Abraxas Petroleum Corporation

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Abraxas Petroleum Corporation

500 North Loop 1604 East, Suite 100
San Antonio, Texas 78232-1239
U.S.A.
Telephone: (210) 490-4788
Fax: (210) 490-8816
Web site: http://www.abraxaspetroleum.com

Public Company Incorporated: 1990
Employees: 48
Sales: $51.7 million (2006)
Stock Exchanges: American
Ticker Symbol: ABP
NAIC: 211111 Crude Petroleum and Natural Gas Extraction

PARTNERSHIP CONSOLIDATION FORMING CORPORATION

ABRAXAS EXPANDING THROUGH DEBT LEVERAGE

HIGH LEVERAGE PROMPTING RISKY DECISION TO SIDESTEP BANKRUPTCY

INCREASING CAPITAL EXPENDITURE FOR RESOURCE DEVELOPMENT

FORMATION OF MASTER PARTNERSHIP TO ELIMINATE DEBT

PRINCIPAL SUBSIDIARIES

PRINCIPAL COMPETITORS

PARTNERSHIP CONSOLIDATION FORMING CORPORATION

Abraxas Petroleum was formed through the consolidation of 23 oil and gas development partnerships. Though Abraxas had been in business since 1977, until 1991 the general partnership, the original Abraxas Petroleum corporation, and the 22 other partnerships operated independently. Neither Abraxas nor the partnerships showed a profit between 1984 and 1989, so Robert Watson, company president since 1977, and the board of directors sought to secure profitability through the operating and administrative efficiencies of a consolidated organization. At the end of 1989, operations resulted in aggregate revenues of $1.8 million and a net loss of $1.2 million. A combined entity would hold energy reserves valued at more than $11 million. With 177 producing oil wells, located in Texas, Kansas, and the Rocky Mountain region, Abraxas owned aggregate proved developed reserves of 402,400 barrels of oil and natural gas liquids and 2.61 million cubic feet (Mcf) of natural gas and proved undeveloped reserves of 40,600 barrels of oil and less than 100,000 cubic feet of gas. However, these numbers reflected a decline in proved reserves due to resource extraction. Through the efficiencies of a consolidation, Abraxas sought to become more effective in developing oil and gas prospects. Moreover, combined assets, which included interests in a bituminous coal mine in western Colorado, gave Abraxas leverage for capital investment.

In 1990 Abraxas consolidated the assets and liabilities of the original company, 18 of the 22 limited partnerships in Texas and Pennsylvania, and another general partnership in Pennsylvania into one Nevada-incorporated organization. In concert with the merger, the new corporation, retaining the Abraxas Petroleum name, became a public entity with access to capital for oil and gas exploration and production through a listing on the NASDAQ. Initial exchange of assets for consolidation occurred through a stock offering to partnership owners, valued at $8 per share for a total of $11.9 million. Abraxas exchanged common stock for the working assets of all the partnerships. Abraxas maintained 50.4 percent ownership in the outstanding common stock and 100 percent of the preferred stock, giving the company’s board and officers, including company President Robert Watson, a controlling interest in the new entity. The company expected a secondary offering in the future to provide funds for expansion.

After completion of the consolidation and initial offering of stock in early 1991, Abraxas pursued growth opportunities in resource development and exploitation, including recompletion of exploratory wells, workover of abandoned wells, and secondary recovery. In December Abraxas acquired interests in 29 oil and gas wells from Nuevo Energy for $2.28 million in cash. The wells, located on the Gulf of Mexico in Texas and in Alabama, provided Abraxas with significant revenue-generating reserves. In July 1992 Abraxas acquired Bennett Petroleum Corporation, including a 12.2 percent interest in the Happy Field Spraberry Lime Unit, in Garza County, Texas, where Abraxas implemented waterflood injection for secondary oil recovery. At four smaller acquisitions in the Permian Basin in 1992, Abraxas installed waterflood injection equipment.

In 1993, the company acquired from Mobil Corporation several oil and gas properties located primarily along the central Gulf Coast of Texas. These included a 50 percent interest in the Portilla field, 25 percent at Stedman Island, and 30 percent at East White Point. Abraxas funded the $41 million acquisition with $16.5 million from a new credit facility, $3.5 million in cash, and $21 million from a pension trust fund that would receive revenue from the properties. In addition to more than doubling Abraxas oil and gas production, the properties provided ample development opportunities through fracture stimulation of the base formation to gain access to the reservoirs.

