Properties
As of December 31, 2019, Magnolia’s assets consisted of a total leasehold position of 670,787 gross (450,854 net) acres, including 39,998 gross (22,088 net) acres in Karnes, Gonzales, DeWitt, and Atascosa Counties, Texas and 630,789 gross (428,766 net) acres in the Giddings Field. As of December 31, 2019, Magnolia had 1,630 gross (1,141 net) wells with total production of 66.8 Mboe/d for the year ended December 31, 2019. As of December 31, 2019, Magnolia was running a one-rig program for the Karnes County Assets and a one-rig program for the Giddings Assets. Approximately 52.8%, 28.2%, and 19.0% of production from Magnolia’s assets was attributable to oil, natural gas, and NGLs, respectively, for the year ended December 31, 2019.
The Karnes County Assets are primarily located in Karnes County, Texas, in the core of the Eagle Ford Shale. The acreage comprising the Karnes County Assets also includes the Austin Chalk formation overlying the Eagle Ford Shale. The Austin Chalk formation has shown itself to be an independent reservoir from the Eagle Ford Shale and represents a very attractive development target. The Karnes County Assets include a well-known, low-risk acreage position that has been developed with a focus on maximizing returns and improving operational efficiencies.
The Giddings Assets are primarily located in Brazos, Fayette, Lee, Grimes, and Washington Counties, Texas. The Austin Chalk formation produces along a northeast-to-southwest trend that is approximately parallel to the Texas Gulf Coast. There are several notable producing fields along the Austin Chalk trend, the largest of which is the Giddings Field. The Giddings Field has seen two major drilling cycles. The first cycle began in the late 1970s and into the early 1980s and consisted primarily of vertical well drilling. The second cycle ran through much of the 1990s and involved primarily horizontal well drilling. The wells included in the Giddings Assets have historically targeted the lower third of the Austin Chalk formation. Recent improvements in drilling and completion technologies have unlocked new development opportunities in the Giddings Field. Wells drilled over the past two years have helped to substantiate the strong economic viability of new drilling activity across the field. Future development results may allow for further expansion of existing location inventory throughout the leasehold.
Reserve Data
Estimated Proved Reserves
The estimates of Magnolia’s proved oil and gas reserves included in this Annual Report on Form 10-K are as of December 31, 2019. The majority of the Company’s proved reserves volumes, approximately 96%, are based on evaluations prepared by the independent petroleum engineering firm of Miller and Lents, in accordance with Standards Pertaining to the Estimating and Auditing of Oil and Gas Reserves Information promulgated by the Society of Petroleum Evaluation Engineers and definitions and guidelines established by the SEC. Miller and Lents was selected for its historical experience and expertise in evaluating hydrocarbon resources.
Proved oil and gas reserves are those quantities of oil and gas, which, by analysis of geoscience and engineering data, can be estimated with reasonable certainty to be economically producible from a given date forward, from known reservoirs, and under existing economic conditions, operating methods, and government regulations prior to the time at which contracts providing the right to operate expire, unless evidence indicates that renewal is reasonably certain, regardless of whether deterministic or probabilistic methods are used for the estimation. The project to extract the hydrocarbons must have commenced or the operator must be reasonably certain that it will commence within a reasonable time. Oil and gas prices applied in estimating proved reserves are determined using an unweighted arithmetic average of the first-day-of-the-month price for the reporting period.
Proved reserves are sub-divided into two categories, proved developed and proved undeveloped. Proved developed reserves include volumes that can be expected to be recovered through existing wells with existing equipment and operating methods. Proved undeveloped reserves are volumes that are expected to be recovered from new wells on undrilled acreage, or from existing wells where a relatively major expenditure is required and there is management commitment to commence the development within a reasonable
timeframe. All of Magnolia’s proved undeveloped reserves, as of December 31, 2019, that are included in this Annual Report are planned to be developed within one year of first reporting.
The technical and economic data used to estimate proved reserves include, but are not limited to, well logs, geologic maps, well-test data, production data, well data, historical price and cost information, and property ownership interests. This technical data, together with standard engineering and geoscience methods, or a combination of methods, including performance analysis, decline curve methods, volumetric analysis, and assessment of analogues, are applied to estimate proved reserves.
The proved developed reserves per well are estimated by applying performance analysis and decline curve methods. For proved developed wells that lack adequate production history, reserves were estimated using performance-based type curves and offset location analogues. Proved undeveloped reserves are estimated by using a combination of geologic and engineering data for planned drilling locations. Performance data along with log and core data was used to delineate consistent, continuous reservoir and performance characteristics in core areas of development to identify areas of technical certainty that meets the criteria for proved reserves. Performance based type curves are applied to forecast proved undeveloped well performance.
Preparation of Oil and Gas Reserve Information
Magnolia’s Director of Reserves, Peter Corbeil, is the technical person primarily responsible for overseeing the internal reserves estimation process. Mr. Corbeil has 20 years of oil and gas industry experience in reservoir engineering, reserves assessment, field development, and technical management. His experience prior to joining Magnolia includes tenures in the corporate reserve groups at three large and diversified oil and gas companies. He holds a Bachelor of Engineering degree and a Master of Business Administration degree and is a member of the Society of Petroleum Engineers.
The Director of Reserves works closely with EVOC’s petroleum engineers and geoscience professionals to ensure the integrity, accuracy, and timeliness of the data furnished to Miller and Lents for the preparation of their reserve reports. Periodically, Magnolia’s internal staff and EVOC’s technical teams meet with the independent reserves engineers to review properties, methods, and assumptions used to prepare reserve estimates for Magnolia’s assets.
The reserve reports were prepared by Miller and Lents’ team of geologists and reservoir engineers who integrate geological, geophysical, engineering and economic data to produce reserve estimates and economic forecasts. The process to prepare Magnolia’s proved reserves as of December 31, 2019 was supervised by Katie M. Reinaker, Senior Vice President and an officer of Miller and Lents. Ms. Reinaker is a professionally qualified licensed Professional Engineer in the State of Texas with more than 10 years of relevant experience in the estimation, assessment, and evaluation of oil and gas reserves.
Reserves estimation involves a degree of uncertainty and estimating volumes of economically recoverable oil and natural gas that cannot be measured in an exact manner. The accuracy of any reserve estimate is a function of the quality of available data and of engineering and geological interpretation. As a result, the estimates of different engineers often vary. In addition, the results of drilling, testing, and production may justify revisions of such estimates. Accordingly, reserve estimates often differ from the quantities of oil, natural gas, and NGLs that are ultimately recovered. Estimates of economically recoverable oil, natural gas, NGLs, and of future net revenues are based on a number of variables and assumptions, all of which may vary from actual results, including geologic interpretation, prices, future production rates, and costs. Please read “Risk Factors” in Item 1A in this Annual Report on Form 10-K.
Proved Reserves
The following table presents the estimated net proved oil and natural gas reserves of Magnolia as of December 31, 2019. This table shows reserves on a boe basis in which natural gas is converted to an equivalent barrel of oil based on a ratio of six Mcf to one Bbl. This ratio is not reflective of the current price ratio between the two products. The proved undeveloped reserves volumes in the table below are expected to be converted to proved developed reserves within one year.
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December 31, 2019
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Oil (MMBbls)
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Natural Gas (Bcf)
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NGLs (MMBbls)
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Total (MMboe)
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Proved reserves
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Total proved developed
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40.3
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165.8
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18.9
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86.8
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Total proved undeveloped
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12.3
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31.4
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5.0
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22.5
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Total proved reserves
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52.6
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197.2
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23.9
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109.3
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Development of Proved Undeveloped Reserves
As of December 31, 2019, the proved undeveloped reserves volumes are expected to be converted to proved developed reserves within one year. The following table summarizes the changes in Magnolia’s proved undeveloped reserves during the year ended December 31, 2019:
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Total (MMboe)
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Proved undeveloped reserves at January 1, 2019
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24.0
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Conversions into proved developed reserves
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(20.4
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)
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Extensions
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15.7
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Acquisitions
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2.6
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Revisions of previous estimates
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0.6
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Proved undeveloped reserves at December 31, 2019
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22.5
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As of December 31, 2019, Magnolia’s assets contained approximately 22.5 MMboe of proved undeveloped reserves, consisting of 12.3 MMBbls of oil, 31.4 Bcf of natural gas, and 5.0 MMBbls of NGLs. The Company’s total estimated proved undeveloped reserves decreased 1.5 MMboe during the year ended December 31, 2019. Magnolia converted 20.4 MMboe of proved undeveloped reserves to proved developed reserves as a result of the drilling activities completed during 2019. Extension adds of 15.7 MMboe were a result of the planned drilling program for the Karnes County Assets and the Giddings Assets. Acquisitions related to purchases of acreage in the Company’s Karnes County Assets resulted in an increase in proved undeveloped reserves of approximately 2.6 MMboe. Revisions of 0.6 MMboe to proved undeveloped reserves were comprised of a 2.2 MMboe positive revision related to infill drilling in the Karnes County Assets that was partially offset by downward revisions of approximately 1.6 MMboe related to technical updates, lower commodity prices, and an updated well schedule to optimize development activity.
During the year ended December 31, 2019, Magnolia incurred costs of approximately $158.8 million to convert the reserves associated with 40 of its net proved undeveloped locations to 20.4 MMboe of proved developed reserves.
Drilling Statistics
The following table describes new development and exploratory wells drilled within Magnolia’s assets during the years ended December 31, 2019, 2018, and 2017. The information should not be considered indicative of future performance, nor should it be assumed that there is necessarily any correlation among the number of productive wells drilled, quantities of reserves found, or economic value. A dry well is a well that proves to be incapable of producing either oil or gas in sufficient quantities to justify completion as an oil and gas well. A productive well is a well that is found to be mechanically capable of producing hydrocarbons in sufficient quantities. Completion refers to installation of permanent equipment for production of oil or gas, or, in the case of a dry well, to reporting to the appropriate authority that the well has been abandoned. As of December 31, 2019, 84 gross (34 net) wells were in various stages of completion. As of December 31, 2019, Magnolia was running a one-rig program for the Karnes County Assets and a one-rig program for the Giddings Assets.
