UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

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

For  the quarterly period ended September 30, 2012

OR

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

Commission file number: 001-16179

 

EPL OIL & GAS, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

 

(504) 569-1875

(Registrant’s telephone number, including area code)

 

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  x    No   ¨ 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨ 

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

 

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

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.    Yes  x    No  ¨ 

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As of October 26, 2012, there were 39,089,591 shares of the Registrant’s Common Stock, par value $0.001 per share, outstanding.

 

 

 

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TABLE OF CONTENTS

 

 

 

 

 

 

 

 

 

 

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PART I—FINANCIAL INFORMATION

Item 1.         FINANCIAL STATEMENTS.  

EPL OIL & GAS, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

 

See accompanying notes to condensed consolidated financial statements. 

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EPL OIL & GAS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

 

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

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EPL OIL & GAS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

 

 

 

See accompanying notes to condensed consolidated financial statements.             

 

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EPL OIL & GAS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

(1) Basis of Presentation

EPL Oil & Gas, Inc. (“we,” “our,” “us,” or “the Company”) was incorporated as a Delaware corporation on January 29, 1998. We are an independent oil and natural gas exploration and production company. Our current operations are concentrated in the U.S. Gulf of Mexico shelf focusing on state and federal waters offshore Louisiana.

Effective September 1, 2012, we changed our legal corporate name from “Energy Partners, Ltd.” to “EPL Oil & Gas, Inc.”  The name change was effected through a short-form merger pursuant to Section 253 of the General Corporation Law of the State of Delaware (the “DGCL”).  Under the DGCL, the merger did not require approval of our stockholders.  The merger had the effect of amending Energy Partners, Ltd.’s certificate of incorporation to reflect our new legal name.

The financial information as of September 30, 2012 and for the three- and nine-month periods ended September 30, 2012 and September 30, 2011 has not been audited. However, in the opinion of management, all adjustments (which include only normal, recurring adjustments) necessary to present fairly the financial position and results of operations for the periods presented have been included therein. Certain information and footnote disclosures normally in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to rules and regulations of the Securities and Exchange Commission. The condensed consolidated balance sheet at December 31, 2011 has been derived from the audited financial statements at that date. Certain reclassifications have been made to the prior period financial statements in order to conform to the classification adopted for reporting in the current period. These financial statements and footnotes should be read in conjunction with the financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2011 (the “2011 Annual Report”). The results of operations and cash flows for the first nine months of the year are not necessarily indicative of the results of operations which might be expected for the entire year.

Subsequent Events – Acquisition, Notes Offering and Expansion of our Senior Credit Facility

On October 31, 2012, we acquired from Hilcorp Energy GOM Holdings, LLC (“Hilcorp”) 100% of the membership interests of Hilcorp Energy GOM, LLC (“Hilcorp Acquisition”), which owns certain shallow water Gulf of Mexico shelf oil and natural gas interests (the “Hilcorp Properties”) for $550 million in cash, subject to customary adjustments to reflect an economic effective date of July 1, 2012.  The Hilcorp Acquisition was financed with the net proceeds from the sale of $300 million in aggregate principal amount of 8.25% senior notes due 2018 (the “Senior Notes”) and borrowings under our expanded senior credit facility. Also on October 31, 2012, we obtained an increase in our senior secured credit facility from $250 million to $750 million. See Note 2, “Acquisitions,” and Note 5, “Indebtedness,” for more information regarding these subsequent events.

(2) Acquisitions

Subsequent Event - The Hilcorp Acquisition

On October 31, 2012,  we acquired the Hilcorp Properties for $550 million in cash, subject to customary adjustments to reflect an economic effective date of July 1, 2012.  As of July 1, 2012, the Hilcorp Properties had estimated proved reserves of approximately 38.7 Mmboe of which 49% were oil and 59% were proved developed reserves.  The primary factors considered by the Company in acquiring the Hilcorp Properties include the belief that the Hilcorp Acquisition provides an opportunity to significantly increase our reserves, production volumes and drilling portfolio, while maintaining our focus on oil-weighted assets in our core area of expertise on the Gulf of Mexico shelf.  The Hilcorp Acquisition also provides us with access to infrastructure and extensive acreage, with significant exploitation and development potential.