After improving reserves and production capacity, completing consolidation of four additional partnerships, and selling the coal mine subsidiaries, Abraxas prepared for a secondary offering of stock. In October the company offered 2.25 million shares of stock at $11.25 per share. The company applied the $23 million in proceeds to pay long-term debt and to fund acquisitions and well development. By the end of 1993, Abraxas operated 267 producing wells and owned interests in another 266 wells. The company reported average daily production of 847 barrels of oil and natural gas liquids and 2.6 Mcf of natural gas. The company’s net proved reserves reached three million barrels of oil and 16.6 Bcf of natural gas. Abraxas estimated the value of the proved reserves at $41.1 million. Revenues rose to $7.5 million. However, the company operated at a loss, at $1.9 million, exclusive of an extraordinary write-down of $2.6 million related to the sale of the Colorado coal mine.

COMPANY PERSPECTIVES

Abraxas’ business strategy is focused on increasing shareholder value while maintaining financial flexibility and liquidity. Abraxas believes growth is best achieved through the drill-bit.

ABRAXAS EXPANDING THROUGH DEBT LEVERAGE

Abraxas continued its expansion program with acquisitions in Texas, Wyoming, and Canada. In July 1994, the company acquired significant producing properties in the Permian Basin in west Texas for $28 million. Activities in Wyoming involved the acquisition of additional interests in producing wells and undeveloped acreage in the Wamsutter area of southwestern Wyoming. With 19,587 gross (14,091 net) acreage, Wamsutter provided Abraxas with significant well development opportunities, particularly the Siberian Ridge field. In January 1996, Abraxas ventured into oil and gas development in Canada, beginning with a $3 million investment in Grey Wolf Exploration. In turn, Grey Wolf invested the funds in Cascade Oil & Gas Ltd., an Alberta subsidiary in southeastern Saskatchewan. Grey Wolf operated Cascade for Canaxas, the ownership subsidiary whose 78 percent interest in Grey Wolf resulted in a 54 percent interest in Cascade. Properties included 154,968 gross acres and 120 gross wells. The October 1996 acquisition of Canadian Gas Gathering Systems (CGGS) for $85 million included 11 natural gas gathering plants and related producing properties.

To fund acquisitions and other capital expenditures and to pay debt, in November 1996, Abraxas completed a private placement of Senior Secured Notes valued at $215 million. Abraxas applied the proceeds to pay the credit facility used for the acquisitions in Canada, Wyoming, and Texas, and the company increased its interests in producing properties on the Texas Gulf Coast. Canaxas acquired undeveloped properties in central Alberta in September 1997. Other capital expenditures involved new well development through fracture stimulation and deep horizontal drilling at three locations in the Edwards limestone formation in south Texas, an 11 well program expected to yield significant natural gas reserves. In October 1997 Abraxas discovered ample natural gas reserves on its Muy Bueno prospect in south Texas.

In January 1998 Abraxas extended its issue of senior notes for an additional $60 million, bringing the total debt to $275 million. By late 1998, however, low prices for natural gas hindered Abraxas’ ability to pursue resource development and service the high level of debt. Already operating at a loss, in 1998 the company lost $84 million on revenues of $60.1 million. To offset the losses and pay debt, Abraxas divested fully developed or noncore assets located in Wyoming, New Mexico, Oklahoma, and Texas. Nevertheless, Abraxas continued to seek growth through new development opportunities. In January 1999 Canaxas acquired a 98.8 percent interest in New Cache Petroleum Ltd., for $60 million plus the assumption of $24 million in debt.

The volatility of gas prices led Abraxas to shift its strategy to emphasize exploration and development, rather than exploitation. As one of the low cost producers among companies of its size, Abraxas succeeded at low risk development and reserve replacement, so once a property was fully developed, the company could liquidate, releasing assets for replacement value properties. For instance, sale of the Wamsutter interest yielded a 30 percent rate of return on investment. Applying fracture stimulation and deep horizontal well development at the Edwards formation, Abraxas found and developed 50 Bcfe in reserves at a low cost of $0.35 per Mcf. Despite these strengths, the company’s high level of debt hindered profitability, pushing the company to the brink of bankruptcy.

