EMPIRE PETROLEUM CORP - Quarter Report: 2021 June (Form 10-Q)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

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FORM 10-Q

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or

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EMPIRE PETROLEUM CORPORATION

(Exact name of registrant as specified in its charter)

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(539) 444-8002

(Registrant’s telephone number, including area code)

(Former name or former address and former fiscal year, if changed since last report)

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Securities registered pursuant to Section 12(b) of the Act:

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  þ     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  þ     No  £

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ☐    No  ☒ 

APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.    Yes  ☐    No  ☐

APPLICABLE ONLY TO CORPORATE ISSUERS

The number of shares of the registrant's common stock, $0.001 par value, outstanding as of June 30, 2021 was 65,661,634. 

EMPIRE PETROLEUM CORPORATION

INDEX TO FORM 10-Q

PART I. FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

EMPIRE PETROLEUM CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

See accompanying notes to unaudited condensed consolidated financial statements

EMPIRE PETROLEUM CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

See accompanying notes to unaudited condensed consolidated financial statements

EMPIRE PETROLEUM CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' DEFICIT

For the Six Months Ended September 30, 2021 and 2020

(UNAUDITED)

See accompanying notes to unaudited condensed consolidated financial statements 

EMPIRE PETROLEUM CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

See accompanying notes to unaudited condensed consolidated financial statements

EMPIRE PETROLEUM CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2021

1.       BASIS OF PRESENTATION AND GOING CONCERN

The accompanying unaudited condensed consolidated financial statements of Empire Petroleum Corporation ("Empire" or the "Company") have been prepared in accordance with United States generally accepted accounting principles (“GAAP”) for interim financial information and the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation of the Company's financial position, the results of operations, and the cash flows for the interim period are included. All adjustments are of a normal, recurring nature. Operating results for the interim period are not necessarily indicative of the results that may be expected for the year ending December 31, 2021.

The information contained in this Form 10-Q should be read in conjunction with the audited financial statements and related notes for the year ended December 31, 2020 which are contained in the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission (the "SEC") on March 31, 2021.

The Company has incurred significant losses in recent years. The continuation of the Company as a going concern is dependent upon the ability of the Company to attain future profitable operations and/or additional debt or equity financing until profitable operations are achieved. The ultimate recoverability of the Company's investment in oil and natural gas interests is dependent upon the existence and discovery of economically recoverable oil and natural gas reserves, the ability of the Company to obtain necessary financing to further develop the interests, and the ability of the Company to attain future profitable production.

As of June 30, 2021, the Company had $1,016,877 of cash and working capital deficit of $13,177,298. The Company has proved reserves which have been acquired within the last two years. The Company plans to continue to look for oil and natural gas investments and will use a combination of debt and equity financing to fund potential acquisitions. The Company expects to also incur costs related to evaluating and acquiring oil and natural gas acquisitions for the foreseeable future. It is expected that management will attempt to raise additional capital for future investment and working capital opportunities.

However, there can be no assurances the Company will be able to refinance or restructure its existing indebtedness, raise sufficient capital to fund its strategic development plans, and meet its various capital needs. As a result of these uncertainties, management has concluded there is substantial doubt regarding the Company’s ability to continue as a going concern.

These financial statements have been prepared on the basis of United States generally accepted accounting principles applicable to a company with continuing operations, which assume that the Company will continue in operation for the foreseeable future and will be able to realize its assets and discharge its obligations in the normal course of operations. Management believes the going concern assumption to be appropriate for these financial statements. If the going concern assumption were not appropriate for these financial statements, then adjustments might be necessary to adjust the carrying value of assets and liabilities and reported expenses.

The Company’s impairment assessment of proved and unproved mineral properties is based on several factors including oil and gas spot market prices and estimated futures prices that existed at June 30, 2021. In2020, crude oil prices in both the spot market and futures market experienced significant volatility. For the year ended December 31, 2020 the Company recorded an impairment expense of $8,671,303 as a result of the decline in oil prices. Further, the effect of lower crude oil prices on the Company’s future financial position or results of operations is not currently determinable due to broader economic and industry uncertainties, including the impact to the operators and other working interest owners of the properties in which the Company owns mineral interests.

In the event crude oil or natural gas prices decline significantly, there is the risk that, among other things:

The occurrence of certain of these events may have a material adverse effect on the Company's business, results of operations and financial condition.

In early March 2020 there was a global outbreak of COVID-19 which has continued and resulted in changes in global supply and demand of certain mineral and energy products. These changes, including the magnitude and length of the economic downturn and any potential resulting direct and indirect negative impact to the Company cannot be determined, but they could have a prospective material impact to the Company’s acquisition and project development activities, and cash flows and liquidity.

As of June 30, 2021, the Company had twenty nine employees. No independent Board members received compensation from the Company in the first six months of 2020; in 2021 independent Board members were compensated $33,000 and $84,000 was accrued but unpaid as of June 30, 2021. For the six months ended June 30, 2021, the Company paid its officers, Mr. Morrisett and Mr. Pritchard, $227,000 each for services rendered. For the six months ended June 30, 2020, the Company paid Mr. Morrisett and Mr. Pritchard $116,000 each for services rendered excluding the value of options awarded.