The Hilcorp Acquisition was financed with the net proceeds from the sale of the Senior Notes and borrowings under our expanded senior credit facility. The Senior Notes were offered in a private placement only to qualified institutional buyers under Rule 144A promulgated under the Securities Act of 1933, as amended (the “Securities Act”), or to persons outside of the United States in compliance with Regulation S promulgated under the Securities Act.  After deducting the initial purchasers’ discount, we realized net proceeds of  $289.5 million.  See Note 5, “Indebtedness,” for more information regarding our Senior Notes.

The Hilcorp Acquisition will be accounted for using the purchase method of accounting for business combinations.  The following allocation of purchase price as of October 31, 2012 is preliminary and includes significant use of estimates.  This preliminary allocation is based on information that was available to management at the time these condensed

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consolidated financial statements were prepared and takes into account current market conditions and estimated market prices for oil and natural gas.  Management has not yet had the opportunity to complete its assessment of fair values of the assets acquired and liabilities assumed.  Accordingly, the allocation may change materially as additional information becomes available and is assessed by management. In addition, the purchase price could change materially as management finalizes adjustments to purchase price provided for by the purchase and sale agreement.

The following table summarizes the estimated values of assets acquired and liabilities assumed and reflects management’s estimate of customary adjustments to purchase price provided for by the purchase and sale agreement of approximately $13.0 million to reflect an economic effective date of July 1, 2012.

 

 

The South Timbalier Acquisition

On May 15, 2012, we acquired from W&T Offshore, Inc. (“W&T”) an asset package consisting of certain shallow-water Gulf of Mexico shelf oil and natural gas interests in our South Timbalier 41 field (the “ST 41 Interests”) located in the Gulf of Mexico for $32.4 million in cash, subject to customary adjustments to reflect an economic effective date of April 1, 2012 (the “ST 41 Acquisition”). We estimate that the proved reserves as of the April 1, 2012 economic effective date totaled approximately 1.2 Mmboe, of which 51% were oil and 84% were proved developed reserves. Prior to the ST41 Acquisition, we owned a 60% working interest in these properties, and W&T owned a 40% working interest. As a result of the ST41 Acquisition, we have become the sole working interest owner of the South Timbalier 41 field. We funded the ST41 Acquisition with cash on hand.

The following allocation of the purchase price as of April 1, 2012 is preliminary and includes estimates. This preliminary allocation is based on information that was available to management at the time these consolidated financial statements were prepared and is subject to revision as management finalizes adjustments to purchase price provided for by the purchase and sale agreement. Accordingly, the allocation may change materially as additional information becomes available and is assessed by management.

The following table summarizes the estimated values of assets acquired and liabilities assumed and reflects adjustments to purchase price provided for by the purchase and sale agreement of approximately $1.5 million to reflect an economic effective date of April 1, 2012.  

 

The ASOP Acquisition

On February 14, 2011, we acquired from Anglo-Suisse Offshore Partners, LLC (“ASOP”) an asset package consisting of certain shallow-water Gulf of Mexico shelf oil and natural gas interests surrounding the Mississippi River delta and a related gathering system (the “ASOP Properties”) for $200.7 million in cash, subject to purchase price adjustments to reflect an economic effective date of January 1, 2011 (the “ASOP Acquisition”). As of December 31, 2010, the ASOP Properties had estimated proved reserves of approximately 8.1 Mmboe, of which 84% were oil and 76% were proved developed reserves. The primary factors considered by the Company in acquiring the ASOP Properties include the belief that the ASOP Acquisition provided an opportunity to significantly increase our reserves, production volumes and drilling portfolio, while maintaining our focus on oil-weighted assets in our core area of expertise in the Gulf of Mexico shelf. We financed the ASOP Acquisition with the proceeds from the sale of $210 million in aggregate principal amount of the 8.25% senior notes due 2018 (the “Original Notes”). After deducting the initial purchasers’ discount and offering expenses, we realized net proceeds of approximately $202 million. See Note 5, “Indebtedness,” for more information regarding our Original Notes.