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Successor
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Predecessor and Giddings Assets
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Year Ended
December 31, 2019
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July 31, 2018
Through
December 31, 2018
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January 1, 2018 Through
July 30, 2018
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Year Ended
December 31, 2017
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Net exploratory wells
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Productive
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—
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—
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—
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—
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Dry
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—
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—
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—
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—
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—
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—
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—
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—
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Net development wells
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Productive
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76
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25
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|
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42
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58
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Dry
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—
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—
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—
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—
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76
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25
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42
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58
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Net total wells
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Productive
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76
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25
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42
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58
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Dry
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—
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—
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—
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—
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Total
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76
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25
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42
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58
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Productive Oil and Gas Wells
Productive wells consist of producing wells and wells mechanically capable of production, including natural gas wells awaiting pipeline connections to commence deliveries and oil wells awaiting connection to production facilities. Gross wells are the total number of producing wells in which Magnolia owns a working interest, and net wells are the sum of the fractional working interests of gross wells. The following table sets forth information relating to the productive wells in which Magnolia owned a working interest as of December 31, 2019.
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Year Ended
December 31, 2019
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Oil
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Gross
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1,179
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Net
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752
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Gas
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Gross
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451
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Net
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389
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Total
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Gross
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1,630
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Net
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1,141
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Production, Pricing, and Lease Operating Cost Data
The following table describes, for each of the last three fiscal years, oil, natural gas, and NGL production volumes, average lease operating costs per boe (including transportation costs, but excluding severance and other taxes), and average sales prices related to Magnolia’s operations:
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Successor
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Predecessor and Giddings Assets
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Year Ended December 31, 2019
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July 31, 2018 Through
December 31, 2018
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January 1, 2018
Through
July 30, 2018
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Year Ended
December 31, 2017
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Production
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Crude oil (MMBbls)
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12.9
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5.1
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6.4
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7.8
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Natural gas (Bcf)
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41.3
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14.1
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13.5
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16.8
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Natural gas liquids (MMBbls)
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4.6
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1.9
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1.7
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2.0
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Average lease operating cost per boe
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$
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5.28
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$
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4.83
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$
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5.42
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$
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5.28
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Average sale price
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Crude oil (MMBbls)
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$
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60.00
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$
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67.37
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$
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69.14
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$
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49.03
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Natural gas (Bcf)
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2.27
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3.04
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2.82
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2.94
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Natural gas liquids (MMBbls)
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15.17
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25.93
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25.99
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21.80
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Gross and Net Undeveloped and Developed Acreage
The following table sets forth certain information regarding the total developed and undeveloped acreage in which Magnolia held an interest as of December 31, 2019:
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December 31, 2019
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Undeveloped acreage
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Gross
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65,984
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Net
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47,298
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Developed acreage
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Gross
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604,803
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Net
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403,556
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Total acreage
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Gross
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670,787
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Net
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450,854
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Undeveloped Acreage Expirations
As of December 31, 2019, Magnolia’s total net undeveloped acres across its assets that will expire in 2020, 2021, and 2022 are 1,129 acres, 6,610 acres, and 3,109 acres, respectively, unless production is established within the spacing units covering the acreage prior to the expiration dates or unless such leasehold rights are extended or renewed. There are no expirations after 2022.
Delivery Commitments
Magnolia has a long term contract with the commitment to deliver a fixed minimum sales volume of oil production from the Karnes County Assets. This contract requires Magnolia to deliver approximately 7,988 MBbls for the period from 2020 through 2021. In addition, the Giddings Assets are subject to a contract with a third-party midstream company that provides for firm pipeline transportation for a portion of the natural gas produced from the Giddings Assets. Under this contract, Magnolia currently has reserved firm capacity of up to 30,000 MMBtu/d, which amount Magnolia has the right to reduce during the term of the agreement based on current capacity requirements. This contract requires Magnolia to pay a pipeline demand fee for the reserved capacity amount. Magnolia expects to fulfill both of these commitments with existing proved developed and proved undeveloped reserves, which are regularly monitored to ensure sufficient availability. In addition, Magnolia monitors current production, anticipated future production, and future development plans in order to meet its commitments.
Operations
General
Pursuant to the Services Agreement entered into in connection with the Business Combination, EVOC, under the direction of Magnolia’s management, has provided services to Magnolia since the Business Combination substantially identical to the services historically provided by EVOC, including all administrative, back office and day-to-day field-level services reasonably necessary to operate Magnolia’s business and its assets, subject to certain exceptions.
Facilities
Production facilities related to Magnolia’s assets are located near producing wells and consist of storage tanks, two-phase and/or three-phase separation equipment, flowlines, metering equipment, and safety systems. Predominant artificial lift methods include gas lift, rod pump lift, and plunger lift.
Magnolia’s assets include a 35.0% ownership interest in an oil and gas gathering system operated by Ironwood Eagle Ford Midstream, LLC, which allows gas and oil production to be delivered and sold to various intrastate and interstate markets, or to various crude oil refining markets on a competitive pricing basis. The majority of gas production related to the Karnes County Assets is currently processed to collect NGLs. The Karnes County Assets also include a saltwater disposal well, which currently handles a portion of water production from the Karnes County Assets.
The Giddings Assets include access to gas gathering systems, which allows production to be delivered to third-party gas processors. The majority of gas production related to the Giddings Assets is currently processed to collect NGLs. Produced gas can be sold to various intrastate and interstate markets on a competitive pricing basis. The Giddings Assets also include a saltwater disposal well that handles a small portion of water production from the Giddings Assets.
Marketing and Customers
For the year ended December 31, 2019, two customers accounted for 43.3% and 18.5%, respectively, of the combined oil, natural gas, and NGL revenue. For the 2018 Successor Period, two customers accounted for 42.2% and 19.1%, respectively, of the combined oil, natural gas, and NGL revenue. For the 2018 Predecessor Period, three customers accounted for 47.6%, 14.5%, and 12.2%, respectively, of the combined oil, natural gas, and NGL revenues. For the 2017 Predecessor Period, four customers accounted for 28.8%, 22.3%, 18.9%, and 10.2%, respectively, of the combined oil, natural gas, and NGL revenues.
No other purchaser accounted for 10% or more of Magnolia’s revenue on a combined basis in each respective period. The loss of any of the purchasers above could adversely affect Magnolia’s revenues in the short term. Please see “Risk Factors” in Item 1A in this Annual Report on Form 10-K for more information.
Magnolia gathers and processes a portion of the natural gas production from the Giddings Assets under acreage dedications with two third-party midstream companies. The gas plant residue volumes are sold either to the gas processor or various third parties utilizing the firm transportation agreement described under “Delivery Commitments” in this item (“Items 1 and 2. Business and Properties”). The NGL production extracted from the Giddings Assets is sold to third parties pursuant to purchase agreements with varying terms. Magnolia sells the majority of the oil production from the Giddings Assets to two third parties at market prices, with such purchasers generally transporting such production from the lease via trucks. The remainder of the oil, natural gas, and NGL production from the Giddings Assets is sold to various third-party purchasers at market prices, typically under contracts with terms of twelve months or less.
In addition, Magnolia sells the natural gas production from the Karnes County Assets to various third parties pursuant to the terms of multiple gas processing and purchase contracts of varying terms. Such natural gas production is gathered and processed under agreements with terms ranging from month-to-month to the life of the applicable lease agreements. Magnolia is subject to the terms of a crude oil gathering agreement with Ironwood Eagle Ford Midstream, LLC that expires in July 2027, which provides an outlet for Magnolia to sell oil production from the Karnes County Assets to third-party purchasers at market prices. The remaining oil production is generally transported from the lease via trucks. The remainder of the oil, natural gas, and NGL production from the Karnes County Assets is sold to various third-party purchasers at market prices, typically under contracts with terms of twelve months or less. The NGL production from the Karnes County Assets is primarily sold to midstream gas processors in the Eagle Ford area.
Competition
The oil and natural gas industry is a highly competitive environment and Magnolia competes with both major integrated and other independent oil and natural gas companies in all aspects of the Company’s business to explore, develop, and operate its properties and market its production. Competitive conditions may be affected by future legislation and regulations as the United States develops new energy and climate-related policies. In addition, some of Magnolia’s competitors may have a competitive advantage when responding to factors that affect demand for oil and natural gas production, such as changing prices, domestic and foreign political conditions, weather conditions, the proximity and capacity of natural gas pipelines and other transportation facilities, and overall economic conditions. Magnolia also faces indirect competition from alternative energy sources, including wind, solar, and electric power. Magnolia’s ability to acquire additional prospects and to find and develop reserves in the future will depend on the Company’s ability to evaluate and select suitable properties and to consummate transactions in a highly competitive environment.
Environmental, Health and Safety Matters
Oil and natural gas operations are substantially affected by federal, state, and local laws and regulations. In particular, oil and natural gas production and related operations are, or have been, subject to price controls, taxes, and numerous other laws and regulations. All of the jurisdictions in which Magnolia’s assets are located have statutory provisions regulating the development and production of oil and natural gas. These laws and regulations can impose recordkeeping, monitoring, and reporting requirements or other operational constraints on the Company’s business, including operational controls for minimizing pollution, costs to remediate releases of regulated substances, including crude oil, into the environment, or costs to remediate sites to which the Company sent regulated substances for disposal. In some cases, these laws can impose strict liability for the entire cost of clean-up on any responsible party without regard to negligence or fault and impose liability on the Company for the conduct of others (such as prior owners or operators of Magnolia’s assets) or conditions others have caused, or for the Company’s acts that complied with all applicable requirements when they were performed. The Company could incur capital, operating, maintenance, and remediation expenditures as a result of environmental laws and regulations. New laws have been enacted, and regulations are being adopted by various regulatory agencies on a continuing basis, and the costs of compliance with these new laws and regulations can only be broadly appraised until their implementation becomes more defined.
Air and Climate Change
Environmental advocacy groups and regulatory agencies in the United States and other countries have focused considerable attention on the emissions of carbon dioxide, methane, and other greenhouse gases (“GHG”) and their potential role in climate change. The federal Clean Air Act (the “CAA”) and comparable state laws restrict the emission of air pollutants from many sources through the imposition of air emissions standards, construction and operating permitting programs, and other compliance requirements. These requirements may result in increased operating costs as a result of the need to install emission control devices or increased emission monitoring and reporting requirements. For example, the U.S. Environmental Protection Agency (the “EPA”) has adopted rules requiring the monitoring and annual reporting of GHG emissions from certain petroleum and natural gas system sources in the U.S., including, among others, onshore and offshore production facilities, which include certain of Magnolia’s assets. Separately, in June 2016, the EPA published performance standards that establish new controls, known as Subpart OOOOa, for emissions of methane from new, modified, or reconstructed sources in the oil and natural gas sector, including production, processing, transmission, and storage activities. Please see “Risk Factors” in Item 1A in this Annual Report on Form 10-K for further discussion of risks related to climate change and the regulation of methane emissions and GHGs.
