W&T OFFSHORE INC - Quarter Report: 2020 September (Form 10-Q)

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

W&T OFFSHORE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

(Unaudited)

See Notes to Condensed Consolidated Financial Statements

W&T OFFSHORE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands except per share data)

(Unaudited)

See Notes to Condensed Consolidated Financial Statements.

W&T OFFSHORE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ DEFICIT

(In thousands)

(Unaudited)

See Notes to Condensed Consolidated Financial Statements

W&T OFFSHORE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

See Notes to Condensed Consolidated Financial Statements.

W&T OFFSHORE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Operations.  W&T Offshore, Inc. (with subsidiaries referred to herein as “W&T,” “we,” “us,” “our,” or the “Company”) is an independent oil and natural gas producer with substantially all of its operations offshore in the Gulf of Mexico.  The Company is active in the exploration, development and acquisition of oil and natural gas properties. Our interests in fields, leases, structures and equipment are primarily owned by the Company and its 100%-owned subsidiary, W & T Energy VI, LLC, and through our proportionately consolidated interest in Monza Energy LLC (“Monza”), as described in more detail in Note 4.

Interim Financial Statements.  The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim periods and the appropriate rules and regulations of the Securities and Exchange Commission (“SEC”).  Accordingly, the condensed consolidated financial statements do not include all of the information and footnote disclosures required by GAAP for complete financial statements for annual periods.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.

Operating results for interim periods are not necessarily indicative of the results that may be expected for the entire year.  These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.

Use of Estimates.  The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and 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 those estimates.

Recent Events.  The pandemic spread of the disease caused by a new strain of coronavirus (“COVID-19”) and other world events have significantly impacted the price of crude oil and the demand for crude oil beginning in March of 2020.  Additionally, average prices for natural gas liquids (“NGLs”) and natural gas decreased for the nine months ended September 30, 2020 compared to the prior year levels, all of which have impacted revenues for the three and nine months ended September 30, 2020.  While average crude oil prices have partially recovered during  June to September 2020 from recent historical lows in April 2020, the perceived risks and volatility have increased in 2020 to date compared to recent years.  Average natural gas prices for the three months ended September 30, 2020 have remained at levels similar to second quarter of 2020 levels.  The Company has taken measures to reduce operating costs and capital expenditures in response.  Management's assessment is the Company has adequate liquidity to meet the criteria of a going concern as defined under GAAP.  See Note 2, Long-Term Debt and Note 12, Subsequent Events, for additional information.  

Accounting Standard Updates effective January 1, 2020 

Credit Losses - In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-13, Financial Instruments – Credit Losses (Topic 326) (“ASU 2016-13”) and subsequently issued additional guidance on this topic.  The new guidance eliminates the probable recognition threshold and broadens the information to consider past events, current conditions and forecasted information in estimating credit losses. The amendment did not have a material impact on our financial statements and did not affect the opening balance of Retained Deficit.

Derivatives and Hedging - In August 2017, the FASB issued Accounting Standards Update No. 2017-12, Derivatives and Hedging (Topic 815) – Targeted Improvements to Accounting for Hedging Activities (“ASU 2017-12”) and subsequently issued additional guidance on this topic.  The amendments in ASU 2017-12 require an entity to present the earnings effect of the hedging instrument in the same income statement line in which the earnings effect of the hedged item is reported.  This presentation enables users of financial statements to better understand the results and costs of an entity’s hedging program.  Also, relative to current GAAP, this approach simplifies the financial statement reporting for qualifying hedging relationships.  As we do not designate our commodity derivative instruments as qualifying hedging instruments, this amendment did not impact the presentation of the changes in fair values of our commodity derivative instruments on our financial statements.

W&T OFFSHORE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Revenue Recognition.  We recognize revenue from the sale of crude oil, NGLs, and natural gas when our performance obligations are satisfied.  Our contracts with customers are primarily short-term (less than 12 months).  Our responsibilities to deliver a unit of crude oil, NGL, and natural gas under these contracts represent separate, distinct performance obligations.  These performance obligations are satisfied at the point in time control of each unit is transferred to the customer.  Pricing is primarily determined utilizing a particular pricing or market index, plus or minus adjustments reflecting quality or location differentials.

Paycheck Protection Program (“PPP”).  On April 15, 2020, the Company received $8.4 million under the U.S. Small Business Administration (“SBA”) PPP.  We have elected an accounting policy to analogize International Accounting Standards 20, Accounting for Government Grants and Disclosure of Government Assistance (“IAS 20”) and account for the PPP as a government grant.  Under IAS 20, a government grant is recognized when there is reasonable assurance that the Company has complied with the provisions of the grant.

The Company submitted an application to the SBA on August 20, 2020, requesting that the PPP funds received be applied to specific covered payroll and non-payroll costs. As of the date of this filing, we have not received any response from the SBA, including any communication regarding the SBA’s acceptance of our application.  Management believes the Company has met all the requirements under the PPP and will not be required to repay any portion of the grant. 