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The following table summarizes the estimated values of assets acquired and liabilities assumed and reflects adjustments to purchase price provided for by the purchase and sale agreement totaling approximately $3.8 million to reflect an economic effective date of January 1, 2011.

 

The Main Pass Acquisition

On November 17, 2011, we acquired certain interests in producing oil and natural gas assets in the shallow-water central Gulf of Mexico shelf (the “Main Pass Interests”) from Stone Energy Offshore, L.L.C. (the “Seller”) for $38.6 million in cash, subject to customary adjustments to reflect the economic effective date of November 1, 2011 (the “Main Pass Acquisition”). The Main Pass Interests consist of additional interests in the Main Pass 296/311 complex that was included in the ASOP Acquisition, along with other unit interests in the Main Pass complex and an interest in a Main Pass 295 primary term lease. We estimate that the proved reserves as of the November 1, 2011 economic effective date totaled approximately 1.3 Mmboe, all of which were proved developed reserves and approximately 96% of which were oil reserves. We funded the Main Pass Acquisition with cash on hand.

The following allocation of the purchase price as of November 1, 2011 is preliminary and includes estimates. This preliminary allocation is based on information that was available to management at the time these consolidated financial statements were prepared and is subject to revision. Accordingly, the allocation may change materially as additional information becomes available and is assessed by management.

The following table summarizes the estimated values of assets acquired and liabilities assumed and reflects adjustments to purchase price provided for by the purchase and sale agreement of approximately $0.7 million to reflect an economic effective date of November 1, 2011.  

 

We have accounted for our acquisitions using the purchase method of accounting for business combinations, and therefore we have estimated the fair value of the assets acquired and the liabilities assumed as of their respective acquisition dates. In the estimation of fair value, management uses various valuation methods including (i) comparable company analysis, which estimates the value of the acquired properties based on the implied valuations of other similar operations; (ii) comparable asset transaction analysis, which estimates the value of the acquired operations based upon publicly announced transactions of assets with similar characteristics; (iii) comparable merger transaction analysis, which, much like comparable asset transaction analysis, estimates the value of operations based upon publicly announced transactions with similar characteristics, except that merger analysis analyzes public to public merger transactions rather than solely asset transactions; and (iv) discounted cash flow analysis. The fair value is based on subjective estimates and assumptions, which are inherently subject to significant uncertainties which are beyond our control. These assumptions represent Level 3 inputs, as further discussed in Note 7, “Fair Value Measurements.”

Results of Operations and Pro Forma Information

Revenues and lease operating expenses attributable to the ST 41 Interests, the ASOP Properties and the Main Pass Interests for the three and nine months ended September 30, 2012 and 2011 were as follows:

 

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We have determined that the presentation of net income attributable to the ST 41 Interests, the ASOP Properties and the Main Pass Interests is impracticable due to the integration of the related operations upon acquisition. We incurred fees of approximately $0.1 million related to the ST 41 Acquisition, which were included in general and administrative expenses in the accompanying condensed consolidated statement of operations for the nine months ended September 30, 2012. We incurred fees of approximately $0.5 million related to the ASOP Acquisition, which were included in general and administrative expenses in the accompanying condensed consolidated statement of operations for the nine months ended September 30, 2011.

The following supplemental pro forma information presents consolidated results of operations as if the ST 41 Acquisition, the ASOP Acquisition and Main Pass Acquisition had occurred on January 1, 2011. Pro forma results of operations for the Hilcorp Acquisition are not included because the historical results for the three months ended September 30, 2012 were not available at the time these condensed consolidated financial statements were prepared. The supplemental unaudited pro forma information was derived from a) our historical consolidated statements of operations, b) the statements of revenues and direct operating expenses for the ST 41 Interests, which were derived from our historical accounting records, c) the statements of revenues and direct operating expenses for the ASOP Properties, which were derived from ASOP’s historical accounting records and d) the statements of revenues and direct operating expenses for the Main Pass Interests, which were derived from the historical accounting records of the Seller. This information does not purport to be indicative of results of operations that would have occurred had the acquisitions occurred on January 1, 2011, nor is such information indicative of any expected future results of operations.