Separately, the EPA finalized a more stringent National Ambient Air Quality Standard (“NAAQS”) for ozone in October 2015 and completed attainment/nonattainment designations in 2018. State implementation of the revised NAAQs in the areas in which Magnolia operates could result in increased costs for emission controls and requirements for additional monitoring and testing, as well as a more cumbersome permitting process. Failure to comply with air quality regulations may also result in administrative, civil, and/or criminal penalties for non-compliance.
Hydraulic Fracturing Activities
Hydraulic fracturing is an important and common practice that is used to stimulate production of oil and/or natural gas from dense subsurface rock formations. The hydraulic fracturing process involves the injection of water, proppants, and chemicals under pressure into targeted subsurface formations to fracture the surrounding rock and stimulate production. Hydraulic fracturing is regularly used by operators of Magnolia’s assets. Hydraulic fracturing is typically regulated by state oil and natural gas commissions, but the EPA has asserted federal regulatory authority pursuant to the U.S. Safe Drinking Water Act (“SDWA”) over certain hydraulic fracturing activities involving the use of diesel fuels and published permitting guidance in February 2014 addressing the performance of such activities using diesel fuels. The EPA has issued final regulations under the CAA establishing performance standards, including standards for the capture of air emissions released during hydraulic fracturing, and also finalized rules under the CWA in June 2016 that prohibit the discharge of wastewater from hydraulic fracturing operations to publicly owned wastewater treatment plants.
At the state level, several states have adopted, or are considering, legal requirements that could impose more stringent permitting, disclosure, and well construction requirements on hydraulic fracturing activities. For example, the Texas Railroad Commission has adopted a “well integrity rule,” which updated the requirements for drilling, putting pipe down, and cementing wells. The rule also imposes new testing and reporting requirements, such as (i) the requirement to submit cementing reports after well completion or after cessation of drilling, whichever is later, and (ii) the imposition of additional testing on wells less than 1,000 feet below usable groundwater. Local governments also may seek to adopt ordinances within their jurisdictions regulating the time, place, and manner of drilling activities in general or hydraulic fracturing activities in particular.
Compliance with existing laws has not had a material adverse effect on operations related to Magnolia’s assets, but if new or far more stringent federal, state, or local legal restrictions relating to the hydraulic fracturing process are adopted in areas where Magnolia’s assets are located, operators could incur potentially significant added costs to comply with such requirements, experience delays or curtailment in the pursuit of development activities, and perhaps even be precluded from drilling wells.
Water
The federal Clean Water Act (“CWA”), and analogous state laws, impose restrictions and strict controls with respect to the discharge of pollutants, including spills and leaks of oil and hazardous substances, into state waters and waters of the United States. The discharge of pollutants into regulated waters is prohibited, except in accordance with the terms of a permit issued by the EPA or an analogous state agency. Federal and state regulatory agencies can impose administrative, civil, and criminal penalties for non-compliance with discharge permits or other requirements of the CWA and analogous state laws and regulations. The CWA also prohibits the discharge of dredge and fill material in regulated waters, including wetlands, unless authorized by permit. In September 2015, the EPA and the U.S. Army Corps of Engineers (“Corps”) issued new rules defining the scope of the EPA’s and the Corps’ jurisdiction under the CWA with respect to certain types of waterbodies and classifying these waterbodies as regulated wetlands (the “WOTUS rule”). However, following the change in presidential administrations, there have been several attempts to modify this rule. For example, on January 23, 2020, the EPA and the Corps finalized the Navigable Waters Protection Rule, which narrows the definition of “waters of the United States” relative to the prior 2015 rulemaking. Legal challenges to the new rule are expected, and multiple challenges to the EPA’s
prior rulemaking remain pending. To the extent any final rule expands the scope of the CWA’s jurisdiction, Magnolia could face increased permitting costs and project delays.
In addition, Magnolia may be required under the CWA to obtain and maintain approvals or permits for the discharge of wastewater or storm water and are required to develop and implement spill prevention, control, and countermeasure plans, also referred to as “SPCC plans,” in connection with on-site storage of significant quantities of oil.
Hazardous Substances and Waste Handling
The Comprehensive Environmental Response, Compensation and Liability Act (the “CERCLA”), also known as the “Superfund” law, and comparable state laws impose liability, without regard to fault or the legality of the original conduct, on certain classes of persons that are considered responsible for the release of a “hazardous substance” into the environment. These persons include the current and past owner or operator of the disposal site or the site where the release occurred and persons that disposed or arranged for the disposal or the transportation for disposal of the hazardous substances at the site where the release occurred.
The Resources Conservation and Recovery Act (the “RCRA”) and analogous state laws, impose detailed requirements for the generation, handling, storage, treatment, and disposal of nonhazardous and hazardous solid wastes. RCRA specifically excludes drilling fluids, produced waters, and other wastes associated with the development or production of crude oil, natural gas, or geothermal energy from regulation as hazardous wastes. However, these wastes may be regulated by the EPA or state agencies under RCRA’s less stringent nonhazardous solid waste provisions, state laws or other federal laws. It is, however, possible that certain oil and natural gas drilling and production wastes now classified as non-hazardous could be classified as hazardous wastes in the future. For example, in December 2016, the EPA and environmental groups entered into a consent decree to address the EPA’s alleged failure to timely assess its RCRA Subtitle D criteria regulations exempting certain exploration and production related oil and natural gas wastes from regulation as hazardous wastes under RCRA. The consent decree requires the EPA to propose a rulemaking no later than March 15, 2019 for revision of certain Subtitle D criteria regulations pertaining to oil and natural gas wastes or to sign a determination that revision of the regulations is not necessary. Due to the government shutdown, the deadline was extended, and in April 2019, the EPA signed a determination that revision of the regulations is not necessary at this time. However, it is possible that these particular oil and natural gas development and production wastes now classified as nonhazardous solid wastes could be classified as hazardous wastes in the future. A loss of the RCRA exclusion for drilling fluids, produced waters, and related wastes could result in an increase in the costs to manage and dispose of generated wastes
Endangered Species Act
The Endangered Species Act (the “ESA”) and (in some cases) comparable state laws were established to protect endangered and threatened species. Pursuant to the ESA, if a species is listed as threatened or endangered, restrictions may be imposed on activities adversely affecting that species’ habitat. The U.S. Fish and Wildlife Service may designate critical habitat and suitable habitat areas that it believes are necessary for survival of a threatened or endangered species. A critical habitat or suitable habitat designation could result in further material restrictions to land use and may materially delay or prohibit land access for oil and natural gas development. The identification or designation of previously unprotected species as threatened or endangered in areas where underlying property operations are conducted could cause increased costs arising from species protection measures or could result in limitations on development activities that could have an adverse impact on the ability to develop and produce reserves within Magnolia’s assets. If a portion of Magnolia’s assets were to be designated as a critical or suitable habitat, it could adversely impact the value of its assets.
OSHA
Magnolia is subject to the requirements of the Occupational Health and Safety Act (“OSHA”) and comparable state statutes whose purpose is to protect the health and safety of workers. Violations can result in civil or criminal penalties as well as required abatement. In addition, the OSHA hazard communication standard, the Emergency Planning and Community Right-to-Know Act, and comparable state statutes and any implementing regulations require that Magnolia organizes and/or discloses information about hazardous materials used or produced in its operations and that this information be provided to employees, state and local governmental authorities, and citizens.
Related Permits and Authorizations
Many environmental laws require permits or other authorizations from state and/or federal agencies before initiating certain drilling, construction, production, operation, or other oil and natural gas activities, and require maintaining these permits and compliance with their requirements for on-going operations. These permits are generally subject to protest, appeal, or litigation, which could in certain cases delay or halt projects and cease production or operation of wells, pipelines, and other operations related to Magnolia’s assets.
Employees
As of December 31, 2019, Magnolia had approximately 45 full-time employees. Additionally, pursuant to the Services Agreement, EVOC and its employees provide Magnolia with day-to-day services reasonably necessary to operate its assets. Magnolia is not a party to any collective bargaining agreements and has not experienced any strikes or work stoppages. Magnolia considers its relations with its employees to be satisfactory.
Item 1A. Risk Factors
The nature of Magnolia’s business activities subjects the Company to certain hazards and risks. The following risks and uncertainties, together with other information set forth in this Annual Report on Form 10-K, should be carefully considered by current and future investors in the Company’s securities. These risks and uncertainties are not the only ones Magnolia faces. Additional risks and uncertainties presently unknown to Magnolia, or currently deemed immaterial, also may impair the Company’s business operations. The occurrence of one or more of these risks or uncertainties could materially and adversely affect the Company’s business, its financial condition, and the results of Magnolia’s operations, which in turn could negatively impact the value of the Company’s securities.
Oil, natural gas, and NGL prices are volatile. A sustained period of low oil, natural gas, and NGL prices could adversely affect Magnolia’s business, financial condition, results of operations, and ability to meet its expenditure obligations and financial commitments.
The prices Magnolia receives for its oil, natural gas, and NGL production will heavily influence its revenue, profitability, access to capital, future rate of growth, and the carrying value of its properties. Oil, natural gas, and NGLs are commodities, and their prices may fluctuate widely in response to market uncertainty and to relatively minor changes in the supply of and demand for oil, natural gas, and NGLs. Historically, oil, natural gas, and NGL prices have been volatile. Likewise, NGLs, which are made up of ethane, propane, isobutane, normal butane, and natural gasoline, each of which has different uses and pricing characteristics, have suffered significant recent declines in realized prices. The prices Magnolia receives for its production and the levels of Magnolia’s production, depend on numerous factors beyond Magnolia’s control, which include the following:
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worldwide and regional economic conditions impacting the global supply and demand for oil, natural gas, and NGLs;
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the price and quantity of foreign imports of oil, natural gas, and NGLs;
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political and economic conditions in or affecting other producing regions or countries, including the Middle East, Africa, South America, and Russia;
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actions of the Organization of the Petroleum Exporting Countries, its members, and other state- controlled oil companies relating to oil price and production controls;
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the level of global exploration, development, and production;
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the level of global inventories;
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prevailing prices on local price indexes in the areas in which Magnolia operates;
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the proximity, capacity, cost, and availability of gathering and transportation facilities;
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localized and global supply, demand fundamentals, and transportation availability; the cost of exploring for, developing, producing, and transporting reserves;
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weather conditions and natural disasters;
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technological advances affecting energy consumption;
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the price and availability of alternative fuels;
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expectations about future commodity prices;
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events that impact global market demand; and
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U.S. federal, state, local, and non-U.S. governmental regulation and taxes.
