9.37
|
%
|
Finance leases
|
|
26.52
|
%
|
|
|
(1)
|
Operating lease assets are reflected in
Operating lease assets and other
in our consolidated balance sheet as of
June 30, 2019
.
|
|
|
(2)
|
Finance lease assets are reflected in
Other property, plant and equipment
in our consolidated balance sheet as of
June 30, 2019
.
|
|
|
(3)
|
Current and noncurrent operating and finance lease liabilities are reflected in
Other accrued liabilities
and
Lease obligations and other,
respectively, in our consolidated balance sheet as of
June 30, 2019
.
|
|
|
(4)
|
Upon adoption of ASU 2016-02 effective January 1, 2019, we recognized operating leases of approximately $10 million. For the six months ended
June 30, 2019
, we also recorded an additional $16 million of operating leases.
|
Future minimum annual rental commitments under non-cancelable future operating and finance lease commitments at
June 30, 2019
, were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
Operating Leases
|
|
Finance Leases
|
|
|
(in millions)
|
2019
|
|
$
|
6
|
|
|
$
|
2
|
|
2020
|
|
10
|
|
|
5
|
|
2021
|
|
3
|
|
|
5
|
|
2022
|
|
2
|
|
|
5
|
|
Thereafter
|
|
6
|
|
|
2
|
|
Total
|
|
$
|
27
|
|
|
$
|
19
|
|
Less: imputed interest
|
|
(4
|
)
|
|
(8
|
)
|
Present value of operating and finance lease obligations
|
|
$
|
23
|
|
|
$
|
11
|
|
8. Incentive Compensation
Long-term Incentive Compensation
Our long-term incentive (LTI) programs consist of restricted stock, stock options, cash-based incentives and performance share units awards. Refer to our
2018
Annual Report on Form 10-K and on Form 10-K/A for further information regarding the terms and details of these awards. We record compensation expense on all of our LTI awards as general and administrative expense over the requisite service period. Pre-tax compensation expense related to all of our LTI awards (both equity and liability based), net of the impact of forfeitures, was approximately
$3 million
for both of the quarters ended
June 30, 2019
and
2018
, and
$7 million
and
$4 million
for the
six
months ended
June 30, 2019
and
2018
, respectively. As of
June 30, 2019
, we had unrecognized compensation expense of
$18 million
of which we will recognize
$7 million
during the remainder of
2019
and
$11 million
thereafter.
Restricted Stock.
A summary of the changes in our non-vested restricted shares for the
six
months ended
June 30, 2019
is presented below:
|
|
|
|
|
|
|
|
|
|
|
Number of Shares
|
|
Weighted Average
Grant Date Fair Value
per Share
|
Non-vested at December 31, 2018
|
|
7,060,334
|
|
|
$
|
2.69
|
|
Granted
|
|
103,000
|
|
|
$
|
0.70
|
|
Vested
|
|
(1,112,910
|
)
|
|
$
|
4.93
|
|
Forfeited
|
|
(754,623
|
)
|
|
$
|
2.60
|
|
Non-vested at June 30, 2019
|
|
5,295,801
|
|
|
$
|
2.24
|
|
Performance Share Units.
In 2018, we granted
618,720
performance share units (PSUs) to certain EP Energy employees. The grant date fair value of the 2018 awards was approximately
$5 million
as determined by a Monte Carlo simulation, utilizing an expected volatility of approximately
90%
and a risk free rate of approximately
3%
. As of
June 30, 2019
, we had a total of
1,487,280
PSUs outstanding. PSUs will vest over a weighted average period of
three
years and earned only upon the achievement of specified stock price goals. Our PSUs are treated as an equity award with the expense recognized on an accelerated basis over the life of the award.
Key Employee Retention Program
On May 29, 2019, the Compensation Committee of the Board of Directors of the Company approved the implementation of a Key Employee Retention Program (a “KERP”) for all employees of the Company. KERP payments totaling approximately
$21 million
were made in July 2019 and were comprised of approximately
$10 million
in lieu of target bonus amounts for 2019 performance, which were already being accrued during the year, plus an incremental amount of approximately
$11 million
in lieu of long-term incentive compensation for 2019. KERP payments are subject to certain termination provisions through June 30, 2020 which would result in the repayment of the award in full.
As of June 30, 2019, our consolidated balance sheet reflects a liability and deferred charge in the amount of approximately
$21 million
and
$20 million
respectively, related to the KERP. For accounting purposes, deferred expense is being amortized over the 13 month term of the KERP agreement. During both the quarter and six months ended
June 30, 2019
, we recorded less than
$1 million
in expense related to the KERP.
9. Related Party Transactions
Joint Venture.
We are party to a drilling joint venture to fund future oil and natural gas development with Wolfcamp Drillco Operating L.P. (the Investor, which is managed and controlled by an affiliate of Apollo Global Management LLC) and indirectly through Access Industries (through an indirect minority ownership interest in the Investor). At
June 30, 2019
and
December 31, 2018
, we had accounts receivable of
$3 million
and
$47 million
, respectively, and payables to our owner of
$9 million
and
$20 million
, respectively, associated with our Investor reflected in our consolidated balance sheets. Refer to our 2018 Annual Report on Form 10-K and on Form 10-K/A for further information on the joint venture agreement.