 

 

 

 

 

 

 

 (3) Earnings per Share

The following table sets forth the calculation of basic and diluted weighted average shares outstanding and earnings (loss) per share for the indicated periods.

 

 

The following table indicates the number of shares underlying outstanding stock-based awards excluded from the computation of dilutive weighted average shares because their effect is antidilutive for the periods indicated.

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(4) Asset Retirement Obligations

Changes in our asset retirement obligations were as follows:

 

 

(5) Indebtedness

The following table sets forth our indebtedness.

In connection with the ASOP Acquisition (see Note 2) on February 14, 2011, we issued $210.0 million in aggregate principal amount of our Original Notes. Furthermore, our credit facility existing on that date was terminated and replaced with a new credit facility.  The termination of our prior credit facility during the nine months ended September 30, 2011 resulted in a loss on early extinguishment of debt of $2.4 million, primarily due to writing off the unamortized deferred financing costs associated with the terminated facility. 

On October 25, 2012,  we issued $300 million in aggregate principal amount of our Senior Notes.  On October 31, 2012, we obtained an increase in our senior credit facility from $250 million to $750 million. The net proceeds from the sale of our Senior Notes and borrowings under our expanded senior secured credit facility were used to fund the Hilcorp Acquisition.  See “– Subsequent Events and Senior Credit Facility” below for more information on these transactions.

Original Notes

On February 14, 2011, in connection with the ASOP Acquisition (see Note 2),  we issued the $210.0 million in aggregate principal amount of our Original Notes under an Indenture, dated as of February 14, 2011 (the “Original Indenture”). As described in Note 2, “Acquisitions,” we used the net proceeds  from the offering of the Original Notes of $202.0 million, after deducting the initial purchasers’ discount and offering expenses payable by us, to acquire the ASOP Properties for a purchase price of $200.7 million, before adjustments to reflect an economic effective date of January 1, 2011, and for general corporate purposes. The Original Notes bear interest from the date of their issuance at an annual rate of 8.25% with interest due semi-annually, in arrears, on February 15th and August 15th of each year, commencing on August 15, 2011. The Original Notes are fully and unconditionally guaranteed, jointly and severally, on an unsecured senior basis initially by each of our existing direct and indirect domestic subsidiaries (other than immaterial subsidiaries). The Original Notes will

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mature on February 15, 2018. For additional information regarding the Original Notes, see Note 7, “Indebtedness,” of our 2011 Annual Report.

Subsequent Events

Senior Credit Facility

On February 14, 2011, we entered into our senior secured credit facility with BMO Capital Markets, as lead arranger, and Bank of Montreal, as administrative agent and a lender, and the other lender parties thereto (“Senior Credit Facility”). The terms of our Senior Credit Facility established a revolving credit facility with a four-year term that could be used for revolving credit loans and letters of credit up to an aggregate principal amount of $250.0 million. On October 31, 2012, in connection with the Hilcorp Acquisition, through an amendment and restatement of our Senior Credit Facility,  the aggregate commitment under this facility was increased to a maximum of $750.0 million and the maturity date was extended to October 31, 2016.  The maximum amount of letters of credit that may be outstanding at any one time is $20.0 million. The amount available under the revolving credit facility is limited by the borrowing base. The Senior Credit Facility is secured by substantially all of our assets, including a) mortgages on at least 80%  of the total value of our oil and gas properties evaluated in the most recently completed reserve report, after giving effect to exploration and production activities, acquisitions and dispositions, and b) the stock of certain wholly-owned subsidiaries. The borrowing base under our Senior Credit Facility has been determined at the discretion of the lenders, based on the collateral value of our proved reserves and the proved reserves of the Hilcorp Properties, and is subject to potential special and regular semi-annual redeterminations. On October 31, 2012, the borrowing base under the expanded credit facility was increased from $200.0 million to $425.0 million. Borrowings under our Senior Credit Facility bear interest ranging from a base rate plus a margin of 0.75% to 1.75% on base rate borrowings and LIBOR plus a margin of 1.75% to 2.75% on LIBOR borrowings.  Commitment fees ranging from 0.375% to 0.50% are payable on the unused portion of the borrowing base. On October 31, 2012, we borrowed $190.0 million under the Senior Credit Facility to fund a portion of the purchase price and related expenses of the Hilcorp Acquisition, and we have approximately $220.0 million in availability under our Senior Credit Facility. For additional information regarding our Senior Credit Facility, see Note 7, “Indebtedness,” of our 2011 Annual Report.