We have elected to follow the income approach under IAS 20 and recognize earnings as funds are applied to covered expenses and classify the application of funds as a reduction of the related expense in the Condensed Consolidated Statement of Operations.  As a result, we have reduced expenses during the nine months ended September 30, 2020 and classified expense reductions consistent with our PPP fund application request.  Within the Condensed Consolidated Statement of Operations, credits to Lease operating expenses of $2.3 million, General and administrative expenses of $4.2 million and reductions to Interest expense, net, of $1.9 million were recognized for the nine months ended September 30, 2020.  Should the SBA reject the Company's application on the utilization of the funds, the Company may be required to repay all or a portion of the funds received under the PPP under an amortization schedule through April 2022 with an annual interest rate of 1%.

Credit Risk and Allowance for Credit Losses.  Our revenue has been concentrated in certain major oil and gas companies.  For the nine months ended September 30, 2020, and the year ended December 31, 2019, approximately 56% and 63%, respectively, of our revenue was from three major oil and gas companies and a substantial majority of our receivables were from sales with major oil and gas companies.  We also have receivables related to joint interest arrangements primarily with mid-size oil and gas companies with a substantial majority of the net receivable balance concentrated in less than ten companies.  A loss methodology is used to develop the allowance for credit losses on material receivables to estimate the net amount to be collected.  The loss methodology uses historical data, current market conditions and forecasts of future economic conditions.  Our maximum exposure at any time would be the receivable balance.  The receivables, Joint interest and other, net, reported on the Condensed Consolidated Balance Sheets are reduced for the allowance for credit losses.  The roll forward of the allowance for credit losses is as follows (in thousands): 

W&T OFFSHORE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Prepaid Expenses and Other Assets.  The amounts recorded are expected to be realized within one year and the major categories are presented in the following table (in thousands):

Oil and Natural Gas Properties and Other, Net – At Cost.  Oil and natural gas properties and equipment are recorded at cost using the full cost method.  There were no amounts excluded from amortization as of the dates presented in the following table (in thousands):

W&T OFFSHORE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Other Assets (long-term). The major categories are presented in the following table (in thousands):

Accrued Liabilities.  The major categories are presented in the following table (in thousands):

Other Liabilities (long-term).  The major categories are presented in the following table (in thousands):

Black Elk Escrow

                $13.9 million of cash was retained in an escrow account and recorded within Restricted Deposits for Asset Retirement Obligations on the Condensed Consolidated Balance Sheet as of September 30, 2020.  The funds were received by W&T as a restricted deposit to be used exclusively for payment of certain asset retirement obligations related to properties sold by W&T to Black Elk Energy Offshore Operations, LLC (“Black Elk”) in connection with the liquidation of Black Elk under Chapter 11 of the U.S. Bankruptcy Code.  $11.1 million was recorded in Other Liabilities as of September 30, 2020 (included in the above table) as our estimate of the additional asset retirement obligations to be funded from the restricted deposit account. 

W&T OFFSHORE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The components of our long-term debt are presented in the following table (in thousands):

Credit Agreement

On October 18, 2018, we entered into the Sixth Amended and Restated Credit Agreement (as amended, the “Credit Agreement”), which matures on October 18, 2022. 

On June 17, 2020, the lenders under the Credit Agreement completed their semi-annual borrowing base redetermination at $215.0 million and entered into the Third Amendment and Waiver (the “Third Amendment”) to the Credit Agreement.  Although the Company had not violated any covenants, the Third Amendment provides less stringent covenant requirements given the recent changes in the oil and gas markets.  The Third Amendment includes, among other things, the following changes to the Credit Agreement (terms used below are defined in the Credit Agreement,):

W&T OFFSHORE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Availability under the Credit Agreement is subject to semi-annual redeterminations of our borrowing base and the next scheduled redetermination is in the fall of 2020.  Additional redeterminations  may be requested at the discretion of either the lenders or the Company.  The borrowing base is calculated by our lenders based on their evaluation of our proved reserves and their own internal criteria.  Any redetermination by our lenders to change our borrowing base will result in a similar change in the availability under the Credit Agreement. 

The Credit Agreement is collateralized by a first priority lien on properties constituting at least 90% of the total proved reserves of the Company as set forth on reserve reports required to be delivered under the Credit Agreement and certain personal property.  The annualized interest rate on borrowings outstanding for the nine months ended September 30, 2020 was 3.7%, which excludes debt issuance costs, commitment fees and other fees.

Letters of credit may be issued in amounts up to $30.0 million, provided sufficient availability under the Credit Agreement exists.  As of September 30, 2020 and December 31, 2019, we had $4.4 million and $5.8 million, respectively, of letters of credit issued and outstanding under the Credit Agreement.

W&T OFFSHORE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

9.75% Senior Second Lien Notes Due 2023

On October 18, 2018, we issued $625.0 million of 9.75% Senior Second Lien Notes due 2023 (the “Senior Second Lien Notes”), which were issued at par with an interest rate of 9.75% per annum and mature on November 1, 2023, and are governed under the terms of the Indenture of the Senior Second Lien Notes (the “Indenture”).  The estimated annual effective interest rate on the Senior Second Lien Notes is 10.3%, which includes amortization of debt issuance costs.  Interest on the Senior Second Lien Notes is payable in arrears on May 1 and November 1 of each year.

During the nine months ended September 30, 2020, we acquired $72.5 million in principal of our outstanding Senior Second Lien Notes for $23.9 million and recorded a non-cash gain on purchase of debt of $47.5 million, which included a reduction of $1.1 million related to the write-off of unamortized debt issuance costs. 

