Talos Energy Inc 8-K, filed Dec 8, 2020
Talos Energy Inc. (TALO)
About this 8-K
Talos Energy Inc filed this 8-K on December 8, 2020.
Items reported
- Item 8.01: Other events
- Item 9.01: Financial statements and exhibits
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM
CURRENT REPORT
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Explanatory Note
On March 2, 2020, Talos Energy Inc. (the “Company”) filed a Current Report on Form 8-K (the “Prior Report”) with the U.S. Securities and Exchange Commission announcing the consummation of a previously announced acquisition of the outstanding limited liability company interests in certain wholly owned subsidiaries (the “Acquisitions”) of each of ILX Holdings, LLC, a Delaware limited liability company (“ILX Holdings”), ILX Holdings II, LLC, a Delaware limited liability company (“ILX Holdings II”), ILX Holdings III, LLC, a Delaware limited liability company (“ILX Holdings III”) and Castex Energy 2014, LLC, a Delaware limited liability company (“Castex 2014” and, together with ILX Holdings, ILX Holdings II and ILX Holdings III, the “Riverstone Sellers”) and Castex Energy 2016, LP, a Delaware limited partnership (“Castex 2016” and, together with the Riverstone Sellers, the “Sellers”) pursuant to separate Purchase and Sale Agreements, dated as of December 10, 2019, as amended from time to time, between the Company, Talos Production Inc., a Delaware corporation, and each of the Sellers. The Acquisitions were consummated on February 28, 2020, with such Acquisitions having an effective date of July 1, 2019. The Prior Report was amended on May 13, 2020 to incorporate by reference and include, respectively, certain historical financial statements and pro forma financial information relating to the Acquisitions. On September 11, 2020, the Company filed a Current Report on Form 8-K to provide certain additional historical financial statements and pro forma financial information relating to the Acquisitions. This Current Report on Form 8-K is being filed to provide certain additional pro forma financial information relating to the Acquisitions.
| Item 8.01. | Other Events. |
The unaudited pro forma combined statement of operations of the Company for the nine months ended September 30, 2020 is filed herewith as Exhibit 99.1 to this Current Report on Form 8-K and incorporated herein by reference.
Also included in this filing as Exhibit 99.2 is the audit letter of independent petroleum engineer, Netherland, Sewell & Associates, Inc., with respect to the Company’s estimated proved reserves at September 30, 2020.
| Item 9.01. | Financial Statements and Exhibits. |
| (d) | Exhibits. |
| Exhibit Number |
Description of Exhibit | |
| 23.1 | Consent of Netherland, Sewell & Associates, Inc. | |
| 99.1 | Talos Energy Inc. Unaudited Pro Forma Combined Statement of Operations for the nine months ended September 30, 2020. | |
| 99.2 | Netherland, Sewell & Associates, Inc. Audit Letter at September 30, 2020. | |
| 104 | Cover Page Interactive Data File (embedded within the Inline XBRL document). | |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.
| TALOS ENERGY INC. | ||||||
| Date: December 8, 2020 | By: | /s/ William S. Moss III | ||||
| Name: | William S. Moss III | |||||
| Title: | Executive Vice President, General Counsel and Secretary | |||||
Exhibit 23.1
CONSENT OF INDEPENDENT PETROLEUM ENGINEERS AND GEOLOGISTS
We hereby consent to the incorporation by reference into the Registration Statements on Form S-3 (No. 333-248754), Form S-3 (No. 333-231925) and Form S-8 (No. 333-225058) of Talos Energy Inc., of (i) our report dated October 21, 2020, containing information relating to Talos Energy Inc.’s estimated reserves as of September 30, 2020, and (ii) all references to our firm or such reports included in such Registration Statements.
| NETHERLAND, SEWELL & ASSOCIATES, INC. | ||
| By: | /s/ Richard B Talley, Jr. | |
| Richard B Talley, Jr., P.E. | ||
| Senior Vice President | ||
Houston, Texas
December 8, 2020
Exhibit 99.1
TALOS ENERGY INC.
UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS
The following unaudited pro forma combined statement of operations presents the combination of the historical financial information of Talos Energy Inc., a Delaware corporation (the “Company” or “Talos”), ILX Holdings, LLC, a Delaware limited liability company (“ILX Holdings”), ILX Holdings II, LLC, a Delaware limited liability company (“ILX Holdings II”), Castex Energy 2014, LLC, a Delaware limited liability company (“Castex 2014”) and Castex Energy 2016, LP, a Delaware limited partnership (“Castex 2016” and, together with Castex 2014, the “Castex Sellers”), adjusted to give effect to the Transactions (as defined below) and related financing consisting of borrowings under the Company’s revolving bank credit facility. In addition, while the Company acquired substantially all of the key operating assets of ILX Holdings, ILX Holdings II and the Castex Sellers, the historical financial information was adjusted to eliminate specified assets and liabilities, and the associated income affect, not in certain of the wholly-owned subsidiaries of ILX Holdings and ILX Holdings II (collectively, the “ILX Target Entities”) and certain wholly-owned subsidiaries of the Castex Sellers (the “Castex Target Entities”), or were considered Excluded Assets in the Purchase Agreements (as defined below).
The unaudited pro forma combined statement of operations for the nine months ended September 30, 2020 combines the historical consolidated statements of operations of Talos, ILX Holdings, ILX Holdings II and the Castex Sellers giving effect to the Transactions and related financing as if they had been consummated on January 1, 2019.
The following unaudited pro forma combined statement of operations is based on, and should be read in conjunction with:
| • | The historical unaudited condensed consolidated financial statements of the Company and the related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in the Company’s Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission (the “SEC”) on November 5, 2020. |
| • | The historical audited consolidated financial statements of the Company and the related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (the “SEC”) on March 12, 2020; |
| • | The historical audited consolidated financial statements of ILX Holdings and the related notes included as Exhibit 99.1 in the Company’s Current Report on Form 8-K filed with the SEC on September 11, 2020; |
| • | The historical audited consolidated financial statements of ILX Holdings II and the related notes included as Exhibit 99.2 in the Company’s Current Report on Form 8-K filed with the SEC on September 11, 2020; |
| • | The historical audited consolidated financial statements of Castex 2014 and the related notes included as Exhibit 99.3 in the Company’s Current Report on Form 8-K filed with the SEC on September 11, 2020; and |
| • | The historical audited consolidated financial statements of Castex 2016 and the related notes included as Exhibit 99.4 in the Company’s Current Report on Form 8-K filed with the SEC on September 11, 2020. |
On February 28, 2020 (the “Closing Date”), the Company acquired the outstanding limited liability interests in certain wholly owned subsidiaries of ILX Holdings, ILX Holdings II, ILX Holdings III, LLC, a Delaware limited liability company (“ILX Holdings III”) and Castex 2014, each a related party and an affiliate of certain entities controlled or affiliated with Riverstone Energy Partners V, L.P. (collectively, the “Riverstone Sellers”), and Castex 2016 (together with the Riverstone Sellers, the “Sellers”) with an effective date of July 1, 2019 (collectively, the “ILX and Castex Acquisition”). The ILX and Castex Acquisition was consummated pursuant to separate Purchase and Sale Agreements, dated December 10, 2019 (as amended from time to time, the “Purchase Agreements”) for aggregate consideration consisting of (i) $385.0 million in cash subject to customary closing adjustments and (ii) an aggregate 110,000 shares (the “Preferred Shares”) of a series of the Company’s preferred stock, par value $0.01 per share, designated as “Series A Convertible Preferred Stock” were issued to the Riverstone Sellers (such issuance, the “Preferred Stock Issuance”) on the terms and subject to the conditions set forth in that certain Certificate of Designation of Preferences, Rights and Limitations relating to the Series A Convertible Preferred Stock (the “Certificate of Designation”) which subsequently converted to 11.0 million shares of the Company’s common stock, par value $0.01 per share (the “Common Stock”) on March 30, 2020 (the “Conversion” and such Common Stock, the “Conversion Stock”). The Preferred Stock Issuance, the ILX and Castex Acquisition, the Conversion and the other transactions contemplated by the Purchase Agreements are referred to herein collectively as the “Transactions”. The cash payment and escrow deposit were funded with borrowings under the revolving bank credit facility.
1
The accompanying unaudited pro forma combined statement of operations was derived by making certain adjustments to the historical financial statements listed above that are (i) directly attributable to the Transactions and related financing, (ii) factually supportable and (iii) with respect to the unaudited pro forma combined statement of operations, expected to have a continuing impact on the combined results. The adjustments are based on currently available information and certain estimates and assumptions. Therefore, the actual adjustments may differ from the pro forma adjustments. However, management believes that the assumptions provide a reasonable basis for presenting the significant effects of the Transactions and related financing and that the pro forma adjustments give appropriate effect to those assumptions and are properly applied in the unaudited pro forma combined financial statements.
