Annual Statements Open main menu

Black Stone Minerals, L.P. - Quarter Report: 2016 September (Form 10-Q)


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
  
(Mark One)
☑︎
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2016
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period _______________ to _______________
Commission File Number: 001-37362
Black Stone Minerals, L.P.
(Exact name of registrant as specified in its charter)
 
Delaware
 
47-1846692
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
1001 Fannin Street, Suite 2020
Houston, Texas
 
77002
(Address of principal executive offices)
 
(Zip code)
(713) 445-3200
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☑ฎ    No ☐  
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   ☑ฎ No  
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer
 
Accelerated filer
Non-accelerated filer

(Do not check if a smaller reporting company)
Smaller reporting company
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ☐    No  ☑︎
As of November 3, 2016, there were 95,736,113 common limited partner units, 95,189,076 subordinated limited partner units, and 52,691 preferred units of the registrant outstanding
 



TABLE OF CONTENTS
 
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 





ii

PART I – FINANCIAL INFORMATION



Item 1. Financial Statements 
BLACK STONE MINERALS, L.P. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands)
 
 
September 30, 2016
 
December 31, 2015
ASSETS
 
 

 
 

CURRENT ASSETS:
 
 

 
 

Cash and cash equivalents
 
$
4,848

 
$
13,233

Accounts receivable
 
64,391

 
41,246

Commodity derivative assets
 
13,285

 
48,260

Prepaid expenses and other current assets
 
1,718

 
856

TOTAL CURRENT ASSETS
 
84,242

 
103,595

PROPERTY AND EQUIPMENT
 
 

 
 

Oil and natural gas properties, at cost, using the successful efforts method of accounting, includes unproved properties of $620,502 and $524,563 at September 30, 2016 and December 31, 2015, respectively
 
2,680,570

 
2,482,211

Accumulated depreciation, depletion, amortization, and impairment
 
(1,630,119
)
 
(1,543,796
)
Oil and natural gas properties, net
 
1,050,451

 
938,415

Other property and equipment, net of accumulated depreciation of $14,706 and $14,660 at September 30, 2016 and December 31, 2015, respectively
 
137

 
179

NET PROPERTY AND EQUIPMENT
 
1,050,588

 
938,594

Deferred charges and other long-term assets
 
2,402

 
19,247

TOTAL ASSETS
 
$
1,137,232

 
$
1,061,436

LIABILITIES, MEZZANINE EQUITY AND EQUITY
 
 

 
 

CURRENT LIABILITIES:
 
 

 
 

Accounts payable
 
$
4,833

 
$
5,036

Accrued liabilities
 
39,394

 
58,003

Commodity derivative liabilities
 
137

 

TOTAL CURRENT LIABILITIES
 
44,364

 
63,039

LONG-TERM LIABILITIES:
 
 

 
 

Credit facility
 
299,000

 
66,000

Accrued incentive compensation
 
6,300

 
7,902

Commodity derivative liabilities
 
152

 

Deferred revenue
 
3,082

 
3,257

Asset retirement obligations
 
11,366

 
10,585

TOTAL LIABILITIES
 
364,264

 
150,783

COMMITMENTS AND CONTINGENCIES (Note 8)
 


 


MEZZANINE EQUITY:
 
 

 
 

Partners' equity - convertible redeemable preferred units, 53 and 77 units outstanding at September 30, 2016 and December 31, 2015, respectively
 
54,015

 
79,162

EQUITY:
 
 

 
 

Partners' equity - general partner interest
 

 

Partners' equity - common units, 95,733 and 96,162 units outstanding at September 30, 2016 and December 31, 2015, respectively
 
510,913

 
574,648

Partners' equity - subordinated units, 95,189 and 95,057 units outstanding at September 30, 2016 and December 31, 2015, respectively
 
206,994

 
255,699

Noncontrolling interests
 
1,046

 
1,144

TOTAL EQUITY
 
718,953

 
831,491

TOTAL LIABILITIES, MEZZANINE EQUITY AND EQUITY
 
$
1,137,232

 
$
1,061,436

The accompanying notes are an integral part of these consolidated financial statements.

1

BLACK STONE MINERALS, L.P. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per unit amounts)


 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2016
 
2015
 
2016
 
2015
REVENUE:
 
 

 
 

 
 

 
 

Oil and condensate sales
 
$
42,780

 
$
44,128

 
$
104,581

 
$
126,584

Natural gas and natural gas liquids sales
 
38,986

 
32,191

 
85,706

 
92,799

Gain (loss) on commodity derivative instruments
 
7,813

 
56,430

 
(12,295
)
 
57,450

Lease bonus and other income
 
9,592

 
4,271

 
26,129

 
16,051

TOTAL REVENUE
 
99,171

 
137,020

 
204,121

 
292,884

OPERATING (INCOME) EXPENSE:
 
 

 
 

 
 

 
 

Lease operating expense
 
5,007

 
4,924

 
14,179

 
16,540

Production costs and ad valorem taxes
 
9,228

 
8,175

 
23,301

 
26,250

Exploration expense
 
6

 
1,817

 
643

 
2,014

Depreciation, depletion, and amortization
 
28,731

 
23,288

 
79,654

 
83,414

Impairment of oil and natural gas properties
 

 
24,854

 
6,775

 
156,683

General and administrative
 
16,677

 
18,994

 
52,213

 
53,530

Accretion of asset retirement obligations
 
206

 
265

 
680

 
805

(Gain) loss on sale of assets, net
 

 
4

 
(4,772
)
 
(20
)
TOTAL OPERATING EXPENSE
 
59,855

 
82,321

 
172,673

 
339,216

INCOME (LOSS) FROM OPERATIONS
 
39,316

 
54,699

 
31,448

 
(46,332
)
OTHER INCOME (EXPENSE)
 
 

 
 

 
 

 
 

Interest and investment income
 
460

 
18

 
651

 
46

Interest expense
 
(2,282
)
 
(870
)
 
(4,773
)
 
(5,530
)
Other income
 
41

 
45

 
148

 
241

TOTAL OTHER EXPENSE
 
(1,781
)
 
(807
)
 
(3,974
)
 
(5,243
)
NET INCOME (LOSS)
 
37,535

 
53,892

 
27,474

 
(51,575
)
NET (INCOME) LOSS ATTRIBUTABLE TO PREDECESSOR
 

 

 

 
(450
)
NET (INCOME) LOSS ATTRIBUTABLE TO NONCONTROLLING INTERESTS SUBSEQUENT TO INITIAL PUBLIC OFFERING
 
8

 
(3
)
 
15

 
137

DISTRIBUTIONS ON REDEEMABLE PREFERRED UNITS SUBSEQUENT TO INITIAL PUBLIC OFFERING
 
(1,324
)
 
(2,973
)
 
(4,439
)
 
(4,783
)
NET INCOME (LOSS) ATTRIBUTABLE TO THE GENERAL PARTNER AND COMMON AND SUBORDINATED UNITS SUBSEQUENT TO INITIAL PUBLIC OFFERING
 
$
36,219

 
$
50,916

 
$
23,050

 
$
(56,671
)
ALLOCATION OF NET INCOME (LOSS) SUBSEQUENT TO INITIAL PUBLIC OFFERING ATTRIBUTABLE TO:
 
 

 
 

 
 

 
 

General partner interest
 
$

 
$

 
$

 
$

Common units
 
23,114

 
25,608

 
24,343

 
(28,502
)
Subordinated units
 
13,105

 
25,308

 
(1,293
)
 
(28,169
)
 
 
$
36,219

 
$
50,916

 
$
23,050

 
$
(56,671
)
NET INCOME (LOSS) ATTRIBUTABLE TO LIMITED PARTNERS PER COMMON AND SUBORDINATED UNIT:
 
 

 
 

 
 

 
 

Per common unit (basic)
 
$
0.24

 
$
0.27

 
$
0.26

 
$
(0.30
)
Weighted average common units outstanding (basic)
 
95,740

 
96,186

 
95,086

 
96,183

Per subordinated unit (basic)
 
$
0.14

 
$
0.27

 
$
(0.01
)
 
$
(0.30
)
Weighted average subordinated units outstanding (basic)
 
95,189

 
95,057

 
95,125

 
95,057

Per common unit (diluted)
 
$
0.24

 
$
0.27

 
$
0.26

 
$
(0.30
)
Weighted average common units outstanding (diluted)
 
96,011

 
96,186

 
95,619

 
96,183

Per subordinated unit (diluted)
 
$
0.14

 
$
0.27

 
$
(0.01
)
 
$
(0.30
)
Weighted average subordinated units outstanding (diluted)
 
95,189

 
95,057

 
95,467

 
95,057

DISTRIBUTIONS DECLARED AND PAID SUBSEQUENT TO INITIAL PUBLIC OFFERING:
 
 

 
 

 
 

 
 

Per common unit
 
$
0.2875

 
$
0.1615

 
$
0.8125

 
$
0.1615

Per subordinated unit
 
$
0.1838

 
$
0.1615

 
$
0.5513

 
$
0.1615


 The accompanying notes are an integral part of these consolidated financial statements.

2

BLACK STONE MINERALS, L.P. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF EQUITY
(Unaudited)
(In thousands, except per unit amounts)



 
 
Common
units
 
Subordinated
units
 
Partners'
equity—
common
units
 
Partners'
equity—
subordinated
units
 
Noncontrolling
interests
 
Total
equity
BALANCE AT DECEMBER 31, 2015
 
96,162

 
95,057

 
$
574,648

 
$
255,699

 
$
1,144

 
$
831,491

Restricted units granted, net of forfeitures
 
702

 
(109
)
 

 

 

 

Equity-based compensation
 

 

 
12,703

 
1,784

 

 
14,487

Conversion of redeemable preferred units
 
184

 
241

 
2,625

 
3,439

 

 
6,064

Repurchases of common units
 
(1,315
)
 

 
(24,696
)
 

 

 
(24,696
)
Distributions
 

 

 
(78,248
)
 
(52,635
)
 
(83
)
 
(130,966
)
Charges to partners' equity for accrued distribution equivalent rights
 

 

 
(462
)
 

 

 
(462
)
Net income (loss)
 

 

 
26,562

 
927

 
(15
)
 
27,474

Distributions on redeemable preferred units
 

 

 
(2,219
)
 
(2,220
)
 

 
(4,439
)
BALANCE AT SEPTEMBER 30, 2016
 
95,733

 
95,189

 
$
510,913

 
$
206,994

 
$
1,046

 
$
718,953

 
The accompanying notes are an integral part of these consolidated financial statements.

3

BLACK STONE MINERALS, L.P. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)


 
 
Nine Months Ended September 30,
 
 
2016
 
2015
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 

 
 

Net income (loss)
 
$
27,474

 
$
(51,575
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 

 
 

Depreciation, depletion, and amortization
 
79,654

 
83,414

Impairment of oil and natural gas properties
 
6,775

 
156,683

Accretion of asset retirement obligations
 
680

 
805

Amortization of deferred charges
 
594

 
724

(Gain) loss on commodity derivative instruments
 
12,295

 
(57,450
)
Net cash received on settlement of commodity derivative instruments
 
39,220

 
46,532

Equity-based compensation
 
33,120

 
13,052

Gain on sale of assets, net
 
(4,772
)
 
(20
)
Changes in operating assets and liabilities:
 
 

 
 

Accounts receivable
 
(23,144
)
 
22,485

Prepaid expenses and other current assets
 
(862
)
 
(453
)
Accounts payable and accrued liabilities
 
(29,063
)
 
3,674

Deferred revenue
 
(175
)
 
(584
)
Settlement of asset retirement obligations
 
(237
)
 
(122
)
NET CASH PROVIDED BY OPERATING ACTIVITIES
 
141,559

 
217,165

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 

 
 

Additions to oil and natural gas properties
 
(63,039
)
 
(42,401
)
Purchase of other property and equipment
 
(5
)
 
(96
)
Proceeds from the sale of oil and natural gas properties
 
177

 
432

Acquisitions of oil and natural gas properties
 
(140,893
)
 
(62,157
)
NET CASH USED IN INVESTING ACTIVITIES
 
(203,760
)
 
(104,222
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 

 
 

Proceeds from issuance of common units of Black Stone Minerals, L.P., net of offering costs
 

 
399,087

Payments for capitalized offering costs
 

 

Borrowings under senior line of credit
 
304,500

 
172,600

Repayments of borrowings under senior line of credit
 
(71,500
)
 
(523,600
)
Distributions to Predecessor unitholders
 

 
(126,383
)
Distributions to Black Stone Minerals, L.P. common and subordinated unitholders
 
(130,883
)
 
(30,886
)
Distributions to preferred unitholders
 
(5,061
)
 
(9,812
)
Distributions to noncontrolling interests
 
(83
)
 
(167
)
Redemptions of redeemable preferred units
 
(18,461
)
 

Repurchases of common and subordinated units
 
(24,696
)
 
(3,015
)
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
 
53,816

 
(122,176
)
NET CHANGE IN CASH AND CASH EQUIVALENTS
 
(8,385
)
 
(9,233
)
CASH AND CASH EQUIVALENTS - beginning of the period
 
13,233

 
14,803

CASH AND CASH EQUIVALENTS - end of the period
 
$
4,848

 
$
5,570

SUPPLEMENTAL DISCLOSURE
 
 
 
 
Interest paid
 
$
4,060

 
$
4,794

 
The accompanying notes are an integral part of these consolidated financial statements.