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Lower commodity prices may reduce Magnolia’s cash flow and borrowing ability. If Magnolia is unable to obtain needed capital or financing on satisfactory terms, its ability to develop future reserves could be adversely affected. Also, using lower prices in estimating proved reserves may result in a reduction in proved reserves volumes due to economic limits. In addition, sustained periods with lower oil and natural gas prices may adversely affect drilling economics and Magnolia’s ability to raise capital, which may require it to re-evaluate and postpone or eliminate its development program, and result in the reduction of some proved undeveloped reserves and related standardized measure. If Magnolia is required to curtail its drilling program, Magnolia may be unable to hold leases that are scheduled to expire, which may further reduce reserves. As a result, a substantial or extended decline in commodity prices may materially and adversely affect Magnolia’s future business, financial condition, results of operations, liquidity, and ability to finance planned capital expenditures.
Magnolia has not entered into hedging arrangements with respect to the oil, natural gas, and NGL production from its properties, and Magnolia will be exposed to the impact of decreases in the price of oil, natural gas, and NGLs.
Magnolia has not entered into hedging arrangements to establish, in advance, a price for the sale of the oil, natural gas, and NGLs it produces. As a result, Magnolia will not be protected against decreases in such prices, and if such prices decrease significantly, Magnolia’s business, results of operations, and cash flow may be materially adversely affected.
Magnolia’s development projects and acquisitions require substantial capital expenditures. Magnolia may be unable to obtain required capital or financing on satisfactory terms, which could lead to a decline in its ability to access or grow production and reserves.
The oil and natural gas industry is capital-intensive. Magnolia makes, and expects to continue to make, substantial capital expenditures related to development and acquisition projects. Magnolia has funded, and expects to continue to fund, its capital budget with cash generated by operations and potentially through borrowings under Magnolia’s secured reserve-based revolving credit facility (the “RBL Facility”). However, Magnolia’s financing needs may require it to alter or increase its capitalization substantially through the issuance of debt or equity securities or the sale of assets. The issuance of additional indebtedness would require that an additional portion of cash flow from operations be used for the payment of interest and principal on its indebtedness, thereby further reducing its ability to use cash flow from operations to fund working capital, capital expenditures, and acquisitions. The issuance of additional equity securities would be dilutive to existing stockholders. The actual amount and timing of future capital expenditures may differ materially from estimates as a result of, among other things: commodity prices; actual drilling results; the availability of drilling rigs and other services and equipment; and regulatory, technological, and competitive developments. A reduction in commodity prices from current levels may result in a decrease in actual capital expenditures, which would negatively impact Magnolia’s ability to grow production.
Magnolia’s cash flow from operations and access to capital is subject to a number of variables, including:
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the prices at which Magnolia’s production is sold;
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the amount of hydrocarbons Magnolia is able to produce from its wells;
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Magnolia’s ability to acquire, locate, and produce new reserves;
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the amount of Magnolia’s operating expenses;
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Magnolia’s ability to borrow under the RBL Facility;
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restrictions in the instruments governing Magnolia’s debt, and Magnolia’s ability to incur additional indebtedness; and
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Magnolia’s ability to access the capital markets.
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If Magnolia’s revenues or the borrowing base under the RBL Facility decrease as a result of lower oil, natural gas, and NGL prices, operational difficulties, declines in reserves or for any other reason, Magnolia may have limited ability to obtain the capital necessary to sustain operations at current levels. If additional capital is needed, Magnolia may not be able to obtain debt or equity financing on terms acceptable to it, if at all. If cash flow generated by Magnolia’s operations or available borrowings under the RBL Facility are insufficient to meet its capital requirements, the failure to obtain additional financing could result in a curtailment of the development of Magnolia’s properties, which in turn could lead to a decline in reserves and production and could materially and adversely affect Magnolia’s business, financial condition, and results of operations. If Magnolia incurs additional indebtedness, the operational risks that Magnolia faces could intensify, and Magnolia may be unable to service its existing debt service obligations.
Part of Magnolia’s business strategy involves using some of the latest available horizontal drilling and completion techniques, which involve risks and uncertainties in their application.
Magnolia’s operations involve utilizing some of the latest drilling and completion (“D&C”) techniques. The difficulties Magnolia faces drilling horizontal wells include:
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landing its wellbore in the desired drilling zone;
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staying in the desired drilling zone while drilling horizontally through the formation;
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running its casing the entire length of the wellbore; and
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being able to run tools and other equipment consistently through the horizontal wellbore.
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Difficulties that Magnolia faces while completing its wells include the following:
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the ability to fracture stimulate the planned number of stages;
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the ability to run tools the entire length of the wellbore during completion operations; and
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the ability to successfully clean out the wellbore after completion of the final fracture stimulation stage.
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Use of new technologies may not prove successful and could result in significant cost overruns or delays or reductions in production, and, in extreme cases, the abandonment of a well. In addition, certain of the new techniques may cause irregularities or interruptions in production due to offset wells being shut in and the time required to drill and complete multiple wells before any such wells begin producing. Furthermore, the results of drilling in new or emerging formations are more uncertain initially than drilling results in areas that are more developed and have a longer history of established production. Newer and emerging formations and areas have limited or no production history and, consequently, Magnolia may be more limited in assessing future drilling results in these areas. If its drilling results are less than anticipated, the return on investment for a particular project may not be as attractive as anticipated, and Magnolia could incur material write-downs of unevaluated properties, and the value of undeveloped acreage could decline in the future.
For example, potential complications associated with the new D&C techniques that Magnolia utilizes may cause Magnolia to be unable to develop its assets in line with current expectations and projections. Further, Magnolia’s recent well results may not be indicative of its future well results.
Drilling for and producing oil and natural gas are high risk activities with many uncertainties that could adversely affect Magnolia’s business, financial condition, or results of operations.
Magnolia’s future financial condition and results of operations will depend on the success of its development, production, and acquisition activities, which are subject to numerous risks beyond its control, including the risk that drilling will not result in commercially viable oil and natural gas production.
Magnolia’s decisions to develop or purchase prospects or properties will depend, in part, on the evaluation of data obtained through geophysical and geological analysis, production data, and engineering studies, which are often inconclusive or subject to varying interpretations. For a discussion of the uncertainty involved in these processes, see “Crude oil, natural gas, and NGL reserves are estimates, and actual recoveries may vary significantly.” In addition, the cost of drilling, completing, and operating wells is often uncertain.
Further, many factors may curtail, delay, or cancel scheduled drilling projects, including:
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delays imposed by, or resulting from, permitting activities, compliance with regulatory requirements, including limitations on wastewater disposal, emission of greenhouse gases (“GHGs”), and hydraulic fracturing;
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pressure or irregularities in geological formations;
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sustained periods of low oil and natural gas prices;
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shortages of or delays in obtaining equipment and qualified personnel or in obtaining water for hydraulic fracturing activities;
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equipment failures, accidents, or other unexpected operational events;
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lack of available gathering facilities or delays in construction of gathering facilities;
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lack of available capacity on interconnecting transmission pipelines;
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adverse weather conditions;
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issues related to compliance with environmental regulations;
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environmental or safety hazards, such as oil and natural gas leaks, oil spills, pipeline and tank ruptures, and unauthorized discharges of brine, well stimulation and completion fluids, toxic gases, or other pollutants into the surface and subsurface environment;
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limited availability of financing on acceptable terms;
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other market limitations in Magnolia’s industry.
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Crude oil, natural gas, and NGL reserves are estimates, and actual recoveries may vary significantly.
The process of estimating oil and natural gas reserves is complex. It requires interpretations of available technical data and many assumptions, including assumptions relating to current and future economic conditions and commodity prices. Any significant inaccuracies in these interpretations or assumptions could materially affect the estimated quantities and present value of reserves. In order to prepare the reserve estimates, Magnolia must project production rates and timing of development expenditures. The Company must also analyze available geological, geophysical, production, and engineering data. The extent, quality, and reliability of this data can vary. The process also requires economic assumptions about matters such as oil and natural gas prices, drilling and operating expenses, capital expenditures, taxes, and availability of funds. Magnolia cannot assure you that its management team’s assumptions with respect to projected production and/or the timing of development expenditures will not materially change in subsequent periods. Magnolia’s management team and board may determine to secure and deploy development capital at a faster or slower pace than currently assumed.
Actual future production, oil prices, natural gas prices, NGL prices, revenues, taxes, development expenditures, operating expenses, and quantities of recoverable oil and natural gas reserves may vary from Magnolia’s estimates. For instance, initial production rates reported by Magnolia or other operators may not be indicative of future or long-term production rates, recovery efficiencies may be worse than expected, and production declines may be greater than anticipated and may be more rapid and irregular when compared
to initial production rates. In addition, estimates of proved reserves may be adjusted to reflect additional production history, results of development activities, current commodity prices, and other existing factors. Any significant variance could materially affect the estimated quantities and present value of reserves. Moreover, there can be no assurance that reserves will ultimately be produced or that proved undeveloped reserves will be developed within the periods anticipated.
Actual future prices and costs may differ materially from those used in the present value estimate. If spot prices are below such calculated amounts, using more recent prices in estimating proved reserves may result in a reduction in proved reserve volumes due to economic limits.
The standardized measure of estimated reserves may not be an accurate estimate of the current fair value of estimated oil and natural gas reserves.
The standardized measure is a reporting convention that provides a common basis for comparing oil and natural gas companies subject to the rules and regulations of the SEC. The standardized measure requires historical twelve-month pricing as required by the SEC as well as operating and development costs prevailing as of the date of computation. Consequently, it may not reflect the prices ordinarily received or that will be received for oil and natural gas production because of varying market conditions, and it also may not reflect the actual costs that will be required to produce or develop the oil and natural gas properties. In addition, the sellers in the Business Combination were generally not subject to U.S. federal, state, or local income taxes other than certain state franchise taxes. Magnolia is subject to U.S. federal, state, and local income taxes. As a result, estimates included in this Annual Report on Form 10-K of future net cash flow may be materially different from the future net cash flows that are ultimately received. Therefore, the standardized measure of estimated reserves included in this Annual Report on Form 10-K should not be construed as accurate estimates of the current fair value of such proved reserves.
Properties Magnolia has acquired or will acquire may not produce as projected, and Magnolia may be unable to determine reserve potential, identify liabilities associated with such properties, or obtain protection from sellers against such liabilities.
