The nature of the business activities conducted by Swift Energy subjects it to certain hazards and risks. The following is a summary of all the material risks relating to our business activities.
Oil and natural gas prices are volatile. A substantial decrease in oil and natural gas prices would adversely affect our financial results.
Our future revenues, net income, cash flow, and the value of our oil and natural gas properties depend primarily upon market prices for oil and natural gas. Oil and natural gas prices historically have been volatile and will likely continue to be volatile in the future. The recent oil and natural gas prices may not continue and could drop precipitously in a short period of time. The prices for oil and natural gas are subject to wide fluctuation in response to relatively minor changes in the supply of and demand for oil and natural gas, market uncertainty, worldwide economic conditions, weather conditions, currency exchange rates, and political conditions in major oil producing regions, especially the Middle East. A significant decrease in price levels for an extended period would negatively affect us in several ways:
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our cash flow would be reduced, decreasing funds available for capital expenditures employed to increase production or replace reserves;
certain reserves would no longer be economic to produce, leading to both lower cash flow and proved reserves;
our lenders could reduce the borrowing base under our bank credit facility because of lower oil and natural gas reserves values, reducing our liquidity and possibly requiring mandatory loan repayments; and
access to other sources of capital, such as equity or long term debt markets, could be severely limited or unavailable in a low price environment.
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Consequently, our revenues and profitability would suffer.
Enactment of Congressional and regulatory proposals under consideration could negatively affect our business.
Numerous legislative and regulatory proposals affecting the oil and gas industry have been proposed or are under consideration by the Obama administration, Congress and various federal agencies. Among these proposals are: (1) climate change legislation introduced in Congress, Environmental Protection Agency regulations, carbon emission "cap-and-trade" regimens, and related proposals, none of which have been have been adopted in final form; (2) proposals contained in the President's budget, along with legislation introduced in Congress, none of which have been enacted by both houses of Congress, to repeal various tax deductions or exemptions available to oil and gas producers, such as the tax deduction for intangible drilling and development costs, which if eliminated could raise the cost of energy production, reduce energy
investment and affect the economics of oil and gas exploration and production activities; and (3)legislation being considered by Congress that would subject the process of hydraulic fracturing to federal regulation under the Safe Drinking Water Act, which could affect Company operations, their effectiveness, and the costs thereof. Any such future laws and regulations could result in increased costs or additional operating restrictions, and could have an effect on demand for oil and gas or prices at which it can be sold. Until any such legislation or regulations are enacted or adopted, it is not possible to gauge their impact on our future operations or our results of operations and financial condition.
Estimates of proved reserves are uncertain, and revenues from production may vary significantly from expectations.
The quantities and values of our proved reserves included in this report are only estimates and subject to numerous uncertainties. Estimates by other engineers might differ materially. The accuracy of any reserves estimate is a function of the quality of available data and of engineering and geological interpretation. These estimates depend on assumptions regarding quantities and production rates of recoverable oil and natural gas reserves, future prices for oil and natural gas, timing and amounts of development expenditures and operating expenses, all of which will vary from those assumed in our estimates. These variances may be significant.
Any significant variance from the assumptions used could result in the actual amounts of oil and natural gas ultimately recovered and future net cash flows being materially different from the estimates in our reserves reports. In addition, results of drilling, testing, production, and changes in prices after the date of the estimates of our reserves may result in substantial downward revisions. These estimates may not accurately predict the present value of net cash flows from our oil and natural gas reserves.
At December 31, 2010, approximately 55% of our estimated proved reserves were undeveloped. Recovery of undeveloped reserves generally requires significant capital expenditures and successful drilling operations. The reserves data assumes that we can and will make these expenditures and conduct these operations successfully, which may not occur.
Our South Louisiana and Southeast Louisiana core areas remain subject to damage from hurricane activity in the Gulf of Mexico, which could cause a pipeline outage or cause us to suffer significant losses.
