31-Mar-2008
Annual Report
ITEM 6 - MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
IMPACT OF CHANGING PRICES
Average prices increased by approximately $8.43 per equivalent crude oil and gas barrel sold during 2007 as compared with average prices for 2006. In 2007 there were 246 separate crude oil price changes, as compared with 240 price changes in 2006. The difference between the highest ($92.00) and lowest ($44.70) posted prices in 2007 was $47.30 per barrel. By comparison, this same differential in 2006 was $21.25 per barrel.
LIQUIDITY AND CAPITAL RESOURCES
The Company had cash and short-term investments of $2,097,000 at December 31, 2007, for a net increase of $27,500, when compared to December 31, 2006. Short-term investments consist of certificates of deposit having original maturities of three months or more. Operating activities generated cash of $1,562,000 during 2007. During 2007, cash was consumed by capital spending of $2,085,000 and principal payments on the Company's long-term debt totaling $37,000. This was offset by proceeds from the sale of fixed assets of $469,000 and proceeds from the issuance of long-term debt of $71,000. The components of the changes in cash for 2007 are described in the Statements of Cash Flows included in Item 7 of this Form 10-KSB. Adequate funds were available to carry out all necessary oil and gas operations and to maintain its equipment. A $500,000 line of credit, unused at December 31, 2007, also provided additional liquidity during 2007.
The Company believes that its existing current assets and the amount of cash it anticipates it will generate from current operations will be sufficient to fund the anticipated liquidity and capital resource needs of the Company for the fiscal year ended December 31, 2008. In addition to its current assets, the Company also has a credit facility for $500,000 available in the event that it needs other resources to fund its liquidity and capital resource needs. Although the Company may increase its capital expenditures during the current fiscal year to enhance its current oil production capacities, it does not anticipate that such expenditures would exceed the amount of liquidity currently available to the Company. The Company's beliefs that its existing assets and the cash expected to be generated from operations will be sufficient during the current fiscal year are based on the following:
14 As of December 31, 2007, the amount of cash, cash equivalents, and short term investments was equal to $2,097,000 in the aggregate.
As of December 31, 2007, the Company had approximately $2,985,000 in current assets, and only $734,000 of current liabilities.
As of December 31, 2007, the Company had only $45,000 of long-term indebtedness (net of current maturities).
The Company is not a party to any off-balance sheet arrangements and does not engage in trading activities involving non-exchange traded contracts. In addition, the Company has no financial guarantees, debt or lease agreements or other arrangements that could trigger a requirement for an early payment or that could change the value of the Company's assets. Management continues to examine various alternatives for increasing capital resources including, among other things, participation with industry and/or private partners in drilling and exploration prospects and specific rework of existing properties to enhance production and expansion of its sales of crude oil and natural gas in California. If necessary, Pyramid could sell certain nonessential assets to raise capital for the benefit of these programs.
The Company drilled two wells in the year ended December 31, 2007. The Company drilled four wells in the year ended December 31, 2006. The Company drilled two wells in the year ended December 31, 2004. The Company drilled one well in the year ended December 31, 2003. No wells were drilled in 2005. Two of the wells drilled, one each in 2006 and 2004 were exploratory wells. The exploratory wells drilled in 2004 and 2006 were abandoned due to non-economic production of crude oil.
The Company's crude oil reserves for the year ended December 31, 2007 increased due primarily to revision of previous estimates. The drilling of two new wells in 2007 and higher average crude oil prices at December 31, 2007, combined to generate higher year-end reserves of proved developed producing properties. Proved developed producing crude oil reserves increased by 120,600 barrels at December 31, 2007.
The Company's gas reserves increased by approximately 267,000 MCF's for the year ended December 31, 2007. The increase is due to the Company's investment in a joint venture gas prospect in Texas.
The Company's crude oil reserves for the year ended December 31, 2006 increased due primarily to the drilling of four wells in 2006. The Company's crude oil reserves for the year ended December 31, 2005 increased due primarily to the recognition of proved developed non-producing and proved undeveloped reserves as a result of the review of the Company's geological data by independent petroleum engineers. The Company's crude oil reserves for the years ended December 31, 2004 and 2003, were stable. The Company was able to replace current production for 2004 and 2005, by drilling the wells in 2004 and 2003.