The unaudited pro forma combined statement of operations and related notes are presented for illustrative purposes only and should not be relied upon as an indication of operating results that Talos would have achieved if the Transactions and related financing had taken place on the specified date. In addition, future results may vary significantly from the results reflected in the unaudited pro forma combined financial statement and should not be relied on as an indication of the future results of Talos.
TALOS ENERGY INC.
UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2020
(In thousands, except per share data)
| Talos Historical |
Target Assets Historical |
Pro Forma Adjustments |
Pro Forma Combined |
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| Note 2 | Note 4 | |||||||||||||||||||
| Revenues: |
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| Oil revenue |
$ | 358,285 | $ | 41,833 | $ | — | $ | 400,118 | ||||||||||||
| Natural gas revenue |
35,375 | 4,306 | — | 39,681 | ||||||||||||||||
| NGL revenue |
9,674 | 1,296 | — | 10,970 | ||||||||||||||||
| Other |
8,441 | — | — | 8,441 | ||||||||||||||||
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| Total revenue |
411,775 | 47,435 | — | 459,210 | ||||||||||||||||
| Operating expenses: |
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| Lease operating expense |
184,187 | 22,454 | (8 | ) | (a | ) | 206,633 | |||||||||||||
| Production taxes |
640 | 339 | — | 979 | ||||||||||||||||
| Depreciation, depletion and amortization |
262,533 | 2,389 | 9,668 | (b | ) | 274,590 | ||||||||||||||
| Write-down of oil and natural gas properties |
57 | — | — | 57 | ||||||||||||||||
| Accretion expense |
37,748 | 810 | — | 38,558 | ||||||||||||||||
| General and administrative expense |
62,484 | 3,735 | (10,026 | ) | (c | ) | 56,193 | |||||||||||||
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| Total operating expenses |
547,649 | 29,727 | (366 | ) | 577,010 | |||||||||||||||
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| Operating income (loss) |
(135,874 | ) | 17,708 | 366 | (117,800 | ) | ||||||||||||||
| Interest expense |
(76,164 | ) | — | (2,407 | ) | (d | ) | (78,571 | ) | |||||||||||
| Price risk management activities income (expense) |
154,653 | — | — | 154,653 | ||||||||||||||||
| Other income |
139 | — | — | 139 | ||||||||||||||||
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| Net income (loss) before income taxes |
(57,246 | ) | 17,708 | (2,041 | ) | (41,579 | ) | |||||||||||||
| Income tax benefit (expense) |
22,384 | — | (3,604 | ) | (e | ) | 18,780 | |||||||||||||
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| Net income (loss) |
$ | (34,862 | ) | $ | 17,708 | $ | (5,645 | ) | $ | (22,799 | ) | |||||||||
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| Net income per common share: |
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| Basic |
$ | (0.54 | ) | $ | (0.34 | ) | ||||||||||||||
| Diluted |
$ | (0.54 | ) | $ | (0.34 | ) | ||||||||||||||
| Weighted average common shares outstanding: |
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| Basic |
65,134 | 67,462 | (f) | |||||||||||||||||
| Diluted |
65,134 | 67,462 | (f) | |||||||||||||||||
2
TALOS ENERGY INC.
NOTES TO THE UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS
Note 1. Basis of Presentation
The unaudited pro forma combined statement of operations for the nine months ended September 30, 2020 combines the historical consolidated statements of operations of Talos, ILX Holdings, ILX Holdings II and the Castex Sellers, giving effect to the Transactions and related financing as if they had been consummated on January 1, 2019. The Transactions and other adjustments are described in Note 4 — Pro Forma Adjustments to these unaudited pro forma combined financial statements.
Certain reclassifications have been made to the historical financial statements of ILX Holdings, ILX Holdings II and the Castex Sellers to reflect the comparability of financial information. However, the pro forma combined financial statements may not reflect all adjustments necessary to conform the accounting policies of ILX Holdings, ILX Holdings II and the Castex Sellers to those of Talos due to the limitations on the availability of information.