2.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of consolidation. The condensed consolidated financial statements of the Company include the accounts of the Company and its wholly owned subsidiaries, Empire Louisiana, LLC ("Empire Louisiana"), Empire North Dakota, LLC ("Empire North Dakota"), Empire New Mexico, LLC (“Empire New Mexico”), Empire ND Acquisitions, LLC (“Empire ND Acquisitions”), Empire Texas, LLC (“Empire Texas”), and Pardus Oil & Gas Operating, LP (“Pardus”). All material intercompany balances and transactions have been eliminated.

Use of estimates in the preparation of financial statements. Preparation of financial statements in conformity with generally accepted accounting principles in the United States of America ("U.S. GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from these estimates. Depletion of oil and natural gas properties is determined using estimates of proved oil and natural gas reserves. There are numerous uncertainties inherent in the estimation of quantities of proved reserves and in the projection of future rates of production and the timing of development expenditures. Similarly, evaluations for impairment of proved and unproved oil and natural gas properties are subject to numerous uncertainties including, among others, estimates of future recoverable reserves, commodity price outlooks and prevailing market rates of other sources of income and costs. Other significant estimates include, but are not limited to, asset retirement obligations, fair value of assets purchased in business combinations, embedded derivatives (conversion features), commodity derivatives, and taxes.

Interim financial statements. The accompanying condensed consolidated financial statements of the Company have not been audited by the Company's independent registered public accounting firm. In preparing the accompanying condensed consolidated financial statements, management has made certain estimates and assumptions that affect reported amounts in the condensed consolidated financial statements and disclosures of contingencies. Actual results may differ from those estimates. The results for interim periods are not necessarily indicative of annual results.

Certain disclosures have been condensed in or omitted from these condensed consolidated financial statements. Accordingly, these condensed notes to the condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 2020.

Inventory. Inventory consists of oil in tanks which has not been delivered and is valued at the contract price to the buyer.

Convertible Debt. The Company accounts for conversion options embedded in a host instrument in accordance with ASC 815, Derivatives and Hedging ("ASC 815). ASC 815 requires a reporting entity to bifurcate conversion options embedded in convertible debt and to account for them as a free standing derivative when the embedded feature is not clearly and closely related to the host instrument and meets the definition of a derivative and does not qualify for the scope exception from derivative accounting.

The Company reviews the terms of convertible debt issued to determine whether there are embedded features, including embedded conversion options, which are required to be bifurcated and accounted for separately as a derivative. In circumstances where the host instrument contains more than one embedded derivative, including the conversion option, that is required to be bifurcated, the derivative instruments are accounted for as a single, compound derivative instrument.

The separated derivative is initially recorded at fair value and subsequently revalued at each reporting date with changes in the fair value reported as other income or expense. When the convertible debt instrument contains embedded derivatives that are bifurcated and accounted for separately as a derivative liability, the total proceeds received are first allocated to the fair value of derivative liability. The remaining proceeds, if any, are then allocated to the debt, resulting in an initial discount on the debt. The debt discount is subsequently amortized under the interest method through periodic charges to interest expense.

For conversion options embedded in a host instrument which are required to be bifurcated and qualify for the scope exception from derivative accounting are accounted for under other models as required by ASC 470-20, Debt with Conversion and Other Options.  

Revenue recognition. The Company recognizes revenues from the sales of oil and natural gas to its customers and presents them aggregated on the Company's condensed consolidated statements of operations. The Company enters into contracts with customers to sell its oil and natural gas production. Revenue on these contracts is recognized in accordance with the five-step revenue recognition model prescribed in ASC 606. Specifically, revenue is recognized when the Company's performance obligations under these contracts are satisfied, which generally occurs with the transfer of control of the oil and natural gas to the purchaser. Control is generally considered transferred when the following criteria are met: (i) transfer of physical custody, (ii) transfer of title, (iii) transfer of risk of loss and (iv) relinquishment of any repurchase rights or other similar rights. Given the nature of the products sold, revenue is recognized at a point in time based on the amount of consideration the Company expects to receive in accordance with the price specified in the contract. Consideration under the oil and natural gas marketing contracts is typically received from the purchaser one to two months after production. At June 30, 2021, the Company had receivables related to contracts with customers of approximately $2,800,000 and joint interest billings of approximately $800,000.

Fair value measurements. The Financial Accounting Standards Board ("FASB") fair value measurement standards define fair value, establish a consistent framework for measuring fair value and establish a fair value hierarchy based on the observability of inputs used to measure fair value.

Impairment of oil and natural gas properties - The fair value of proved and unproved oil and natural gas properties was measured using valuation techniques that convert the future cash flows to a single discounted amount. Significant inputs to the valuation of proved and unproved oil and natural gas properties include estimates of: (i) recoverable reserves; (ii) production rates; (iii) future operating and development costs; (iv) future commodity prices; and (v) a market-based weighted average costs of capital. The Company utilized a combination of the New York Mercantile Exchange ("NYMEX") strip pricing and consensus pricing to value the reserves, then applied various discount rates depending on the classification of reserves and other risk characteristics. For significant acquisitions, management utilized the assistance of a third-party valuation expert to estimate the value of the oil and natural gas properties acquired.

