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life of our remaining oil and natural gas properties of approximately 10 years.
Accordingly, the combination of a relatively low ratio of future development costs
and a relatively long depletable life on our Camp Hill properties has resulted
in a relatively low overall historical depletion rate and DD&A expense. This has
resulted in a capitalized cost basis associated with producing properties being
depleted over a longer period than the associated production and revenue stream,
causing the build-up of nondepleted capitalized costs associated with properties
that have been completely depleted. This combination of factors, in turn, has
had a favorable impact on our earnings, which have been higher than they would
have been had the Camp Hill properties not resulted in a relatively low overall
depletion rate and DD&A expense and longer depletion period. As a hypothetical
illustration of this impact, the removal of our Camp Hill proved undeveloped reserves
starting January 1, 2002 would have reduced our earnings by (i) an estimated $11.2
million in 2002 (comprised of after-tax charges for a $7.1 million full cost ceiling
impairment and a $4.1 million depletion expense increase), (ii) an estimated $5.9
million in 2003 (due to higher depletion expense) and (iii) an estimated $3.4
million in 2004 (due to higher depletion expense), and (iv) an estimated $6.9
million in 2005 (due to higher depletion expense). We
expect our relatively low historical depletion rate to continue until the high
level of nonproducing reserves to total proved reserves is reduced and the life
of our proved developed reserves is extended through development drilling and/or
the significant addition of new proved producing reserves through acquisition
or exploration. If our level of total proved reserves, finding cost and current
prices were all to remain constant, this continued build-up of capitalized costs
increases the probability of a ceiling test write-down. We
depreciate other property and equipment using the straight-line method based on
estimated useful lives ranging from five to 10 years. Oil
and Natural Gas Reserve Estimates The proved reserve
data as of December 31, 2005 included in this document are estimates prepared
by Ryder Scott Company, DeGolyer and MacNaughton, and Fairchild & Wells, Inc.,
Independent Petroleum Engineers. Reserve engineering is a subjective process of
estimating underground accumulations of hydrocarbons that cannot be measured in
an exact manner. The process relies on judgment and the interpretation of available
geologic, geophysical, engineering and production data. The extent, quality and
reliability of this data can vary. The process also requires certain economic
assumptions regarding drilling and operating expense, capital expenditures, taxes
and availability of funds. The SEC mandates some of these assumptions such as
oil and natural gas prices and the present value discount rate. Proved
reserve estimates prepared by others may be substantially higher or lower than
our estimates. Because these estimates depend on many assumptions, all of which
may differ from actual results, reserve quantities actually recovered may be significantly
different than estimated. Material revisions to reserve estimates may be made
depending on the results of drilling, testing, and rates of production. You
should not assume that the present value of future net cash flows is the current
market value of our estimated proved reserves. In accordance with SEC requirements,
we based the estimated discounted future net cash flows from proved reserves on
prices and costs on the date of the estimate. Our rate
of recording depreciation, depletion and amortization expense for proved properties
is dependent on our estimate of proved reserves. If these reserve estimates decline,
the rate at which we record these expenses will increase. A 10% increase or decrease
in our proved reserves would have increased or decreased our depletion expense
by 5.9% for the year ended December 31, 2005. As of
December 31, 2005, approximately 81% of our proved reserves were proved undeveloped
and proved nonproducing. Moreover, some of the producing wells included in our
reserve reports as of December 31, 2005 had produced for a relatively short period
of time as of that date. Because most of our reserve estimates are calculated
using volumetric analysis, those estimates are less reliable than estimates based
on a lengthy production history. Volumetric analysis involves estimating the volume
of a reservoir based on the net feet of pay of the structure and an estimation
of the area covered by the structure based on seismic analysis. In addition, realization
or recognition of our proved undeveloped reserves will depend on our development
schedule and plans. Lack of certainty with respect to development plans for proved
undeveloped reserves could cause the discontinuation of the classification of
these reserves as proved. We have from time to time chosen to delay development
of our proved undeveloped reserves in the Camp Hill Field in East Texas in favor
of pursuing shorter-term exploration projects with higher potential rates of return,
adding to our lease position in this field and further evaluating additional economic
enhancements for this field’s development. The average life of the Camp Hill proved
undeveloped reserves is approximately 15 years, with 50% of these reserves being
booked over 8 years ago. Although we have recently accelerated the pace of the
development of the Camp Hill project, there can be no assurance that the aforementioned
discontinuance will not occur. | |