4

BLACK STONE MINERALS, L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     
NOTE 1—BUSINESS AND BASIS OF PRESENTATION
Description of the business: Black Stone Minerals, L.P. (“BSM” or the “Partnership”) is a publicly traded Delaware limited partnership formed on September 16, 2014. On May 6, 2015, BSM completed its initial public offering (the “IPO”) of 22,500,000 common units representing limited partner interests at a price to the public of $19.00 per common unit. BSM received proceeds of $391.5 million from the sale of its common units, net of underwriting discount, structuring fee, and offering expenses (including costs previously incurred and capitalized). BSM used the net proceeds from the IPO to repay substantially all indebtedness outstanding under its credit facility. On May 1, 2015, BSM’s common units began trading on the New York Stock Exchange under the symbol “BSM.”
Black Stone Minerals Company, L.P., a Delaware limited partnership, and its subsidiaries (collectively referred to as “BSMC” or the “Predecessor”) own oil and natural gas mineral interests in the United States. In connection with the IPO, BSMC was merged into a wholly owned subsidiary of BSM, with BSMC as the surviving entity. Pursuant to the merger, the Class A and Class B common units representing limited partner interests of the Predecessor were converted into an aggregate of 72,574,715 common units and 95,057,312 subordinated units of BSM at a conversion ratio of 12.9465:1 for 0.4329 common units and 0.5671 subordinated units, and the preferred units of BSMC were converted into an aggregate of 117,963 preferred units of BSM at a conversion ratio of one to one. The merger was accounted for as a combination of entities under common control with assets and liabilities transferred at their carrying amounts in a manner similar to a pooling of interests. Unless otherwise stated or the context otherwise indicates, all references to the “Partnership” or similar expressions for time periods prior to the IPO refer to Black Stone Minerals Company, L.P. and its subsidiaries, the Predecessor, for accounting purposes. For time periods subsequent to the IPO, these terms refer to Black Stone Minerals, L.P. and its subsidiaries.
In addition to mineral interests, which make up the vast majority of the asset base, the Partnership’s assets also include nonparticipating and overriding royalty interests. These interests, which are substantially non-cost-bearing, are collectively referred to as “mineral and royalty interests.” As of September 30, 2016, the Partnership’s mineral and royalty interests were located in most of the major onshore oil and natural gas producing basins spread across 41 states and 61 onshore oil and natural gas producing basins of the continental United States. The Partnership also owns non-operated working interests in certain oil and natural gas properties.
Basis of presentation: The accompanying unaudited interim consolidated financial statements of the Partnership have been prepared in accordance with generally accepted accounting principles (“GAAP”) in the United States and pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). These unaudited interim consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and, therefore, do not include all disclosures required for financial statements prepared in conformity with U.S. GAAP. Accordingly, the accompanying unaudited interim consolidated financial statements and related notes should be read in conjunction with the Partnership’s consolidated financial statements for the years ended December 31, 2015, 2014, and 2013 included in the Partnership’s 2015 Annual Report on Form 10-K. The financial statements include the consolidated results of the Partnership. All intercompany balances and transactions have been eliminated.
Certain reclassifications have been made to the prior periods presented to conform to the current period financial statement presentation. The reclassifications have no effect on the consolidated financial position, results of operations, or cash flows of the Partnership. In the opinion of management, all material adjustments, which are of a normal and recurring nature, necessary for a fair presentation of the results for the periods presented have been reflected. The results of operations for the three months and nine months ended September 30, 2016 are not necessarily indicative of the results to be expected for the full year.
The Partnership evaluates the significant terms of its investments to determine the method of accounting to be applied to each respective investment. Investments in which the Partnership has less than a 20% ownership interest and does not have control or exercise significant influence are accounted for under the cost method. The Partnership’s cost method investment is included in deferred charges and other long-term assets in the consolidated balance sheets. Investments in which the Partnership exercises control are consolidated, and the noncontrolling interests of such investments, which are not attributable directly or indirectly to the Partnership, are presented as a separate component of net income and equity in the accompanying consolidated financial statements.
The consolidated financial statements include undivided interests in oil and natural gas property rights. The Partnership accounts for its share of oil and natural gas property rights by reporting its proportionate share of assets, liabilities, revenues, costs, and cash flows within the relevant lines on the accompanying consolidated balance sheets, statements of operations, and statements of cash flows.

5

BLACK STONE MINERALS, L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Segment reporting: The Partnership operates in a single operating and reportable segment. Operating segments are defined as components of an enterprise for which separate financial information is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and assess performance. The Partnership’s chief executive officer has been determined to be the chief operating decision maker and allocates resources and assesses performance based upon financial information at the consolidated level.

NOTE 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Significant accounting policies: Our significant accounting policies are disclosed in the Partnership’s Annual Report on Form 10-K for the year ended December 31, 2015. There have been no changes in such policies or the application of such policies during the nine months ended September 30, 2016.
New accounting pronouncements: In May 2014, the Financial Accounting Standards Board (the “FASB”) issued an accounting standards update on a comprehensive new revenue recognition standard that will supersede Accounting Standards Codification (“ASC”) 605, Revenue Recognition. The new accounting guidance creates a framework under which an entity will allocate the transaction price to separate performance obligations and recognize revenue when each performance obligation is satisfied. Under the new standard, entities will be required to use judgment and make estimates, including identifying performance obligations in a contract, estimating the amount of variable consideration to include in the transaction price, allocating the transaction price to each separate performance obligation, and determining when an entity satisfies its performance obligations. The standard allows for either “full retrospective” adoption, meaning the standard is applied to all of the periods presented with a cumulative catch-up as of the earliest period presented, or “modified retrospective” adoption, meaning the standard is applied only to the most current period presented in the financial statements with a cumulative catch-up as of the current period. In July 2015, the FASB decided to defer the original effective date by one year to be effective for annual reporting periods beginning after December 15, 2017 instead of December 15, 2016 for public entities. The Partnership is evaluating the impact that the new accounting guidance will have on its consolidated financial statements and related disclosures and has not yet determined the method by which it will adopt the standard.
In February 2016, the FASB issued Accounting Standard Update (“ASU”) No. 2016-02, Leases (Topic 842), which requires lessees to recognize the lease assets and lease liabilities classified as operating leases on the balance sheet. The amendment will be effective for reporting periods beginning on or after December 15, 2018, and early adoption is permitted. The Partnership is evaluating the impact that the new accounting guidance will have on its consolidated financial statements and related disclosures.
In March 2016, the FASB issued ASU No. 2016-09, Compensation – Stock Compensation (Topic 718): Improvements to employee share-based payment accounting, which includes provisions intended to simplify various aspects related to how share-based compensation payments are accounted for and presented in the financial statements. This amendment will be effective prospectively for reporting periods beginning on or after December 15, 2016, and early adoption is permitted. The Partnership is evaluating the impact that the new accounting guidance will have on its consolidated financial statements and related disclosures.
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, to address diversity in practice of how certain cash receipts and cash payments are currently presented and classified in the statement of cash flows. The ASU addresses the topic of separately identifiable cash flows and application of the predominance principle. Classification of cash receipts and payments that have aspects of more than one class of cash flows should be determined first by applying specific guidance, and then by the nature of each separately identifiable cash flow. In situations where there is an absence of specific guidance and the cash flow has aspects of more than one type of classification, the predominance principle should be applied whereby the cash flow classification should depend on the activity that is likely to be the predominant source or use of cash flows. The amendments in this ASU are effective for public business entities for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years. Early adoption is permitted. The Partnership is evaluating the impact that the new accounting guidance will have on its consolidated financial statements and related disclosures


NOTE 3—ASSET RETIREMENT OBLIGATIONS
The asset retirement obligation (“ARO”) liability reflects the present value of estimated costs of dismantlement, removal, site reclamation, and similar activities associated with the Partnership’s working-interest oil and natural gas properties. The Partnership utilizes current retirement costs to estimate the expected cash outflows for retirement obligations. The Partnership estimates the ultimate productive life of its properties, a credit-adjusted risk-free rate, and an inflation factor in order to determine the current present value of this obligation. To the extent future revisions to these assumptions impact the

6

BLACK STONE MINERALS, L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

present value of the existing ARO liability, a corresponding adjustment is made to the oil and natural gas property balance. The following table describes changes to the Partnership’s ARO liability during the period:
 
 
For the nine months ended
 
September 30, 2016
 
(In thousands)
Beginning asset retirement obligations
$
10,585

   Liabilities incurred
202

   Liabilities settled
(237
)
   Accretion expense
680

   Revisions
136

Ending asset retirement obligations
$
11,366

 
 
NOTE 4—ACQUISITIONS
Acquisitions of proved oil and natural gas properties and working interests are considered business combinations and are recorded at their estimated fair value as of the acquisition date. Acquisitions of unproved oil and natural gas properties are considered asset acquisitions and are recorded at cost.
On January 8, 2016, the Partnership acquired mineral and royalty interests in the Permian Basin for $10.0 million in cash.
On June 15, 2016, the Partnership acquired an oil and natural gas mineral asset package primarily located in Weld County, Colorado for $34.0 million in cash. The following table summarizes the fair values assigned to the properties acquired:
 
 
(In thousands)
Proved oil and natural gas properties
$
18,948

Unproved oil and natural gas properties
14,082

Net working capital
1,038

Asset retirement obligations
(50
)
   Total fair value
$
34,018

 
On June 17, 2016, the Partnership acquired a diverse oil and natural gas mineral package from Freeport-McMoRan Oil and Gas, Inc. for $87.6 million in cash. The following table summarizes the fair values assigned to the properties acquired:
 
 
(In thousands)
Proved oil and natural gas properties
$
20,787

Unproved oil and natural gas properties
65,745

Net working capital
1,026

   Total fair value
$
87,558


On August 8, 2016, the Partnership acquired mineral interests located in Midland and Glasscock counties of Texas for $8.3 million in cash.
Throughout 2016, the Partnership funded certain other oil and natural gas asset acquisitions for an aggregate amount of $1.0 million in cash.
 
 

NOTE 5—DERIVATIVES AND FINANCIAL INSTRUMENTS
The Partnership’s ongoing operations expose it to changes in the market price for oil and natural gas. To mitigate the inherent commodity price risk associated with its operations, the Partnership uses oil and natural gas derivative instruments.

7

BLACK STONE MINERALS, L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

From time to time, such instruments may include fixed-price-swap contracts, fixed price contracts, costless collars, and other contractual arrangements. The Partnership enters into oil and natural gas derivative instrument contracts that contain netting arrangements with each counterparty. The Partnership does not enter into derivative instruments for speculative purposes.
As of September 30, 2016, the Partnership’s open derivative contracts consisted of only fixed-price-swap contracts. A fixed-price-swap contract between the Partnership and the counterparty specifies a fixed commodity price and a future settlement date. The Partnership will receive from, or pay to, the counterparty the difference between the fixed-swap price and the market price on the settlement date. We have not designated any of our contracts as fair value or cash flow hedges. Accordingly, the changes in fair value of the contracts are included in the consolidated statement of operations in the period of the change. All derivative gains and losses from our derivative contracts have been recognized in “Revenue” on our consolidated statements of operations. All derivative instruments that have not yet been settled in cash are reflected as either derivative assets or liabilities in the Partnership’s accompanying consolidated balance sheets as of September 30, 2016 and December 31, 2015. See Note 6 – Fair Value Measurement for further discussion.
The table below summarizes the fair value and classification of the Partnership’s derivative instruments:
 
As of September 30, 2016
Classification
 
Balance Sheet Location
 
Gross Fair
Value
 
Effect of
Counterparty
Netting
 
Net Carrying
Value on
Balance Sheet
 
 
 
 
 

 
(In thousands)
 
 
Assets:
 
 
 
 

 
 

 
 

Current asset
 
Commodity derivative assets
 
$
15,269

 
$
(1,984
)
 
$
13,285

Long-term asset
 
Deferred charges and other
long-term assets
 
73

 
(50
)
 
23

Total assets
 
 
 
$
15,342

 
$
(2,034
)
 
$
13,308

Liabilities:
 
 
 
 

 
 

 
 

Current liability
 
Commodity derivative liabilities
 
$
2,121

 
$
(1,984
)
 
$
137

Long-term liability
 
Commodity derivative liabilities
 
202

 
(50
)
 
152

Total liabilities
 
 
 
$
2,323

 
$
(2,034
)
 