15 Certain properties that the Company owns have become uneconomic and have been shut-in. When these properties are not operated, any reserves that could be assigned to these properties are not included in the year-end engineering report of total Company reserves. Another major factor that directly affects the Company's future reserve base is the price of crude oil at December 31 of any given year. The year-end price of oil and gas has a significant impact on the estimated future net recoverable oil and gas reserves from proved developed properties. At certain depressed price levels, some of the Company's oil and gas properties are not economical to operate and thus its year-end engineering reserve reports do not assign any oil and gas reserves to these properties. Conversely, if year-end prices should increase to a certain level, the reserves on these leases would be economic to produce and would increase the Company's reserves.
FORWARD-LOOKING INFORMATION
Looking forward into 2008, crude oil prices have increased by approximately $11.80 per barrel as of March 27, 2008, compared to prices at December 31, 2007. There have been 59 separate price changes since December 31, 2007.
In mid March 2008, the Company retained Pfeiffer High Investor Relations, Inc. to develop and implement a comprehensive investor relations program for the Company. Pfeiffer High is a full-service investor relations firm based in Denver. Since 1982, the firm has been helping public companies maximize shareholder value by implementing comprehensive investor relations programs to raise awareness among buy and sell-side analysts, institutional portfolio managers, brokers, individual investors and the financial media.
In early March 2008, the Company drilled a new well on its Santa Fe property located in the Carneros Creek field. The well encountered over 90 feet of oil zone and was completed at a depth of 3,325 feet and is currently awaiting production equipment and perforating. Results from this well will be provided after the well has been tested and put on production.
The Company has plans for drilling additional wells in 2008 both in California and Texas. Management believes that after the gas sales begin in Texas, the Joint Venture group will be proposing a new well on the acreage the joint venture holds.
In late 2007, management selected one of the Company's older wells in the Carneros Creek field to be hydraulically fractured. After studying the successful results of this test, management selected three more existing wells to be stimulated. In February of 2008, these wells were hydraulically fractured and since that time, all three of the wells have increased daily oil production, varying from three-to-five fold, over prior daily production. Management is encouraged with these successes and is evaluating additional wells in the area to stimulate in the near future.
In December 2007, the Company participated with a joint venture group in the drilling of a directional 1,100 foot lateral hole that encountered excellent gas shows in sections of a fractured carbonate zone, at a depth below 12,000
16 feet. In mid-January 2008, the well was hydraulically fractured with the injection of 9,700 barrels of gelled fluid carrying 500,000 pounds of proppant. Post frac testing indicated natural gas rates of over 4,000,000 cubic feet a day and approximately 40 barrels a day of condensate. The gas tested at over 1,200 BTU per cubic foot and the bottom hole pressures observed were in excess of 8,000 psi during testing. Currently the well is shut-in waiting for the installation of a 3.8 mile gas sales pipeline. Participants in the joint venture expect gas sales to begin sometime in mid-2008. The joint venture group currently holds oil and gas leases on approximately 5,700 contiguous acres surrounding this well. The Company expects additional joint venture drilling operations on this acreage to begin shortly after completion of the gas sales pipeline. Pyramid Oil Company owns a gross 12.5% working interest (before payout) in this joint venture prospect.
The Company continues to seek and evaluate opportunities within the energy sector, to enhance the value of the Company. The Company's growth in 2008 will be highly dependant on the amount of success the Company has in its operations and capital investments, including the outcome of wells that have not yet been drilled. The Company's capital investment program may be modified during the year due to explorations and development successes or failures, market conditions and other variables. The production and sales of oil and gas involves many complex processes that are subject to numerous uncertainties, including reservoir risk, mechanical failures, human error and market conditions.
The Company has positioned itself, over the past several years, to withstand various types of economic uncertainties, with a program of consolidating operations on certain producing properties and concentrating on properties that provide the major revenue sources. The drilling of a new well and several limited work-overs of certain wells have allowed the Company to maintain its crude oil reserves for the last three years. The Company expects to maintain its reserve base in 2008, by drilling new wells and routine maintenance of its existing wells.