The Senior Second Lien Notes are secured by a second-priority lien on all of our assets that are secured under the Credit Agreement.  The Senior Second Lien Notes contain covenants that limit or prohibit our ability and the ability of certain of our subsidiaries to: (i) make investments; (ii) incur additional indebtedness or issue certain types of preferred stock; (iii) create certain liens; (iv) sell assets; (v) enter into agreements that restrict dividends or other payments from the Company’s subsidiaries to the Company; (vi) consolidate, merge or transfer all or substantially all of the assets of the Company; (vii) engage in transactions with affiliates; (viii) pay dividends or make other distributions on capital stock or subordinated indebtedness; and (ix) create subsidiaries that would not be restricted by the covenants of the Indenture.  These covenants are subject to exceptions and qualifications set forth in the Indenture.  In addition, most of the above described covenants will terminate if both S&P Global Ratings, a division of S&P Global Inc., and Moody’s Investors Service, Inc. assign the Senior Second Lien Notes an investment grade rating and no default exists with respect to the Senior Second Lien Notes.

Covenants 

As of September 30, 2020 and for all prior measurement periods, we were in compliance with all applicable covenants of the Credit Agreement and the Indenture.

Fair Value Measurements 

For information about fair value measurements of our long-term debt, refer to Note 3.

W&T OFFSHORE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Derivative Financial Instruments

We measure the fair value of our open derivative financial instruments by applying the income approach, using models with inputs that are classified within Level 2 of the valuation hierarchy.  The inputs used for the fair value measurement of our open derivative financial instruments are the exercise price, the expiration date, the settlement date, notional quantities, the implied volatility, the discount curve with spreads and published commodity future prices.  Our open derivative financial instruments are reported in the Condensed Consolidated Balance Sheets using fair value.  See Note 6, Derivative Financial Instruments, for additional information on our derivative financial instruments.

The following table presents the fair value of our open derivative financial instruments (in thousands):

Long-Term Debt

We believe the carrying value of our debt under the Credit Agreement approximates fair value because the interest rates are variable and reflective of current market rates. The fair value of our Senior Second Lien Notes was measured using quoted prices, although the market is not a very active market.  The fair value of our long-term debt was classified as Level 2 within the valuation hierarchy.  See Note 2, Long-Term Debt for additional information on our long-term debt.

The following table presents the carrying value and fair value of our long-term debt (in thousands):

W&T OFFSHORE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

In March 2018, W&T and two other initial members formed and initially funded Monza, which jointly participates with us in the exploration, drilling and development of certain drilling projects (the “Joint Venture Drilling Program”) in the Gulf of Mexico.  Subsequent to the initial closing, additional investors joined as members of Monza during 2018 and total commitments by all members, including W&T's commitment to fund its retained interest in Monza projects held outside of Monza, are $361.4 million.  W&T contributed 88.94% of its working interest in certain identified undeveloped drilling projects to Monza and retained 11.06% of its working interest.  The Joint Venture Drilling Program is structured so that we initially receive an aggregate of 30.0% of the revenues less expenses, through both our direct ownership of our retained working interest in the Monza projects and our indirect interest through our interest in Monza, for contributing 20.0% of the estimated total well costs plus associated leases and providing access to available infrastructure at agreed-upon rates.  Any exceptions to this structure are approved by the Monza board. 

The members of Monza are made up of third-party investors, W&T and an entity owned and controlled by Mr. Tracy W. Krohn, our Chairman and Chief Executive Officer.  The Krohn entity invested as a minority investor on the same terms and conditions as the third-party investors, and its investment is limited to 4.5% of total invested capital within Monza.  The entity affiliated with Mr. Krohn has made a capital commitment to Monza of $14.5 million.

Monza is an entity separate from any other entity with its own separate creditors who will be entitled, upon its liquidation, to be satisfied out of Monza’s assets prior to any value in Monza becoming available to holders of its equity.  The assets of Monza are not available to pay creditors of the Company and its affiliates.

Through September 30, 2020, nine wells have been completed.  As of September 30, 2020, one additional well was drilled to target depth, but not completed as of this date.  W&T is the operator for seven of the nine wells completed through September 30, 2020.  

Through September 30, 2020, members of Monza made partner capital contributions, including our contributions of working interest in the drilling projects, to Monza totaling $289.3 million and received cash distributions totaling $67.7 million.  Our net contribution to Monza, reduced by distributions received, as of September 30, 2020 was $52.5 million.  W&T is obligated to fund certain cost overruns to the extent they occur, subject to certain exceptions, for the Joint Venture Drilling Program wells above budgeted and contingency amounts, of which the total exposure cannot be estimated at this time.