The fair value of asset retirement obligations is included in proved oil and natural gas properties with a corresponding liability. The fair value was determined based on a discounted cash flow model, which included assumptions of the estimated current abandonment costs, discount rate, inflation rate and timing associated with the incurrence of these costs.

The inputs used to value oil and natural gas properties for impairments and asset retirement obligations require significant judgment and estimates made by management and represent Level 3 inputs.

Embedded conversion feature – The conversion features of the Secured Convertible Note have been accounted for as a separated derivative and recorded at fair value using a binomial pricing model. The inputs used to value the derivative conversion feature require significant judgment and estimates made by management and represent Level 3 inputs.

Investment in related party – The value of the investment in related party is based on the cost of the investment due to its nature.

Financial instruments and other- The fair values determined for accounts receivable, accrued expenses and other current liabilities were equivalent to the carrying value due to their short-term nature.

Related Party Transactions. Transactions between related parties are considered to be related party transactions even though they may not be given accounting recognition. FASB ASC 850, Related Party Disclosures (“FASB ASC 850”) requires that transactions with related parties that would make a difference in decision making shall be disclosed so that users of the financial statements can evaluate their significance. Related party transactions typically occur within the context of the following relationships: affiliates of the entity; entities for which investments in their equity securities is typically accounted for under the equity method by the investing entity; trusts for the benefit of employees; principal owners of the entity and members of their immediate families; management of the entity and members of their immediate families; and other parties that can significantly influence the management or operating policies of the transacting parties and can significantly influence the other to an extent that one or more of the transacting parties might be prevented from fully pursuing its own separate interests.

3.       INVESTMENT IN RELATED PARTY

Concurrent with the acquisition and financing of the XTO properties (See Notes 7 and 11), the Company made an investment in Energy Evolution Fund LP, an affiliate of Energy Evolution Ltd, a related party, in the amount of $1,250,000. The Energy Evolution Fund, LP is a hedge fund focused on global petroleum and sustainable energy. The investment in related party is accounted for as an investment in an equity security and recorded at historical cost. The investment was mutually terminated on August 19, 2021 (See Note 17).

4.       PROPERTY AND EQUIPMENT

On January 27, 2020, the Company purchased lease interests in approximately 4,936 acres in Montana for $500,000.

In February, 2020, the Company in two transactions sold all of its interest in leases of approximately 337 acres in Montana for $1,160,400. The Company recognized a gain on the transactions of $1,143,760.

On April 6, 2020 the Company purchased oil and natural gas properties in Texas (see Note 6).

In May, 2021 the Company purchased oil and natural gas properties in New Mexico (see Note 7).

NYMEX strip prices experienced significant volatility in 2020, resulting in a significant decrease in value of the Company’s economically recoverable proved oil and natural gas reserves. As such, the carrying amount of the Company’s proved oil and natural gas properties exceeded the expected undiscounted future net cash flows for certain leases, resulting in impairment charges against earnings of $800,452 for the six months ended June 30, 2020. The Company did not recognize an impairment of proved oil and natural gas properties during the six months ended June 30, 2021.

The aggregate capitalized costs of oil and natural gas properties as of June 30, 2021, are as follows:

Other property and equipment consists of operating lease asset (See Note 11), vehicles, office furniture and equipment.

5.       OVINTIV OIL AND NATURAL GAS PROPERTIES

On March 3, 2020 the Company entered into a Purchase and Sale Agreement (“the Ovintiv Agreement”) with Ovintiv USA, Inc. and several related companies to purchase certain oil and natural gas properties in Montana and North Dakota. The purchase price was $8,500,000, subject to adjustments with an effective date of January 1, 2020 and a closing date of April 30, 2020.

The Company made an $850,000 deposit relating to the purchase. Due to the COVID-19 pandemic and governmental state of emergency orders related thereto, the Company was unable to meet with and obtain financing to complete the purchase from its lenders. The Ovintiv Agreement was terminated and the parties agreed to settle with the Company receiving a $50,000 return of its deposit. The Company estimated a loss on the deposit of $725,000 in the quarter ending June 30, 2020 which is included in general and administrative expense, with the remainder recorded in the quarter ending September 30, 2020. No amounts were outstanding as of December 31, 2020.

6.       ACQUISITION OF PARDUS OIL AND NATURAL GAS PROPERTIES

On April 6, 2020 the Company, through its wholly owned subsidiary, Empire Texas, entered into a Purchase and Sale Agreement (“the Pardus Agreement”) with Pardus Oil & Gas, LLC and Pardus Oil & Gas Operating GP, LLC to purchase certain oil and natural gas properties in Texas comprising 139 gross wells and approximately 30,000 net acres, 77.3 miles of gathering lines and pipelines and related facilities and equipment, and all general and limited partner interest in Pardus Oil & Gas Operating, LP. The purchase price, as amended, included the assumption of certain obligations totaling $1,584,042 and a cash payment of $40,000 for a total purchase price of $1,624,042. The transaction closed on April 7, 2020.