$
289

 
As of December 31, 2015
Classification
 
Balance Sheet Location
 
Gross Fair
Value
 
Effect of
Counterparty
Netting
 
Net Carrying
Value on
Balance Sheet
 
 
 
 
 

 
(In thousands)
 
 
Assets:
 
 
 
 

 
 

 
 

Current asset
 
Commodity derivative assets
 
$
48,260

 
$

 
$
48,260

Long-term asset
 
Deferred charges and other
long-term assets
 
16,274

 

 
16,274

Total assets
 
 
 
$
64,534

 
$

 
$
64,534

Liabilities:
 
 
 
 

 
 

 
 

Current liability
 
Commodity derivative liabilities
 
$

 
$

 
$

Long-term liability
 
Commodity derivative liabilities
 

 

 

Total liabilities
 
 
 
$

 
$

 
$


8

BLACK STONE MINERALS, L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Changes in the fair values of the Partnership’s derivative instruments (both assets and liabilities) are presented on a net basis in the accompanying consolidated statements of operations. Changes in the fair value of the Partnership’s commodity derivative instruments (both assets and liabilities) are as follows:
 
 
For the Nine Months Ended September 30,
Derivatives not designated as hedging instruments
 
2016
 
2015
 
 
(In thousands)
Beginning fair value of commodity derivative instruments
 
$
64,534

 
$
37,471

Gain (loss) on oil derivative instruments
 
(8,906
)
 
37,305

Gain (loss) on natural gas derivative instruments
 
(3,389
)
 
20,145

Net cash received on settlements of oil derivative
   instruments
 
(23,034
)
 
(32,274
)
Net cash received on settlements of natural gas
   derivative instruments
 
(16,186
)
 
(14,258
)
Net change in fair value of commodity derivative
   instruments
 
(51,515
)
 
10,918

Ending fair value of commodity derivative instruments
 
$
13,019

 
$
48,389

The Partnership had the following open derivative contracts for oil as of September 30, 2016:
 
 

 

 
Range (Per Bbl)
Period and Type of Contract
 
Volume
(Bbl)
 
Weighted Average
(Per Bbl)
 
Low
 
High
Oil Swap Contracts:
 
 

 
 

 
 

 
 

2016
 
 

 
 

 
 

 
 

Third Quarter
 
190,000

 
$
54.32

 
$
35.74

 
$
62.53

Fourth Quarter
 
598,000

 
54.68

 
36.31

 
63.07

2017
 
 

 
 

 
 

 
 

First Quarter
 
364,000

 
$
62.69

 
$
52.73

 
$
63.65

Second Quarter
 
339,000

 
54.00

 
53.49

 
54.38

The Partnership had the following open derivative contracts for natural gas as of September 30, 2016:
 
 

 

 
Range (Per MMBtu)
Period and Type of Contract
 
Volume
(MMBtu)
 
Weighted Average
(Per MMBtu)
 
Low
 
High
Natural Gas Swap Contracts:
 
 

 
 

 
 

 
 

2016
 
 

 
 

 
 

 
 

Fourth Quarter
 
8,820,000

 
$
3.11

 
$
2.29

 
$
3.41

2017
 
 

 
 

 
 

 
 

First Quarter
 
8,040,000

 
$
3.42

 
$
3.08

 
$
3.52

Second Quarter
 
7,550,000

 
3.10

 
2.85

 
3.18

Third Quarter
 
6,820,000

 
2.97

 
2.90

 
3.12

Fourth Quarter
 
6,170,000

 
3.08

 
2.92

 
3.29


9

BLACK STONE MINERALS, L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The Partnership entered into the following derivative contracts for oil subsequent to September 30, 2016:
 
 
Volume
(Bbl)
 
Weighted Average
(Per Bbl)
 
Range (Per Bbl)
Period and Type of Contract
 
 
 
Low
 
High
Oil Swap Contracts:
 
 

 
 

 
 

 
 

2017
 
 

 
 

 
 

 
 

First Quarter
 
30,000

 
$
50.77

 
$
50.34

 
$
51.20

Second Quarter
 
66,000

 
51.69

 
51.45

 
51.96

Third Quarter
 
396,000

 
52.63

 
52.04

 
53.24

Fourth Quarter
 
396,000

 
53.12

 
52.57

 
53.67

The Partnership entered into the following derivative contracts for natural gas subsequent to September 30, 2016:
 
 
Volume
(MMBtu)
 
Weighted Average
(Per MMBtu)
 
Range (Per MMBtu)
Period and Type of Contract
 
 
 
Low
 
High
Natural Gas Swap Contracts:
 
 

 
 

 
 

 
 

2016
 
 

 
 

 
 

 
 

Fourth Quarter
 
540,000

 
$
3.02

 
$
2.89

 
$
3.15

2017
 
 

 
 

 
 

 
 

First Quarter
 
810,000

 
$
3.27

 
$
3.23

 
$
3.32

Second Quarter
 
750,000

 
2.98

 
2.96

 
3.00

Third Quarter
 
910,000

 
3.03

 
3.01

 
3.10

Fourth Quarter
 
870,000

 
3.11

 
3.03

 
3.28




10

BLACK STONE MINERALS, L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 6—FAIR VALUE MEASUREMENT
Fair value is defined as the amount at which an asset (or liability) could be bought (or incurred) or sold (or settled) in an orderly transaction between market participants at the measurement date. Further, ASC 820 establishes a framework for measuring fair value, establishes a fair value hierarchy based on the quality of inputs used to measure fair value, and includes certain disclosure requirements. Fair value estimates are based on either (i) actual market data or (ii) assumptions that other market participants would use in pricing an asset or liability, including estimates of risk.
ASC 820 establishes a three-level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy categorizes assets and liabilities measured at fair value into one of three different levels depending on the observability of the inputs employed in the measurement. The three levels are defined as follows:
Level 1—Unadjusted quoted prices for identical assets or liabilities in active markets.
Level 2—Quoted prices for similar assets or liabilities in non-active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
Level 3—Inputs that are unobservable and significant to the fair value measurement (including the Partnership’s own assumptions in determining fair value).
A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The Partnership’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability. There were no transfers into, or out of, the three levels of the fair value hierarchy for the nine months ended September 30, 2016 or the year ended December 31, 2015.
The carrying value of our cash and cash equivalents, receivables and payables approximate fair value due to the short-term nature of the instruments. The estimated carrying value of all debt as of September 30, 2016 and December 31, 2015 approximated the fair value due to variable market rates of interest. These debt fair values, which are Level 3 measurements, were estimated based on the Partnership’s incremental borrowing rates for similar types of borrowing arrangements, when quoted market prices were not available. The estimated fair values of the Partnership’s financial instruments are not necessarily indicative of the amounts that would be realized in a current market exchange.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The Partnership estimated the fair value of derivative instruments using the market approach via a model that uses inputs that are observable in the market or can be derived from, or corroborated by, observable data. See Note 5 – Derivatives and Financial Instruments for further discussion.
The following table presents information about the Partnership’s assets and liabilities measured at fair value on a recurring basis: 
 
 
Fair Value Measurements Using
 
Effect of
Counterparty
Netting
 
 
 
 
Level 1
 
Level 2
 
Level 3
 
 
Total
 
 
(In thousands)
As of September 30, 2016
 
 

 
 

 
 

 
 

 
 

Financial Assets
 
 

 
 

 
 

 
 

 
 

Commodity derivative instruments
 
$

 
$
15,342

 
$

 
$
(2,034
)
 
$
13,308

Financial Liabilities
 
 

 
 

 
 

 
 

 
 

Commodity derivative instruments
 

 
2,323

 

 
(2,034
)
 
289

As of December 31, 2015
 
 

 
 

 
 

 
 

 
 

Financial Assets
 
 

 
 

 
 

 
 

 
 

Commodity derivative instruments
 
$

 
$
64,534

 
$

 
$

 
$
64,534

Financial Liabilities
 
 

 
 

 
 

 
 

 
 

Commodity derivative instruments
 

 

 

 

 


11

BLACK STONE MINERALS, L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
Nonfinancial assets and liabilities measured at fair value on a nonrecurring basis include certain nonfinancial assets and liabilities as may be acquired in a business combination and measurements of oil and natural gas property values for assessment of impairment.
The determination of the fair values of proved and unproved properties acquired in business combinations are estimated by discounting the projected cash flows from the acquired assets at market based rates of return. The factors used to determine fair value include estimates of economic reserves, future operating and development costs, future commodity prices, and a risk-adjusted discount rate. The Partnership has designated these measurements as Level 3. The Partnership’s fair value assessments for recent acquisitions are included in Note 4 – Acquisitions.
Oil and natural gas properties are measured at fair value on a nonrecurring basis using the income approach when assessing for impairment. Proved and unproved oil and natural gas properties are reviewed for impairment when events and circumstances indicate a possible decline in the recoverability of the carrying value of those properties. When assessing producing properties for impairment, the Partnership compares the expected undiscounted projected future cash flows of the producing properties to the carrying amount of the producing properties to determine recoverability. When the carrying amount exceeds its estimated undiscounted future cash flows, the carrying amount is written down to its fair value, which is measured as the present value of the projected future cash flows of such properties. The factors used to determine fair value include estimates of economic reserves, future operating and development costs, future commodity prices, and a risk-adjusted discount rate.
The Partnership’s estimates of fair value have been determined at discrete points in time based on relevant market data. These estimates involve uncertainty and cannot be determined with precision. There were no significant changes in valuation techniques or related inputs as of September 30, 2016 or December 31, 2015.
The following table presents information about the Partnership’s assets measured at fair value on a nonrecurring basis:
 
 
 
Fair Value Measurements Using
 
Net Book
Value
1
 
 
 
 
Level 1
 
Level 2
 
Level 3
 
 
Impairment
 
 
(In thousands)
Three months ended September 30, 2016
 
 

 
 

 
 

 
 

 
 

Impaired oil and natural gas properties
 
$


$


$


$


$

Three months ended September 30, 2015
 














Impaired oil and natural gas properties
 
$


$


$
37,959


$
62,813


$
24,854

Nine months ended September 30, 2016
 
 


 


 


 


 

Impaired oil and natural gas properties
 
$


$


$
3,042


$
9,817


$
6,775

Nine months ended September 30, 2015
 
 


 


 


 


 

Impaired oil and natural gas properties
 
$


$


$
127,630


$
284,313


$
156,683

 
1 Amount represents net book value at the date of assessment.
 
 
NOTE 7—CREDIT FACILITY
The Partnership maintains a senior secured revolving credit agreement (the “Senior Line of Credit”). The Senior Line of Credit has a maximum credit amount of $1.0 billion. On October 28, 2015, the Senior Line of Credit was amended to extend the term of the agreement from February 3, 2017 to February 4, 2019. The amount of the borrowing base is derived from the value of the Partnership’s oil and natural gas properties as determined by the lender syndicate using pricing assumptions that often differ from the current market for future prices. The Partnership’s semi-annual borrowing base redetermination process resulted in a decrease of the borrowing base from $550.0 million to $450.0 million, effective April 15, 2016. The Partnership's fall 2016 borrowing base redetermination process resulted in an increase in the borrowing base from $450.0 million to $500.0 million, which became effective October 31, 2016. Drawings on the Senior Line of Credit are used for the acquisition of oil and natural gas properties and for other general business purposes.
Throughout 2016, borrowings under the Senior Line of Credit bore interest at LIBOR plus a margin between 1.50% and 2.50%, or the Prime rate plus a margin between 0.50% and 1.50%, with the margin depending on the borrowing base utilization

12

BLACK STONE MINERALS, L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

percentage of the loan. The prime rate is determined to be the higher of the financial institution’s prime rate or the federal funds effective rate plus 0.50% per annum.
Effective October 31, 2016, borrowings under the Senior Line of Credit bore interest at LIBOR plus a margin between 2.00% and 3.00%, or the Prime rate plus a margin between 1.00% and 2.00%, with the margin depending on the borrowing base utilization of the loan.
The weighted-average interest rate of the Senior Line of Credit was 2.53% and 1.92% as of September 30, 2016 and December 31, 2015, respectively. Accrued interest is payable at the end of each calendar quarter or at the end of each interest period, unless the interest period is longer than 90 days in which case interest is payable at the end of every 90-day period. In addition, a commitment fee is payable at the end of each calendar quarter based on either a rate of 0.375% if the borrowing base utilization percentage is less than 50%, or 0.500% per annum if the borrowing base utilization percentage is equal to or greater than 50%. The Senior Line of Credit is secured by substantially all of the Partnership’s producing oil and natural gas assets.
The Senior Line of Credit contains various limitations on future borrowings, leases, hedging, and sales of assets. Additionally, the Senior Line of Credit requires the Partnership to maintain a current ratio of not less than 1.0:1.0 and a ratio of total debt to EBITDAX (Earnings before Interest, Taxes, Depreciation, Amortization, and Exploration) of not more than 3.5:1.0. As of September 30, 2016, the Partnership was in compliance with all financial covenants for the Senior Line of Credit.
The aggregate principal balance outstanding was $299.0 million and $66.0 million at September 30, 2016 and December 31, 2015, respectively. The unused portion of the available borrowings under the Senior Line of Credit was $151.0 million and $484.0 million at September 30, 2016 and December 31, 2015, respectively.
 