The Company may be subject to future costs necessary for compliance with the new implementation of air and water environmental quality requirements of the various state and federal governmental agencies. The requirements and costs are unknown at this time, but management believes that costs could be significant in some cases. As the scope of the requirements become more clearly defined, management may be better equipped to determine the true costs to the Company.
The Company continues to absorb the costs for various state and local fees and permits under new environmental programs, the sum of which were not material during 2007. The Company retains outside consultants to assist the Company in maintaining compliance with these regulations. The Company is actively pursuing an ongoing policy of upgrading and restoring older properties to comply with current and proposed environmental regulations. The costs of upgrading and restoring older properties to comply with environmental regulations have not been determined. Management believes that these costs will not have a material adverse effect upon its financial position or results of operations.
17 ANALYSIS OF SIGNIFICANT CHANGES IN RESULTS OF OPERATIONS
Results of Operations for the Fiscal Year Ended December 31, 2007 Compared to the Fiscal Year Ended December 31, 2006
REVENUES
OIL AND GAS SALES
Oil and gas sales increased by 14% for the year ended December 31, 2007, when compared with the same period for 2006. The increase is due primarily to higher average prices for 2007. The average price of the Company's oil and gas increased by approximately $8.43 per equivalent barrel for 2007 when compared to 2006. This was offset by a slight decrease in crude oil production/sales of approximately 350 barrels.
GAIN ON SALE OF FIXED ASSETS
The gain on the sale of fixed assets for 2007, reflects primarily the sale of real property (160 acres of grazing land). Proceeds from the sale were $448,471 for a gain of $440,473.
OPERATING EXPENSES
Operating expenses increased by approximately 5% for the year ended December 31, 2007, when compared with the same period of 2006. The cost to produce an equivalent barrel of crude oil increased by approximately $1.20 per barrel for 2007 when compared to 2006, for a total cost of approximately $24.00 per equivalent barrel. The increase in operating expenses is due primarily to an increase of approximately 3.6% in labor costs. Labor costs increased due to an increase in hourly labor rates that was effective July 1, 2006 and a bonus payment for the Company's manager of field operations.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses increased by approximately 45% for the year ended December 31, 2007. The increase is due primarily to a 30% increase in audit fees and accounting services. Compensation costs also increased by approximately 15%.
Accounting services increased by 17% due to the Company's hiring of a consulting firm that specializes in compliance with Section 404 of Sarbanes- Oxley, which requires management to assess the design and operational effectiveness of its existing internal controls over financial reporting. Audit fees increased by 12% due to higher audit fee billings and accruals for the 2007 year-end audit.
18 Compensation costs increased by 10.5% due to a severance award agreement for the Company's President, that was approved by the Board of Directors in January of 2007 (see Note 14 of Notes to Financial Statements). Salaries increased by 5% due to the hiring of a part-time employee effective July 1, 2007 and salary increases that were effective July 1, 2006
PROVISION FOR DEPLETION, DEPRECIATION AND AMORTIZATION
The provision for depletion, depreciation and amortization increased by 44% for 2007, when compared with the same period for 2006. The increase is due primarily to a 41% increase in depletion of the Companies oil and gas properties. The increase in depletion is due primarily to an increase in depletion on two of the Company's oil and gas properties, the Santa Fe Energy and Anderson leases. The increase on these two properties is due primarily to higher crude oil production due to the completion of four new wells in 2006 and two new wells in 2007.
OTHER COSTS AND EXPENSES
Other costs and expenses decreased by approximately $50,000. The decrease is due primarily to the one-time costs of approximately $40,000 associated with the listing of the Company's common stock on the American Stock Exchange (AMEX) that was effective August 21, 2006.
INTEREST INCOME
Interest income increased by approximately $17,000 due primarily to higher interest rates for 2007, as compared with the same period of 2006.
INCOME TAXES
Income taxes increased by approximately $299,000 due primarily to an increase in taxable income for both Federal and California. Taxable income for 2007, increased due primarily to higher sales of oil and gas and a gain of approximately $442,000 on the sale of fixed assets.