The following table sets forth the Company's purchase price allocation:

The fair values of assets acquired and liabilities assumed were based on the following key inputs:

Oil and natural gas properties

The value of oil and gas properties was based on an allocation of the purchase price which included assignment of values to the other identifiable assets acquired and liabilities assumed.

The fair value of asset retirement obligations are included in proved oil and natural gas properties with a corresponding liability in the table above. The fair value was determined based on a discounted cash flow model, which included assumptions of the estimated current abandonment costs, discount rate, inflation rate and timing associated with the incurrence of these costs.

The inputs used to value oil and natural gas properties and asset retirement obligations require significant judgment and estimates made by management and represent non-recurring Level 3 inputs

Financial instruments and other

The fair values determined for accounts payable - trade were equivalent to the carrying value due to their short-term nature and include liabilities primarily related to well activity prior to close.

Inventory acquired as a part of the acquisition was based on oil in tanks at the date of acquisition multiplied by the day’s spot price.

7.       ACQUISITION OF XTO OIL AND NATURAL GAS PROPERTIES

On March 12, 2021 the Company, through its wholly owned subsidiary Empire New Mexico, entered into a purchase and sale agreement with XTO Holdings, LLC (a subsidiary of ExxonMobil) (the “Seller’) to acquire, among other things, certain oil and natural gas properties in New Mexico. The purchase price was $17,800,000 subject to customary adjustments. The Company wired a deposit of $1,780,000 to the Seller on March 12, 2021. The transaction closed on May 14, 2021 with an effective date of January 1, 2021.

The XTO acquisition has been accounted for as an asset acquisition using the acquisition method of accounting under FASB ASC 805, Business Combinations (“ASC 805”). Under the accounting for asset acquisitions, the acquisition is recorded using a cost accumulation and allocation model under which the cost of the acquisition is allocated on a relative fair value basis to the assets acquired and liabilities assumed. For asset acquisitions under ASC 805, acquisition-related transaction costs are capitalized as a component of the cost of the assets acquired.

As a condition of the sale, the Company purchased a $5,000,000 performance bond for the benefit of the seller for proper plugging, abandonment and restoration of the purchased properties. The performance bond is collateralized with a letter of credit in the amount of $3,750,000. To effect the letter of credit, the Company entered into a Promissory Note Agreement with Bank of Oklahoma, NA in the amount of $3,750,000 which is due on demand with an interest rate established by the Bank, currently at 4 percent. The Promissory Note, and associated letter of credit, is collateralized with a bank certificate of deposit in a corresponding amount. In addition, the Company is required to deposit $100,000 per month, up to $1,250,000, into a sinking fund to be held by the surety.

The following table sets forth the Company's preliminary purchase price allocation:

The value of oil and gas properties was based on an allocation of the purchase price which included assignment of values to the other identifiable assets acquired and liabilities assumed. The value of inventory, vehicles, and royalty suspense was based on carrying value at the time of the acquisition.

The fair value of asset retirement obligations are included in proved oil and natural gas properties with a corresponding liability in the table above. The fair value was determined based on a discounted cash flow model, which included assumptions of the estimated current abandonment costs, discount rate, inflation rate and timing associated with the incurrence of these costs.

8.       JOINT DEVELOPMENT AGREEMENT

On August 6, 2020 the Company, through its wholly owned subsidiary, Empire Texas, entered into a joint development agreement (the “JDA”) with Petroleum & Independent Exploration, LLC and related entities (“PIE”), a related party (See Note 14), dated August 1, 2020. Under the terms of the JDA, PIE will perform recompletion or workover on specified mutually agreed upon wells (“Workover Wells”) owned by Empire Texas. To fund the work, PIE entered into a term loan agreement with Empire Texas dated August 1, 2020, whereby PIE will loan up to $2,000,000, at an interest rate of 6% per annum, maturing August 7, 2024 unless terminated earlier by PIE. Proceeds of the loan will be used for recompletion or workover of the Workover Wells. As of June 30, 2021 approximately $446,000 has been advanced from the loan and is included in Long Term Notes Payable on the Condensed Consolidated Balance Sheet. As part of the JDA, Empire Texas will assign to PIE a combined 85% working and revenue interest in the Workover Wells; an assignment was completed in October 2020 for the initial three Workover Wells. Of the assigned interest, 70% working and revenue interest will be used to repay the obligations under the term loan agreement. Once the term loan is repaid, PIE will reassign a 35% working and revenue interest to Empire Texas in each of the Workover Wells and retain a 50% working and revenue interest (See Note 10). Activity resulting from the JDA is being treated as a conveyance.

In addition, PIE and Empire entered into a Securities Purchase Agreement (“Securities Agreement”) whereby PIE purchased for $525,000 (a) 3,500,000 shares of Empire common stock, (b) warrants to purchase 2,625,000 shares of Empire common stock at an exercise price of $0.20 per share, (c) warrants to purchase 1,800,000 shares of Empire common stock at an exercise price of $0.25 per share, (d) warrants to purchase 8,136,518 shares of Empire common stock at an exercise price of $0.10 per share, and (e) warrants to purchase up to 11,066,667 shares of Empire common stock at an exercise price of $0.141 per share, pursuant to various vesting provisions as detailed in the Securities Agreement. On March 11, 2021 the Company amended the Securities Agreement to remove the vesting provisions for the warrants and PIE exercised all of its warrants for an aggregate exercise price of $3,349,052 (See Note 13).