Senior Notes

On October 25, 2012, we issued the $300 million in aggregate principal amount of our Senior Notes under an Indenture dated as of October 25, 2012 (the “Indenture”).  As described in Note 2, “Acquisitions,” we used the net proceeds from the offering of the Senior Notes of $289.5 million, after deducting the initial purchasers’ discount, to fund a portion of the Hilcorp Acquisition.  The Senior Notes bear interest from August 15, 2012 at an annual rate of 8.25% with interest due semi-annually, in arrears on February 15th and August 15th of each year commencing on February 15, 2013. The Senior Notes are fully and unconditionally guaranteed on a senior basis initially by each of our existing direct and indirect domestic subsidiaries (other than immaterial subsidiaries). The Senior Notes mature on February 15, 2018.

The Senior Notes have terms that are substantially identical to the terms of our Original Notes, other than with respect to special mandatory redemption provisions related to the closing of the Hilcorp Acquisition (which are now inapplicable because the Hilcorp Acquisition has closed).  However, the notes were issued under a different indenture as a separate class of securities and therefore, until exchanged for an issue of additional notes to be publicly registered (the “Exchange Notes”), will not trade together with the Original Notes.  Pursuant to a registration rights agreement executed as part of the sale of the Senior Notes (the “Registration Rights Agreement”), we have agreed to issue publicly registered additional notes under our Original Indenture in exchange for the Senior Notes.

On or after February 15, 2015, we may on any one or more occasions redeem all or a part of the Senior Notes upon not less than 30 days nor more than 60 days’ notice, at the redemption prices (expressed as percentages of principal amount) set forth below, plus accrued and unpaid interest and special interest, if any, on the notes redeemed, to the applicable date, if redeemed during the twelve-month period beginning on February 15 of the years indicated below, subject to the rights of holders of notes on the relevant record date to receive interest on the relevant interest payment date:

 

 

Any such redemption and notice may, in our discretion, be subject to the satisfaction of one or more conditions,   precedent, including, but not limited to, the occurrence of a change of control. Unless we default in the payment of the

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redemption price, interest will cease to accrue on the Senior Notes or portions thereof called for redemption on the applicable redemption date.

At any time prior to February 15, 2014, we may, at our option, on any one or more occasions redeem up to 35% of the aggregate principal amount of outstanding Senior Notes (which amount includes additional notes issued under the Indenture), upon not less than 30 nor more than 60 days’ notice, at a redemption price equal to 108.25% of the principal amount of the notes redeemed, plus the accrued and unpaid interest and special interest, if any, to the redemption date, with the net proceeds of any of certain equity offerings, provided that: (1) at least 65% of the aggregate principal amount of notes issued under the Indenture (which amount includes additional notes under the Indenture) remains outstanding immediately after the occurrence of such redemption; and (2) the redemption occurs with 90 days of the date after the closing of such equity offering.

