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Dear Fellow Shareholders,
The past year has been one of turmoil for both the world financial markets and the oil and gas industry. The first indication of what was to come was the sudden downturn in real estate markets which was followed by a near collapse of the banking system. As these markets were in freefall, oil and gas began to spiral downward. Oil prices went from a high of $145 a barrel in June 2008 to a low of $34 a barrel in December 2008. As a result, the landscape of small, public oil and gas companies has been altered significantly. This collapse in oil prices created a “domino effect,” first adversely impacting the value of reserves, followed by borrowing base redeterminations and ensuing demands for the reduction of outstanding balances by financial institutions. This created forced liquidations of assets, and many companies did not or may not recover. Many are already gone. However, unlike many companies, Earthstone did not face demands for loan balance reduction as we are debt free. Our strong balance sheet and cash reserve levels allowed us to weather the storm much better than most.
Although financially sound, Earthstone was significantly affected by the commodity price decline. Primarily due to the decline in the price of both oil and gas, the Company’s reserves declined by 42%. This overshadowed the positive impact of reserve additions contributed by new Antenna-Federal gas wells in Colorado and an increase in Earthstone’s barrel of oil equivalent (BOE) production of 13.4%. In addition, in December 2008 as a result of price declines, we incurred a $2.7 million non-cash charge to income and a corresponding write-down of our oil and gas asset base. Based on accounting rules, as commodity prices improve, it is expected that those reserves that were written off or “lost” will be “found” in the future, although the non-cash charge won’t be recovered. Not only did the $2.7 million impairment affect reserves, it also lowered pre-tax earnings by $.15 per share.
The upheaval of the financial markets has affected the majority of all traded securities, including Earthstone. While our share price has improved, it certainly is not where we want it to be, and we are as disappointed as our shareholders are. Due to our belief that the share price was, and continues to be, undervalued, we initiated and continue to fund, a share buyback program.
During the period when oil prices were in excess of $100 per barrel, many companies made investments based on those prices. This proved to be an unfortunate strategy for a number of producers. Our strategy was different. When we saw oil prices soaring we realized that the price of acquisitions and adding reserves was also soaring. We were cautious, and while others were charging ahead, we retired debt and built a strong balance sheet. We believe this strategy has served us well. Going forward there are three components to our growth strategy. They are: pursue exploration and development drilling, acquire significant and strategic producing properties and increase cash flow from existing oil and gas properties.
By the time you read this, we expect to have drilled the first well on our Flat Lake Prospect in northern Montana. Four years in the making, this exploration play is one of the more aggressive moves that we have made since Christmas Meadows. This Earthstone-operated drilling operation targets the Red River formation, along with a number of other formations along the way. And, with over 4,000 acres under lease, if this venture is successful, we have some “room to run.” We expect to continue participating in projects generated by others and hope to be reporting our participation in several more Bakken wells in North Dakota.
Earthstone’s strong balance sheet and cash position has not gone unnoticed. In January 2009, an unsolicited share exchange offer to take the Company over was proposed, but never commenced. Earthstone’s Board of Directors concluded that the exchange offer was coercive and inadequate to gain control of Earthstone and its assets. While certainly the Board was concerned about the disruption of its long term strategy, more important was the dilutive nature of the offer to our shareholders.
At this year’s Annual Meeting of Shareholders in December 2009, we have proposed a number of changes for the Company that we believe are in the best interest of our shareholders. Along with amending and restating our Articles of Incorporation which need to be updated, we are strengthening the ability of the Board to negotiate on shareholders’ behalf in the event of an unsolicited offer for the Company and its assets. The most exciting thing we are hoping to accomplish at this meeting is to put in place actions that should allow the Company to list its shares on a national securities exchange. We believe this will be advantageous for Earthstone Energy’s shares of common stock as we expect it should enhance our exposure to a larger investor pool, reduce bid/ask spreads, increase daily share trading volumes and generally make the stock more appealing. In addition, we are proposing a change in the name of the Company to more accurately reflect what we do.
The last couple of years have been ones of unrest and difficult change. Along with all independent oil and gas producers, we have been buffeted by the external financial reverberations of the markets. Moreover, we have dealt with a number of other external and internal issues that have taken a significant amount of management time. Those issues are behind us. Our focus is on growing the Company by adding reserves and production, and we have confidence that our efforts will prove fruitful.
Ray Singleton,
President
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