9.       COMMODITY DERIVATIVE FINANCIAL INSTRUMENTS

The Company uses derivative financial instruments to manage its exposure to commodity price fluctuations. Commodity derivative instruments are used to reduce the effect of volatility of price changes on the oil and natural gas the Company produces and sells. The Company does not enter into derivative financial instruments for speculative or trading purposes. The Company’s derivative financial instruments consist of oil swaps.

The Company does not designate its derivative instruments to qualify for hedge accounting. Accordingly, the Company reflects changes in the fair value of its derivative instruments in its condensed consolidated statements of operations as they occur. Unrealized gains and losses related to the swap contracts are recognized and recorded as an asset or liability on the Company’s condensed consolidated balance sheets.

The following table summarizes the net realized and unrealized amounts reported in earnings related to the commodity derivative instruments for the three and six months ended June 30, 2021 and 2020:

The following represents the Company’s net cash receipts from (payments on) derivatives for the three and six months ended June 30, 2021 and 2020:

The following table sets forth the Company’s outstanding derivative contracts at June 30, 2021. The Company has no outstanding natural gas derivatives.

10.     DEBT

The following table represents the Company’s outstanding debt.

On March 10, 2021 the Company entered into the Third Amendment to its Senior Revolver Loan Agreement (“the Amended Agreement”) with CrossFirst Bank (“CrossFirst”). The Amended Agreement commitment amount is $8,520,000 which is reduced by $180,000 per calendar quarter beginning June 30, 2021 and the maximum amount that can be advanced under the Agreement is $20,000,000 and includes interest at Wall Street Journal Prime plus 150 basis points (4.75% as of June 30, 2021). The Amended Agreement matures on March 27, 2022. Collateral for the loan is a lien on all of the assets of the Company’s wholly owned subsidiaries, Empire Louisiana and Empire North Dakota, and a first priority mortgage lien, pledge of and security interest in not less than 80% of Empire Louisiana’s and Empire North Dakota’s producing oil, gas and other leasehold and mineral interests. The Amended Agreement requires the Company maintain commodity derivatives at certain thresholds based on projected production and, beginning March 31, 2021, to maintain certain covenants including an EBITDAX to interest expense of at least 3:1 and funded debt to EBITDAX of 6:1 on a trailing twelve-month basis and reducing quarterly to 4:1 as of March 31, 2022 and thereafter. As of June 30, 2021, the Company has an outstanding loan balance of $7,669,500 under the Amended Agreement. The Company was not in compliance with the commodity derivative requirement as of June 30, 2021. The Company was in compliance with the other covenants at June 30, 2021. On July 7, 2021 the Company entered into the Fourth Amendment to its Senior Revolver Loan Agreement, which among other things waived the Company's non-compliance with the commodity derivative requirement and extended the maturity to March 27, 2024. Accordingly, the Company's outstanding loan balance is presented as long-term as of June 30, 2021 (See Note 17).

During 2016 and 2017, the Company issued $260,000 of Senior Unsecured Promissory Notes which contained a conversion feature allowing the investors to convert the Notes into shares of the Company’s common stock. In 2019, all but three of the Note holders converted their notes with a balance of $157,500 into 1,575,000 shares of the Company’s common stock. In January 2020, three of the Senior Unsecured Promissory Note investors exercised the conversion feature and converted their $102,500 notes for 1,025,000 shares of the Company's common stock. All of the Senior Unsecured Promissory Notes have been converted to common stock of the Company as of June 30, 2020.

On April 1, 2020, in conjunction with the purchase of assets from Pardus Oil & Gas, LLC (see Note 5), the Company entered into a unsecured promissory note agreement with the seller in the amount of $378,000. The note was payable in one installment on April 1, 2021 and bears interest at the one-year LIBOR rate (1% as of June 30, 2021). The note was paid on April 1, 2021 (See Note 6).

On May 5, 2020, the Company received an SBA Payroll Protection Plan (“PPP”) loan for $160,700. The loan matured on May 5, 2022 and had an interest rate of 1%. In June, 2021 the Company was informed that the SBA had forgiven the entire loan balance.

In August 2020, concurrent with the Joint Development Agreement with Petroleum and Independent Exploration, LLC (“PIE”), a related party, the Company entered into a term loan agreement dated August 1, 2020, whereby PIE will loan up to $2,000,000, at an interest rate of 6% per annum, maturing August 7, 2024 unless terminated earlier by PIE. The loan proceeds will be used for recompletion or workover of certain designated wells. In addition, the Company assigned a 70% working and revenue interest to PIE in the designated wells which will be applied to repayment of the loan. As of June 30, 2021, $462,959 has been advanced from the loan (See Note 8).

On April 30,2021 the Company received a Second Draw SBA Payroll Protection Plan (“PPP”) loan for $106,850. The loan matures on April 30, 2026 and has an interest rate of 1%. There are no payments due until ten months after the covered period at which time the payment amount will be determined based on the portion of the loan which has not been forgiven under criteria established by the SBA, using an amortization of the remaining term of the loan. The Company expects that the loan amount will be forgiven based on currently published guidelines of the United States Small Business Administration.