The pro forma adjustments represent management’s estimates based on information available as of the date hereof and are subject to change as additional information becomes available and additional analyses are performed. The pro forma financial statement does not reflect the impact of possible revenue or earnings enhancements, cost savings from operating efficiencies or synergies, or asset dispositions. Also, the pro forma financial statement does not reflect possible adjustments related to restructuring or integration activities or transaction or other costs following the Transactions that are not expected to have a continuing impact. Further, one-time transaction-related expenses anticipated to be incurred prior to, or concurrent with, closing of the Transactions are not included in the pro forma statements of operations.
The unaudited pro forma combined financial information has been prepared using the acquisition method of accounting with Talos as the accounting acquirer of the assets acquired from the ILX Target Entities and the Castex Target Entities (the “Target Assets”). Under the acquisition method of accounting, the purchase price is allocated to the identifiable tangible and intangible assets acquired and liabilities assumed based on their respective fair values, with any excess in purchase price allocated to goodwill. The fair value of identifiable assets acquired and liabilities assumed from the Transactions are based on a preliminary estimate of fair value using assumptions described in the accompanying notes to the unaudited pro forma combined financial information that the Company believes is reasonable. See Note 3 — Preliminary Purchase Price Allocation, for additional information.
3
Note 2. Consolidation of Acquired Entities
The following table illustrates the historical income statements of ILX Holdings, ILX Holdings II and the Castex Sellers, including the elimination of expenses associated with specific assets and liabilities not acquired by Talos, that form the Target Assets Historical column on the unaudited pro forma combined statement of operations for the nine months ended September 30, 2020. Certain reclassifications have been made to the ILX Holdings, ILX Holdings II and the Castex Sellers’ historical financial statements to reflect the comparability of financial information.
| ILX Holdings Historical |
ILX Holdings II Historical |
Castex 2014 Historical |
Castex 2016 Historical |
Excluded Assets |
Total Target Assets Historical |
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| Revenues: |
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| Oil revenue |
$ | 16,515 | $ | 20,034 | $ | 5,029 | $ | 255 | — | $ | 41,833 | |||||||||||||||||
| Natural gas revenue |
825 | 668 | 2,810 | 3 | — | 4,306 | ||||||||||||||||||||||
| NGL revenue |
441 | 502 | 313 | 40 | — | 1,296 | ||||||||||||||||||||||
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| Total revenue |
17,781 | 21,204 | 8,152 | 298 | — | 47,435 | ||||||||||||||||||||||
| Operating expenses: |
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| Lease operating expense |
9,795 | 6,638 | 5,820 | 234 | (33 | ) | (a | ) | 22,454 | |||||||||||||||||||
| Production taxes |
— | — | 329 | 10 | — | 339 | ||||||||||||||||||||||
| Depreciation, depletion and amortization |
— | — | 2,190 | 199 | — | 2,389 | ||||||||||||||||||||||
| Write-down on oil and natural gas properties |
— | — | — | — | — | — | ||||||||||||||||||||||
| Accretion expense |
66 | 214 | 480 | 50 | — | 810 | ||||||||||||||||||||||
| General and administrative expense |
1,327 | 1,088 | 1,253 | 67 | — | 3,735 | ||||||||||||||||||||||
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| Total operating expenses |
11,188 | 7,940 | 10,072 | 560 | (33 | ) | 29,727 | |||||||||||||||||||||
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| Operating income (loss) |
6,593 | 13,264 | (1,920 | ) | (262 | ) | 33 | 17,708 | ||||||||||||||||||||
| Interest expense |
— | (3,113 | ) | (512 | ) | (11 | ) | 3,636 | (b | ) | — | |||||||||||||||||
| Price risk management activities income |
290 | 971 | 425 | — | (1,686 | ) | (c | ) | — | |||||||||||||||||||
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| Net income (loss) |
$ | 6,883 | $ | 11,122 | $ | (2,007 | ) | $ | (273 | ) | 1,983 | $ | 17,708 | |||||||||||||||
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| (a) | Reflects the removal of direct lease operating expense associated with the Katmai Field which is considered an Excluded Asset for ILX Holdings II from the Transactions under the applicable Purchase Agreement. |
| (b) | Reflects the exclusion of interest expense associated with debt instruments held by ILX Holdings II and the Castex Sellers as the interest expense associated with debt instruments which are not included in the Transactions. |
| (c) | Reflects the elimination of price risk management income (expense) associated with derivatives held by ILX Holdings, ILX Holdings II and the Castex Sellers, which are considered Excluded Assets under the Purchase Agreements. |
Note 3. Preliminary Purchase Price Allocation
Preliminary Estimated Purchase Price
The unaudited pro forma combined statement of operations was prepared using the acquisition method of accounting with Talos as the accounting acquirer of the Target Assets. Under the acquisition method of accounting, the purchase price is allocated to the identifiable tangible and intangible assets acquired and liabilities assumed based on their respective fair values, with any excess purchase price allocated to goodwill.