 

NOTE 8—COMMITMENTS AND CONTINGENCIES
Environmental Matters
The Partnership’s business includes activities that are subject to U.S. federal, state, and local environmental regulations with regard to air, land, and water quality and other environmental matters.
The Partnership does not consider the potential remediation costs that could result from issues identified in any environmental site assessments to be significant to the consolidated financial statements and no provision for potential remediation costs has been made.
Litigation
From time to time, the Partnership is involved in legal actions and claims arising in the ordinary course of business. The Partnership believes existing claims as of September 30, 2016 will be resolved without material adverse effect on the Partnership’s financial condition or operations.
 
 
NOTE 9—INCENTIVE COMPENSATION
On January 12, 2016, each non-employee director on the Board of Directors of the Partnership’s general partner (the “Board”) was granted 12,368 fully vested common units for service during 2015. On February 19, 2016, the Compensation Committee of the Board approved a grant of awards to each of the Partnership’s executive officers and certain other employees. These awards consisted of restricted common units and restricted performance units (in the form of phantom units) with distribution equivalent rights. The grants included 717,654 restricted common units subject to limitations on transferability, customary forfeiture provisions, and service-based graded vesting requirements through January 7, 2019. The holders of restricted common unit awards have all of the rights of a common unitholder, including non-forfeitable distribution rights with respect to their restricted common units. The grant-date fair value of these awards, net of estimated forfeitures, is recognized ratably using the straight-line attribution method. The Compensation Committee of the Board also approved a grant of 717,654 restricted performance units that are subject to both performance-based and service-based vesting provisions. The number of common units issued to a recipient upon vesting of a restricted performance unit will be calculated based on performance against certain metrics that relate to the Partnership’s average performance over each calendar year during the performance period commencing January 1, 2016. The target number of common units subject to each restricted performance unit is one; however, based on the achievement of performance criteria, the number of common units that may be received in settlement of

13

BLACK STONE MINERALS, L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

each restricted performance unit can range from zero to two times the target number. The restricted performance units are eligible to become earned at the end of the performance period on December 31, 2018.  Compensation expense related to the restricted performance unit awards is determined by multiplying the number of common units underlying such awards that, based on the Partnership’s estimate, are likely to vest, by the grant-date fair value and recognized using the accelerated attribution method. Distribution equivalent rights for the restricted performance unit awards that are expected to vest are charged to partners’ capital. The Compensation Committee of the Board also approved the dollar-value targets for performance-based short-term incentive compensation for executive officers of the Partnership and certain other employees. The Partnership expects to ultimately settle the authorized awards at the end of the performance period in common units of the Partnership.
On April 25, 2016, the Compensation Committee of the Board approved a resolution to change the settlement feature of certain employee long-term incentive compensation plans from cash to equity. As a result of the modification, $10.1 million of cash-settled liabilities were reclassified to equity-settled liabilities during the second quarter of 2016 and the remaining unamortized expense of the awards will be amortized as equity-settled liabilities.
The table below summarizes incentive compensation expense recorded in general and administrative expenses in the consolidated statements of operations for the three months and nine months ended September 30, 2016 and 2015, respectively.
 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
Incentive compensation expense
 
2016
 
2015
 
2016
 
2015
 
 
(In thousands)
 
(In thousands)
Cash—long-term incentive plan
 
$
580

 
$
3,434

 
$
2,990

 
$
10,914

Equity-based compensation—restricted common and subordinated units
 
4,487

 
3,136

 
10,420

 
7,086

Equity-based compensation—restricted performance units
 
3,066

 
2,070

 
11,105

 
3,330

Board of Directors incentive plan
 
428

 
484

 
1,385

 
2,636

Total incentive compensation expense
 
$
8,561

 
$
9,124

 
$
25,900

 
$
23,966

 
 
NOTE 10—REDEEMABLE PREFERRED UNITS
The Partnership had 52,691 and 77,216 preferred units outstanding with a carrying value of $54.0 million and $79.2 million as of September 30, 2016 and December 31, 2015, respectively. The aforementioned amounts included accrued distributions of $1.3 million and $1.9 million as of September 30, 2016 and December 31, 2015, respectively. The redeemable preferred units are classified as mezzanine equity on the consolidated balance sheets since redemption is outside the control of the Partnership. The preferred units are entitled to an annual distribution of 10% of the funded capital of the preferred units, payable on a quarterly basis in arrears.
The preferred units are convertible into common and subordinated units at any time at the option of the preferred unitholders. The preferred units have an adjusted conversion price of $14.2683 and an adjusted conversion rate of 30.3431 common units and 39.7427 subordinated units per preferred unit, which reflects the reverse split described in Note 1 – Business and Basis of Presentation and the capital restructuring related to the IPO. The preferred unitholders can elect to have the Partnership redeem, at face value, up to 28,266 preferred units as of December 31, 2017 and 24,425 preferred units as of December 31, 2018, plus any accrued and unpaid distributions. 
The Partnership shall have the right, at its sole option, to redeem an amount of preferred units equal to the units being redeemed by an owner of preferred units as of each December 31. Any amount of a given year’s preferred units eligible for redemption not redeemed as of December 31 shall automatically convert to common and subordinated units in the following year.
For the nine months ended September 30, 2016, 18,461 preferred units were redeemed for $19.0 million, including accrued unpaid yield. For the nine months ended September 30, 2016, 6,064 preferred units totaling $6.1 million were converted into 184,006 common units and 240,986 subordinated units as a result of the mandatory conversion subsequent to December 31, 2015. For the year ended December 31, 2015, 39,240 preferred units totaling $39.2 million were converted into the equivalent of 1,190,664 common units and 1,559,502 subordinated units on an adjusted basis.




14

BLACK STONE MINERALS, L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 11—EARNINGS PER UNIT
The Partnership applies the two-class method for purposes of calculating earnings per unit (“EPU”). The holders of the Partnership’s restricted common and subordinated units have all the rights of a unitholder, including non-forfeitable distribution rights. As participating securities, the restricted common and subordinated units are included in the calculation of basic earnings per unit. For the periods presented, the amount of earnings allocated to these participating units was not material. Net income (loss) attributable to the Partnership is allocated to the Partnership’s general partner and the common and subordinated unitholders in proportion to their pro rata ownership after giving effect to distributions, if any, declared during the period. The redeemable preferred units could be converted into 1.6 million common units and 2.1 million subordinated units as of September 30, 2016. At September 30, 2016, if the redeemable preferred units were converted to common and subordinated units, the effect would be anti-dilutive. Therefore, the redeemable preferred units are not included in the diluted EPU calculation. The Partnership’s restricted performance unit awards are contingently issuable units that are considered in the calculation of diluted EPU. The Partnership assesses the number of units that would be issuable, if any, under the terms of the arrangement if the end of the reporting period were the end of the contingency period. For the nine months ended September 30, 2016, there were 271,256 common units related to the Partnership’s restricted performance unit awards included in the calculation of diluted EPU.
The following table sets forth the computation of basic and diluted earnings per common and subordinated unit:
 
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
 
2016
 
2015
 
2016
 
2015
 
 
(In thousands, except per unit  amounts)
 
(In thousands, except per unit  amounts)
NET INCOME (LOSS)
 
$
37,535

 
$
53,892

 
$
27,474

 
$
(51,575
)
NET (INCOME) LOSS ATTRIBUTABLE TO PREDECESSOR
 

 

 

 
(450
)
NET (INCOME) LOSS ATTRIBUTABLE TO NONCONTROLLING INTERESTS SUBSEQUENT TO INITIAL PUBLIC OFFERING
 
8

 
(3
)
 
15

 
137

DISTRIBUTIONS ON REDEEMABLE PREFERRED UNITS SUBSEQUENT TO INITIAL PUBLIC OFFERING
 
(1,324
)
 
(2,973
)
 
(4,439
)
 
(4,783
)
NET INCOME (LOSS) ATTRIBUTABLE TO THE GENERAL PARTNER AND COMMON AND SUBORDINATED UNITS SUBSEQUENT TO INITIAL PUBLIC OFFERING
 
$
36,219

 
$
50,916

 
$
23,050

 
$
(56,671
)
ALLOCATION OF NET INCOME (LOSS) SUBSEQUENT TO INITIAL PUBLIC OFFERING ATTRIBUTABLE TO:
 
 

 
 

 
 

 
 

General partner interest
 
$

 
$

 
$

 
$

Common units
 
23,114

 
25,608

 
24,343

 
(28,502
)
Subordinated units
 
13,105

 
25,308

 
(1,293
)
 
(28,169
)
 
 
$
36,219

 
$
50,916

 
$
23,050

 
$
(56,671
)
NET INCOME (LOSS) ATTRIBUTABLE TO LIMITED PARTNERS PER COMMON AND SUBORDINATED UNIT:
 
 

 
 

 
 

 
 

Per common unit (basic)
 
$
0.24

 
$
0.27

 
$
0.26

 
$
(0.30
)
Weighted average common units outstanding (basic)
 
95,740

 
96,186

 
95,086

 
96,183

Per subordinated unit (basic)
 
$
0.14

 
$
0.27

 
$
(0.01
)
 
$
(0.30
)
Weighted average subordinated units outstanding (basic)
 
95,189

 
95,057

 
95,125

 
95,057

Per common unit (diluted)
 
$
0.24

 
$
0.27

 
$
0.26

 
$
(0.30
)
Weighted average common units outstanding (diluted)
 
96,011

 
96,186

 
95,619

 
96,183

Per subordinated unit (diluted)
 
$
0.14

 
$
0.27

 
$
(0.01
)
 
$
(0.30
)
Weighted average subordinated units outstanding (diluted)
 
95,189

 
95,057

 
95,467

 
95,057



15

BLACK STONE MINERALS, L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 12—SUBSEQUENT EVENTS                      
On October 5, 2016, Marc Carroll, Senior Vice President ("SVP") and Chief Financial Officer ("CFO"),  informed the Partnership that he will step down as CFO and SVP effective November 11, 2016. Mr. Carroll will enter into a consulting arrangement with the Partnership that will extend into 2017 to help ensure an orderly transition to his successor.
On October 24, 2016, the Partnership announced that it expects to appoint Jeffrey P. Wood as its SVP and CFO effective November 11, 2016. The Partnership expects that Mr. Wood will enter into a severance agreement with Black Stone Natural Resources Management Company, in a form substantially similar to that entered into by the General Partner’s other executive officers, that will provide for the payment of cash severance payments and benefits in the event Mr. Wood’s employment is terminated under certain circumstances, but he has not yet been entered into such agreement. The Partnership also expects that Mr. Wood will receive awards under the Partnership’s Long-Term Incentive Plan with terms substantially similar to the awards granted to the General Partner’s other executive officers, but it has not yet awarded him any grants under that plan.
As discussed in Note 7, the Partnership's fall 2016 borrowing base redetermination process resulted in an increase in the borrowing base from $450.0 million to $500.0 million with an effective date of October 31, 2016.
On November 7, 2016, the Board approved a distribution for the period June 30, 2016 to September 30, 2016 of $0.2875 per common unit and $0.18375 per subordinated unit. Distributions will be payable on November 25, 2016 to unitholders of record at the close of business on November 17, 2016.