Approximately 27% of our 2010 reserves and 52% of our 2010 production are located in our South Louisiana and Southeast Louisiana core areas. Hurricane activity in 2007 and 2008 resulted in production curtailments and physical damage to our Gulf Coast operations. For example, a significant percentage of our production was shut down by Hurricanes Katrina and Rita in 2005, and by Hurricanes Gustav and Ike in 2008. Due to increased costs after the 2005 hurricanes, we no longer carry business interruption insurance. If hurricanes damage the Gulf Coast region where we have a significant percentage of our operations, our cash flow would suffer. This decrease in cash flow, depending on the extent of the decrease, could reduce the funds we would have available for capital expenditures and reduce our
ability to borrow money or raise additional capital.
The continuing pressure on the global credit and financial markets could materially and adversely impact our financial results.
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As extensively reported, global credit and financial markets experienced extreme disruptions beginning in the second half of 2008, severely diminishing liquidity and credit availability, volatility in consumer confidence, declines in economic growth, increases in unemployment rates, and uncertainty about economic stability. We cannot assure you that there will not be further deterioration in credit, financial, or commodities markets. These economic conditions have led to higher volatility for crude oil and natural gas prices, as demonstrated by the decline in commodity prices which occurred during the later part of 2008 and into 2009. Our profitability will be significantly affected by decreased demand and lower commodity prices. Our future access to capital and the availability of future financing could be
limited due to tightening credit markets that could affect our ability to fund our capital projects.
Our operating results may be adversely affected if economic conditions impact the financial viability of our insurers, oil and gas purchasers, suppliers and commodity derivatives counterparties.
Global economic conditions may adversely affect the financial viability of and increase the credit risk associated with our purchasers, suppliers, insurers, and commodity derivative counterparties to perform under the terms of contracts or financial arrangements we have with them. Although we have heightened our level of scrutiny of our contractual counterparties, our assessment of the risk of non-performance by various parties is subject to sudden swings in the financial and credit markets. This same crisis may adversely impact insurers and their ability to pay current and future insurance claims that we may have.
Negative credit market conditions may adversely affect our access to capital, our liquidity and ability to refinance our debt.
Our future access to capital could be limited due to tightening credit markets that could affect our ability to fund our future capital projects. Negative credit market conditions could materially affect our liquidity and may inhibit our lenders from fully funding our line of credit or cause them to make the terms of our line of credit costlier or more restrictive. We are subject to semi-annual reviews of our borrowing base and commitment amount under our line of credit, and do not know the result of future redeterminations or the effect of then current oil and gas prices on that process. Additionally, our line of credit matures in October 2015, and although it has a zero balance as of December 31, 2010, long-term restriction or freezing of the capital markets may affect the availability or pricing of our renewal of the line of credit
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We have previously incurred a write-down of the carrying values of our properties and could incur additional write-downs in the future.
The SEC accounting rules require that on a quarterly basis we review the carrying value of our oil and natural gas properties for possible write-down or impairment. Starting with our financial statements ending December 31, 2009 the unescalated prices are calculated under the rules using a twelve month rolling average price from the first business day of each month. Any capital costs in excess of the ceiling must be permanently written down. Low oil and gas prices at December 31, 2008 and March 31, 2009 led to $473.1 and $50.0 million non-cash after-tax write-downs of our oil and gas properties, respectively. If oil and gas prices decline in the future, to the degree such that we incur additional capital costs on oil and gas properties and add proved reserves, we may be required to record further write-downs of our oil and
gas properties in subsequent periods.
Our oil and natural gas exploration and production business involves high risks and we may suffer uninsured losses.
These risks include blowouts, explosions, adverse weather effects and pollution and other environmental damage, any of which could result in substantial losses to the Company due to injury or loss of life, damage to or destruction of wells, production facilities or other property, clean-up responsibilities, regulatory investigations and penalties and suspension of operations. Although the Company currently maintains insurance coverage that it considers reasonable and that is similar to that maintained by comparable companies in the oil and gas industry, it is not fully insured against certain of these risks, such as business interruption, either because such insurance is not available or because of the high premium costs and deductibles associated with obtaining such insurance.
Our level of debt could reduce our financial flexibility.