The ILX and Castex Acquisition was consummated pursuant to separate Purchase Agreements for aggregate consideration consisting of (i) $385.0 million in cash subject to customary closing adjustments and (ii) an aggregate 110,000 Preferred Shares which subsequently converted to 11.0 million shares of Conversion Stock on March 30, 2020.
4
The following table summarizes the purchase price, subject to customary post-closing adjustments (in thousands, except per share data):
| Talos Conversion Stock |
11,000 | |||
| Talos Common Stock price per share(1) |
$ | 14.20 | ||
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| Conversion Stock value |
$ | 156,200 | ||
| Cash consideration |
$ | 385,000 | ||
| Customary closing adjustments |
(88,034 | ) | ||
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| Net cash consideration paid at closing |
$ | 296,966 | ||
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| Total purchase price |
$ | 453,166 | ||
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| (1) | Represents the closing price of the Company’s Common Stock on February 28, 2020, the date of the closing of the ILX and Castex Acquisition. The purchase price was based on the value of the Conversion Stock as the value approximates the value of the Preferred Shares as a result of the automatic conversion and dividend rights described in that certain Certificate of Designation, Preferences, Rights and Limitations. |
While the Company has substantially completed the determination of the fair values of the assets acquired and liabilities assumed, the Company is still finalizing the fair value analysis related to the oil and natural gas properties acquired and asset retirement obligations assumed. The Company anticipates finalizing the determination of fair values by December 31, 2020.
The following table presents the preliminary allocation of the purchase price to the assets acquired and liabilities assumed, (in thousands):
| Current assets(1) |
$ | 9,739 | ||
| Property and equipment |
490,516 | |||
| Other long-term assets |
148 | |||
| Current liabilities |
(15,036 | ) | ||
| Other long term liabilities |
(32,201 | ) | ||
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| Allocated purchase price |
$ | 453,166 | ||
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| (1) | Includes trade and other receivables of $6.9 million, which the Company expects all to be realizable. |
Note 4. Pro Forma Adjustments
The following adjustments and assumptions were made in the preparation of the unaudited pro forma combined statement of operations:
| (a) | Reflects the elimination of dry hole and geological costs recognized by ILX Holdings and ILX Holdings II, which was based on their accounting policies which followed the successful method of accounting for oil and natural gas properties. |
| (b) | Reflects the change in depletion that would have been recorded with respect to the fair value attributable to proved oil and natural gas properties acquired as a result of the application of the full cost method of accounting for oil and natural gas activities following the ILX and Castex Acquisition. The pro forma depletion rate for the nine months ended September 30, 2020 was estimated using the proved property amounts based on the preliminary purchase price allocation and estimates of reserves as of the Closing Date, adjusted for actual production. |
| (c) | Reflects the elimination of direct, incremental costs of the ILX and Castex Acquisition reflected in the Company’s, ILX Holdings, ILX Holdings II and the Castex Sellers’ historical consolidated statements of operations during the nine months ended September 30, 2020. |
| (d) | Reflects an increase in interest expense associated with $297.0 million of additional borrowings under the revolving bank credit facility to fund the ILX and Castex Acquisition. |
| Interest on borrowings under the revolving bank credit facility is based on a current rate of LIBOR plus 3.25%. These borrowings bear interest at variable rates and are subject to interest rate risk. A 1/8% change to the interest rate would result in a change in interest expense related to variable rate financing of $0.1 million for the nine months ended September 30, 2020. |
| (e) | Reflects the impact of the change in tax status of the Target Assets from being treated as a partnership for U.S. federal and state income tax purposes to an entity subject to federal and state income taxes. As of September 30, 2020, the Company’s valuation allowance primarily relates to various state operating loss, carry forwards and foreign deferred tax assets. |
| (f) | The weighted average basic and diluted shares of common stock outstanding was calculated assuming that the 11 million shares of Conversion Stock issued to the Sellers were outstanding as of January 1, 2019. |
5
Exhibit 99.2
October 21, 2020
Mr. Floyd Bone
Talos Energy Inc.