The Company has an outstanding Letter of Credit in the amount of $3,750,000 which was issued in conjunction with the purchase of oil and natural gas properties from XTO (See Note 7). To effect the letter of credit, the Company entered into a Promissory Note Agreement with Bank of Oklahoma, NA in the amount of $3,750,000 which is due on demand with an interest rate established by the Bank, currently at 4 percent. The Promissory Note, and associated letter of credit, is collateralized with a bank certificate of deposit in a corresponding amount.

11.     CONVERTIBLE NOTES PAYABLE

On May 14, 2021 Empire New Mexico entered into a Senior Secured Convertible Note Agreement (the “Secured Note”) in the amount of $16,250,000 with Energy Evolution Master Fund, Ltd., a related party (“Energy Evolution”) (See Note 14). The Secured Note is collateralized by all assets of Empire New Mexico, matures on December 31, 2021 and bears an interest rate of 3.8%. The Secured Note provides that up to 40% of the balance, together with accrued interest, can be converted into the Company’s common stock at the lesser of $1.25 per share or the offering price if the Company has a subsequent capital raise or an aggregate of 5,200,000 shares of common stock (without giving effect to any interest that may be converted). Additionally, the conversion price is reduced by $0.25 per share if any amount is due on the Secured Note as of October 1, 2021 or the Company has not filed a registration statement with the United States Securities and Exchange Commission within 120 days of the Secured Note. If the registration statement described above is not filed within 120 days of the date of the Secured Note, Energy Evolution has the option to convert 50% of the Secured Note amount into common stock of the Company at a rate of $1.00 per share. In such event, the maximum number of shares into which the Secured Note may be converted increases to 8,125,000 shares of the Company’s common stock (without giving effect to any interest that may be converted). In addition, if any principal amount of the Secured Note remains outstanding on October 1, 2021, the conversion price shall be reduced by $0.25, provided the conversion price cannot be reduced by more than $0.25.  The Company agreed to use commercially reasonable best efforts to (i) cause the number of members serving on the Company’s Board of Directors to be increased to six, (ii) cause an additional designee of Energy Evolution or its affiliate to be appointed to the Company’s Board of Directors, and (c) cause one of the designated directors of Energy Evolution or its affiliate to be appointed the Chairman of Empire Petroleum’s Board of Directors with the power to cast the deciding vote in case of a deadlocked board vote. The Secured Note may be prepaid without penalty, but Empire New Mexico must provide at least 30 days’ prior written notice so the holders thereof may exercise their conversion rights. As of June 30, 2021, there were no conversions of the Secured Note to shares of the Company’s common stock. The Company made prepayments of $2,800,000 on the Secured Note through June 30, 2021.

The embedded conversion option has been bifurcated and accounted for separately as a derivative financial instrument. The separated derivative was initially recorded at fair value at the inception date and revalued as of June 30, 2021 resulting in a fair value of $5,530,677 and $6,126,961, respectively. The change in fair value for the three months ended June 30, 2021 of $596,284 and recorded in Other Income.

As partial consideration for the issuance of the Secured Note, Energy Evolution received a closing fee of 1,500,000 shares of the Company’s common stock and warrants to purchase 3,000,000 shares of common stock for $1.00 per share which expire on May 14, 2022. The Company determined these were equity-classified financing instruments and the proceeds are allocated on a relative fair value basis between the debt, warrants, and common shares at issuance. At issuance, the discount associated with the Secured Note was $10,125,177; consisting of $5,530,677 relating to the embedded derivative liability, $1,500 and $2,773,500 in common stock and paid in capital, respectively, relating to the issuance of shares of the Company's common stock, and $1,819,500 in paid in capital relating to the issuance of warrants to purchase common stock. The fair value of the warrants was determined using a Black-Scholes model. The warrants were exercised during the three months ended June 30, 2021 and the Company received cash proceeds of $3,000,000. The discount associated with the Secured Note related to the embedded conversion liability and the issuance of the equity-classified financing instruments is amortized under the interest method and resulted in interest expense of $2,289,966 for the three months ended June 30, 2021.

In May, 2021 the Empire New Mexico entered into $3,243,000 of Unsecured Convertible Notes (the “Unsecured Notes”) with a group of accredited investors, including the Company's related party Energy Evolution, constituting $1,500,000 of the total Unsecured Convertible Notes. The Unsecured Notes mature on May 9, 2022 with a single payment and bear interest at 5%. The Unsecured Note holders may convert their notes to common stock of the Company at the lesser of $1.25 per share or the price per share offered by the Company if the Company has a future capital raise for an aggregate 2,594,400 shares of common stock (without giving effect to any interest that may be converted). Pursuant to the Unsecured Notes, the Company agreed to use commercially reasonable best efforts to cause a registration statement on Form S-3 to be filed with Securities Exchange Commission within 90 days for all Common Stock underlying the Unsecured Notes. Empire New Mexico has the right to force conversion in the event that (a) the 20-day weighted average price of the Common Stock trades above $3.50 per share on the OTCQB or any exchange and (b) the Registration Statement has become effective. The Unsecured Notes may be prepaid without penalty, but Empire New Mexico must provide at least 30 days’ prior written notice so the holders thereof may exercise their conversion rights. As of June 30, 2021 Energy Evolution had converted their $1,500,000 Unsecured Note to 1,200,000 shares of the Company’s common stock (See Note 13).