16


Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited consolidated financial statements and notes thereto presented in this Quarterly Report on Form 10-Q, as well as our audited financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2015. This discussion and analysis contains forward-looking statements that involve risks, uncertainties, and assumptions. Actual results may differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth under “Cautionary Note Regarding Forward-Looking Statements” and “Part II, Item 1A. Risk Factors.”
Unless the context clearly indicates otherwise, references in this Quarterly Report on Form 10-Q to “BSM,” the “Partnership,” “we,” “our,” “us,” or similar terms for time periods prior to the IPO refer to Black Stone Minerals Company, L.P. and its subsidiaries, the predecessor for accounting purposes. For time periods subsequent to the IPO, these terms refer to Black Stone Minerals, L.P. and its subsidiaries.
Cautionary Note Regarding Forward-Looking Statements
Certain statements and information in this Quarterly Report on Form 10-Q may constitute “forward-looking statements.”  The words “believe,” “expect,” “anticipate,” “plan,” “intend,” “foresee,” “should,” “would,” “could,” or other similar expressions are intended to identify forward-looking statements, which are generally not historical in nature.  These forward-looking statements are based on our current expectations and beliefs concerning future developments and their potential effect on us.  While management believes that these forward-looking statements are reasonable as and when made, there can be no assurance that future developments affecting us will be those that we anticipate.  All comments concerning our expectations for future revenues and operating results are based on our forecasts for our existing operations and do not include the potential impact of any future acquisitions.  Our forward-looking statements involve significant risks and uncertainties (some of which are beyond our control) and assumptions that could cause actual results to differ materially from our historical experience and our present expectations or projections.  Important factors that could cause actual results to differ materially from those in the forward-looking statements include, but are not limited to, those summarized below:

our ability to execute our business strategies;

the volatility of realized oil and natural gas prices;

the level of production on our properties;

regional supply and demand factors, delays, or interruptions of production;

our ability to replace our oil and natural gas reserves;

our ability to identify, complete, and integrate acquisitions;

general economic, business, or industry conditions;

competition in the oil and natural gas industry;

the ability of our operators to obtain capital or financing needed for development and exploration operations;

title defects in the properties in which we invest;

the availability or cost of rigs, equipment, raw materials, supplies, oilfield services, or personnel;

restrictions on the use of water;

the availability of transportation facilities;

the ability of our operators to comply with applicable governmental laws and regulations and to obtain permits and governmental approvals;


17


federal and state legislative and regulatory initiatives relating to hydraulic fracturing;

future operating results;

future cash flows and liquidity, including our ability to generate sufficient cash to pay quarterly distributions;

exploration and development drilling prospects, inventories, projects, and programs;

operating hazards faced by our operators;

the ability of our operators to keep pace with technological advancements; and 

certain factors discussed elsewhere in this filing.
For additional information regarding known material factors that could cause our actual results to differ from our projected results, please see “Risk Factors” in our Annual Report on Form 10-K.
Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date hereof.  We undertake no obligation to publicly update or revise any forward-looking statements after the date they are made, whether as a result of new information, future events, or otherwise.
Overview
We are one of the largest owners of oil and natural gas mineral interests in the United States. Our principal business is maximizing the value of our existing portfolio of mineral and royalty assets through active management and expanding our asset base through acquisitions of additional mineral and royalty interests. We maximize value through marketing our mineral assets for lease, creatively structuring terms on those leases to encourage and accelerate drilling activity, and selectively participating alongside our lessees on a working-interest basis in low-risk development-drilling opportunities on our interests. Our primary business objective is to grow our reserves, production, and cash generated from operations over the long term, while paying, to the extent practicable, a growing quarterly distribution to our unitholders.
On May 1, 2015 our common units began trading on the New York Stock Exchange under the symbol “BSM.” On May 6, 2015, we completed our initial public offering of 22,500,000 common units representing limited partner interests at a price to the public of $19.00 per common unit.  
As of September 30, 2016, our mineral and royalty interests were located in 41 states and 61 onshore basins in the continental United States. These non-cost-bearing interests include ownership in over 45,000 producing wells. We also own non-operated working interests, largely on our mineral and royalty interests. We recognize oil and natural gas revenue from our mineral and royalty and non-operated working interests in producing wells when the oil and natural gas production from the associated acreage is sold. Our other sources of revenue include mineral lease bonus and delay rentals, which are recognized as revenue according to the terms of the lease agreements.
Recent Developments
Common Unit Repurchase Program
On March 4, 2016, the Board of Directors of our general partner (the “Board”) authorized the repurchase of up to $50.0 million in common units through a program that terminated on September 15, 2016. The repurchase program authorized us to make repurchases on a discretionary basis as determined by management, subject to market conditions, applicable legal requirements, available liquidity, and other appropriate factors. We repurchased a total of 1.3 million common units for an aggregate cost of $24.7 million. The repurchase program was funded from our cash on hand or available revolving credit facility. Repurchased common and subordinated units were canceled.



18



Acquisitions
On January 8, 2016, we acquired mineral and royalty interests in the Permian Basin for $10.0 million. On June 15, 2016, we acquired an oil and natural gas mineral package primarily located in Weld County, Colorado for $34.0 million. On June 17, 2016, we acquired a diverse oil and natural gas mineral asset package from Freeport-McMoRan Oil and Gas Inc. and certain of its affiliates for $87.6 million. On August 8, 2016, the Partnership acquired mineral interests located in Midland and Glasscock Counties of Texas for $8.3 million. Throughout 2016, the Partnership acquired certain other oil and natural gas assets for $1.0 million in the aggregate.
Business Environment
The information presented below is designed to give a broad overview of the oil and natural gas business environment as it affects us.
Commodity Prices
Oil and natural gas prices have been historically volatile based upon the dynamics of supply and demand. Recently, oil and natural gas prices have remained significantly below prices seen over the past five years. The Energy Information Administration (“EIA”) expects global oil inventory builds to continue in the near future but the builds are forecast to remain well below the levels that occurred in 2015 and early 2016; consistent inventory draws are forecast to begin in mid 2017. Despite continued increases in global oil inventories and U.S. oil rig counts, market reactions to a potential Organization of Petroleum Exporting Countries ("OPEC") production freeze deal could put upward price pressure on prices in the near term. After an unofficial meeting in Algeria on September 28, 2016, members of OPEC announced a framework agreement that could lead to a cap on OPEC crude oil production. Important details of the agreement, including target outputs for individual countries, remain to be established at a regularly scheduled meeting in November; even if a consensus is reached, the extent of compliance with such an agreement is questionable. During the nine months ended September 30, 2016, the West Texas Intermediate (“WTI”) spot price reached a low of $26.19 per Bbl on February 11, 2016, but rebounded to a high of $51.23 per Bbl on June 8, 2016.
The EIA forecasts natural gas production will increase through 2016 and through 2017. Natural gas pipeline exports to Mexico have risen in 2016. The EIA projects the liquified natural gas ("LNG") gross exports will rise with the start of Cheniere Energy Inc.'s Sabine Pass LNG plant in Louisiana.  The EIA projects that increases in natural gas prices will continue to gradually rise through the remainder of 2016 and 2017. During the nine months ended September 30, 2016, Henry Hub spot natural gas prices ranged from a low of $1.49 per MMBtu on March 4, 2016 to a high of $3.19 per MMBtu on September 21, 2016.
To manage the variability in cash flows associated with the projected sale of our oil and natural gas production, we use various derivative instruments, which have recently consisted of fixed-price swap contracts.
 
The following table reflects commodity prices at the end of each quarter for the periods presented:

 
 
2016
 
2015
Benchmark Prices
 
Third
Quarter
 
Second
Quarter
 
First Quarter
 
Third
Quarter
 
Second
Quarter
 
First Quarter
WTI spot oil price ($/Bbl)
 
$
47.72

 
$
48.27

 
$
36.94

 
$
45.06

 
$
59.48

 
$
47.72

Henry Hub spot natural gas ($/MMBtu)
 
$
2.84

 
$
2.94

 
$
1.98

 
$
2.47

 
$
2.80

 
$
2.65

 
Source: EIA
Rig Count
As we are not an operator, drilling on our acreage is dependent upon the exploration and production companies that lease our acreage. In addition to drilling plans that we seek from our operators, we also monitor rig counts in an effort to identify existing and future leasing and drilling activity on our acreage.

19


The following table shows the rig count at the close of each quarter for the periods presented:
 
 
2016
 
2015
U.S. Rotary Rig Count
 
Third
Quarter
 
Second
Quarter
 
First Quarter
 
Third
Quarter
 
Second
Quarter
 
First Quarter
Oil
 
425

 
330

 
372

 
641

 
628

 
813

Natural gas
 
96

 
90

 
92

 
197

 
228

 
233

Other
 
1

 
1

 

 

 
3

 
2

Total
 
522

 
421

 
464

 
838

 
859

 
1,048

 
Source: Baker Hughes Incorporated
Natural Gas Storage
A substantial portion of our revenue is derived from sales of oil production attributable to our interests; however, the majority of our production is natural gas. Natural gas prices are significantly influenced by storage levels throughout the year. Accordingly, we monitor the natural gas storage reports regularly in the evaluation of our business and its outlook.
Historically, natural gas supply and demand fluctuates on a seasonal basis. From April to October, when the weather is warmer and natural gas demand is lower, natural gas storage levels generally increase. From November to March, storage levels typically decline as utility companies draw natural gas from storage to meet increased heating demand due to colder weather. In order to maintain sufficient storage levels for increased seasonal demand, a portion of natural gas production during the summer months must be used for storage injection. The portion of production used for storage varies from year to year depending on the demand from the previous winter and the demand for electricity used for cooling during the summer months. Natural gas injections during the refill season have been below the five-year average levels in most weeks due to the high use of natural gas for electricity generation. Warm weather last winter left inventories at record high levels going into the injection season so current natural gas stock levels remain substantially higher than five-year average levels.
The following table shows natural gas storage volumes by region at the close of each quarter for the periods presented:
 
 
 
2016
 
2015
Region
 
Third
Quarter
 
Second
Quarter
 
First Quarter
 
Third
Quarter
 
Second
Quarter
 
First Quarter
 
 
(Bcf)
East
 
899

 
632

 
439

 
837

 
552

 
255

Midwest
 
1,045

 
742

 
555

 
952

 
546

 
261

Mountain
 
237

 
198

 
147

 
201

 
155

 
114

Pacific
 
318

 
315

 
262

 
355

 
333

 
269

South Central
 
1,181

 
1,253

 
1,065

 
1,192

 
993

 
562

Total
 
3,680

 
3,140

 
2,468

 
3,537

 
2,579

 
1,461

 
Source: EIA
How We Evaluate Our Operations
We use a variety of operational and financial measures to assess our performance. Among the measures considered by management are the following:

volumes of oil and natural gas produced;

commodity prices including the effect of derivative instruments; and

EBITDA, Adjusted EBITDA, and cash available for distribution.


20


Volumes of Oil and Natural Gas Produced
In order to track and assess the performance of our assets, we monitor and analyze our production volumes from the various basins and plays that comprise our extensive asset base. We also regularly compare projected volumes to actual reported volumes and investigate unexpected variances.
Commodity Prices
Factors Affecting the Sales Price of Oil and Natural Gas
The prices we receive for oil, natural gas, and natural gas liquids (“NGLs”) vary by geographical area. The relative prices of these products are determined by the factors affecting global and regional supply and demand dynamics, such as economic conditions, production levels, availability of transportation, weather cycles, and other factors. In addition, realized prices are influenced by product quality and proximity to consuming and refining markets. Any differences between realized prices and NYMEX prices are referred to as differentials. All of our production is derived from properties located in the United States. As a result of our geographic diversification, we are not exposed to concentrated differential risks associated with any single play, trend, or basin.

Oil. The substantial majority of our oil production is sold at prevailing market prices, which fluctuate in response to many factors that are outside of our control. NYMEX light sweet crude oil, commonly referred to as WTI, is the prevailing domestic oil pricing index. The majority of our oil production is priced at the prevailing market price with the final realized price affected by both quality and location differentials.
The chemical composition of crude oil plays an important role in its refining and subsequent sale as petroleum products.  As a result, variations in chemical composition relative to the benchmark crude oil, usually WTI, will result in price adjustments, which are often referred to as quality differentials. The characteristics that most significantly affect quality differentials include the density of the oil, as characterized by its American Petroleum Institute (“API”) gravity, and the presence and concentration of impurities, such as sulfur.
Location differentials generally result from transportation costs based on the produced oil’s proximity to consuming and refining markets and major trading points.