333 Clay Street, Suite 3300
Houston, Texas 77002
Dear Mr. Bone:
In accordance with your request, we have audited the estimates prepared by Talos Energy Inc. (Talos), as of September 30, 2020, of the proved reserves and future revenue to the Talos interest in certain oil and gas properties located in Louisiana, Mississippi, Texas, and the Gulf of Mexico. It is our understanding that the proved reserves estimates shown herein constitute all of the proved reserves owned by Talos. We have examined the estimates with respect to reserves quantities, reserves categorization, future producing rates, future net revenue, and the present value of such future net revenue, using the definitions set forth in U.S. Securities and Exchange Commission (SEC) Regulation S-X Rule 4-10(a). The estimates of reserves and future revenue have been prepared in accordance with the definitions and regulations of the SEC and, with the exception of the inclusion of future income taxes, conform to the FASB Accounting Standards Codification Topic 932, Extractive Activities—Oil and Gas. We completed our audit on or about the date of this letter. This report has been prepared for Talos’s use in filing with the SEC; in our opinion the assumptions, data, methods, and procedures used in the preparation of this report are appropriate for such purpose.
The following table sets forth Talos’s estimates of the net reserves and future net revenue, as of September 30, 2020, for the audited properties:
| Net Reserves | Future Net Revenue (M$) | |||||||||||||||||||
| Category |
Oil (MBBL) |
NGL (MBBL) |
Gas (MMCF) |
Total | Present Worth at 10% |
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| Proved Developed Producing |
58,609.5 | 4,497.5 | 123,810.7 | 1,869,943.6 | 1,408,051.4 | |||||||||||||||
| Proved Developed Non-Producing |
33,210.2 | 4,127.1 | 80,524.6 | 981,139.3 | 660,610.1 | |||||||||||||||
| Proved Undeveloped |
29,677.0 | 3,184.9 | 61,497.2 | 509,091.7 | 317,750.7 | |||||||||||||||
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| Total Proved |
121,496.8 | 11,809.5 | 265,832.5 | 3,360,174.7 | 2,386,412.2 | |||||||||||||||
Totals may not add because of rounding.
The oil volumes shown include crude oil and condensate. Oil and natural gas liquids (NGL) volumes are expressed in thousands of barrels (MBBL); a barrel is equivalent to 42 United States gallons. Gas volumes are expressed in millions of cubic feet (MMCF) at standard temperature and pressure bases.
When compared on a field-by-field basis, some of the estimates of Talos are greater and some are less than the estimates of Netherland, Sewell & Associates, Inc. (NSAI). However, in our opinion the estimates shown herein of Talos’s reserves and future revenue are reasonable when aggregated at the proved level and have been prepared in accordance with the Standards Pertaining to the Estimating and Auditing of Oil and Gas Reserves Information promulgated by the Society of Petroleum Engineers (SPE Standards). Additionally, these estimates are within the recommended 10 percent tolerance threshold set forth in the SPE Standards. We are satisfied with the methods and procedures used by Talos in preparing the September 30, 2020, estimates of reserves and future revenue, and we saw nothing of an unusual nature that would cause us to take exception with the estimates, in the aggregate, as prepared by Talos.
Reserves categorization conveys the relative degree of certainty; reserves subcategorization is based on development and production status. The estimates of reserves and future revenue included herein have not been adjusted for risk. Talos’s estimates do not include probable or possible reserves that may exist for these properties, nor do they include any value for undeveloped acreage beyond those tracts for which undeveloped reserves have been estimated.
Prices used by Talos are based on the 12-month unweighted arithmetic average of the first-day-of-the-month price for each month in the period October 2019 through September 2020. For oil and NGL volumes, the average West Texas Intermediate spot price of $43.63 per barrel is adjusted by field for quality, transportation fees, and market differentials. For gas volumes, the average Henry Hub spot price of $1.967 per MMBTU is adjusted by field for energy content, transportation fees, and market differentials. All prices are held constant throughout the lives of the properties. The average adjusted product prices weighted by production over the remaining lives of the properties are $44.31 per barrel of oil, $10.89 per barrel of NGL, and $1.97 per MCF of gas.