Results of Operations for the Fiscal Year Ended December 31, 2006 Compared to the Fiscal Year Ended December 31, 2005
REVENUES
Oil and gas sales increased by 14% for the year ended December 31, 2006, when compared with the same period for 2005. Oil and gas sales increased by 21% due to higher average prices for 2006. The average price of the Company's oil and gas increased by approximately $10.66 per equivalent barrel for 2006 when compared to 2005. This was offset by a decrease in crude oil production/sales of approximately 5,000 barrels.
PAGE <19> OPERATING EXPENSES
Operating expenses increased by approximately 10% for the year ended December 31, 2006, when compared with the same period of 2005. The cost to produce an equivalent barrel of crude oil increased by approximately $3.50 per barrel for 2006 when compared to 2005, for a total cost of approximately $22.80 per equivalent barrel. The increase in operating expenses is due to an increase of 6% in labor costs, an increase of 2% in equipment rental and an increase of 2% in insurance expense. This was offset by a decrease of 4% in outside services. The remaining increase in operating expenses of 4%, is due to a number of offsetting positive and negative changes in various cost categories of less than 1% each.
Labor costs increased due to an increase in hourly labor rates and a bonus payment that was awarded to all employees. The increase in labor costs was necessary to ensure that the Company remained competitive with the local labor market. In addition, the Company hired an additional field level employee in March of 2006. Equipment rental increased due to rental of equipment for the Anderson #6 well. The Company rented a temporary crude oil storage tank, blowout prevention equipment and gas flare for this well. This accounted for almost all of the increase in equipment rental. Insurance costs increased due to higher premiums for liability insurance and health insurance. The reduction in the cost of outside services is due to lower expenditures for well work-overs. Fewer work-overs were done in the year ended December 31, 2006 versus the same period for 2005.
EXPLORATION COSTS
In 2005, the Company entered into a Joint Venture Agreement with E & B Natural Resources for the drilling of an exploratory well on the Company's Santa Fe energy lease, section 32. E & B Natural Resources was the operator during the drilling of this well. The new well was drilled in the first quarter of 2006. As of December 31, 2006, the Company's share of costs for leaseholds and the drilling and completion of this well was approximately $348,000. In November of 2006, a decision was made by the Company and its joint venture partners to abandon this well due to the fact that the well could not produce economic quantities of oil and gas. Therefore, the Company reclassified its share of costs for this well as exploration costs in the fourth quarter of 2006.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses increased by approximately 28% for the year ended December 31, 2006. The increase is due primarily to a 13% increase in salaries. The increase in salaries is due primarily to bonuses that were paid during the third quarter of 2006 and salary increases that were effective July 1, 2006. Outside consulting fees increased by 6% due to the hiring of a petroleum engineer on a part-time basis. Audit fees increased by 4% due to additional costs of complying with Sarbanes-Oxley legislation.
20 PROVISION FOR DEPLETION, DEPRECIATION AND AMORTIZATION
The provision for depletion, depreciation and amortization increased by 29% for 2006, when compared with the same period for 2005. The increase is due primarily to a 23% increase in depletion of the Companies oil and gas properties. The increase in depletion is due primarily to an increase in depletion on two of the Company's oil and gas properties, the Santa Fe Energy and Anderson leases. The increase on these two properties is due primarily to higher crude oil production due to the completion of two new wells in the second quarter of 2006 and a new well in the third quarter of 2006.
OTHER COSTS AND EXPENSES
Other costs and expenses increased by approximately $67,000. The increase is due primarily to the costs associated with the listing of the Company's common stock on the American Stock Exchange (AMEX) that was effective August 21, 2006.
INTEREST INCOME
Interest income increased by approximately $30,000 due to higher interest rates for 2006, as compared with the same period of 2005.
OTHER INCOME
The increase in other income is due primarily to the sale of excess oil tools in the amount of $25,000.
CRITICAL ACCOUNTING POLICIES
COSTS INCURRED IN OIL AND GAS PRODUCING ACTIVITIES
The Company has adopted the "successful efforts" method of accounting for its oil and gas exploration and development activities, as set forth in the Statement of Financial Accounting Standards No. 19, as amended, issued by the Financial Accounting Standards Board.