Natural Gas. The NYMEX price quoted at Henry Hub is a widely used benchmark for the pricing of natural gas in the United States. The actual volumetric prices realized from the sale of natural gas differ from the quoted NYMEX price as a result of quality and location differentials. 
Quality differentials result from the heating value of natural gas measured in Btus and the presence of impurities, such as hydrogen sulfide, carbon dioxide, and nitrogen. Natural gas containing ethane and heavier hydrocarbons has a higher Btu value and will realize a higher volumetric price than natural gas made up of predominantly methane, which has a lower Btu value. Natural gas with a higher concentration of impurities will realize a lower volumetric price due to the presence of the impurities in the natural gas when sold or the cost of treating the natural gas to meet pipeline quality specifications.
Natural gas, which currently has a limited global transportation system, is subject to price variances based on local supply and demand conditions and the cost to transport natural gas to end user markets.
Hedging
We enter into derivative instruments to partially mitigate the impact of commodity price volatility on our cash generated from operations. From time to time, such instruments may include fixed-price swaps, fixed-price contracts, costless collars, and other contractual arrangements. We generally employ a “rolling hedge” strategy whereby we hedge a significant portion of our proved developed producing reserves 12 to 24 months into the future. The impact of these derivative instruments could affect the amount of revenue we ultimately realize. Since 2015, we have only entered into fixed-price swap contracts. Under fixed-price swap contracts, a counterparty is required to make a payment to us if the settlement price for any settlement period is less than the swap strike price. Conversely, we are required to make a payment to the counterparty if the settlement price for any settlement period is greater than the swap strike price. We may employ contractual arrangements other than fixed-price swap contracts in the future to mitigate the impact of price fluctuations. If commodity prices decline in the future, our hedging contracts will partially mitigate the effect of lower prices on our future revenue.
Our open oil and natural gas derivative contracts as of September 30, 2016 and as of the date of this filing are detailed in Note 5 – Derivatives and Financial Instruments to our unaudited consolidated financial statements included elsewhere in this

21


Quarterly Report on Form 10-Q. Our credit agreement limits the extent to which we can hedge our future production. Under the terms of our credit agreement, we are able to hedge substantially all of our estimated production from our proved developed producing reserves based on the most recent reserve information provided to our lenders. We do not enter into derivative instruments for speculative purposes. Including derivative contracts entered into subsequent to September 30, 2016, we have hedged 92.6% and 78.7% of our available oil and condensate hedge volumes and 96.8% and 99.7% of our available natural gas hedge volumes for the remainder of 2016 and 2017, respectively.
Non-GAAP Financial Measures
EBITDA, Adjusted EBITDA, and cash available for distribution are supplemental non-GAAP financial measures used by our management and external users of our financial statements such as investors, research analysts, and others, to assess the financial performance of our assets and our ability to sustain distributions over the long term without regard to financing methods, capital structure, or historical cost basis.
We define EBITDA as net income (loss) before interest expense, income taxes and depreciation, depletion, and amortization. We define Adjusted EBITDA as EBITDA adjusted for impairment of oil and natural gas properties, accretion of ARO, unrealized gains and losses on commodity derivative instruments, and non-cash equity-based compensation. We define cash available for distribution as Adjusted EBITDA plus or minus amounts for certain non-cash operating activities, estimated replacement capital expenditures, capital expenditures, cash interest expense, and distributions to noncontrolling interests and preferred unitholders.
EBITDA, Adjusted EBITDA, and cash available for distribution should not be considered an alternative to, or more meaningful than, net income (loss), income (loss) from operations, cash flows from operating activities, or any other measure of financial performance presented in accordance with GAAP as measures of our financial performance. EBITDA, Adjusted EBITDA, and cash available for distribution have important limitations as analytical tools because they exclude some but not all items that affect net income (loss), the most directly comparable GAAP financial measure. Our computation of EBITDA, Adjusted EBITDA, and cash available for distribution may differ from computations of similarly titled measures of other companies.

22


The following table presents a reconciliation of EBITDA, Adjusted EBITDA, and cash available for distribution to net income (loss), the most directly comparable GAAP financial measure, for the periods indicated:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2016
 
2015
 
2016
 
2015
 
 
(Unaudited)
(In thousands)
Net income (loss)
 
$
37,535

 
$
53,892

 
$
27,474

 
$
(51,575
)
Adjustments to reconcile to Adjusted EBITDA:
 
 

 
 

 
 

 
 

Add:
 
 

 
 

 
 

 
 

Depreciation, depletion and amortization
 
28,731

 
23,288

 
79,654

 
83,414

Interest expense
 
2,282

 
870

 
4,773

 
5,530

EBITDA
 
68,548

 
78,050

 
111,901

 
37,369

Add:
 
 

 
 

 
 

 
 

Impairment of oil and natural gas properties
 

 
24,854

 
6,775

 
156,683

Accretion of asset retirement obligations
 
206

 
265

 
680

 
805

Equity-based compensation1
 
7,981

 
5,690

 
33,120

 
13,052

Unrealized loss on commodity derivative instruments
 

 

 
51,515

 

Less:
 
 
 
 
 
 
 
 
Unrealized gain on commodity derivative instruments
 
(2,511
)
 
(44,053
)
 

 
(10,918
)
Adjusted EBITDA
 
74,224

 
64,806

 
203,991

 
196,991

Adjustments to reconcile to cash generated from operations:
 
 

 
 

 
 

 
 

Add:
 
 

 
 

 
 

 
 

Incremental general and administrative related to initial public offering
 

 
270

 

 
950

Loss on sales of assets, net
 

 
4

 

 

Less:
 
 

 
 

 
 
 
 

Change in deferred revenue
 
(396
)
 
(94
)
 
(175
)
 
(584
)
Cash interest expense
 
(2,083
)
 
(628
)
 
(4,179
)
 
(4,806
)
Gain on sales of assets, net
 

 

 
(4,772
)
 
(20
)
 Estimated replacement capital expenditures2
 
(3,750
)
 

 
(7,500
)
 

Cash generated from operations
 
67,995

 
64,358

 
187,365

 
192,531

Less:
 
 

 
 

 
 

 
 

Cash paid to noncontrolling interests
 
(29
)
 
(45
)
 
(83
)
 
(167
)
Redeemable preferred unit distributions
 
(1,324
)
 
(2,973
)
 
(4,439
)
 
(8,823
)
Cash generated from operations available for distribution on common and subordinated units and reinvestment in our business
 
$
66,642

 
$
61,340

 
$
182,843

 
$
183,541

 
1 On April 25, 2016, the Compensation Committee of the Board approved a resolution to change the settlement feature of certain employee long-term incentive compensation plans from cash to equity. As a result of the modification, $10.1 million of cash-settled liabilities were reclassified to equity-settled liabilities during the second quarter of 2016.
2 On August 3, 2016, the Board established a replacement capital expenditure estimate of $15.0 million for the period of April 1, 2016 to March 31, 2017. There was no established estimate of replacement capital expenditure prior to this period.
Factors Affecting the Comparability of Our Financial Results
Our historical financial condition and results of operations for the periods presented may not be comparable, either from period to period or going forward, because we will incur higher general and administrative expenses than in prior periods as a result of operating as a publicly traded partnership. These incremental expenses include costs associated with SEC reporting requirements, including annual and quarterly reports to unitholders; tax return and Schedule K-1 preparation and distribution fees; Sarbanes-Oxley Act compliance; New York Stock Exchange listing fees; independent registered public accounting firm fees; legal fees, investor-relations activities, registrar and transfer agent fees; director and officer insurance; and additional compensation. These direct, incremental general and administrative expenses are not included in our historical results of operations for periods prior to our IPO.

23


Results of Operations
Three Months Ended September 30, 2016 Compared to Three Months Ended September 30, 2015
 
The following table shows our production, revenues, pricing, and expenses for the periods presented:
 
 
Three Months Ended September 30,
 
 
2016
 
2015
 
Variance
 
 
(Unaudited)
(Dollars in thousands, except for realized prices and per Boe data)
Production:
 
 

 
 

 
 

 
 

Oil and condensate (MBbls)1
 
1,015

 
936

 
79

 
8.4
 %
Natural gas (MMcf)1
 
13,207

 
10,411

 
2,796

 
26.9
 %
Equivalents (MBoe)
 
3,216

 
2,671

 
545

 
20.4
 %
Revenue:
 
 

 
 

 
 
 
 
Oil and condensate sales
 
$
42,780

 
$
44,128

 
(1,348
)
 
(3.1
)%
Natural gas and natural gas liquids sales
 
38,986

 
32,191

 
6,795

 
21.1
 %
Gain (loss) on commodity derivative instruments
 
7,813

 
56,430

 
(48,617
)
 
(86.2
)%
Lease bonus and other income
 
9,592

 
4,271

 
5,321

 
124.6
 %
Total revenue
 
$
99,171

 
$
137,020

 
(37,849
)
 
(27.6
)%
Realized prices:
 
 

 
 

 
 
 
 
Oil and condensate ($/Bbl)
 
$
42.15

 
$
47.15

 
(5.00
)
 
(10.6
)%
Natural gas ($/Mcf)1
 
2.95

 
3.09

 
(0.14
)
 
(4.5
)%
Equivalents ($/Boe)
 
$
25.42

 
$
28.57

 
(3.15
)
 
(11.0
)%
Operating expenses:
 
 

 
 

 
 
 
 
Lease operating expense
 
$
5,007

 
$
4,924

 
83

 
1.7
 %
Production costs and ad valorem taxes
 
9,228

 
8,175

 
1,053

 
12.9
 %
Exploration expense
 
6

 
1,817

 
(1,811
)
 
(99.7
)%
Depreciation, depletion, and amortization
 
28,731

 
23,288

 
5,443

 
23.4
 %
Impairment of oil and natural gas properties
 

 
24,854

 
(24,854
)
 
(100.0
)%
General and administrative
 
16,677

 
18,994

 
(2,317
)
 
(12.2
)%
Other expense:
 
 

 
 
 
 
 
 
Interest expense
 
$
2,282

 
$
870

 
1,412

 
162.3
 %
Per Boe:
 
 
 
 
 
 
 
 
Lease operating expense
 
$
1.56

 
$
1.84

 
(0.28
)
 
(15.2
)%
Lease operating expense (per working interest Boe)
 
4.25

 
6.71

 
(2.46
)
 
(36.7
)%
Production costs and ad valorem taxes
 
2.87

 
3.06

 
(0.19
)
 
(6.2
)%
Depreciation, depletion, and amortization
 
8.93

 
8.72

 
0.21

 
2.4
 %
General and administrative
 
5.19

 
7.11

 
(1.92
)
 
(27.0
)%
 
1  
As a mineral-and-royalty-interest owner, we are often provided insufficient and inconsistent data on NGL volumes by our operators. As a result, we are unable to reliably determine the total volumes of NGLs associated with the production of natural gas on our acreage. Accordingly, no NGL volumes are included in our reported production; however, revenue attributable to NGLs is included in our natural gas revenue and our calculation of realized prices for natural gas.

Revenue
Total revenue for the quarter ended September 30, 2016 decreased compared to the quarter ended September 30, 2015. Production for the quarter ended September 30, 2016 averaged 35.0 MBoe per day, an increase of 6.0 MBoe per day compared to the corresponding period in 2015. The decrease in total revenue is primarily due to smaller gains from commodity derivative instruments as compared to the corresponding period in 2015. Increased production volumes and higher lease bonus partially offset the overall decrease in total revenue.

24


Oil and condensate sales. Oil and condensate sales during the period were lower than the third quarter of 2015 primarily due to lower realized prices. Our total oil and condensate production was higher than the third quarter of 2015, but the increased production was more than offset by the decline in realized prices. Our mineral-and-royalty-interest oil and condensate volumes accounted for 74.0% and 75.3% of total oil and condensate volumes for the quarters ended September 30, 2016 and 2015, respectively. Our mineral-and-royalty-interest oil and condensate volumes increased 6.4% in the third quarter of 2016 relative to the corresponding period in 2015, primarily driven by production increases from new wells in the Bakken/Three Forks and Wolfcamp plays. Our working-interest oil and condensate volumes increased by 14.4% during the third quarter of 2016 versus the same period in 2015 to 2.9 MBbls per day.   
Natural gas and natural gas liquids sales. Natural gas and NGL sales increased for the quarter ended September 30, 2016 as compared to the same period for 2015. Higher production volumes, due to new wells in the Haynesville and Wilcox plays, were primarily responsible for the increase in our natural gas and NGL revenues. Lower realized natural gas and NGL prices for the quarter ended September 30, 2016 versus the corresponding period in 2015 partially offset the impact of increased production volumes. Mineral-and-royalty-interest production accounted for 58.4% and 71.0% of our natural gas volumes for the quarters ended September 30, 2016 and 2015, respectively.
Gain (loss) on commodity derivative instruments. During the third quarter of 2016, we recognized $3.7 million of gains from oil commodity contracts, which included cash received of $4.3 million, compared to gains of $41.0 million in the same period of 2015. During the third quarter of 2016, we recognized $4.1 million of gains from natural gas commodity contracts, which included cash received of $1.0 million, compared to recognized gains of $15.4 million in the same period of 2015.
Lease bonus and other income. When we lease our mineral interests, we generally receive an upfront cash payment, or a lease bonus. In the third quarter of 2016, we successfully closed several significant lease transactions. Specifically, these transactions related to the Wolfcamp play in Texas and the Marcellus/Utica play in Pennsylvania.
Operating and Other Expenses
Lease operating expense. Lease operating expense includes normally recurring expenses associated with our non-operated working interests necessary to produce hydrocarbons from our oil and natural gas wells, as well as certain nonrecurring expenses, such as well repairs. Lease operating expense increased for the quarter ended September 30, 2016 as compared to the same period in 2015, primarily due to costs associated with higher production volumes. Lower workover and other service-related expenses and a higher percentage of working-interest volumes being produced from natural gas wells partially offset the overall increase in lease operating expenses.  
Production costs and ad valorem taxes. Production taxes include statutory amounts deducted from our production revenues by various state taxing entities. Depending on the regulations of the states where the production originates, these taxes may be based on a percentage of the realized value or a fixed amount per production unit. This category also includes the costs to process and transport our production to applicable sales points. Ad valorem taxes are jurisdictional taxes levied on the value of oil and natural gas minerals and reserves. Rates, methods of calculating property values, and timing of payments vary between taxing authorities. For the quarter ended September 30, 2016, production costs and ad valorem taxes increased from the quarter ended September 30, 2015, generally as a result of higher production volumes. The 2016 amount includes $2.7 million of proceeds from a settlement related to improper cost deductions by an operator. In addition, lower realized prices and lower estimated mineral reserve valuations served to partially offset the increase in these costs.
Exploration expense. Exploration expense typically consists of dry-hole expenses and geological and geophysical costs, including seismic costs, and is expensed as incurred under the successful efforts method of accounting. Exploration expense signficantly decreased for the three months ended September 30, 2016 as compared to the same period in 2015. The 2015 expense represents costs incurred to acquire 3-D seismic information, related to our mineral and royalty interests, from a third-party service provider.
Depreciation, depletion, and amortization. Depletion is an estimate of the amount of cost basis of oil and natural gas properties attributable to the volume of hydrocarbons extracted during a period, calculated on a units-of-production basis. Estimates of proved developed producing reserves are a major component of the calculation of depletion. We adjust our depletion rates semi-annually based upon mid-year and year-end reserve reports, except when circumstances indicate that there has been a significant change in reserves or costs. Depreciation, depletion, and amortization increased for the quarter ended September 30, 2016 as compared to the same period in 2015, primarily due to the impact of higher production rates and costs associated with new reserve additions. A reduced cost basis resulting from impairment charges recorded during 2016 and the fourth quarter of 2015 favorably affected depletion expense.