HIGH LEVERAGE PROMPTING RISKY DECISION TO SIDESTEP BANKRUPTCY

High leverage resulted in a continuing struggle to meet interest expense, hindering cash flow for capital investment and perpetuating losses. The company’s stock declined to $1 per share, leading the NASDAQ to delist the company in June 1999 for its inability to meet the minimum $5 per share. Facing bankruptcy in late 1999, Watson and the board chose to issue 16.1 million shares of common stock and contingent value rights (CVR) for an additional 16.1 million shares, receiving $82 million in proceeds to pay long-term debt. CVRs were issued under an agreement that if the share value increased from $1 to $5.97, and remained at that rate for 30 of the 45 days up to the December 31, 2000, deadline, the bondholders could recoup their investment by cashing in their stock. However, stagnant share valuation would require Abraxas to issue 104 million shares, though it had only 22 million shares outstanding. Hence, majority ownership of Abraxas could shift to the bondholders. Low prices for natural gas, at $2.50 per thousand cubic feet in late 1999, added to the company’s financial troubles, but by late 2000, contracts at the low rates expired and Abraxas’ natural gas revenues increased to $7.25 per thousand cubic feet. Abraxas stock rose to $4.50 per share, reducing the potential stock outlay, but not enough to prevent serious dilution of stock ownership. Abraxas renegotiated the CVR agreement, to extend the deadline to May 21, 2001; failure to meet this requirement, however, led Abraxas to issue a second lien due in 2004.

KEY DATES

1990:: Consolidation of partnerships prepares Abraxas for expansion.
1993:: Acquisitions increase proved resources to 6.9 million barrels of oil equivalent.
1996:: Senior notes valued at $275 million fund several property acquisitions.
1999:: NASDAQ delisting and CVR (contingent value rights) exchange offer prevents bankruptcy.
2002:: Continuing losses prompt Abraxas to divest assets and reduce debt.
2005:: Abraxas spins off Canadian operations and focuses on domestic resource development and production.
2007:: Master partnership is formed with intention to spin off producing assets in Texas.

Meanwhile, Abraxas continued to pursue development opportunities in Texas, Wyoming, and Canada. During 2000, Abraxas developed 11 wells in Texas, all of them productive, while horizontal drilling resulted in one productive well in Wyoming. Abraxas met with a 63 percent success rate at 16 wells begun in Canada. In September 2000 Grey Wolf Exploration exchanged properties near Alberta for long-life natural gas producing properties and undeveloped land with high potential. Through a stock transaction in October 2001, Abraxas acquired 90.4 percent of the outstanding stock of Grey Wolf Exploration, a step toward 100 percent ownership of the company.

Further capital development was hindered by $31.3 million in interest expense in 2001 and the debt consumed the company’s attention. As Abraxas faced the expiration of $63.5 million in notes due in March 2003 and another $191 million due in 2004, the company sought to reduce debt and improve cash flow. Abraxas sold properties in the United States and Canada for $29 million in 2001, leaving it with assets in Wyoming, Texas, and Canada. Abraxas applied those funds to development of strong resource plays in Texas and Canada. Abraxas divested the natural gas processing plant and reserves from its Grey Wolf unit for $21.5 million. Sale of additional Texas assets garnered $32.7 million by July 2002. In November, Abraxas announced an agreement to sell a group of Canadian assets to a royalty trust for $138 million in cash. While the sale resulted in significant reduction in natural gas reserves, Canaxas maintained an interest in 300,000 undeveloped acres and all of its interests in the productive Ladyfern area, with estimated natural gas reserves of one trillion cubic feet. Moreover, the sale allowed Abraxas to pay the March 2003 notes, as well as a $40 million credit facility that supported its Grey Wolf operations. While the sale of assets offset losses, Abraxas nonetheless recorded a net loss of $118.5 million on revenues of $21.5 million in 2002.