Consolidation and Carrying Amounts

Our interest in Monza is considered to be a variable interest that we account for using proportional consolidation.  Through September 30, 2020, there have been no events or changes that would cause a redetermination of the variable interest status.  We do not fully consolidate Monza because we are not considered the primary beneficiary of Monza.  As of September 30, 2020, in the Condensed Consolidated Balance Sheet, we recorded $11.6 million, net, in Oil and natural gas properties and other, net, $1.6 million in Other assets, $0.2 million in Asset Retirement Obligations ("ARO") and $1.6 million, net, increase in working capital in connection with our proportional interest in Monza’s assets and liabilities.  As of December 31, 2019, in the Condensed Consolidated Balance Sheet, we recorded $16.1 million, net, in Oil and natural gas properties and other, net, $5.3 million in Other assets, $0.1 million in ARO and $2.7 million, net, increase in working capital in connection with our proportional interest in Monza’s assets and liabilities.  Additionally, during the nine months ended September 30, 2020 and during the year ended December 31, 2019, we called on Monza to provide cash to fund its portion of certain Joint Venture Drilling Program projects in advance of capital expenditure spending, and the unused balances as of September 30, 2020 and December 31, 2019 were $7.7 million and $5.3 million, respectively, which are included in the Condensed Consolidated Balance Sheet in Advances from joint interest partners.  For the nine months ended September 30, 2020, in the Condensed Consolidated Statement of Operations, we recorded $6.7 million in Total revenues and $8.9 million in Operating costs and expenses in connection with our proportional interest in Monza’s operations.  For the nine months ended September 30, 2019, in the Condensed Consolidated Statement of Operations, we recorded $7.4 million in Total revenues and, $4.6 million in Operating costs and expenses in connection with our proportional interest in Monza’s operations.

W&T OFFSHORE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Our ARO represent the estimated present value of the amount incurred to plug, abandon and remediate our properties at the end of their productive lives.

A summary of the changes to our ARO is as follows (in thousands):

Our market risk exposure relates primarily to commodity prices and, from time to time, we use various derivative instruments to manage our exposure to this commodity price risk from sales of our crude oil and natural gas.  All of the present derivative counterparties are also lenders or affiliates of lenders participating in our Credit Agreement.  We are exposed to credit loss in the event of nonperformance by the derivative counterparties; however, we currently anticipate that each of our derivative counterparties will be able to fulfill their contractual obligations.  We are not required to provide additional collateral to the derivative counterparties and we do not require collateral from our derivative counterparties.

We have elected not to designate our commodity derivative contracts as hedging instruments; therefore, all current period changes in the fair value of derivative contracts are recognized in earnings during the periods presented.  The cash flows of all of our commodity derivative contracts are included in Net cash provided by operating activities on the Condensed Consolidated Statements of Cash Flows.

We entered into commodity contracts for crude oil and natural gas which related to a portion of our expected future production.  The crude oil contracts are based on West Texas Intermediate (“WTI”) crude oil prices and the natural gas contracts are based off the Henry Hub prices, both of which are quoted off the New York Mercantile Exchange (“NYMEX”).  The open contracts as of September 30, 2020 are presented in the following tables:

W&T OFFSHORE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

W&T OFFSHORE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The following amounts were recorded in the Condensed Consolidated Balance Sheets in the categories presented and include the fair value of open contracts, and closed contracts which had not yet settled (in thousands):

The amounts recorded on the Condensed Consolidated Balance Sheets are on a gross basis.  If these were recorded on a net settlement basis, it would not have resulted in any material differences in reported amounts.

Changes in the fair value and settlements of our commodity derivative contracts were as follows (in thousands):

Cash receipts on commodity derivative contract settlements, net, are included within Net cash provided by operating activities on the Condensed Consolidated Statements of Cash Flows and were as follows (in thousands):

W&T OFFSHORE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Our contract arrangements accounted for under the applicable GAAP for lease contracts consist of office leases, a land lease and various pipeline right-of-way contracts.  For these contracts, a right-of-use ("ROU") asset and lease liability was established based on our assumptions of the term, inflation rates and incremental borrowing rates.  All of these lease contracts are operating leases.

During the nine months ended September 30, 2020, we terminated the existing office lease and executed a new lease on separate office space.  The remaining term of the current office lease extends to December 2020.  The term of the new office lease extends to February 2032.  When calculating the ROU asset and lease liability at the commencement of the new office lease, we have reduced future cash outflows by the lease incentive to be received.

The term of each pipeline right-of-way contract is 10 years with various effective dates, and each has an option to renew for up to another ten years.  It is expected renewals beyond 10 years can be obtained as renewals were granted to the previous lessees.  The land lease has an option to renew every five years extending to 2085.  The expected term of the rights-of way and land leases was estimated to approximate the life of the related reserves.   

We recorded ROU assets and lease liabilities using a discount rate of 9.75% for the office leases and 10.75% for the other leases due to their longer expected term. 

Amounts related to leases recorded within our Condensed Consolidated Balance Sheet are as follows (in thousands):

W&T OFFSHORE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Awards to Employees. In 2010, the W&T Offshore, Inc. Amended and Restated Incentive Compensation Plan (as amended from time to time, the “Plan”) was approved by our shareholders.  During 2019, 2018 and 2017, the Company granted restricted stock units (“RSUs”) under the Plan to certain of its employees.  RSUs are a long-term compensation component, and are subject to satisfaction of certain predetermined performance criteria and adjustments at the end of the applicable performance period based on the results achieved.  In addition to share-based awards, the Company may grant to its employees cash-based incentive awards under the Plan, which may be used as short-term and long-term compensation components of the awards, and are subject to satisfaction of certain predetermined performance criteria.