25


Impairment of oil and natural gas properties. Individual categories of oil and natural gas properties are assessed periodically to determine if the net book value for these properties has been impaired. Management periodically conducts an in-depth evaluation of the carrying amounts of property acquisitions, successful exploratory wells, development activity, undeveloped leasehold, and mineral interests to identify impairments. There were no impairments for the quarter ended September 30, 2016. Impairments totaled $24.9 million for the quarter ended September 30, 2015 primarily due to changes in reserve values resulting from declines in future expected net cash flows and other factors at September 30, 2015.
General and administrative. General and administrative expenses are costs not directly associated with the production of oil and natural gas and include the cost of employee salaries and related benefits, office expenses, and fees for professional services. For the quarter ended September 30, 2016, general and administrative expenses decreased as compared to the same period in 2015. In 2016, costs attributable to our long-term incentive plans were approximately $2.0 million lower than in the corresponding prior period in 2015.
Interest expense. Interest expense was higher in the third quarter of 2016 due to increased borrowings under our credit facility. Average outstanding borrowings during the third quarter of 2016 were higher than the third quarter of 2015 due to mid-year 2015 repayments towards our credit facility using proceeds received from our IPO during 2015.

26


Nine Months Ended September 30, 2016 Compared to Nine Months Ended September 30, 2015
The following table shows our production, revenues, pricing, and expenses for the periods presented:
 
 
Nine Months Ended September 30,
 
 
2016
 
2015
 
Variance
 
 
(Dollars in thousands, except for realized prices and per Boe data)
Production:
 
 

 
 

 
 

 
 

Oil and condensate (MBbls)1
 
2,848

 
2,668

 
180


6.7
 %
Natural gas (MMcf)1
 
36,014

 
31,817

 
4,197

 
13.2
 %
Equivalents (MBoe)
 
8,850

 
7,971

 
879

 
11.0
 %
Revenue:
 
 

 
 

 
 
 
 
Oil and condensate sales
 
$
104,581

 
$
126,584

 
(22,003
)
 
(17.4
)%
Natural gas and natural gas liquids sales
 
85,706

 
92,799

 
(7,093
)
 
(7.6
)%
Gain (loss) on commodity derivative instruments
 
(12,295
)
 
57,450

 
(69,745
)
 
(121.4
)%
Lease bonus and other income
 
26,129

 
16,051

 
10,078

 
62.8
 %
Total revenue
 
$
204,121

 
$
292,884

 
(88,763
)
 
(30.3
)%
Realized prices:
 
 

 
 

 
 
 
 
Oil and condensate ($/Bbl)
 
$
36.72

 
$
47.45

 
(10.73
)
 
(22.6
)%
Natural gas ($/Mcf)1
 
2.38

 
2.92

 
(0.54
)
 
(18.5
)%
Equivalents ($/Boe)
 
$
21.50

 
$
27.52

 
(6.02
)
 
(21.9
)%
Operating expenses:
 
 

 
 

 
 
 
 
Lease operating expense
 
$
14,179

 
$
16,540

 
(2,361
)
 
(14.3
)%
Production costs and ad valorem taxes
 
23,301

 
26,250

 
(2,949
)
 
(11.2
)%
Exploration expense
 
643

 
2,014

 
(1,371
)
 
(68.1
)%
Depreciation, depletion, and amortization
 
79,654

 
83,414

 
(3,760
)
 
(4.5
)%
Impairment of oil and natural gas properties
 
6,775

 
156,683

 
(149,908
)
 
(95.7
)%
General and administrative
 
52,213

 
53,530

 
(1,317
)
 
(2.5
)%
Other expense:
 
 

 
 

 
 
 
 
Interest expense
 
$
4,773

 
$
5,530

 
(757
)
 
(13.7
)%
Per Boe:
 
 

 
 

 
 
 
 
Lease operating expense
 
$
1.60

 
$
2.08

 
(0.48
)
 
(23.1
)%
Lease operating expense (per working interest Boe)
 
4.71

 
6.96

 
(2.25
)
 
(32.3
)%
Production costs and ad valorem taxes
 
2.63

 
3.29

 
(0.66
)
 
(20.1
)%
Depreciation, depletion, and amortization
 
9.00

 
10.46

 
(1.46
)
 
(14.0
)%
General and administrative
 
5.90

 
6.72

 
(0.82
)
 
(12.2
)%
 
1 
As a mineral-and-royalty-interest owner, we are often provided insufficient and inconsistent data on NGL volumes by our operators. As a result, we are unable to reliably determine the total volumes of NGLs associated with the production of natural gas on our acreage. Accordingly, no NGL volumes are included in our reported production; however, revenue attributable to NGLs is included in our natural gas revenue and our calculation of realized prices for natural gas.
Revenue
Total revenues for the nine months ended September 30, 2016 decreased compared to the nine months ended September 30, 2015. Production for the nine months ended September 30, 2016 averaged 32.3 MBoe per day, an increase of 3.1 MBoe per day, or 10.6%, compared to the corresponding period in 2015. The decrease in total revenue from the corresponding prior period is primarily due to a $69.7 million difference in the impact of commodity derivative instruments and effect of lower realized commodity prices, the impact of which totaled $50.0 million, partially offset by the impact of $10.1 million higher lease bonus and $20.8 million related to increased production volumes.
Oil and condensate sales. Oil and condensate sales during for the nine months ended September 30, 2016 were lower than the corresponding period in 2015 primarily due to lower realized prices. Oil and condensate production for the nine months ended September 30, 2016 was higher than in the nine months ended September 30, 2015, but the increased production

27


was more than offset by a decline in realized prices. Our mineral-and-royalty-interest oil and condensate volumes accounted for 77.2% and 76.6% of total oil and condensate volumes for the nine months ended September 30, 2016 and 2015, respectively. Our mineral-and-royalty-interest oil and condensate volumes increased 7.5% for the nine months ended September 30, 2016 relative to the corresponding period in 2015, primarily driven by production increases from new wells in the Bakken/Three Forks and Wolfcamp plays. Our working-interest oil and condensate volumes increased by 4.1% to 2.4 MBbls per day during the nine months ended September 30, 2016 versus the same period in 2015 primarily due to activity in the Bakken play.
Natural gas and natural gas liquids sales. Natural gas and NGL sales decreased for the nine months ended September 30, 2016 as compared to the same period for 2015. A decline in the realized natural gas and NGL price for the nine months ended September 30, 2016 versus the corresponding period in 2015 was primarily responsible for the decline in our natural gas and NGL revenues. The unfavorable price variance was partially offset by a 13.2% increase in production volumes.   This production increase was primarily generated by production from new wells in the Haynesville/Bossier and Wilcox plays.  Mineral-and-royalty-interest production accounted for 60.7% and 67.0% of our natural gas volumes for the nine months ended September 30, 2016 and 2015, respectively.
Gain (loss) on commodity derivative instruments. During the nine months ended September 30, 2016, we recognized $8.9 million of losses from oil commodity contracts, which included $23.0 million in cash received, compared to a recognized gain of $37.3 million in the same period of 2015. During the first nine months of 2016, we recognized $3.4 million of losses from natural gas commodity contracts, which included $16.2 million of cash received, compared to a recognized gain of $20.1 million in the same period of 2015.
Lease bonus and other income. Lease bonus and other income increased for the nine months ended September 30, 2016 as compared to the same period in 2015. In the first nine months of 2016, we successfully closed several significant lease transactions in Jasper, Tyler, Pecos and Newton counties of Texas, in the Red River parish of Louisiana, and in Pike and Potter counties of Pennsylvania.
Operating and Other Expenses
Lease operating expense. Lease operating expense decreased for the nine months ended September 30, 2016 as compared to the same period in 2015, primarily due to lower costs associated with workover and other service-related costs and a higher percentage of working-interest volumes being produced from natural gas wells.  
Production costs and ad valorem taxes. For the nine months ended September 30, 2016, production costs and ad valorem taxes decreased from the nine months ended September 30, 2015, generally as a result of lower realized prices and estimated mineral reserve valuations. In addition, the 2016 amount includes $2.7 million of proceeds from a settlement related to improper cost deductions by an operator.
Exploration expense. Exploration expense decreased for the nine months ended September 30, 2016 as compared to the same period in 2015. The 2016 and 2015 expense represents costs incurred to acquire 3-D seismic information, related to our mineral and royalty interests, from a third-party service provider.
Depreciation, depletion, and amortization.  Depreciation, depletion, and amortization decreased for the nine months ended September 30, 2016 as compared to the same period in 2015, primarily due to the impact of a reduced cost basis resulting from impairment charges recorded during 2016 and the fourth quarter of 2015. The impact of higher production rates and costs associated with new reserve additions partially offset the overall decrease in depreciation, depletion, and amortization.
Impairment of oil and natural gas properties. Impairments totaled $6.8 million for the nine months ended September 30, 2016 primarily due to changes in reserve values resulting from declines in future expected realized net cash flows.
General and administrative. For the nine months ended September 30, 2016, general and administrative expenses decreased as compared to the same period in 2015. During the nine months ended September 30, 2016, costs attributable to our long-term incentive plans were $1.6 million lower than in the corresponding prior period of 2015.
Interest expense. Interest expense decreased due to lower average outstanding borrowings under our credit facility. Average outstanding borrowings during the first nine months of 2016 were lower than the nine months ended September 30, 2015, primarily due to payments made towards the outstanding balance of our credit facility subsequent to our IPO.

28


Liquidity and Capital Resources
Overview
Our primary sources of liquidity are cash generated from operations, borrowings under our credit facility, and proceeds from the issuance of equity and debt. Our primary uses of cash are for distributions to our unitholders and for investing in our business, specifically the acquisition of mineral and royalty interests and our selective participation on a non-operated working-interest basis in the development of our oil and natural gas properties. 
The board of directors of our general partner has adopted a policy pursuant to which distributions equal in amount to the applicable minimum quarterly distribution will be paid on each common and subordinated unit for each quarter to the extent we have sufficient cash generated from our operations after establishment of cash reserves, if any, and after we have made the required distributions to the holders of our outstanding preferred units. However, we do not have a legal or contractual obligation to pay distributions quarterly or on any other basis, at the applicable minimum quarterly distribution rate or at any other rate, and there is no guarantee that we will pay distributions to our unitholders in any quarter. Our minimum quarterly distribution provides the common unitholders a specified priority right to distributions over the subordinated unitholders. The board of directors of our general partner may change the foregoing distribution policy at any time and from time to time.
We intend to finance our future acquisitions and working-interest capital needs with cash generated from operations, borrowings from our credit facility, and proceeds from any future issuances of equity and debt. Replacement capital expenditures are expenditures necessary to replace our existing oil and natural gas reserves or otherwise maintain our asset base over the long-term. Like a number of other master limited partnerships, we are required by our partnership agreement to retain cash from our operations in an amount equal to our estimated replacement capital requirements. The board of directors of our general partner established a replacement capital expenditure estimate of $15.0 million for the period of April 1, 2016 to March 31, 2017.
Cash Flows
The following table shows our cash flows for the periods presented: 
 
 
Nine Months Ended September 30,
 
 
2016
 
2015
 
 
(Unaudited)
(In thousands)
Cash flows provided by operating activities
 
$
141,559

 
$
217,165

Cash flows used in investing activities
 
(203,760
)
 
(104,222
)
Cash flows provided by (used in) financing activities
 
53,816

 
(122,176
)
 
Nine Months Ended September 30, 2016 Compared to Nine Months Ended September 30, 2015
Operating Activities. Our operating cash flows are dependent, in large part, on our production, realized commodity prices, derivative settlements, lease bonus revenue, and operating expenses. Our cash flows from operations decreased from $217.2 million for the nine months ended September 30, 2015 to $141.6 million for the nine months ended September 30, 2016. The decrease was primarily due to lower cash collections of $58.5 million related to lower oil and natural gas sales and changes in working capital as compared to the corresponding period in 2015.
Investing Activities. Net cash used in investing activities increased by $99.5 million in the first nine months of 2016 as compared to the corresponding period in 2015 due to four mineral and property acquisitions that were closed during the first nine months of 2016 and higher capital expenditures for our working interest properties.
Financing Activities. For the nine months ended September 30, 2016 we generated cash from financing activities as we increased our borrowings under our credit facility and lowered distributions as compared to the corresponding period in 2015. Financing activities were further impacted by the repurchase of common and subordinated units.