Acquiring oil and natural gas properties requires Magnolia to assess reservoir and infrastructure characteristics, including recoverable reserves, future oil and gas prices and their applicable differentials, development and operating costs, and potential liabilities, including environmental liabilities. In connection with these assessments, Magnolia performs a review of the subject properties that it believes to be generally consistent with industry practices. Such assessments are inexact and inherently uncertain. For these reasons, the properties Magnolia has acquired or will acquire may not produce as expected. In connection with the assessments, Magnolia performs a review of the subject properties, but such a review may not reveal all existing or potential problems. In the course of due diligence, Magnolia may not review every well, pipeline, or associated facility. Magnolia cannot necessarily observe structural and environmental problems, such as groundwater contamination, when a review is performed. Magnolia may be unable to obtain or successfully enforce contractual indemnities from the seller for liabilities created prior to Magnolia’s purchase of the property. Magnolia may be required to assume the risk of the physical condition of the properties in addition to the risk that the properties may not perform in accordance with its expectations. Additionally, the success of future acquisitions will depend on Magnolia’s ability to integrate effectively the then-acquired business into its then-existing operations. The process of integrating acquired assets may involve unforeseen difficulties and may require a disproportionate amount of managerial and financial resources. Magnolia’s failure to achieve consolidation savings, to incorporate the additionally acquired assets into its then-existing operations successfully, or to minimize any unforeseen operational difficulties, or the failure to acquire future assets at all, could have a material adverse effect on its financial condition and results of operations.
Because Magnolia has a limited operating history, it may be difficult to evaluate its ability to successfully implement its business strategy.
Because of Magnolia’s limited operating history, the operating performance of its future assets and business strategy are not yet proven. As a result, it may be difficult to evaluate Magnolia’s business and results of operations to date and to assess its future prospects. In addition, Magnolia may encounter risks and difficulties experienced by companies whose performance is dependent upon recently acquired assets, such as failing to operate its assets as expected, higher than expected operating costs, equipment breakdown or failures, and operational errors. Further, Magnolia’s assets are operated on a day-to-day basis by EVOC’s employees pursuant to the Services Agreement, and Magnolia may be less involved in the day-to-day operations of the assets. As a result of the foregoing, Magnolia may be less successful in achieving a consistent operating level capable of generating cash flows from operations as compared to a company that has had a longer operating history. In addition, Magnolia may be less equipped to identify and address operating risks and hazards in the conduct of its business than those companies that have had longer operating histories.
Magnolia is not the operator on all of its acreage or drilling locations, and, therefore, is not able to control the timing of exploration or development efforts, associated costs, or the rate of production of any non-operated assets and could be liable for certain financial obligations of the operators or any of its contractors to the extent such operator or contractor is unable to satisfy such obligations.
Magnolia conducts many of its exploration and production operations through joint operating agreements with other parties under which the Company may not control decisions, either because the Company does not have a controlling interest or is not an operator under the agreement. There is risk that these parties may at any time have economic, business, or legal interests or goals that are inconsistent with Magnolia’s, and therefore decisions may be made that are not what the Company believes are in its best interest. Moreover, parties to these agreements may be unable or unwilling to meet their economic or other obligations, and Magnolia may be required to fulfill those obligations alone. In either case, the value of Magnolia’s investment may be adversely affected.
Magnolia’s use of a contract operator to operate its assets may adversely affect Magnolia’s business.
EVOC provides certain oil and gas operating services, including providing operating services for the substantial majority of Magnolia’s assets under the Services Agreement, the term of which extends through at least October 29, 2020, subject to possible earlier termination. There can be no assurance that Magnolia’s use of an experienced contract operator will make its operations successful. For example, EV Energy Partners, L.P., an entity that EVOC previously provided operating services for, entered bankruptcy in April of 2018. Magnolia cannot be certain that its use of EVOC to provide contract operating services will continue to be economical or that EVOC will be able or willing to provide similar or additional services to Magnolia during or after the term of the Services Agreement. In addition, other factors may exist that materially and adversely affect Magnolia’s future business, financial condition, results of operations, liquidity, and ability to finance planned capital expenditures, negating the benefits of low operating costs.
Adverse weather conditions may negatively affect Magnolia’s operating results and ability to conduct drilling activities.
Adverse weather conditions may cause, among other things, increases in the costs of, and delays in, drilling or completing new wells, power failures, temporary shut-in of production, and difficulties in the transportation of oil, natural gas, and NGLs. Any decreases in production due to poor weather conditions will have an adverse effect on revenues, which will in turn negatively affect cash flow from operations.
Magnolia’s operations are substantially dependent on the availability of water. Restrictions on its ability to obtain water may have an adverse effect on its financial condition, results of operations, and cash flows.
Water is an essential component of oil and natural gas production during both the drilling and hydraulic fracturing processes. Drought conditions have persisted in the areas where Magnolia’s assets are located in past years. These drought conditions have led governmental authorities to restrict the use of water, subject to their jurisdiction, for hydraulic fracturing to protect local water supplies. If Magnolia is unable to obtain water to use in operations, it may be unable to economically produce oil and natural gas, which could have a material and adverse effect on its financial condition, results of operations, and cash flows.
Magnolia’s producing properties are predominantly located in South Texas, making Magnolia vulnerable to risks associated with operating in a limited geographic area.
Substantially all of Magnolia’s producing properties are geographically concentrated in the Karnes County portion of the Eagle Ford Shale in South Texas and the Giddings Field of the Austin Chalk. As a result, Magnolia may be disproportionately exposed to various factors, including, among others: (i) the impact of regional supply and demand factors, (ii) delays or interruptions of production from wells in such areas caused by governmental regulation, (iii) processing or transportation capacity constraints, (iv) market limitations, (v) availability of equipment and personnel, (vi) water shortages or other drought related conditions, or (vii) interruption of the processing or transportation of oil, natural gas, or NGLs. The concentration of Magnolia’s assets in a limited geographic area also increases its exposure to changes in local laws and regulations, certain lease stipulations designed to protect wildlife and unexpected events that may occur in the regions such as natural disasters, seismic events, industrial accidents, or labor difficulties. Any one of these factors has the potential to cause producing wells to be shut-in, delay operations, decrease cash flows, increase operating and capital costs, and prevent development of lease inventory before expirations. Any of the risks described above could have a material adverse effect on Magnolia’s business, financial condition, results of operations, and cash flow.
The marketability of Magnolia’s production is dependent upon transportation and other facilities, certain of which it does not control. If these facilities are unavailable, Magnolia’s operations could be interrupted and its revenues reduced.
The marketability of Magnolia’s oil and natural gas production depend in part upon the availability, proximity, and capacity of transportation facilities owned by third parties. Oil production is generally transported by gathering systems, including, with respect to the Karnes County Assets, the gathering system owned by Ironwood Eagle Ford Midstream, LLC. The remaining oil is generally then transported by the purchaser by truck. Natural gas production is generally transported by third-party gathering lines and, with respect to natural gas production from the Karnes County Assets, by the gathering system owned by Ironwood Eagle Ford Midstream, LLC. Magnolia does not control all of the trucks and transportation facilities used to transport production from the properties, and access to them may be limited or denied. Insufficient production from wells to support the construction of pipeline facilities by purchasers or a significant disruption in the availability of Magnolia’s or third-party transportation facilities or other production facilities could adversely impact
Magnolia’s ability to deliver to market or produce oil and natural gas and thereby cause a significant interruption in Magnolia’s operations. If, in the future, Magnolia is unable, for any sustained period, to implement acceptable delivery or transportation arrangements or encounter production related difficulties, it may be required to shut in or curtail production. Any such shut-in or curtailment, or an inability to obtain favorable terms for delivery of the oil and natural gas produced from Magnolia’s fields, would materially and adversely affect its financial condition and results of operations.
Magnolia may incur losses as a result of title defects in the properties in which it invests.
The existence of a material title deficiency can render a lease worthless and adversely affect Magnolia’s results of operations and financial condition. While Magnolia typically obtains title opinions prior to commencing drilling operations on a lease or in a unit, the failure of title may not be discovered until after a well is drilled, in which case Magnolia may lose the lease and the right to produce all or a portion of the minerals under the property. Additionally, if an examination of the title history of a property reveals that an oil or natural gas lease or other developed right has been purchased in error from a person who is not the owner of the mineral interest desired, Magnolia’s interest would substantially decline in value. In such cases, the amount paid for such oil or natural gas lease or leases would be lost.
The development of proved undeveloped reserves may take longer and may require higher levels of capital expenditures than anticipated. Therefore, proved undeveloped reserves may not be ultimately developed or produced.
As of December 31, 2019, Magnolia’s assets contained 22.5 MMboe of proved undeveloped reserves consisting of 12.3 MMBbls of oil, 31.4 Bcf of natural gas, and 5.0 MMBbls of NGLs. Development of these proved undeveloped reserves may take longer and require higher levels of capital expenditures than anticipated. Magnolia’s ability to fund these expenditures is subject to a number of risks. Magnolia may be unable to obtain required capital or financing on satisfactory terms, which could lead to a decline in its ability to access or grow production and reserves. Delays in the development of reserves, increases in costs to drill and develop such reserves, or decreases in commodity prices will reduce the value of the proved undeveloped reserves and future net revenues estimated for such reserves, and may result in some projects becoming uneconomic. In addition, delays in the development of reserves could cause Magnolia to have to reclassify proved undeveloped reserves as unproved reserves. Furthermore, there is no certainty that Magnolia will be able to convert proved undeveloped reserves to developed reserves, or that undeveloped reserves will be economically viable or technically feasible to produce.
Certain factors could require Magnolia to write-down the carrying values of its properties, including commodity prices decreasing to a level such that future undiscounted cash flows from its properties are less than their carrying value.
Accounting rules require that Magnolia periodically review the carrying value of its properties for possible impairment. Based on prevailing commodity prices, specific market factors, circumstances at the time of prospective impairment reviews, the continuing evaluation of development plans, production data, economics, and other factors, Magnolia may be required to write-down the carrying value of its properties. A write-down constitutes a non-cash impairment charge to earnings. Commodity prices have been cyclical, settling as low as $46.92 per barrel for oil on the WTI spot price and $1.75 per MMBtu on the Henry Hub spot price for natural gas in 2019. Likewise, NGLs have seen significant volatility in realized prices. Further declines in commodity prices may adversely affect proved reserve values, which would likely result in a proved property impairment of Magnolia’s properties, which could have a material adverse effect on results of operations for the periods in which such charges are taken. Magnolia could experience material write-downs as a result of lower commodity prices or other factors, including low production results or high lease operating expenses, capital expenditures, or transportation fees.
Unless Magnolia replaces its reserves with new reserves and develops those new reserves, its reserves and production will decline, which would adversely affect future cash flows and results of operations.