If we experience a change of control (as defined in the Indenture), each holder of the Senior Notes will have the right to require us to repurchase all or any part (equal to $2,000 or an integral multiple of $1,000 in excess thereof) of the Senior Notes at a price in cash equal to 101% of the aggregate principal amount of the Senior Notes repurchased, plus accrued and unpaid interest and special interest, if any, to the date of purchase. If we engage in certain asset sales, within 360 days of such sale, we generally must use the net cash proceeds from such sales to repay outstanding senior secured debt (other than intercompany debt or any debt owed to an affiliate), to acquire all or substantially all of the assets, properties or capital stock of one or more companies in our industry, to make capital expenditures or to invest in our business. When any such net proceeds that are not so applied or invested exceed $20.0 million, we must make an offer to purchase the Senior Notes and other pari passu debt that is subject to similar asset sale provisions in an aggregate principal amount equal to the excess net cash proceeds. The offer price of each Senior Note (or other pari passu debt) in any such offer to purchase will be 100% of its principal amount, plus accrued and unpaid interest and special interest, if any, to the repurchase date, and will be payable in cash.

The Indenture, among other things, limits our ability to: (i) declare or pay dividends, redeem subordinated debt or make other restricted payments; (ii) incur or guarantee additional debt or issue preferred stock; (iii) create or incur liens; (iv) incur dividend or other payment restrictions affecting restricted subsidiaries; (v) consummate a merger, consolidation or sale of all or substantially all of our assets; (vi) enter into sale-leaseback transactions, (vii) enter into transactions with affiliates; (viii) engage in business other than our current business; or (ix) issue or sell capital stock of certain subsidiaries. These covenants are subject to a number of important exceptions and qualifications set forth in the Indenture.

Under the Registration Rights Agreement, we and our guarantor subsidiaries (the “Guarantors”) agreed to file a registration statement with the Securities and Exchange Commission (the “SEC”) offering to exchange the Senior Notes for the Exchange Notes under the Original Indenture which notes have terms substantially identical to the Senior Notes (except that the Exchange Notes will not be subject to restrictions on transfer or contain terms with respect to the payment of liquidation damages).We and the Guarantors have agreed to (i) file a registration statement for the Exchange Notes with the SEC on or prior to March 24, 2013, which is the date that is 150 days after the October 25, 2012 closing of the Senior Notes offering; (ii) use commercially reasonable efforts to cause the registration statement to be declared effective as soon as practicable, but in any event on or prior to May 23, 2013, which is the date that is 210 days after the October 25, 2012 closing of the Senior Notes offering; and (iii) use commercially reasonable efforts to close the exchange offer on or prior to 30 business days after the registration statement is declared effective. In certain circumstances, we may be required to file a shelf registration statement to cover resales of the notes. The use of the shelf registration statement will be subject to certain customary suspension periods. If we and the Guarantors do not meet these deadlines, we will be required to pay special interest to holders of  notes under certain circumstances.

(6) Derivative Instruments and Hedging Activities

We enter into derivative transactions to reduce exposure to fluctuations in the price of oil and natural gas for a portion of our production. Our fixed-price swaps fix the sales price for a limited amount of our production and, for the contracted volumes, eliminate our ability to benefit from increases in the sales price of the production. Our collars limit our exposure to declines in the sales price of oil while giving us the ability to benefit from increases to a certain level in the sales price of oil for a limited amount of our production. Derivative instruments are carried at their fair value on the condensed consolidated balance sheets as Fair value of commodity derivative instruments, and all unrealized and realized gains and losses are recorded in Gain (loss) on derivative instruments in Other income (expense) in the condensed consolidated statements of operations. See Note 7 for information regarding fair values of our derivative instruments.

The following table sets forth our derivative instruments outstanding as of September 30, 2012.

Oil Contracts

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Gas Contracts

 

 

Pursuant to the terms of the Hilcorp purchase and sale agreement, Hilcorp Energy GOM, LLC contracted fixed-price oil and natural gas swaps, on our behalf, which were outstanding at September 30, 2012 as follows:

 

 

 

 

The following table presents information about the components of our gain (loss) on derivative instruments.