As of September 30, 2020, there were 10,874,043 shares of common stock available for issuance in satisfaction of awards under the Plan.  The shares available for issuance are reduced on a one-for-one basis when RSUs are settled in shares of common stock, which shares of common stock are issued net of withholding tax through the withholding of shares.  The Company has the option following vesting to settle RSUs in stock or cash, or a combination of stock and cash. The Company expects to settle RSUs that vest in the future using shares of common stock.

RSUs currently outstanding relate to the 2019 and 2018 grants.  The 2019 and 2018 grants were subject to predetermined performance criteria applied against the applicable performance period.  All the RSUs currently outstanding are subject to employment-based criteria and vesting generally occurs in December of the second year after the grant.  See the table below for anticipated vesting by year.

We recognize compensation cost for share-based payments to employees over the period during which the recipient is required to provide service in exchange for the award.  Compensation cost is based on the fair value of the equity instrument on the date of grant.  The fair values for the RSUs granted during 2019, 2018 and 2017 were determined using the Company’s closing price on the grant date.  We also estimate forfeitures, resulting in the recognition of compensation cost only for those awards that are expected to actually vest.

All RSUs awarded are subject to forfeiture until vested and cannot be sold, transferred or otherwise disposed of during the restricted period.

A summary of activity related to RSUs during the nine months ended September 30, 2020 is as follows:

For the outstanding RSUs issued to the eligible employees as of September 30, 2020, vesting is expected to occur as follows (subject to forfeitures): 

W&T OFFSHORE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Awards to Non-Employee Directors.  Under the W&T Offshore, Inc. 2004 Directors Compensation Plan (as amended from time to time, the “Director Compensation Plan”), shares of restricted stock (“Restricted Shares”) have been granted to the Company’s non-employee directors.  Grants to non-employee directors were made during 2020, 2019, 2018 and 2017.  During the second quarter of 2020, our shareholders approved increasing the shares available by 500,000 shares.  As of September 30, 2020, there were 473,244 shares of common stock available for issuance in satisfaction of awards under the Director Compensation Plan.  The shares available are reduced on a one-to-one basis when Restricted Shares are granted.

We recognize compensation cost for share-based payments to non-employee directors over the period during which the recipient is required to provide service in exchange for the award.  Compensation cost is based on the fair value of the equity instrument on the date of grant.  The fair values for the Restricted Shares granted were determined using the Company’s closing price on the grant date.  No forfeitures were estimated for the non-employee directors’ awards.

The Restricted Shares are subject to service conditions and vesting occurs at the end of specified service periods unless otherwise approved by the Board of Directors.  Restricted Shares cannot be sold, transferred or disposed of during the restricted period.  The holders of Restricted Shares generally have the same rights as a shareholder of the Company with respect to such Restricted Shares, including the right to vote and receive dividends or other distributions paid with respect to the Restricted Shares.

A summary of activity related to Restricted Shares during the nine months ended September 30, 2020 is as follows:

For the outstanding Restricted Shares issued to the non-employee directors as of September 30, 2020, vesting is expected to occur as follows (subject to any forfeitures):

Share-Based Compensation.  Share-based compensation expense is recorded in the line General and administrative expenses in the Condensed Consolidated Statements of Operations.  No share-based awards have been granted to date in 2020 under the Plan, and therefore, no share-based compensation expense for 2020 has been recorded.  The Compensation Committee has deferred its decision regarding the potential awarding of incentive compensation, including by the exercise of discretion.  The tax benefit related to compensation expense recognized under share-based payment arrangements was not meaningful and was minimal due to our income tax situation.  A summary of incentive compensation expense under share-based payment arrangements is as follows (in thousands):

W&T OFFSHORE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Unrecognized Share-Based Compensation.  As of September 30, 2020, unrecognized share-based compensation expense related to our awards of RSUs and Restricted Shares was $1.9 million and $0.4 million, respectively.  Unrecognized share-based compensation expense will be recognized through November 2021 for RSUs and April 2022 for Restricted Shares.

Cash-Based Incentive Compensation.  In addition to share-based compensation, short-term, cash-based incentive awards were granted under the Plan to substantially all eligible employees in 2019 and 2018.  The short-term, cash-based incentive awards, which are generally a short-term component of the Plan, are performance-based awards consisting of one or more business criteria or individual performance criteria and a targeted level or levels of performance with respect to each of such criteria.  In addition, these cash-based incentive awards included an additional financial condition requiring Adjusted EBITDA less reported Interest Expense Incurred (terms as defined in the awards) for any fiscal quarter plus the three preceding quarters to exceed defined levels measured over defined time periods for each cash-based incentive award.  No cash-based incentive awards have been granted to date in 2020 under the Plan, and therefore, no cash-based incentive award compensation expense for 2020 has been recorded. The Compensation Committee has deferred its decision regarding the potential awarding of incentive compensation, including by the exercise of discretion.  During 2018, long-term, cash-based incentive awards were granted to certain employees subject to pre-defined performance criteria.  Expense is recognized over the service period once the business criteria, individual performance criteria and financial condition are met. 