Producing oil and natural gas reservoirs generally are characterized by declining production rates that vary depending upon reservoir characteristics and other factors. Unless Magnolia conducts successful ongoing exploration and development activities or continually acquires properties containing proved reserves, proved reserves will decline as those reserves are produced. Magnolia’s future reserves and production, and therefore future cash flow and results of operations, are highly dependent on Magnolia’s success in efficiently developing current reserves and economically finding or acquiring additional recoverable reserves. Magnolia may not be able to develop, find, or acquire sufficient additional reserves to replace future production. If Magnolia is unable to replace such production, the value of its reserves will decrease, and its business, financial condition, and results of operations would be materially and adversely affected.
Magnolia depends upon a small number of significant purchasers for the sale of most of its oil, natural gas, and NGL production. The loss of one or more of such purchasers could, among other factors, limit Magnolia’s access to suitable markets for the oil, natural gas, and NGLs it produces.
Magnolia normally sells its production to a relatively small number of customers, as is customary in the oil and natural gas
business. In 2019, there were two purchasers who accounted for an aggregate 62% of the total revenue attributable to Magnolia’s assets. The loss of any significant purchaser could adversely affect Magnolia’s revenues in the short term. Magnolia expects to depend upon these or other significant purchasers for the sale of most of its oil and natural gas production. Magnolia cannot ensure that it will continue to have ready access to suitable markets for its future oil and natural gas production.
Magnolia may not be able to generate sufficient cash to service all of its indebtedness and may be forced to take other actions to satisfy debt obligations, which may not be successful.
Magnolia’s ability to make scheduled payments on or to refinance its indebtedness obligations, including the RBL Facility and the 6.0% Senior Notes due 2026 (the “2026 Senior Notes”), depends on Magnolia’s financial condition and operating performance, which are subject to prevailing economic and competitive conditions, industry cycles and certain financial, business and other factors affecting Magnolia’s operations, many of which are beyond Magnolia’s control. Magnolia may not be able to maintain a level of cash flow from operating activities sufficient to permit Magnolia to pay the principal, premium, if any, and interest on its indebtedness. Failure to make required payments on its indebtedness will result in an event of default under the agreement governing the applicable indebtedness, entitling the requisite lenders of such indebtedness to accelerate the payment of obligations thereunder and to exercise other remedies, including in respect of collateral (if any) securing such indebtedness. As of December 31, 2019, the Company had $400.0 million of principal debt related to the 2026 Senior Notes outstanding and no outstanding borrowings related to the RBL Facility and $550.0 million of borrowing capacity of the RBL Facility.
If Magnolia’s cash flow and capital resources are insufficient to fund debt service obligations, Magnolia may be forced to reduce or delay investments and capital expenditures, sell assets, seek additional capital, or restructure or refinance existing indebtedness. Magnolia’s ability to restructure or refinance indebtedness will depend on the condition of the capital markets and its financial condition at such time. Any refinancing of indebtedness may be at higher interest rates and may require Magnolia to comply with more onerous covenants, which could further restrict business operations. The terms of Magnolia’s existing or future debt instruments may restrict it from adopting some of these alternatives. In addition, any failure to make payments of interest and principal on outstanding indebtedness on a timely basis would likely harm its ability to incur additional indebtedness. In the absence of sufficient cash flows and capital resources, Magnolia could face substantial liquidity problems and might be required to dispose of material assets or operations to meet debt service and other obligations. The RBL Facility and the indenture governing the 2026 Senior Notes limit Magnolia’s ability to dispose of assets and use the proceeds from such dispositions. Magnolia may not be able to consummate those dispositions, and the proceeds of any such disposition may not be adequate to meet any debt service obligations then due. These alternative measures may not be successful and may not permit Magnolia to meet scheduled debt service obligations.
Restrictions in Magnolia’s existing and future debt agreements could limit Magnolia’s growth and ability to engage in certain activities.
Magnolia’s ability to meet its expenses and debt obligations and comply with the covenants and restrictions contained therein will depend on its future performance, which will be affected by financial, business, economic, industry, regulatory, and other factors, many of which are beyond Magnolia’s control. If market or other economic conditions deteriorate, Magnolia’s ability to comply with these covenants may be impaired. For example, Magnolia’s RBL Facility requires Magnolia to maintain quarterly compliance with a leverage and current ratio and the satisfaction of certain conditions, including the absence of defaults and events of default thereunder, to borrow money. Magnolia’s debt agreements also restrict the payment of dividends and distributions by certain of its subsidiaries to it, which could affect its access to cash. In addition, Magnolia’s ability to comply with the financial and other restrictive covenants in the agreements governing its indebtedness will be affected by the levels of cash flow from operations, future events, and other circumstances beyond Magnolia’s control. Breach of these covenants or restrictions will result in a default under Magnolia’s debt agreements, which if not cured or waived within the applicable grace period (if any), would permit the acceleration of all indebtedness outstanding thereunder by the requisite holders of such indebtedness. Upon acceleration, the indebtedness would become immediately due and payable, together with accrued and unpaid interest, and any commitments of a lender to make further loans to Magnolia may terminate. Even if new financing were then available, it may not be on terms that are acceptable to Magnolia. In addition to accelerating the indebtedness, the requisite group of affected lenders may exercise remedies upon the incurrence of an event of default, including through foreclosure, in respect of the collateral securing any such secured financing arrangements. Moreover, any subsequent replacement of Magnolia’s financing arrangements may require it to comply with more restrictive covenants, which could further restrict business operations.
Any significant reduction in Magnolia’s borrowing base under the RBL Facility as a result of the periodic borrowing base redeterminations or otherwise may negatively impact Magnolia’s ability to fund its operations.
The RBL Facility limits the amounts Magnolia can borrow up to a borrowing base amount, which the lenders determine, in good faith, in accordance with their respective usual and customary oil and gas lending criteria, based upon the loan value of the proved oil and gas reserves located within the geographic boundaries of the United States included in the most recent reserve report provided to the lenders. As of December 31, 2019, the Company had $550.0 million of borrowing base capacity of the RBL Facility.
The RBL Facility requires periodic borrowing base redeterminations based on reserve reports. Additionally, the borrowing base is subject to unscheduled reductions due to certain issuances of new junior lien indebtedness, unsecured indebtedness or subordinated indebtedness, certain sales or acquisitions of borrowing base properties, or early monetizations or terminations of certain hedge or swap positions. An unscheduled redetermination may also be requested by the requisite lenders under the RBL Facility, once within a twelve month period, or by Magnolia, twice within a twelve month period. A reduced borrowing base could render Magnolia unable to access adequate funding under the RBL Facility. Additionally, if the aggregate amount outstanding under the RBL Facility exceeds the borrowing base at any time, Magnolia would be required to repay any indebtedness in excess of the borrowing base or to provide mortgages on additional borrowing base properties to eliminate such excess. As a result of a mandatory prepayment and/or reduced access to funds under the RBL Facility, Magnolia may be unable to implement its drilling and development plan, make acquisitions, or otherwise carry out business plans, which would have a material adverse effect on its financial condition and results of operations.
Magnolia’s operations are subject to environmental and occupational health and safety laws and regulations that may expose the Company to significant costs and liabilities.
Magnolia’s operations are subject to stringent and complex federal, state, and local laws and regulations governing the discharge of materials into the environment, health and safety aspects of the Company’s operations or otherwise relating to environmental protection. These laws and regulations may impose numerous obligations applicable to Magnolia’s operations, including the acquisition of a permit or other approval before conducting regulated activities; the restriction of types, quantities, and concentration of materials that can be released into the environment; the limitation or prohibition of drilling activities on certain lands lying within wilderness, wetlands, and other protected areas; the application of specific health and safety criteria addressing worker protection; and the imposition of substantial liabilities for pollution resulting from the Company’s operations. Failure to comply with these laws and regulations may result in the assessment of sanctions, including administrative, civil or criminal penalties.
Certain environmental laws impose strict joint and several liability for costs required to remediate and restore sites where hazardous substances, hydrocarbons or solid wastes have been stored or released. Magnolia may be required to remediate contaminated properties currently or formerly operated by the Company or facilities of third parties that received waste generated by the Companies.
Magnolia may incur substantial losses and be subject to substantial liability claims as a result of operations. Additionally, Magnolia may not be insured for, or insurance may be inadequate to protect Magnolia against, these risks.
Magnolia is not insured against all risks. Losses and liabilities arising from uninsured and underinsured events could materially and adversely affect its business, financial condition, or results of operations.
Magnolia’s development activities are subject to all of the operating risks associated with drilling for and producing oil and natural gas, including the possibility of:
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environmental hazards, such as uncontrollable releases of oil, natural gas, brine, well fluids, toxic gas, or other pollution into the environment, including groundwater, air, and shoreline contamination, or the presence of endangered or threatened species;
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abnormally pressured formations;
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mechanical difficulties, such as stuck oilfield drilling and service tools and casing collapse;
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fires, explosions, and ruptures of pipelines;
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personal injuries and death;
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terrorist attacks targeting oil and natural gas related facilities and infrastructure.
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Any of these events could adversely affect Magnolia’s ability to conduct operations or result in substantial loss as a result of claims for:
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injury or loss of life;
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damage to and destruction of property, natural resources, and equipment;
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pollution and other environmental damage;
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regulatory investigations and penalties; and
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repair and remediation costs.
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Magnolia may elect not to obtain insurance for any or all of these risks if it believes that the cost of available insurance is excessive relative to the risks presented. In addition, pollution and environmental risks generally are not fully insurable. The occurrence of an event that is not fully covered by insurance could have a material adverse effect on business, financial condition, and results of operations.
Properties that Magnolia decides to drill may not yield oil or natural gas in commercially viable quantities.
Properties that Magnolia decides to drill that do not yield oil or natural gas in commercially viable quantities will adversely affect its results of operations and financial condition. There is no way to predict in advance of drilling and testing whether any particular prospect will yield oil or natural gas in sufficient quantities to recover drilling or completion costs or to be economically viable. The use of seismic data and other technologies and the study of producing fields in the same area will not enable Magnolia to know conclusively prior to drilling whether oil or natural gas will be present or, if present, whether oil or natural gas will be present in commercial quantities. Magnolia cannot ensure that the analogies drawn from available data from other wells, more fully explored prospects or producing fields will be applicable to its drilling prospects. Further, Magnolia’s drilling operations may be curtailed, delayed, or canceled as a result of numerous factors, including:
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unexpected drilling conditions;
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pressure or lost circulation in formations;
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equipment failures or accidents;
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adverse weather conditions;
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compliance with environmental and other governmental or contractual requirements; and
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increases in the cost of, and shortages or delays in the availability of, electricity, supplies, materials, drilling or workover rigs, equipment, and services.