 

 

 

 

 

 

 

(7) Fair Value Measurements

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC Topic 820, “Fair Value Measurements and Disclosures,”

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establishes a fair value hierarchy with three levels based on the reliability of the inputs used to determine fair value. These levels include: Level 1, defined as inputs such as unadjusted quoted prices in active markets for identical assets and liabilities; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs for use when little or no market data exists, therefore requiring an entity to develop its own assumptions. In May 2011, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) No. 2011-04, “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs” (“ASU 2011-04”), which became effective for us in the quarter ended March 31, 2012. ASU 2011-04 includes additional guidance related to fair value measurement principles and additional disclosure requirements. The impact of adopting ASU 2011-04 was immaterial.

As of September 30, 2012 and December 31, 2011, we held certain financial assets and liabilities that are required to be measured at fair value on a recurring basis, primarily our commodity derivative instruments. The fair values of our derivative instruments were measured according to the market approach or, if necessary, the income approach using price inputs published by NYMEX and IntercontinentalExchange, Inc., or ICE. These price inputs include settled exchange prices and quoted prices for assets and liabilities similar to those held by us and meet the definition of Level 2 inputs within the fair value hierarchy. The following table sets forth our financial assets and liabilities that are accounted for at fair value on a recurring basis:

 

On May 21, 2012, we entered into an agreement with an insurance company whereby, if a named wind storm occurs in a specified area of the Gulf of Mexico and that storm meets certain strength criteria, the insurance company will pay a fixed amount of cash proceeds to us. This agreement is considered a weather derivative under the applicable authoritative guidance related to financial instruments. We recognized the premium paid as a current asset, which we are amortizing to expense over the term of the agreement. At September 30, 2012, we estimate that the fair value of this financial instrument approximates the carrying amount of approximately $1.0 million, based on the amount of premium paid, which is a Level 3 input within the fair value hierarchy.

As of September 30, 2012 and December 31, 2011, the carrying amount of our Original Notes was $204.9 million and $204.4 million, respectively, which reflects the $210.0 million principal amount, net of the unamortized amount of initial purchasers’ discount of $5.1  million and $5.6 million at September 30, 2012 and December 31, 2011, respectively. As of September 30, 2012 and December 31, 2011, we estimated the fair value of the Original Notes at approximately $207.9 million and $202.7 million, respectively, based on quoted prices, which are Level 1 inputs within the fair value hierarchy.

We evaluate our capitalized costs of proved oil and natural gas properties for potential impairment when circumstances indicate that the carrying values may not be recoverable. Our assessment of possible impairment of proved oil and natural gas properties is based on our best estimate of future prices, costs and expected net future cash flows by property (generally analogous to a field or lease). An impairment loss is indicated if undiscounted net future cash flows are less than the carrying value of a property. The impairment expense is measured as the shortfall between the net book value of the property and its estimated fair value, which is measured based on the discounted net future cash flows from the property. The inputs used to estimate the fair value of our oil and natural gas properties are based on our estimates of future events, including projections of future oil and natural gas sales prices, amounts of recoverable oil and natural gas reserves, timing of future production, future costs to develop and produce our oil and natural gas and discount factors. These inputs meet the definition of Level 3 inputs within the fair value hierarchy. Impairments for the nine months ended September 30, 2012 were primarily due to the decline in our estimate of future natural gas prices affecting certain of our natural gas producing fields and to reservoir performance of one of our natural gas producing fields. Impairments for the three and nine months ended September 30, 2011 were primarily related to reservoir performance at certain of our natural gas producing fields. These fields were determined to have future net cash flows less than their carrying values resulting in their write down to estimated fair value.

As addressed in Note 2, “Acquisitions,” we apply fair value concepts in estimating and allocating the fair value of assets acquired and liabilities assumed in acquisitions in accordance with purchase accounting for business combinations. The inputs to the estimated fair values of assets acquired and liabilities assumed are described in Note 2.

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(8) Commitments and Contingencies

On June 20, 2012, we were the high bidder on six leases at the Central Gulf of Mexico Lease Sale 216/222. The six high bid lease blocks cover a total of 27,148 acres on a gross and net basis and are all located in the shallow Gulf of Mexico shelf within our core area of operations. Our share of the high bids totaled approximately $7 million.  As of September 30, 2012, we had been awarded two (2)  of the leases totaling $0.8 million.  As of October 31, 2012, we had been awarded all six leases, with amounts due subsequent to September 30, 2012 totaling $6.2 million.