A summary of compensation expense related to share-based awards and cash-based awards is as follows (in thousands):

W&T OFFSHORE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Tax Benefit and Tax Rate.  Income tax benefit for the three months and nine months ended September 30, 2020, was $21.1 million and $23.3 million, respectively.  Income tax benefit for the three and nine months ended September 30, 2019, was $55.5 million and $67.0 million, respectively.  For the three and nine months ended September 30, 2020, our effective tax rate primarily differed from the statutory Federal tax rate for adjustments recorded related to the enactment of the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) on March 27, 2020 and the issuance by the United States Treasury Department (Treasury) of final and proposed regulations under Internal Revenue Code (“IRC”) Section 163(j) on July 28, 2020 that provided additional guidance and clarification related to the business interest expense limitation.  Included in the income tax benefit for the three and nine months ended September 30, 2020 is $19.0 million and $27.5 million, respectively, related to changes in our interest expense limitation due to the enactment of the CARES Act and final and proposed regulations under IRC Section 163(j).  During the three months ended September 30, 2019, we released a portion of the valuation allowance on our net deferred tax assets based on the Company’s quarterly assessment of the realizability of net deferred tax assets, resulting in an income tax benefit of $55.8 million.  During the nine months ended September 30, 2019, we reversed a liability related to an uncertain tax position that was effectively settled with the Internal Revenue Service ("IRS"), resulting in an income tax benefit of $11.5 million.  Our effective tax rate was not meaningful for any of the periods presented.  

Valuation Allowance.  Deferred tax assets are recorded related to net operating losses and temporary differences between the book and tax basis of assets and liabilities expected to produce tax deductions in future periods.  The realization of these assets depends on recognition of sufficient future taxable income in specific tax jurisdictions in which those temporary differences or net operating losses are deductible.  In assessing the need for a valuation allowance on our deferred tax assets, we consider whether it is more likely than not that some portion or all of them will not be realized.     

As of September 30, 2020 and December 31, 2019, our valuation allowance was $24.7 million and $54.4 million, respectively, and relates primarily to state net operating losses and the disallowed interest limitation carryover.

Calculation of Interim Provision for Income Tax.  Historically, we have calculated the provision for income taxes during interim reporting periods by applying an estimate of the annual effective tax rate for the full year to income (loss) for the interim period.  In the third quarter of 2020, we concluded that we could not calculate a reliable estimate of our annual effective tax rate due to the range of potential impacts the global COVID-19 pandemic may have on our business and results of operations.  Accordingly, we computed the effective tax rate for the nine-month period ending September 30, 2020 using actual results.

Income Taxes Receivable, Refunds and Payments.  As of December 31, 2019, we had current income taxes receivable of $1.9 million, which was received during the nine months ended September 30, 2020.  The refund related primarily to a net operating loss (“NOL”) carryback claim for 2017 that was carried back to prior years.  During the nine months ended September 30, 2020, we did not make any income tax payments of significance.  During the three and nine months ended September 30, 2019, we received $16.9 million in income tax refunds.  During the same periods, we recorded interest income of $0.5 million and $4.5 million related to these income tax claims, respectively.  During the nine months ended  September 30, 2019, we did not make any income tax payments of significance.

The tax years 2017 through 2019 remain open to examination by the tax jurisdictions to which we are subject.

W&T OFFSHORE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The following table presents the calculation of basic and diluted (loss) earnings per common share (in thousands, except per share amounts): 

Appeal with the Office of Natural Resources Revenue (“ONRR”).  In 2009, we recognized allowable reductions of cash payments for royalties owed to the ONRR for transportation of their deepwater production through our subsea pipeline systems.  In 2010, the ONRR audited our calculations and support related to this usage fee, and in 2010, we were notified that the ONRR had disallowed approximately $4.7 million of the reductions taken.  We recorded a reduction to other revenue in 2010 to reflect this disallowance with the offset to a liability reserve; however, we disagree with the position taken by the ONRR.  We filed an appeal with the ONRR, which ultimately led to our posting a bond in the amount of $7.2 million and cash collateral of $6.9 million with the surety in order to appeal the IBLA decision, of which the cash collateral held by the surety was subsequently returned during the first quarter of 2020.  We have continued to pursue our legal rights and, at present, the case is in front of the U.S. District Court for the Eastern District of Louisiana where parties have now filed their Motions for Summary Judgment, and the opposition and reply briefs will be completed by February 2, 2021.

Royalties – “Unbundling” Initiative.  The ONRR has publicly announced an “unbundling” initiative to revise the methodology employed by producers in determining the appropriate allowances for transportation and processing costs that are permitted to be deducted in determining royalties under Federal oil and gas leases.  The ONRR’s initiative requires re-computing allowable transportation and processing costs using revised guidance from the ONRR going back 84 months for every gas processing plant that processed our gas. In the second quarter of 2015, pursuant to the initiative, we received requests from the ONRR for additional data regarding our transportation and processing allowances on natural gas production related to a specific processing plant. We also received a preliminary determination notice from the ONRR asserting that our allocation of certain processing costs and plant fuel use at another processing plant was not allowed as deductions in the determination of royalties owed under Federal oil and gas leases. We have submitted revised calculations covering certain plants and time periods to the ONRR. As of the filing date of this Form 10-Q, we have not received a response from the ONRR related to our submissions.  These open ONRR unbundling reviews, and any further similar reviews, could ultimately result in an order for payment of additional royalties under our Federal oil and gas leases for current and prior periods.  While the amounts paid for the nine months ended September 30, 2020 and 2019 were immaterial, we are not able to determine the range of any additional royalties or, if and when assessed, whether such amounts would be material.