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Magnolia may be unable to make additional attractive acquisitions or successfully integrate acquired businesses, and any inability to do so may disrupt its business and hinder its ability to grow.
In the future, Magnolia may make acquisitions of assets or businesses that are expected to complement or expand the Company’s current business. However, there is no guarantee that Magnolia will be able to identify attractive acquisition opportunities. In the event it is able to identify attractive acquisition opportunities, Magnolia may not be able to complete the acquisition or do so on commercially acceptable terms. Competition for acquisitions may also increase the cost of, or cause Magnolia to refrain from, completing acquisitions.
The success of completed acquisitions will depend on Magnolia’s ability to effectively integrate the acquired business into its existing operations. The process of integrating acquired businesses may involve unforeseen difficulties and may require a disproportionate amount of its managerial and financial resources. In addition, possible future acquisitions may be larger and for purchase prices significantly higher than those paid for earlier acquisitions. No assurance can be given that it will be able to identify additional suitable acquisition opportunities, negotiate acceptable terms, obtain financing for acquisitions on acceptable terms, or successfully acquire identified targets. Magnolia’s failure to achieve consolidation savings, to integrate the acquired businesses and assets into its then-existing operations successfully, or to minimize any unforeseen operational difficulties could have a material adverse effect on its financial condition and results of operations.
Certain of Magnolia’s properties are subject to land use restrictions, which could limit the manner in which Magnolia conducts business.
Certain of Magnolia’s properties are subject to land use restrictions, including city ordinances, which could limit the manner in which Magnolia conducts business. Such restrictions could affect, among other things, access to and the permissible uses of facilities as well as the manner in which Magnolia produces oil and natural gas and may restrict or prohibit drilling in general. The costs incurred to comply with such restrictions may be significant in nature, and Magnolia may experience delays or curtailment in the pursuit of development activities and perhaps even be precluded from the drilling of wells.
The unavailability or high cost of drilling rigs, equipment, supplies, personnel, and oilfield services could adversely affect Magnolia’s ability to execute its development plans within its budget and on a timely basis.
The demand for drilling rigs, pipe, and other equipment and supplies, as well as for qualified and experienced field personnel to drill wells and conduct field operations, geologists, geophysicists, engineers, and other professionals in the oil and natural gas industry, can fluctuate significantly, often in correlation with oil, natural gas, and NGL prices, causing periodic shortages of supplies and needed personnel. Magnolia’s operations are concentrated in areas in which oilfield activity levels have increased rapidly, and as a result, demand for such drilling rigs, equipment, and personnel, as well as access to transportation, processing, and refining facilities in these areas, have increased, as have the costs for those items. To the extent that commodity prices improve in the future, the demand for and prices of these goods and services are likely to increase, and Magnolia could encounter delays in securing, or an inability to secure, the personnel, equipment, power, services, resources, and facilities access necessary for it to resume or increase Magnolia’s development activities, which could result in production volumes being below its forecasted volumes. In addition, any such negative effect on production volumes, or significant increases in costs, could have a material adverse effect on cash flow and profitability. Furthermore, if it is unable to secure a sufficient number of drilling rigs at reasonable costs, Magnolia may not be able to drill all of its acreage before its leases expire.
Magnolia could experience periods of higher costs if commodity prices rise. These increases could reduce profitability, cash flow, and ability to complete development activities as planned.
Historically, capital and operating costs have risen during periods of increasing oil, natural gas, and NGL prices. These cost increases have resulted from a variety of factors that Magnolia will be unable to control, such as increases in the cost of electricity, steel, and other raw materials; increased demand for labor, services, and materials as drilling activity increases; and increased taxes. Decreased levels of drilling activity in the oil and natural gas industry in recent periods have led to declining costs of some drilling equipment, materials, and supplies. However, such costs may rise faster than increases in Magnolia’s revenue if commodity prices rise, thereby negatively impacting its profitability, cash flow, and ability to complete development activities as scheduled and on budget.
Magnolia may be involved in legal proceedings that could result in substantial liabilities.
Like many oil and gas companies, from time to time, Magnolia expects to be involved in various legal and other proceedings, such as title, royalty or contractual disputes, regulatory compliance matters, and personal injury or property damage matters, in the ordinary course of its business. Such legal proceedings are inherently uncertain, and their results cannot be predicted. Regardless of the outcome, such proceedings could have an adverse impact on Magnolia because of legal costs, diversion of management, other personnel, and other factors. In addition, it is possible that a resolution of one or more such proceedings could result in liability, penalties, or sanctions, as well as judgments, consent decrees, or orders requiring a change in its business practices, which could materially and adversely affect its business, operating results, and financial condition. Accruals for such liability, penalties, or sanctions may be insufficient, and judgments and estimates to determine accruals or range of losses related to legal and other proceedings could change from one period to the next, and such changes could be material.
Climate change laws and regulations restricting emissions of GHGs could result in increased operating costs and reduced demand for the oil and natural gas produced by Magnolia, while potential physical effects of climate change could disrupt production and cause it to incur significant costs in preparing for or responding to those effects.
The EPA has determined that emissions of carbon dioxide, methane, and other GHGs present an endangerment to public health and the environment and has adopted regulations pursuant to the CAA to reduce GHG emissions from various sources.
The EPA has adopted rules requiring the monitoring and reporting of GHG emissions from specified onshore and offshore oil and natural gas production sources in the United States on an annual basis, which will include certain of Magnolia’s operations. These reporting requirements cover all segments of the oil and natural gas industry, including gathering and boosting facilities as well as completions and workovers from hydraulically fractured oil wells. Separately, in June 2016, the EPA published the Oil and Natural Gas Sector: Emission Standards for New, Reconstructed, and Modified Sources Reconsideration that establish new controls, known as Subpart OOOOa, for emissions of methane from new, modified, or reconstructed sources in the oil and gas sector (“the 2016 OOOOa”). Following the change in presidential administration, there have been attempts to modify these regulations. Most recently, in August 2019, the EPA proposed amendments to the 2016 standards that, among other things, would rescind methane-specific requirements applicable to sources in the oil and natural gas industry but retain emissions limits for volatile organic compounds. Legal challenges to any final rulemaking that rescinds the 2016 standards are expected. As a result, Magnolia cannot predict the scope of any final methane regulatory requirements or the cost to comply with such requirements.
Although there has been no federal legislation to reduce GHG emissions, a number of states have developed programs that are aimed at reducing GHG emissions by means of cap and trade programs, carbon taxes, or encouraging the use of renewable energy or alternative low-carbon fuels. Cap and trade programs typically require major sources of GHG emissions to acquire and surrender emission allowances in return for emitting those GHGs. In addition, efforts have been made and continue to be made in the international community toward the adoption of international treaties or protocols that would address global climate change issues. For example, in April 2016, the United States signed the Paris Agreement, which includes nonbinding pledges to limit or reduce future emissions. In November 2019, the United States formally initiated the one year withdrawal from the agreement but may later choose to rejoin the Paris Agreement or enter into a future international agreement related to GHGs. However, the terms on which the United States may reenter the Paris Agreement, or a separately negotiated agreement, are unclear at this time.
Substantial limitations on GHG emissions could adversely affect demand for the oil and natural gas produced by Magnolia and lower the value of its reserves. Recently, activists concerned about the potential effects of climate change have directed their attention at sources of funding for fossil-fuel energy companies, which has resulted in certain financial institutions, funds, and other sources of capital restricting or eliminating their investment in oil, natural gas, and NGL activities. Ultimately, this could make it more difficult to secure funding for exploration and production activities. Additionally, activist shareholders have introduced proposals that may seek to force companies to adopt aggressive emission reduction targets or to shift away from more carbon-intensive industries. Separately, activists may also pursue other means of curtailing oil and gas operations, such as through litigation. The Company continually monitors the global
climate change agenda initiatives, including stakeholder concerns, and responds accordingly based on its assessment of such initiatives on its business.
A negative shift in investor or shareholder sentiment of the oil and gas industry could adversely affect Magnolia’s business and ability to raise debt and equity capital.
Certain segments of the investor community have developed negative sentiment towards investing in the oil and gas industry. Recent equity returns in the sector versus other industry sectors have led to lower oil and gas representation in certain key equity market indices. In addition, some investors, including investment advisors and certain sovereign wealth, pension funds, university endowments, and family foundations, have stated policies to disinvest in the oil and gas sector based on their social and environmental considerations. Certain other stakeholders have also pressured commercial and investment banks to reduce or stop financing oil and gas and related infrastructure projects.
In addition, shareholder activism has been recently increasing in the oil and gas industry, and shareholders may attempt to effect changes to Magnolia’s business or governance, whether by shareholder proposals, public campaigns, proxy solicitations, or otherwise. Such actions could adversely impact the Company’s business by distracting management and other personnel from their primary responsibilities, require the Company to incur increased costs, and/or result in reputational harm.
Such developments, including environmental activism and initiatives aimed at limiting climate change and reducing air pollution, could result in downward pressure on the stock prices of oil and gas companies, including Magnolia’s. This may also potentially result in a reduction of available capital funding for potential development projects, impacting the Company’s future financial results.
Federal, state, and local legislative and regulatory initiatives relating to hydraulic fracturing as well as governmental reviews of such activities could result in increased costs, additional operating restrictions or delays in the completion of oil and natural gas wells, and adversely affect Magnolia’s production.
The hydraulic fracturing process involves the injection of water, proppants, and chemicals under pressure into targeted subsurface formations to fracture the surrounding rock and stimulate production. It is typically done at substantial depths in formations with low permeability. Magnolia routinely uses fracturing techniques in the U.S. and other regions to expand the available space for natural gas and oil to migrate toward the wellbore. Hydraulic fracturing is typically regulated by state oil and natural gas commissions, but certain federal agencies have asserted regulatory authority over certain aspects of the process. For example, the EPA finalized regulations under the CWA in June 2016 prohibiting wastewater discharges from hydraulic fracturing and certain other natural gas operations to publicly owned wastewater treatment plants. Separately, in December 2016, the EPA released its final report on the potential impacts of hydraulic fracturing on drinking water resources. The EPA report concluded that “water cycle” activities associated with hydraulic fracturing may impact drinking water resources under certain limited circumstances.