29


Capital Expenditures
At the beginning of each calendar year, we establish a capital budget and then monitor it throughout the year. Our capital budget is created based upon our estimate of internally-generated cash flows and the ability to borrow and raise additional capital. Actual capital expenditure levels will vary, in part, based on actual cash generated, the economics of wells proposed by our operators for our participation, and the successful closing of acquisitions. The timing, size, and nature of acquisitions are unpredictable.
Our 2016 drilling expenditures are expected to be between $70.0 million and $75.0 million. We expect to invest between $65.0 million and $70.0 million in the Haynesville/Bossier play with the remainder expected to be spent primarily in the Bakken/Three Forks and Wolfcamp plays. During the nine months ended September 30, 2016, we spent $50.4 million related to drilling and completion costs and $1.1 million related to prospect leasehold acreage, primarily in the aforementioned plays. We also spent $140.9 million related to four mineral acquisitions in the current period as well as a final holdback payment from an acquisition in 2015. See Note 4 – Acquisitions for further discussion.
Credit Facility
On January 23, 2015, we amended and restated our $1.0 billion senior secured revolving credit agreement. Under this third amended and restated credit facility, the commitment of the lenders equals the lesser of the aggregate maximum credit amounts of the lenders and the borrowing base, which is determined based on the lenders’ estimated value of our oil and natural gas properties. On October 28, 2015, the third amended and restated credit facility was further amended to extend the term of the agreement from February 3, 2017 to February 4, 2019. Borrowings under the third amended and restated credit facility may be used for the acquisition of properties, cash distributions, and other general corporate purposes.  Our regular, semi-annual borrowing base redetermination process resulted in a decrease of the borrowing base from $550.0 million to $450.0 million, effective April 15, 2016. The Partnership's fall 2016 borrowing base redetermination process resulted in an increase in the borrowing base from $450.0 million to $500.0 million, which became effective October 31, 2016. As of September 30, 2015, we had outstanding borrowings of $299.0 million at a weighted-average interest rate of 2.53%.
The borrowing base under the third amended and restated credit agreement is redetermined semi-annually, typically on or around April 1 and October 1 of each year, by the administrative agent, taking into consideration the estimated loan value of our oil and gas properties consistent with the administrative agent’s normal oil and gas lending criteria. The administrative agent’s proposed redetermined borrowing base must be approved by all lenders to increase our existing borrowing base, and by two-thirds of the lenders to maintain or decrease our existing borrowing base. In addition, we and the lenders (at the election of two-thirds of the lenders) each have discretion to have the borrowing base redetermined once in between scheduled redeterminations,.
Outstanding borrowings under the third amended and restated credit facility bear interest at a floating rate elected by us equal to an alternative base rate (which is equal to the greatest of the Prime rate, the Federal Funds effective rate plus 0.50%, or 1-month LIBOR plus 1.00%) or LIBOR, in each case, plus the applicable margin. Throughout 2016, the applicable margin ranged from 0.50% to 1.50% in the case of the alternative base rate and from 1.50% to 2.50% in the case of LIBOR, in each case depending on the amount of borrowings outstanding in relation to the borrowing base. Subsequent to the closing of our fall redetermination, the applicable margin ranges from 1.00% to 2.00% in the case of the alternative base rate and from 2.00% to 3.00 % in the case of LIBOR, depending on the borrowings outstanding in relation to the borrowing base.
We are obligated to pay a quarterly commitment fee ranging from a 0.375% to 0.500% annualized rate on the unused portion of the borrowing base, depending on the amount of the borrowings outstanding in relation to the borrowing base. Principal may be optionally repaid from time to time without premium or penalty, other than customary LIBOR breakage, and is required to be paid (a) if the amount outstanding exceeds the borrowing base, whether due to a borrowing base redetermination or otherwise, in some cases subject to a cure period, or (b) at the maturity date. The third amended and restated credit facility is secured by liens on substantially all of our producing properties.
The third amended and restated credit agreement contains various affirmative, negative, and financial maintenance covenants. These covenants, among other things, limit additional indebtedness, additional liens, sales of assets, mergers and consolidations, dividends and distributions, transactions with affiliates, and entering into certain swap agreements, as well as require the maintenance of certain financial ratios. The third amended and restated credit agreement contains two financial covenants: total debt to EBITDAX of 3.5:1.0 or less; and a modified current ratio of 1.0:1.0 or greater. Distributions are not permitted if there is a default under the third amended and restated credit agreement (including due to a failure to satisfy one of the financial covenants) or during any time that our borrowing base is lower than the loans outstanding under the third amended and restated credit facility. The lenders have the right to accelerate all of the indebtedness under the third amended and restated

30


credit facility upon the occurrence and during the continuance of any event of default, and the third amended and restated credit agreement contains customary events of default, including non-payment, breach of covenants, materially incorrect representations, cross-default, bankruptcy, and change of control. There are no cure periods for events of default due to non-payment of principal and breaches of negative and financial covenants, but non-payment of interest and breaches of certain affirmative covenants are subject to customary cure periods. As of September 30, 2016, we were in compliance with all debt covenants.
Contractual Obligations
As of September 30, 2016, there have been no material changes to our contractual obligations previously disclosed in our 2015 Annual Report on Form 10-K.
Off-Balance Sheet Arrangements
As of September 30, 2016, we did not have any material off-balance sheet arrangements.
Critical Accounting Policies and Related Estimates
As of September 30, 2016, there have been no significant changes to our critical accounting policies and related estimates previously disclosed in our 2015 Annual Report on Form 10-K.
New and Revised Financial Accounting Standards
The effects of new accounting pronouncements are discussed in the notes to our unaudited consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q.


31


Item 3.
Quantitative and Qualitative Disclosures about Market Risk 

Commodity Price Risk
Our major market risk exposure is the pricing of oil, natural gas, and natural gas liquids produced by our operators. Realized prices are primarily driven by the prevailing global prices for oil and prices for natural gas and NGLs in the United States. Prices for oil, natural gas, and natural gas liquids have been volatile for several years, and we expect this unpredictability to continue in the future. The prices that our operators receive for production depend on many factors outside of our or their control. To reduce the impact of fluctuations in oil and natural gas prices on our revenues, we use commodity derivative instruments to reduce our exposure to price volatility of oil and natural gas. The counterparties to the contracts are unrelated third parties. The contracts settle monthly in cash based on a designated floating price. The designated floating price is based on the NYMEX benchmark for oil and natural gas. We have not designated any of our contracts as fair value or cash flow hedges. Accordingly, the changes in fair value of the contracts are included in net income in the period of the change. See Note 5 – Derivatives and Financial Instruments and Note 6 – Fair Value Measurement to the unaudited consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for additional information.
Commodity prices have declined in recent years. To estimate the effect lower prices would have on our reserves, we applied a 10% discount to the SEC commodity pricing for the twelve months ended September 30, 2016. Applying this discount results in an approximate 3.0% reduction of proved reserve volumes as compared to the undiscounted September 30, 2016 SEC pricing scenario.
Counterparty and Customer Credit Risk
Our derivative contracts expose us to credit risk in the event of nonperformance by counterparties. While we do not require our counterparties to our derivative contracts to post collateral, we do evaluate the credit standing of such counterparties as we deem appropriate. This evaluation includes reviewing a counterparty’s credit rating and latest financial information. As of September 30, 2016, we had ten counterparties, all of which are rated Baa2 or better by Moody’s. Six of our counterparties are lenders under our credit facility.
Our principal exposure to credit risk results from receivables generated by the production activities of our operators. The inability or failure of our significant operators to meet their obligations to us or their insolvency or liquidation may adversely affect our financial results. However, we believe the credit risk associated with our operators and customers is acceptable.
Interest Rate Risk
We have exposure to changes in interest rates on our indebtedness. As of September 30, 2016, we had $299.0 million of outstanding borrowings under our credit facility, bearing interest at a weighted-average interest rate of 2.53%. The impact of a 1% increase in the interest rate on this amount of debt would have resulted in an increase in interest expense, and a corresponding decrease in our results of operations, of $2.2 million for the nine months ended September 30, 2016, assuming that our indebtedness remained constant throughout the period. We may use certain derivative instruments to hedge our exposure to variable interest rates in the future, but we do not currently have any interest rate hedges in place.
 
 
Item 4.
Controls and Procedures

Disclosure Controls and Procedures
As required by Rule 13a-15(b) under the Securities Exchange Act of 1934 (the “Exchange Act”), we have evaluated, under the supervision and with the participation of management of our general partner, including our general partner’s principal executive officer and principal financial officer, the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Quarterly Report on Form 10-Q. Our disclosure controls and procedures are designed to provide reasonable assurance that the information required to be disclosed by us in reports that we file or submit under the Exchange Act is accumulated and communicated to management, including our general partner’s principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure and is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. Based upon that evaluation, our general partner’s principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of September 30, 2016.

32


Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during the quarter ended September 30, 2016 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1.
Legal Proceedings
Due to the nature of our business, we are, from time to time, involved in routine litigation or subject to disputes or claims related to our business activities. In the opinion of our management, none of the pending litigation, disputes or claims against us, if decided adversely, will have a material adverse effect on our financial condition, cash flows or results of operations.

Item 1A.
Risk Factors
In addition to the other information set forth in this report, readers should carefully consider the risks under the heading “Risk Factors” in our 2015 Annual Report on Form 10-K. There has been no material change in our risk factors from those described in our 2015 Annual Report on Form 10-K. These risks are not the only risks that we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may materially adversely affect our business, financial condition or results of operations.

Item 2.         Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 6.
Exhibits
The information required by this Item 6 is set forth in the Index to Exhibits accompanying this Quarterly Report on Form 10-Q and is incorporated herein by reference.


33


SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
BLACK STONE MINERALS, L.P.
 
 
 
By:
 
Black Stone Minerals GP, L.L.C.,
its general partner
 
 
 
 
Date: November 8, 2016
By:
 
/s/ Thomas L. Carter, Jr.
 
 
 
Thomas L. Carter, Jr.
 
 
 
President and Chief Executive Officer
 
 
 
(Principal Executive Officer)
 
 
 
 
Date: November 8, 2016
By:
 
/s/ Marc Carroll
 
 
 
Marc Carroll
 
 
 
Senior Vice President and Chief Financial Officer
 
 
 
(Principal Financial Officer)


34


Exhibit Index
 
 
 
Exhibit Number
 
Description
 
 
 
3.1
 
Certificate of Limited Partnership of Black Stone Minerals, L.P. (incorporated herein by reference to Exhibit 3.1 to Black Stone Minerals, L.P.’s Registration Statement on Form S-1 filed on March 19, 2015 (SEC File No. 333-202875)).
 
 
 
3.2
 
Certificate of Amendment to Certificate of Limited Partnership of Black Stone Minerals, L.P. (incorporated herein by reference to Exhibit 3.2 to Black Stone Minerals, L.P.’s Registration Statement on Form S-1 filed on March 19, 2015 (SEC File No. 333-202875)).
 
 
 
3.3
 
First Amended and Restated Agreement of Limited Partnership of Black Stone Minerals, L.P., dated May 6, 2015, by and among Black Stone Minerals GP, L.L.C. and Black Stone Minerals Company, L.P., as amended (incorporated herein by reference to Exhibit 3.2 of Black Stone Minerals, L.P.’s Current Report on Form 8-K filed on April 19, 2016 (SEC File No. 001-37362)).
 
 
 
3.4
 
Amendment No. 1 to First Amended and Restated Agreement of Limited Partnership of Black Stone Minerals, L.P., dated as of April 15, 2016 (incorporated herein by reference to Exhibit 3.1 of Black Stone Minerals, L.P.’s Current Report on Form 8-K filed on April 19, 2016 (SEC File No. 001-37362)).
 
 
 
*31.1
 
Certification of Chief Executive Officer of Black Stone Minerals, L.P. pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
 
*31.2
 
Certification of Chief Financial Officer of Black Stone Minerals, L.P. pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
 
*32.1
 
Certification of Chief Executive Officer and Chief Financial Officer of Black Stone Minerals, L.P. pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
 
 
 
 
*101.INS
 
XBRL Instance Document
 
 
 
*101.SCH
 
XBRL Schema Document
 
 
 
*101.CAL
 
XBRL Calculation Linkbase Document
 
 
 
*101.LAB
 
XBRL Label Linkbase Document
 
 
 
*101.PRE
 
XBRL Presentation Linkbase Document
 
 
 
*101.DEF
 
XBRL Definition Linkbase Document
 
*      Filed or furnished herewith.


35