We maintain restricted escrow funds in a trust for future abandonment costs at our East Bay field. The trust was originally funded over time with $15 million and, with accumulated interest, increased to $16.7 million at December 31, 2008. We may draw from the trust upon completion of qualifying abandonment activities at our East Bay field. At September 30, 2012, we had $6.0 million remaining in restricted escrow funds for decommissioning work in our East Bay field, which will remain restricted until substantially all required decommissioning in the East Bay field is complete. Amounts on deposit in the trust account are reflected in Restricted cash on our consolidated balance sheets.

We record liabilities when we deliver production that is in excess of our interest in certain properties. In addition to these imbalances, we may, from time to time, be allocated cash sales proceeds in excess of amounts that we estimate are due to us for our interest in production. These allocations may be subject to further review, may require more information to resolve or may be in dispute. In July 2010, we were notified by a purchaser of oil production from one of our non-operated fields that we were allocated, and received sales proceeds from, more oil production than we actually sold to that purchaser. These third party misallocations may date back to 2006. The oil purchaser’s initial estimate of the oil volumes misallocated to us was approximately 74,000 barrels, which may be valued at up to $6.9 million based on information provided by the oil purchaser. We have previously recorded an amount that we believe may be payable related to a potential reallocation, which amount is reflected in Accrued expenses in the accompanying condensed consolidated balance sheets as of September 30, 2012 and December 31, 2011.

We and our oil and gas joint interest owners are subject to periodic audits of the joint interest accounts for leases in which we participate and/or operate. As a result of these joint interest audits, amounts payable or receivable by us for costs incurred or revenue distributed by the operator or by us on a lease may be adjusted, resulting in adjustments, increases or decreases, to our net costs or revenues and the related cash flows. Such adjustments may be material. When they occur, these adjustments are recorded in the current period, which generally is one or more years after the related cost or revenue was incurred or recognized by the joint account.

In the ordinary course of business, we are a defendant in various other legal proceedings. We do not expect our exposure in these other proceedings, individually or in the aggregate, to have a material adverse effect on our financial position, results of operations or liquidity.

(9) New Accounting Pronouncements

In December 2011, the FASB issued ASU No. 2011-11, “Balance Sheet (Topic 201): Disclosures about Offsetting Assets and Liabilities” (“ASU 2011-11”). ASU 2011-11 requires disclosure of information about offsetting and related arrangements to enable users of financial statements to understand the effect or potential effect of netting arrangements on an entity’s financial position, including the effect or potential effect of rights of setoff associated with certain financial instruments and derivative instruments. The required disclosures are effective for our annual report for the year ending December 31, 2013 and for interim periods within that year. We have not yet completed our review of the required disclosures; however, we expect the impact on our reporting to be immaterial.

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(10) Supplemental Condensed Consolidating Financial Information

In connection with the Original Notes and the Senior Notes offering described in Note 5, all of our existing direct and indirect domestic subsidiaries (other than immaterial subsidiaries) (the “Guarantor Subsidiaries”) jointly, severally and unconditionally guaranteed the payment obligations under our 8.25% senior notes due 2018. The following supplemental financial information sets forth, on a consolidating basis, the balance sheets, statements of operations and cash flow information for EPL Oil & Gas, Inc. (Parent Company Only) and for the Guarantor Subsidiaries. We have not presented separate financial statements and other disclosures concerning the Guarantor Subsidiaries because management has determined that such information is not material to investors.

The supplemental condensed consolidating financial information has been prepared pursuant to the rules and regulations for condensed financial information and does not include all disclosures included in annual financial statements. Certain reclassifications were made to conform all of the financial information to the financial presentation on a consolidated basis. The principal eliminating entries eliminate investments in subsidiaries, intercompany balances and intercompany revenues and expenses.

Supplemental Condensed Consolidating Balance Sheet

As of September 30, 2012

 

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Supplemental Condensed Consolidating Balance Sheet

As of December 31, 2011