From time to time the U.S. Congress has considered proposals to regulate hydraulic fracturing under the SDWA. While, to date, those proposals have not been enacted, several states have already enacted or are otherwise considering legislation to regulate hydraulic fracturing practices through more stringent permitting, fluid disclosure, and well construction requirements on hydraulic-fracturing operations or otherwise seek to ban fracturing activities altogether. Hydraulic fracturing of wells and subsurface water disposal via injection wells are also under public and governmental scrutiny due to potential environmental and physical impacts, including possible contamination of groundwater and drinking water and possible links to seismic events. In addition, some municipalities have significantly limited or prohibited drilling activities and/or hydraulic fracturing or are considering doing so. Although it is not possible at this time to predict the final outcome of the legislation regarding hydraulic fracturing, any new federal, state, or local restrictions on hydraulic fracturing that may be imposed in areas in which the Company conducts business could result in increased compliance costs or additional operating restrictions in the U.S.
Competition in the oil and natural gas industry is intense, making it more difficult for Magnolia to acquire properties, market oil or natural gas, and secure trained personnel.
Magnolia’s ability to acquire additional prospects and to find and develop reserves in the future will depend on its ability to evaluate and select suitable properties for acquisitions and to consummate transactions in a highly competitive environment for acquiring properties, marketing oil and natural gas, and securing trained personnel. Also, there is substantial competition for capital available for investment in the oil and natural gas industry. Many other oil and natural gas companies possess and employ greater financial, technical, and personnel resources than Magnolia. Those companies may be able to pay more for productive properties and exploratory prospects and to evaluate, bid for, and purchase a greater number of properties and prospects than Magnolia’s financial or personnel resources permit. In addition, other companies may be able to offer better compensation packages to attract and retain qualified personnel than Magnolia will able to offer. The cost to attract and retain qualified personnel has historically continually increased due to competition and may increase substantially in the future. Magnolia may not be able to compete successfully in the future in acquiring prospective reserves, developing reserves, marketing hydrocarbons, attracting and retaining quality personnel, and raising additional capital, which could have a material adverse effect on its business.
The loss of senior management or technical personnel could adversely affect operations.
Magnolia depends on the services of its senior management and technical personnel. Magnolia does not maintain, nor does Magnolia plan to obtain, any insurance against the loss of any of these individuals. The loss of the services of its senior management could have a material adverse effect on its business, financial condition, and results of operations. Magnolia is also dependent, in part, upon EVOC’s technical personnel in connection with operating its assets pursuant to the Services Agreement. A loss by EVOC of its technical personnel could adversely affect Magnolia’s business and results of operations.
Magnolia may not be able to keep pace with technological developments in its industry.
The oil and natural gas industry is characterized by rapid and significant technological advancement and the introduction of new products and services using new technologies. As others use or develop new technologies, Magnolia may be placed at a competitive disadvantage or may be forced by competitive pressures to implement those new technologies at substantial cost. In addition, other oil and natural gas companies may have greater financial, technical, and personnel resources that allow them to enjoy technological advantages and that may in the future allow them to implement new technologies before Magnolia can. Magnolia may not be able to respond to these competitive pressures or implement new technologies on a timely basis or at an acceptable cost. If one or more of the technologies it expects to use were to become obsolete, Magnolia’s business, financial condition, or results of operations could be materially and adversely affected.
There are inherent limitations in all control systems, and misstatements due to error or fraud that could seriously harm Magnolia’s business may occur and not be detected.
Magnolia’s management does not expect that Magnolia’s internal and disclosure controls will prevent all possible error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. In addition, the design of a control system must reflect the fact that there are resource constraints and the benefit of controls must be relative to their costs. Because of the inherent limitations in all control systems, an evaluation of controls can only provide reasonable assurance that all material control issues and instances of fraud, if any, in Magnolia have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Further, controls can be circumvented by the individual acts of some persons or by collusion of two or more persons. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. Magnolia is also dependent, in part, upon EVOC’s internal and disclosure controls in connection with operating its assets pursuant to the Services Agreement. A failure of Magnolia’s or EVOC’s controls and procedures to detect error or fraud could seriously harm Magnolia’s business and results of operations.
Magnolia’s business could be adversely affected by security threats, including cyber security threats, and related disruptions.
Magnolia relies heavily on its information systems, and the availability and integrity of these systems is essential to conducting Magnolia’s business and operations. Technical system flaws, power loss, cyber security risks, including cyber or phishing-attacks, unauthorized access, malicious software, data privacy breaches by employees or others with authorized access, ransomware, and other cyber security issues could compromise Magnolia’s computer and telecommunications systems and result in disruptions to the Company’s business operations or the access, disclosure, or loss of Company data and proprietary information. Additionally, as a producer of natural gas and oil, Magnolia faces various security threats that could render its information or systems unusable, and threats to the security of its facilities and infrastructure or third-party facilities and infrastructure, such as gathering and processing and other facilities, refineries
and pipelines. If any of these security breaches were to occur, they could lead to losses of, or damage to, sensitive information, facilities, infrastructure, and systems essential to its business and operations, as well as data corruption, communication interruptions, or other disruptions to its operations, which, in turn, could have a material adverse effect on its business, financial position, results of operations, and cash flows.
Magnolia’s implementation of various procedures and controls to monitor and mitigate such security threats and to increase security for its information, systems, facilities, and infrastructure may result in increased costs. Moreover, there can be no assurance that such procedures and controls will be sufficient to prevent security breaches from occurring. Magnolia is also dependent, in part, upon EVOC’s information systems in connection with operating its assets pursuant to the Services Agreement. A failure in the security of EVOC’s information systems could seriously harm Magnolia’s business and results of operations.
Magnolia is subject to certain requirements of Section 404 of the Sarbanes-Oxley Act. If the Company fails to comply with the requirements of Section 404 or if the Company or its auditors identify and report material weaknesses in internal control over financial reporting, Magnolia’s investors may lose confidence in the Company’s reported information and Magnolia’s stock price may be negatively affected.
Magnolia is required to comply with certain provisions of Section 404 of the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”). Section 404 requires that the Company documents and tests its internal control over financial reporting and issues the management’s assessment of the Company’s internal control over financial reporting. This section also requires that the Company’s independent registered public accounting firm issue an attestation report on such internal control. If Magnolia fails to comply with the requirements of Section 404 of the Sarbanes-Oxley Act, or if the Company or its auditors identify and report material weaknesses in Magnolia’s internal control over financial reporting, the accuracy and timeliness of the filing of the Company’s annual and quarterly reports may be materially adversely affected and could cause investors to lose confidence in Magnolia’s reported financial information, which could have a negative effect on the trading price of the Company’s Class A Common Stock. In addition, a material weakness in the effectiveness of the Company’s internal control over financial reporting could result in an increased chance of fraud and the loss of customers, reduce Magnolia’s ability to obtain financing, and require additional expenditures to comply with these requirements, each of which could have a material adverse effect on the Company’s business, results of operations, and financial condition.
Risks Related to Magnolia’s Class A Common Stock and Capital Structure
Magnolia is a holding company. Magnolia’s sole material asset is its equity interest in Magnolia LLC, and Magnolia is accordingly dependent upon distributions from Magnolia LLC to pay taxes and cover its corporate and other overhead expenses.
Magnolia is a holding company and has no material assets other than its equity interest in Magnolia LLC. Magnolia has no independent means of generating revenue. To the extent Magnolia LLC has available cash, Magnolia intends to cause Magnolia LLC to make (i) generally pro rata distributions to its unitholders, including Magnolia, in an amount at least sufficient to allow Magnolia to pay its taxes and (ii) non-pro rata payments to Magnolia to reimburse it for its corporate and other overhead expenses. To the extent that Magnolia needs funds and Magnolia LLC or its subsidiaries are restricted from making such distributions or payments under applicable law or regulation or under the terms of any financing arrangements, or are otherwise unable to provide such funds, Magnolia’s liquidity and financial condition could be materially adversely affected.
Magnolia’s second amended and restated certificate of incorporation and bylaws, as well as Delaware law, contain provisions that could discourage acquisition bids or merger proposals, which may adversely affect the market price of Magnolia’s Class A Common Stock.
Magnolia’s second amended and restated certificate of incorporation authorizes its board of directors to issue preferred stock without stockholder approval. If Magnolia’s board of directors elects to issue preferred stock, it could be more difficult for a third-party to acquire Magnolia. In addition, some provisions of Magnolia’s second amended and restated certificate of incorporation and its bylaws could make it more difficult for a third-party to acquire control of Magnolia, even if the change of control would be beneficial to its stockholders, including:
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limitations on the removal of directors;
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limitations on the ability of Magnolia’s stockholders to call special meetings;
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providing that the board of directors is expressly authorized to adopt, or to alter or repeal Magnolia’s bylaws; and
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establishing advance notice and certain information requirements for nominations for election to its board of directors and for proposing matters that can be acted upon by stockholders at stockholder meetings.
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In addition, certain change of control events may have the effect of accelerating any payments due under Magnolia’s RBL Facility, and could, in certain defined circumstances, require Magnolia to make an offer to repurchase its outstanding Senior Notes and/
or result in the acceleration of payments required by the indenture governing its outstanding notes, which could be substantial and accordingly serve as a disincentive to a potential acquirer of the Company.
Future sales of Magnolia’s Class A Common Stock in the public market, or the perception that such sales may occur, could reduce Magnolia’s stock price, and any additional capital raised by Magnolia through the sale of equity or convertible securities may dilute your ownership in the Company.
Magnolia may sell additional shares of Class A Common Stock or securities convertible into shares of its Class A Common Stock in subsequent offerings. Magnolia cannot predict the size of future issuances of its Class A Common Stock or securities convertible into Class A Common Stock or the effect, if any, that such future issuances will have on the market price of its Class A Common Stock. Sales of substantial amounts of Magnolia’s Class A Common Stock (including shares issued in connection with an acquisition or in connection with Magnolia’s existing or future equity compensation plans), or the perception that such sales could occur, may adversely affect prevailing market prices of its Class A Common Stock.
Unanticipated changes in effective tax rates or adverse outcomes resulting from examination of Magnolia’s income or other tax returns could adversely affect its financial condition and results of operations.
Magnolia is subject to taxes by U.S. federal, state, and local tax authorities. Magnolia’s future effective tax rates could be subject to volatility or adversely affected by a number of factors, including:
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changes in the valuation of Magnolia’s deferred tax assets and liabilities;
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expected timing and amount of the release of any tax valuation allowances;
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tax effects of stock based compensation;
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costs related to intercompany restructurings; or
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changes in tax laws, regulations, or interpretations thereof.
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In addition, Magnolia may be subject to audits of its income, sales, and other transaction taxes by U.S. federal, state, and local taxing authorities. Outcomes from these audits could have an adverse effect on the Company’s financial condition and results of operations.