W&T OFFSHORE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Notices of Proposed Civil Penalty Assessment.  During the nine months ended September 30, 2020 and 2019, we did not pay any civil penalties to the Bureau of Safety and Environmental Enforcement ("BSEE") related to Incidents of Noncompliance (“INCs”) at various offshore locations.  We currently have nine open civil penalties issued by the BSEE from INCs, which have not been settled as of the filing date of this Form 10-Q.  The INCs underlying these open civil penalties cite alleged non-compliance with various safety-related requirements and procedures occurring at separate offshore locations on various dates ranging from July 2012 to January 2018.  The proposed civil penalties for these INCs total $7.7 million.  As of September 30, 2020 and December 31, 2019, we have accrued approximately $3.5 million, which is our best estimate of the final settlements once all appeals have been exhausted.  Our position is that the proposed civil penalties are excessive given the specific facts and circumstances related to these INCs.  We are exploring the possibility of settling these civil penalties with the BSEE.

Other Claims.  We are a party to various pending or threatened claims and complaints seeking damages or other remedies concerning our commercial operations and other matters in the ordinary course of our business.  In addition, claims or contingencies may arise related to matters occurring prior to our acquisition of properties or related to matters occurring subsequent to our sale of properties.  In certain cases, we have indemnified the sellers of properties we have acquired, and in other cases, we have indemnified the buyers of properties we have sold.  We are also subject to federal and state administrative proceedings conducted in the ordinary course of business including matters related to alleged royalty underpayments on certain federal-owned properties.  Although we can give no assurance about the outcome of pending legal and federal or state administrative proceedings and the effect such an outcome may have on us, we believe that any ultimate liability resulting from the outcome of such proceedings, to the extent not otherwise provided for or covered by insurance, will not have a material adverse effect on our consolidated financial position, results of operations or liquidity.

COVID-19 Impacts on Economic Environment.  Subsequent to September 30, 2020, COVID-19 outbreaks levels have continued and, in some cases, increased in some areas of the United States.  The impacts of the COVID-19 pandemic on the economy combined with actions of certain foreign governments of oil producing countries have caused s significant decrease in global crude oil demand contributing to a substantial decrease in crude oil prices compared to the prior year and an increase in the volatility of the crude oil market.  Additionally, prices for NGLs and natural gas have been impacted, but to a lesser degree.  This economic environment has caused oil and gas operators to reduce their capital expenditure budgets, reduce activity and shut-in significant production.  The full impact of the COVID-19 pandemic and the volatility in crude oil prices continue to evolve as of the date of this Quarterly Report.  However, the scope and length of this economic downturn and the effect on future prices and demand of crude oil, NGLs and natural gas cannot be determined and we could be adversely affected in future periods.

In response to the market changes, we reduced our capital expenditure budget in 2020, experienced production shut-ins from non-operated oil and gas properties and shut-in a limited number of our operated oil and gas properties.  We are actively monitoring the impact on our results of operations, financial position, and liquidity and may need to make further changes in response to the market for oil, NGLs and natural gas.

Hurricanes Impact on our Production.  In the second and third quarters of 2020, the Gulf of Mexico experienced multiple hurricanes that required us to shut-in wells due to their impact.  In October 2020, we experienced additional hurricane activity which required shutting in most of our fields for several days.  We have since returned substantially all wells to production that were shut-in due to the hurricanes, as have operators of properties in which we have a non-operator interest.  One of our fields had planned downtime which was extended due to hurricane activity and had not returned to production as of the end of October 2020.  While no major structural damage was incurred, which has been assessed through October, increased costs for repairs are expected in the fourth quarter of 2020. 

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

Forward-Looking Statements

The following discussion and analysis should be read in conjunction with our accompanying unaudited condensed consolidated financial statements and the notes to those financial statements included in Item 1 of this Quarterly Report on Form 10-Q.  The following discussion contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”).  These forward-looking statements involve risks, uncertainties and assumptions. If the risks or uncertainties materialize or the assumptions prove incorrect, our results may differ materially from those expressed or implied by such forward-looking statements and assumptions.  All statements other than statements of historical fact are statements that could be deemed forward-looking statements, such as those statements that address activities, events or developments that we expect, believe or anticipate will or may occur in the future.  These statements are based on certain assumptions and analyses made by us in light of our experience and perception of historical trends, current conditions, expected future developments and other factors we believe are appropriate in the circumstances.  Known material risks that may affect our financial condition and results of operations are discussed in Item 1A, Risk Factors, and market risks are discussed in Item 7A, Quantitative and Qualitative Disclosures About Market Risk, of our Annual Report on Form 10-K for the year ended December 31, 2019 and this Quarterly Report on Form 10-Q, Part II, Item 1A, Risk Factors, and may be discussed or updated from time to time in subsequent reports filed with the Securities and Exchange Commission. Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date hereof.  We assume no obligation, nor do we intend to update these forward-looking statements.  Unless the context requires otherwise, references in this Quarterly Report on Form 10-Q to “W&T,” “we,” “us,” “our” and the “Company” refer to W&T Offshore, Inc. and its consolidated subsidiaries.

Overview 

We are an independent oil and natural gas producer, active in the exploration, development and acquisition of oil and natural gas properties in the Gulf of Mexico.  As of September 2020, we hold working interests in 50 offshore fields in federal and state waters (41 producing and nine fields capable of producing).  We currently have under lease approximately 772,000 gross acres (523,000 net acres) spanning across the OCS off the coasts of Louisiana, Texas, Mississippi and Alabama, with approximately 557,000 gross acres on the conventional shelf and approximately 215,000 gross acres in the deepwater.  A majority of our daily production is derived from wells we operate.  Our interest in fields, leases, structures and equipment are primarily owned by W&T Offshore, Inc. and our wholly-owned subsidiary, W & T Energy VI, LLC, a Delaware limited liability company and through our proportionately consolidated interest in Monza, as described in more detail in Financial Statements and Supplementary Data – Note 4 – Joint Venture Drilling Program under Part I, Item 1 in this Form 10-Q.

Recent Events

Due to circumstances related to the outbreak of COVID-19, various measures have been taken by federal, state and local governments to reduce the rate of spread of COVID-19.  These measures and other factors have resulted in a decrease of general economic activity and a corresponding decrease in global and domestic energy demand impacting commodity pricing.  In addition, actions by the Organization of Petroleum Exporting Countries and other high oil exporting countries like Russia (“OPEC+”) have negatively impacted crude oil prices.  These rapid and unprecedented events have pushed crude oil storage near capacity and drove prices down significantly in the second quarter of 2020.  These events have been the primary cause of the significant supply-and-demand imbalance for oil, significantly lowering oil pricing in 2020 compared to the prior year.  Through October 2020, COVID-19 outbreak levels have continued and, in some cases, increased in some areas of the United States.  Should these conditions continue in future periods, they could constrain our ability to store and move production to downstream markets, delay or curtail development activity or temporarily shut-in production, any or all of which could further reduce our cash flow.

In the second and third quarters of 2020, the Gulf of Mexico experienced multiple hurricanes that required us to shut-in wells due to their impact.  In October 2020, we experienced additional hurricane activity which required shutting in most of our fields for several days. We have since returned substantially all wells to production that were shut-in due to the hurricanes, as have operators of properties in which we have a non-operator interest.  One of our fields had planned downtime which was extended due to hurricane activity and had not returned to production as of the end of October 2020.  While no major structural damage was incurred, which has been assessed through October, increased costs for repairs estimated at $5 million are expected in the fourth quarter of 2020.  

During the fourth quarter of 2020, we will begin the consolidation of our two gas processing plants in Alabama.  We estimate future cost savings of approximately $5 million per year related to the plant consolidation efforts.

The Company has responded to COVID-19 events and current economic conditions as follows:

See the Liquidity and Capital Resources section in this Part II for a discussion of our liquidity and other aspects as a result of the decrease in commodity prices.   See Item 1A, Risk Factors, under Item II of this Form 10-Q. 

Oil and Natural Gas Production and Commodity Pricing

Our financial condition, cash flow and results of operations are significantly affected by the volume of our crude oil, NGLs and natural gas production and the prices that we receive for such production.  Our production volumes for the nine months ended September 30, 2020 were comprised of 36.7% crude oil and condensate, 11.1% NGLs and 52.2% natural gas, determined on a barrel of oil equivalent (“Boe”) using the energy equivalency ratio of six thousand cubic feet (“Mcf”) of natural gas to one barrel of crude oil, condensate or NGLs.  The conversion ratio does not assume price equivalency, and the price per one Boe for crude oil, NGLs and natural gas has differed significantly in the past.  For the nine months ended September 30, 2020, revenues from the sale of crude oil and NGLs made up 69.4% of our total revenues compared to 82.0% for the nine months ended September 30, 2019.  For the nine months ended September 30, 2020, our combined total production expressed in equivalent volumes on a daily basis was 18.5% higher than for the nine months ended September 30, 2019, primarily due to the acquisition of the Mobile Bay properties described below.  For the nine months ended September 30, 2020, our total revenues were 34.2% lower than the nine months ended September 30, 2019 due to lower realized prices for crude oil, NGLs and natural gas and partially offset by higher volumes.  See Results of Operations – Nine Months Ended September 30, 2020 Compared to the Nine Months Ended September 30, 2019 in this Item 2 for additional information. 

In August 2019, we completed the purchase of Exxon Mobil Corporation's (“Exxon”) interests in and operatorship of oil and gas producing properties in the eastern region of the Gulf of Mexico offshore Alabama and related onshore and offshore facilities and pipelines (the “Mobile Bay Properties”).  For the nine months ended September 30, 2020, the average net production of the Mobile Bay Properties was approximately 15,800 net Boe per day.  

According to Baker Hughes, the number of working rigs drilling for oil and natural gas on land in the U.S. as reported in their October 16, 2020 report was significantly lower than a year ago, decreasing to 282 rigs compared to 851 rigs a year ago.  The oil rig count decreased to 205 rigs compared to 713 rigs a year ago and the gas and miscellaneous rigs decreased to 77 rigs from 138 a year ago.  In the Gulf of Mexico, the number of working rigs was 14 rigs (all oil) compared to 21 (20 oil and one natural gas) a year ago.   

Results of Operations

The following tables set forth selected financial and operating data for the periods indicated (all values are net to our interest unless indicated otherwise):

NM – not meaningful