Operating costs used by Talos are based on historical operating expense records. These costs include the per-well overhead expenses allowed under joint operating agreements along with estimates of costs to be incurred at and below the district and field levels. Operating costs used by Talos for certain assets have been reduced by expenditure reimbursements, as allowed under production handling agreements, from working interest and third-party partners. Operating costs have been divided into field-level costs, per-well costs, and per-unit-of-production costs. The field-level costs are allocated by month among the proved reserves categories based on the proportionate share of the total proved future net revenue. Talos’s estimates of proved developed producing reserves and revenue are consequently dependent on completion of the proved drilling and workover programs. Headquarters general and administrative overhead expenses of Talos are included to the extent that they are covered under joint operating agreements for the operated properties. Capital costs used by Talos are based on authorizations for expenditure and actual costs from recent activity. Capital costs are included as required for workovers, new development wells, and production equipment. Abandonment costs used are Talos’s estimates of the costs to abandon the wells, platforms, and production facilities; these estimates do not include any salvage value for the lease and well equipment. Operating, capital, and abandonment costs are not escalated for inflation.
The reserves shown in this report are estimates only and should not be construed as exact quantities. Proved reserves are those quantities of oil and gas which, by analysis of engineering and geoscience data, can be estimated with reasonable certainty to be economically producible; probable and possible reserves are those additional reserves which are sequentially less certain to be recovered than proved reserves. Estimates of reserves may increase or decrease as a result of market conditions, future operations, changes in regulations, or actual reservoir performance. In addition to the primary economic assumptions discussed herein, estimates of Talos and NSAI are based on certain assumptions including, but not limited to, that the properties will be developed consistent with current development plans as provided to us by Talos, that the properties will be operated in a prudent manner, that no governmental regulations or controls will be put in place that would impact the ability of the interest owner to recover the reserves, and that projections of future production will prove consistent with actual performance. If the reserves are recovered, the revenues therefrom and the costs related thereto could be more or less than the estimated amounts. Because of governmental policies and uncertainties of supply and demand, the sales rates, prices received for the reserves, and costs incurred in recovering such reserves may vary from assumptions made while preparing these estimates.
It should be understood that our audit does not constitute a complete reserves study of the audited oil and gas properties. Our audit consisted primarily of substantive testing, wherein we conducted a detailed review of all properties. In the conduct of our audit, we have not independently verified the accuracy and completeness of information and data furnished by Talos with respect to ownership interests, oil and gas production, well test data, historical costs of operation and development, product prices, or any agreements relating to current and future operations of the properties and sales of production. However, if in the course of our examination something came to our attention that brought into question the validity or sufficiency of any such information or data, we did not rely on such information or data until we had satisfactorily resolved our questions relating thereto or had independently verified such information or data. Our audit did not include a review of Talos’s overall reserves management processes and practices.
We used standard engineering and geoscience methods, or a combination of methods, including performance analysis, volumetric analysis, analogy, and reservoir modeling, that we considered to be appropriate and necessary to establish the conclusions set forth herein. As in all aspects of oil and gas evaluation, there are uncertainties inherent in the interpretation of engineering and geoscience data; therefore, our conclusions necessarily represent only informed professional judgment.
Supporting data documenting this audit, along with data provided by Talos, are on file in our office. The technical persons primarily responsible for conducting this audit meet the requirements regarding qualifications, independence, objectivity, and confidentiality set forth in the SPE Standards. Richard B. Talley, Jr., a Licensed Professional Engineer in the State of Texas, has been practicing consulting petroleum engineering at NSAI since 2004 and has over 5 years of prior industry experience. Edward C. Roy III, a Licensed Professional Geoscientist in the State of Texas, has been practicing consulting petroleum geoscience at NSAI since 2008 and has over 11 years of prior industry experience. We are independent petroleum engineers, geologists, geophysicists, and petrophysicists; we do not own an interest in these properties nor are we employed on a contingent basis.
| Sincerely, | ||||||||
| NETHERLAND, SEWELL & ASSOCIATES, INC. | ||||||||
| Texas Registered Engineering Firm F-2699 | ||||||||
| By: | /s/ C.H. (Scott) Rees III | |||||||
| C.H. (Scott) Rees III, P.E. | ||||||||
| Chairman and Chief Executive Officer | ||||||||
| By: | /s/ Richard B. Talley, Jr. |
By: | /s/ Edward C. Roy III | |||||
| Richard B. Talley, Jr., P.E. 102425 | Edward C. Roy III, P.G. 2364 | |||||||
| Senior Vice President | Vice President | |||||||
| Date Signed: October 21, 2020 | Date Signed: October 21, 2020 | |||||||
RBT:ALA
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