The Company determined the embedded conversion features of the Unsecured Notes were equity-classified financing instrument. The fair value of the conversion feature was determined using a beneficial conversion model based on the a 60-day weighted average stock price and the maximum number of shares to be received if converted. As issuance, the amount recorded to additional paid in capital was $544,824. The discount associated with these transactions is amortized under the interest method and resulted in interest expense of $289,949 for the three months ended June 30, 2021.

As an inducement for investors to enter into the Unsecured Convertible Notes, the Company’s Chief Executive Officer and President collectively offered to each investor the right to purchase a number of shares of common stock equal to 40% of such investor’s principal balance under its Unsecured Convertible Note at $0.75 per share (the “right to buy”). Energy Evolution exercised its right to buy 600,000 shares of the Company’s common stock. In conjunction with this transaction, each of the Company’s Chief Executive Officer and President partially exercised a warrant to purchase 300,000 shares at an exercise price of $0.25. The Company determined that offering the “right to buy” shares resulted in an expense of $989,155 of the Company based on the fair value of contributions made by the Company’s Chief Executive Officer and President on its behalf. The fair value of the “right to buy” shares was determined using a Black-Scholes model. The expense is including in General and Administrative in the Condensed Consolidated Statement of Operations.

12.     LEASES

As a lessee, the Company leases its corporate office headquarters in Tulsa, Oklahoma and three field offices. The leases expire between 2024 and 2027. The corporate office has an option to renew for an additional five-year term. The option to renew the lease is generally not considered reasonably certain to be exercised. Therefore, the period covered by such optional period is not included in the determination of the term of the lease and the lease payments during these periods are similarly excluded from the calculation of right-of-use lease asset and lease liability balances.

The Company recognizes right-of use lease expense on a straight-line basis, except for certain variable expenses that are recognized when the variability is resolved, typically during the period in which they are paid. Variable right-of-use lease payments typically include charges for property taxes, insurance, and variable payments related to non-lease components, including common area maintenance.

Right of use lease expense was $78,712 for the six months ended June 30, 2021. Cash paid for right of use lease was $72,045 for the period.

Supplemental balance sheet information related to the right of use leases as of June 30, 2021:

The weighted average remaining term for the Company’s right of use leases is 4.7 years.

Maturities of lease liabilities as of June 30, 2021:

13.     EQUITY

Diluted Earnings per Share ("EPS") gives effect to all dilutive potential common shares outstanding during the period. The computation of Diluted EPS does not assume conversion, exercise or contingent exercise of securities that would have an anti-dilutive effect on losses. As a result, if there is a loss from continuing operations, Diluted EPS is computed in the same manner as Basic EPS. At June 30, 2021 and 2020, the Company had 10,000,000 and 5,004,167 respectively, options outstanding that were not included in the calculation of earnings per share for the periods then ended. Such financial instruments may become dilutive and would then need to be included in future calculations of Diluted EPS. At June 30, 2021 and 2020, the outstanding options and convertible notes were considered anti-dilutive because the strike prices were above the market price and the Company has incurred operating losses year to date.

On April 3, 2019, the Board of Directors of the Company adopted the Empire Petroleum Corporation 2019 Stock Option Plan (the "Stock Option Plan"). The total number of shares of common stock that may be issued pursuant to stock options under the Stock Option Plan is 10,000,000. Further, on April 3, 2019 the Company granted Mr. Pritchard and Mr. Morrissett each, options to purchase 2,500,000 shares of common stock of the Company at an exercise price of $0.33 per share. The options vested in three installments with 1,250,000 vesting immediately and 625,000 vesting each in April 2020 and April 2021. All of the options expire in April, 2029. The value allocated to the vested options was the fair value determined using the Black-Scholes option valuation with the following assumptions:  no dividend yield, expected annual volatility of 213%, risk free interest rate of 2.32% and an expected useful life of 5.375 years. The fair value of the vested options of $812,500 was recorded as compensation expense and allocated to Paid in Capital in 2019. In 2021 and 2020, the fair value of the options which vested in April of the respective year of $406,250 was recorded as compensation expense and allocated to Paid in Capital. All of the options were vested as of June 30, 2021.

On August 7, 2020 concurrently with the Joint Development Agreement with Petroleum & Independent Exploration, LLC and related entities (“PIE”), the companies entered into a Securities Purchase Agreement (“Securities Agreement”) whereby PIE purchased for $525,000 (a) 3,500,000 shares of Empire common stock, (b) warrants to purchase 2,625,000 shares of Empire common stock at an exercise price of $0.20 per share, (c) warrants to purchase 1,800,000 shares of Empire common stock at an exercise price of $0.25 per share, (d) warrants to purchase 8,136,518 shares of Empire common stock at an exercise price of $0.10 per share, and (e) warrants to purchase up to 11,066,667 shares of Empire common stock at an exercise price of $0.141 per share pursuant to various vesting provisions as detailed in the Securities Agreement. The value allocated to the warrants was the fair value determined using the Black-Scholes option valuation with the following assumptions:  no dividend yield, expected annual volatility of 147%, risk free interest rate of .19% and an expected useful life of 4 years. The fair value of the warrants of $450,848 was allocated to paid in capital (See Note 8). On March 11, 2021 the Company amended the Securities Agreement to remove the vesting provisions for the warrants and PIE exercised the warrants for an aggregate exercise price of $3,349,052 (See Note 8).