The Company initially capitalizes expenditures for oil and gas property acquisitions until they are either determined to be successful (capable of commercial production) or unsuccessful. The carrying value of all undeveloped oil and gas properties is evaluated periodically and reduced if such carrying value appears to have been impaired. Leasehold costs relating to successful oil and gas properties remain capitalized while leasehold costs which have been proven unsuccessful are charged to operations in the period the leasehold costs are proven unsuccessful. Costs of carrying and retaining unproved properties are expensed as incurred.
21 The costs of drilling and equipping development wells are capitalized, whether the wells are successful or unsuccessful. The costs of drilling and equipping exploratory wells are capitalized until they are determined to be either successful or unsuccessful. If the wells are successful, the costs of the wells remain capitalized. If, however, the wells are unsuccessful, the capitalized costs of drilling the wells, net of any salvage value, are charged to operations in the period the wells are determined to be unsuccessful.
The Company adopted the Financial Accounting Standards Board Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" (the Statement). The Statement specifies when an impairment loss should be recognized and how impairment losses should be measured for long-lived assets to be held and used and for long-lived assets to be disposed of. In accordance with the Statement, the costs of proved oil and gas properties and equipment are periodically assessed on a lease by lease basis to determine if such costs exceed undiscounted future cash flows, and if conditions warrant an impairment reserve will be provided based on the estimated future discounted cash flows. The Company recorded an impairment reserve of $9,302 and $21,699 at December 31, 2006 and 2004, respectively. There were no material impairment reserves recorded in the year ended December 31, 2005.
DEPLETION, DEPRECIATION, AND AMORTIZATION
Depletion of leasehold costs of producing oil and gas properties is provided on the unit-of-production method, by individual property unit, based on estimated recoverable proved reserves. Depreciation and amortization of the costs of producing wells and related equipment are provided on the unit-of-production method, by individual property unit, based on estimated recoverable proved developed reserves. Amortization of the costs of undeveloped oil and gas properties is based on the Company's experience, giving consideration to the holding periods of leaseholds. The average depletion per equivalent barrel of crude oil produced for 2007, 2006 and 2005 were $5.03, $3.22 and $1.99, respectively.
Drilling and operating equipment, buildings, automotive, office and other property and equipment and leasehold improvements are stated at cost. Depreciation and amortization are computed using the straight-line method over the shorter of the estimated useful lives or the applicable lease terms (range of 3 to 19 years). Any permanent impairment of the carrying value of property and equipment is provided for at the time such impairments become known.
22 IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS
In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations, or SFAS No. 141R, which replaces SFAS No. 141. SFAS No. 141R establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any non-controlling interest in the acquiree and the goodwill acquired. SFAS No. 141R also establishes disclosure requirements which will enable users to evaluate the nature and financial effects of the business combination. SFAS No.141R is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Management anticipates that the adoption of this standard will have no impact to the Company's financial position, results of operations, or cash flows.
In December 2007, the FASB issued SFAS No. 160, Non-controlling Interests in Consolidated Financial Statements, an Amendment of Accounting Research Bulletin No. 51, which establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the non-controlling interest, changes in a parent's ownership interest and the valuation of retained non-controlling equity investments when a subsidiary is de-consolidated. SFAS No. 160 also establishes reporting requirements that provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the non-controlling owners. SFAS No. 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Management anticipates that the adoption of this standard will have no impact to the Company's financial position, results of operations, or cash flows.
In June 2007, the Emerging Issues Task Force (EITF) issued Issue No. 07-3, Accounting for Non-refundable Advance Payments for Goods or Services To Be Used in Future Research and Development Activities (EITF 07-3) which concluded that non-refundable advance payments for goods or services to be received in the future for use in research and development activities should be deferred and capitalized. The capitalized amounts should be expensed as the related goods are delivered or services are performed. Such capitalized amounts should be charged to expense if expectations change such that the goods will not be delivered or services will not be performed. The provisions of EITF 07-3 are effective for new contracts entered into during fiscal years beginning after December 15, 2007. The consensus may not be applied to earlier periods and early adoption is not permitted. Management anticipates that the adoption of this standard will have no impact to the Company's financial position, results of operations, or cash flows.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities-Including an amendment of FASB Statement No. 115 (SFAS No. 159), which permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. Management anticipates that the adoption of this standard will have no impact to the Company's financial position, results of operations, or cash flows. 23
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