INCREASING CAPITAL EXPENDITURE FOR RESOURCE DEVELOPMENT

Still encumbered by debt, the company sought to balance productivity with debt maintenance. In December 2002 Abraxas sought to benefit from its stronger stock price, averaging $5 per share on high natural gas prices, to initiate an exchange offer for Senior Secured Notes due 2004 for new notes due in 2007. However, resource development was limited by bondholder covenants restricting capital expenditures to less than $10 million in 2003 and 2004. Refinancing in October 2004 released the company from the covenants and funded capital spending for productive development. New projects in late 2004 included deep horizontal drilling at the Devonian formation in the Oates SW field in west Texas and several waterflood projects at mature fields. South Texas development involved 16 new wells. The company renewed its oil development activity in Wyoming.

Abraxas shifted its focus to domestic production after the company fully divested the balance of its Canadian assets with the spinoff of Grey Wolf Exploration in February 2005. The initial public offering of stock garnered net proceeds of $57 million used to repay debt and to eliminate a working capital deficit. The divestment freed Abraxas to pursue exploratory drilling and well development at its high-potential Texas properties. In May 2005 Abraxas completed two horizontal wells at the Edwards field that generated initial gross production of more than 6 Mcf per day, settling at 5 Mcf daily. A third well, completed in July, produced 2.5 Mcf per day. The company made its first significant domestic acquisition in several years with the purchase of mineral rights from a ranching family in west Texas. Hudgins Ranch carried an estimated 2 Bcfe of natural gas reserves on 12,000 contiguous acres, and Abraxas expected the acreage to hold up to 76 wells, including nine abandoned wells to be reentered. Net proceeds of $11.3 million, from a private placement of four million shares to institutional investors, funded accelerated natural gas drilling in the Oates SW field area and the Hudgins Ranch. The company experienced delays in development due to problems obtaining supplies and equipment and finding crews. By August development of the La Escalera #1AH well was completed, with production averaging 5.2 Mcfe per day. Moreover, site development enabled Abraxas to evaluate resources at shallow depths. The workover of an abandoned well on the ranch was successfully completed in late 2005.

Despite a more manageable debt load, Abraxas struggled to become profitable. The continuous sale of assets supported profitability in 2004 and 2005 as Abraxas reported net income of $12.4 million on $33.9 million in revenues in 2004, and $19.1 million net income on $48.6 million in revenues in 2005. Anticipating losses in 2006, in September the company sold its Three Rivers assets at the Edwards formation for $12 million, earning a profit on the cost of acquisition and development, and enabling the company to earn a profit of $1.2 million on $51.7 million in revenues. Low prices for natural gas hurt profits, so Abraxas did not plan to replace the assets until drilling costs came into alignment with gas prices. Instead, the company increased production at existing properties, an increase of 26 percent to 7.7 Bcfe. As a result, proved reserves at the end of 2006 declined 6 percent to 99 Bcfe, of which 83 percent were natural gas reserves. At the end of 2006, the company owned interests in 102,000 acres and operated 130 crude oil wells and 45 natural gas wells (net). With 48 percent proved developed reserves, the company’s reserve life exceeded 15 years. Abraxas planned to continue this focus on growth through production.

FORMATION OF MASTER PARTNERSHIP TO ELIMINATE DEBT

In the spring of 2007 Abraxas formed a master limited partnership with the intention of eliminating all debt, then at $147 million. Abraxas transferred 85 percent of long-lived natural gas and oil producing properties and reserves, estimated at 65 Bcfe, located in the Delaware and Gulf Coast Basins to the partnership, called Abraxas Energy Partners. Abraxas sold a 53 percent interest in the limited partnership to private investors through the Lehman Brothers MLP Opportunity Fund, raising $100 million. An additional $22.5 million was raised through the sale of common stock to the partnership investors. A new credit facility provided an additional $35 million toward the payment of all notes, accrued interest, and fees. The balance remaining, of approximately $8.5 million, funded drilling and development and general corporate administration. Properties retained by Abraxas Petroleum included largely undeveloped natural gas and oil assets in west Texas, along the Gulf Coast, and at the Powder River Basin in Wyoming. Assets included the Oates SW field, where the horizontal drilling at an abandoned well resulted in significant production of natural gas, at 4.5 Mcfe per day, in June 2007.

Abraxas Petroleum maintained a 47 percent interest in Abraxas Energy Partners, but planned to take the entity public by November 15, 2008. The initial public offering of two million shares of stock was expected to garner $55.6 million. Though Abraxas Petroleum never paid dividends, Abraxas Energy offered $1.50 per share annually.

Mary Tradii