During February and March 2021, the Company issued to a group of accredited investors 8,993,858 shares of its common stock and warrants to purchase 8,993,858 shares of its common stock for $.50 per share which expires on December 31, 2022. Proceeds from the sale were $3,147,850. The value allocated to the warrants was the fair value determined using the Black-Scholes option valuation with the following assumptions:  no dividend yield, expected annual volatility of 180%, risk free interest rate of .14% and an expected useful life of 21 months. The fair value of the warrants of $2,350,407 was allocated to Paid in Capital. For the six months ended June 30, 2021, warrants for 1,547,314 shares of common stock have been exercised. 

In connection with the purchase of XTO assets (See Note 7) the Company issued a Senior Secured Convertible Note due December 31, 2021, in the aggregate principal amount $16,250,000 (the “Secured Convertible Note”) to Energy Evolution Fund Ltd, a related party (See Note 11). As partial consideration for the issuance of the Secured Convertible Note, Empire issued to Energy Evolution Ltd (i) 1,500,000 shares of common stock along with (ii) a warrant certificate to purchase up to 3,000,000 shares of common stock at an exercise price of $1.00 per Warrant Share until May 14, 2022. Under the warrant certificate, the exercise price is subject to customary downward adjustments. The value allocated to the common stock, conversion feature, and warrants was $10,125,177.

Additionally, in conjunction with the purchase of XTO assets (See Note 7), the Company entered into $3,243,000 of Unsecured Convertible Notes (the “Unsecured Notes”) with a group of accredited investors. The Unsecured Notes mature on May 9, 2022 with a single payment and bear interest at 5% (See Note 11). The Unsecured Note holders may convert their notes to common stock of the Company at the lesser of $1.25 per share or the price per share offered by the Company if the Company has a future capital raise. At June 30, 2021 $1,500,000 of the Unsecured Notes have been converted into 1,200,000 shares of common stock of the Company. The value allocated to the conversion feature was $544,824. 

14.     RELATED PARTY TRANSACTIONS

The Energy Evolution Master Fund, Ltd. (“Energy Evolution”) is a related party of the Company as it beneficially owns approximately 21.4% of the Company’s outstanding shares of common stock as of June 30, 2021. Additionally, a board member of Energy Evolution is a related party of the Company as he separately beneficially owns approximately 23.58% of the Company’s outstanding shares of common stock as of June 30, 2021. The board member also is a majority owner of Petroleum & Independent Exploration, LLC and related entities (“PIE ”).

In March 2021, the majority owner of PIE, through the exercise of warrants, became a significant shareholder of the Company’s outstanding shares of stock (See Note 12). The Company has a joint development agreement with PIE to perform recompletion or workover on specified mutually agreed upon wells (See Note 8). As of June 30, 2021, the Company has incurred obligations of $462,959 as a part of the joint development agreement (See Note 10).

In connection with the purchase of XTO assets (See Note 7) the Company issued a Senior Secured Convertible Note due December 31, 2021, in the aggregate principal amount $16,250,000 (the “Secured Note”) to Energy Evolution Ltd (See Note 11). As partial consideration for the issuance of the Secured Note, Empire issued to Energy Evolution Ltd (i) 1,500,000 shares of common stock along with (ii) a warrant certificate to purchase up to 3,000,000 shares of common stock at an exercise price of $1.00 per warrant share until May 14, 2022. Under the warrant certificate, the exercise price is subject to customary downward adjustments. As of June 30, 2021 the Company has repaid principal $2,800,000 plus interest of $56,472 on the Secured Note.

Additionally, Energy Evolution Ltd, provided an Unsecured Convertible Note in the principal balance of $1,500,000 (See Note 11). The funds received by the Company in connection with the issuance of the Unsecured Convertible Notes were used to pay a performance bond required in connection with the XTO acquisition. Energy Evolution Ltd. has converted its Unsecured Convertible Note to 1,200,000 shares of the Company’s common stock as of June 30, 2021.

Energy Evolution, Ltd also purchased 600,000 shares of the Company’s common stock in May, 2021 which had been offered as an inducement to purchase the Unsecured Convertible Notes (See Note 10).

Concurrent with the acquisition and financing of the XTO assets (See Note 7), the Company made an investment in Energy Evolution Fund LP, an affiliate of Energy Evolution Ltd, a related party, in the amount of $1,250,000 (See Note 3). The investment was mutually terminated on August 19, 2021 (See Note 17).

15.     SUPPLEMENTAL CASH FLOW INFORMATION

Supplemental Cash Flow Information for the six months ended June 30, 2021 and 2020: