10-K 1 unt-20121231x10k.htm 10-K UNT-2012.12.31-10K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2012
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from                     to                     
Commission file number: 1-9260
UNIT CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
73-1283193
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
 
 
7130 South Lewis, Suite 1000
Tulsa, Oklahoma
74136
(Address of principal executive offices)
(Zip Code)
(Registrant’s telephone number, including area code) (918) 493-7700
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Name of each exchange on which registered
Common Stock, par value $.20 per share
NYSE
Rights to Purchase Series A Participating
Cumulative Preferred Stock
NYSE
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes [x]    No [ ]
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.
Yes [ ]    No [x]
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 [x]    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 [x]    No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [x]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer    [x]
 
Accelerated filer    [ ]
 
Non-accelerated filer    [ ]
 
Smaller reporting company    [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes [ ]    No [x]
As of June 30, 2012, the aggregate market value of the voting and non-voting common equity (based on the closing price of the stock on the NYSE on June 30, 2012) held by non-affiliates was approximately $1,089,162,162. Determination of stock ownership by non-affiliates was made solely for the purpose of this requirement, and the registrant is not bound by these determinations for any other purpose.
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class
Outstanding at February 15, 2013
Common Stock, $0.20 par value per share
49,158,255 shares
DOCUMENTS INCORPORATED BY REFERENCE
Document
Parts Into Which Incorporated
Portions of the registrant’s definitive proxy statement (the “Proxy Statement”) with respect to its annual meeting of shareholders scheduled to be held on May 1, 2013. The Proxy Statement shall be filed within 120 days after the end of the fiscal year to which this report relates.
Part III
Exhibit Index—See Page 120




FORM 10-K
UNIT CORPORATION

TABLE OF CONTENTS
 
 
 
Page
 
 
 
 
PART I
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 1B.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
PART II
 
 
 
 
Item 5.
 
 
 
Item 6.
 
 
 
Item 7.
 
 
 
Item 7A.
 
 
 
Item 8.
 
 
 
Item 9.
 
 
 
Item 9A.
 
 
 
Item 9B.
 
 
 
 
PART III
 
 
 
 
Item 10.
 
 
 
Item 11.
 
 
 
Item 12.
 
 
 
Item 13.
 
 
 
Item 14.
 
 
 
 
PART IV
 
 
 
 
Item 15.
 
 



The following are explanations of some of the terms used in this report.
ARO – Asset retirement obligations.
ASC – FASB Accounting Standards Codification.
ASU – Accounting Standards Update.
Bcf – Billion cubic feet of natural gas.
Bcfe – Billion cubic feet of natural gas equivalent. Determined using the ratio of one barrel of crude oil or NGLs to six Mcf of natural gas.
Bbl – Barrel, or 42 U.S. gallons liquid volume.
Boe – Barrel of oil equivalent. Determined using the ratio of six Mcf of natural gas to one barrel of crude oil or NGLs.
BOKF – Bank of Oklahoma Financial Corporation.
Btu – British thermal unit, used in terms of gas volumes. Btu is used to refer to the amount of natural gas required to raise the temperature of one pound of water by one degree Fahrenheit at one atmospheric pressure.
Development drilling – The drilling of a well within the proved area of an oil or gas reservoir to the depth of a stratigraphic horizon known to be productive.
DD&A – Depreciation, depletion, and amortization.
FASB – Financial and Accounting Standards Board.
Finding and development costs – Costs associated with acquiring and developing proved natural gas and oil reserves which are capitalized under generally accepted accounting principles, including any capitalized general and administrative expenses.
Gross acres or gross wells – The total acres or wells in which a working interest is owned.
IF – Inside FERC (U.S. Federal Energy Regulatory Commission).
LIBOR – London Interbank Offered Rate.
MBbls – Thousand barrels of crude oil or other liquid hydrocarbons.
Mcf – Thousand cubic feet of natural gas.
Mcfe – Thousand cubic feet of natural gas equivalent. Determined using the ratio of one barrel of crude oil or NGLs to six Mcf of natural gas.
MMBbls – Million barrels of crude oil or other liquid hydrocarbons.
MMBoe – Million barrels of oil equivalents.
MMBtu – Million Btu’s.
MMcf – Million cubic feet of natural gas.

MMcfe – Million cubic feet of natural gas equivalent. Determined using the ratio of one barrel of crude oil or NGLs to six Mcf of natural gas.
Net acres or net wells – The sum of the fractional working interests owned in gross acres or gross wells.
NGLs – Natural gas liquids.
NGPL-TXOK – Natural Gas Pipeline Co. of America/Texok zone.
NYMEX – The New York Mercantile Exchange.
OPIS – Oil Price Information Service.
PEPL – Panhandle East Pipeline Co.
Play – A term applied by geologists and geophysicists identifying an area with potential oil and gas reserves.
Producing property – A natural gas or oil property with existing production.
Proved developed reserves – Reserves that can be expected to be recovered through existing wells with existing equipment and operating methods or in which the cost of the required equipment is relatively minor compared to the cost of a new well; and through installed extraction equipment and infrastructure operational at the time of the reserves estimate . For additional information, see the SEC’s definition in Rule 4-10(a)(3) of Regulation S-X.
Proved reserves – Proved oil and gas reserves are those quantities of oil and gas, which, by analysis of geosciences and engineering data, can be estimated with reasonable certainty to be economically producible – from a given date forward, from known reservoirs and under existing economic conditions, operating methods, and government regulations – prior to the time at which contracts providing the right to operate expire, unless evidence indicates that renewal is reasonably certain, regardless of whether deterministic or probabilistic methods are used for the estimation. The project to extract the hydrocarbons must have commenced or the operator must be reasonably certain that it will commence the project within a reasonable time. For additional information, see the SEC’s definition in Rule 4-10(a)(2)(i) through (iii) of Regulation S-X.
Proved undeveloped reserves – Proved reserves that are expected to be recovered from new wells on undrilled acreage, or from existing wells where a relatively major expenditure is required for recompletion. For additional information, see the SEC’s definition in Rule 4-10(a)(4) of Regulation S-X.
Reasonable certainty (in regards to reserves) – If deterministic methods are used, reasonable certainty means a high degree of confidence that the quantities will be recovered. If probabilistic methods are used, there should be at least a 90% probability that the quantities actually recovered will equal or exceed the estimate.
Reliable technology – A grouping of one or more technologies (including computational methods) that has been field tested and has been demonstrated to provide reasonably certain results with consistency and repeatability in the formation being evaluated or in an analogous formation.
SARs – Stock appreciation rights.
Unconventional play – Plays targeting tight sand, carbonates, coal bed, or oil and gas shale reservoirs. The reservoirs tend to cover large areas and lack the readily apparent traps, seals, and discrete hydrocarbon-water boundaries that typically define conventional reservoirs. These reservoirs generally require horizontal wells and fracture stimulation treatments or other special recovery processes in order to produce economically.

Undeveloped acreage – Lease acreage on which wells have not been drilled or completed to a point that would permit the production of economic quantities of natural gas or oil regardless of whether the acreage contains proved reserves.
Well spacing – The regulation of the number and location of wells over an oil or gas reservoir, as a conservation measure. Well spacing is normally accomplished by order of the appropriate regulatory conservation commission.
Workovers – Operations on a producing well to restore or increase production.
WTI – West Texas Intermediate, the benchmark crude oil in the United States.



UNIT CORPORATION
Annual Report
For The Year Ended December 31, 2012

PART I

Item 1.     Business

Unless otherwise indicated or required by the context, the terms “Company”, “Unit”, “us”, “our”, “we”, and “its” refer to Unit Corporation and, as appropriate, one or more of Unit Corporation and its subsidiaries.

Our executive offices are at 7130 South Lewis, Suite 1000, Tulsa, Oklahoma 74136; our telephone number is (918) 493-7700.

Information regarding our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to these reports, will be made available in print, free of charge, to any shareholders who request them. They are also available on our internet website at www.unitcorp.com, as soon as reasonably practicable after we electronically file these reports with or furnish them to the Securities and Exchange Commission (SEC). Materials we file with the SEC may be read and copied at the SEC’s Public Reference Room at 100 F. Street, N.E. Room 1580, N.W., Washington, D.C. 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet website at www.sec.gov that contains reports, proxy and information statements, and other information regarding our company that we file electronically with the SEC.

In addition, we post on our Internet website, www.unitcorp.com, copies of our corporate governance documents. Our corporate governance guidelines and code of ethics, and the charters of our Board’s Audit, Compensation, and Nominating and Governance Committees, are available free of charge on our website or in print to any shareholder who requests them. We may from time to time provide important disclosures to investors by posting them in the investor information section of our website, as allowed by SEC rules.

GENERAL

We were founded in 1963 as an oil and natural gas contract drilling company. Today, in addition to our drilling operations, we have operations in the exploration and production and mid-stream areas. We operate, manage, and analyze our results of operations through our three principal business segments:

Contract Drilling – carried out by our subsidiary Unit Drilling Company and its subsidiaries. This segment contracts to drill onshore oil and natural gas wells for others, and for our own account.
Oil and Natural Gas – carried out by our subsidiary Unit Petroleum Company. This segment explores, develops, acquires, and produces oil and natural gas properties for our own account.
Mid-Stream – carried out by our subsidiary Superior Pipeline Company, L.L.C. and its subsidiaries. This segment buys, sells, gathers, processes, and treats natural gas for third parties and for our own account.

Each of these companies may conduct operations through subsidiaries of their own.

The following table provides certain information about us as of February 15, 2013:
 
Number of drilling rigs we own
127

Completed gross wells in which we own an interest
10,068

Number of natural gas treatment plants we own
3

Number of processing plants we own
14

Number of natural gas gathering systems we own
39




1


2012 SEGMENT OPERATIONS HIGHLIGHTS

Contract Drilling
Placed into service in our Rocky Mountain division two new 1,500 horsepower, diesel-electric drilling rigs. 
Refurbished, upgraded, or returned into service 15 drilling rigs after being stacked for use to meet increasing horizontal drilling activity.
Sold an idle 600 horsepower mechanical drilling rig to an unaffiliated third-party.

Oil and Natural Gas
Attained net proved oil, NGLs, and natural gas reserves of 150.0 million barrels of oil equivalents (MMBoe), a 29% increase over 2011 reserves.
Increased net proved oil and NGLs reserves by 35% over 2011.
Total production of 14.2 MMBoe or an 18% increase over 2011.
Participated in the drilling of 171 wells.
Acquired approximately 83,000 net acres with approximately 600 potential horizontal drilling locations primarily in the Granite Wash, Cleveland, and various other plays in western Oklahoma and the Texas Panhandle from Noble Energy, Inc. (Noble).
Sold our interest in certain Bakken properties representing approximately 35% of our total acreage in the Bakken play. Proceeds, net of related expenses, were $226.6 million.
Sold certain oil and natural gas assets located in Brazos and Madison Counties, Texas, for approximately $44.1 million.
Announced a field discovery in our Wilcox play having estimated reserve potential of 229 Bcfe, gross (159 Bcfe, net).

Mid-Stream
Gas gathered increased from 216 MMbtu per day in 2011 to 289 MMbtu per day in 2012, a 34% increase.
Gas processed increased from 116 MMbtu per day in 2011 to 166 MMbtu per day in 2012, a 42% increase.
NGLs sold increased from 412,000 gallons per day in 2011 to 543,000 gallons per day in 2012, a 32% increase.
Completed the installation of a 45 MMcf per day turbo expander plant at our Hemphill facility increasing our total processing capacity at that facility to approximately 160 MMcf per day.
Completed the installation of a second gas processing plant at our Cashion facility increasing the total processing capacity of the facility to approximately 45 MMcf per day.
Completed initial construction of a new gathering system, known as the Bellmon system, and the related installation of a 20 MMcf per day gas processing plant.
Completed construction of the first phase of a 7-mile gathering system at our Pittsburgh Mills facility located in Allegheny and Butler Counties, Pennsylvania.
Added an additional 370 miles of pipeline (approximately a 40% increase) and connected 99 new wells to our various gathering systems.
Acquired four gathering systems as a result of the acquisition from Noble.

FINANCIAL INFORMATION ABOUT SEGMENTS

See Note 16 of our Notes to Consolidated Financial Statements in Item 8 of this report for information with respect to each of our segment’s revenues, profits or losses, and total assets.


2


CONTRACT DRILLING

General.    Our contract drilling business is conducted through Unit Drilling Company and its subsidiary Unit Texas Drilling L.L.C. Through these companies we drill onshore oil and natural gas wells for our own account as well as for a wide range of other oil and natural gas companies. Our drilling operations are mainly located in Oklahoma, Texas, Louisiana, Kansas, Wyoming, Colorado, Utah, Montana, and North Dakota.

The following table identifies certain information concerning our contract drilling operations:
 
 
Year Ended December 31,
 
2012
 
2011
 
2010
Number of drilling rigs owned at year end
127.0

 
127.0

 
121.0

Average number of drilling rigs owned during year
127.4

 
123.7

 
123.9

Average number of drilling rigs utilized
73.9

 
76.1

 
61.4

Utilization rate (1)
58
%
 
61
%
 
50
%
Average revenue per day (2)
$
19,774

 
$
17,520

 
$
14,134

Total footage drilled (feet in 1,000’s)
10,551

 
9,749

 
7,961

Number of wells drilled
773

 
742

 
593

_________________________
(1)
Utilization rate is determined by dividing the average number of drilling rigs used by the average number of drilling rigs owned during the year.
(2)
Represents the total revenues minus rental revenue from our contract drilling operations divided by the total number of days our drilling rigs were used minus the rental days during the year.

Description and Location of Our Drilling Rigs.    An on-shore drilling rig is composed of major equipment components such as engines, drawworks or hoists, derrick or mast, substructure, pumps to circulate the drilling fluid, blowout preventers, and drill pipe. As a result of the normal wear and tear of operating 24 hours a day, several of the major components of a drilling rig, like engines, mud pumps, and drill pipe, must be replaced or rebuilt on a periodic basis. Other components, like the substructure, mast, and drawworks, can be used for extended periods of time with proper maintenance. We also own additional equipment used in the operation of our drilling rigs, including top drives, skidding systems, large air compressors, trucks, and other support equipment.

The maximum depth capacities of our various drilling rigs range from 5,000 to 40,000 feet. In 2012, 90 of our 127 drilling rigs were used in drilling services.

The following table shows certain information about our drilling rigs (including their distribution) as of February 15, 2013:

Divisions
Contracted
Rigs
 
Non-Contracted
Rigs
 
Total
Rigs
 
Average
Rated
Drilling
Depth
(ft)
Mid-Continent
23

 
12

 
35

 
19,386

Woodward
11

 
6

 
17

 
13,853

Panhandle
10

 
15

 
25

 
12,720

Gulf Coast
6

 
10

 
16

 
18,250

Rocky Mountain
19

 
15

 
34

 
17,647

Totals
69

 
58

 
127

 
16,724


Drilling rig utilization steadily increased throughout 2010 and 2011, and began declining throughout 2012 due primarily to drilling efficiencies attained by operators, more acreage in certain plays being held by production, and weakness in NGLs

3


prices. Our active drilling rig count at the start of 2010 was 42 drilling rigs and increased to 82 drilling rigs at the end of 2011 and finished out 2012 at 62 drilling rigs.

Mid-Continent, Woodward, and Panhandle - We have long held a strong position and market presence in the mid-continent area of Oklahoma and the Texas Panhandle.  This area is commonly referred to as the Anadarko Basin, which also encompasses portions of Kansas.  Historically, the Anadarko Basin has been known as a gas producing area, but it is also rich in oil and NGL production.  Within this basin during the last several years, operators have focused their operations on the Cana Woodford, Granite Wash, Marmaton and Mississippian horizontal plays.   Three of our divisions work in this basin.  During 2012, our Mid-Continent, Panhandle, and Woodward divisions averaged 24.0, 10.0, and 11.6 drilling rigs operating, respectively.  Our Arkoma division, which operated in the dry gas producing area of eastern Oklahoma, averaged only 1.0 drilling rig operating for 2012.  As a result, we consolidated that division into the Mid-Continent division at the end of the year.

Gulf Coast - Our Gulf Coast division provides drilling rigs to the onshore areas of Louisiana, Texas Gulf Coast, East Texas, and South Texas.  During 2012, this division averaged 7.2 drilling rigs operating.  Within this division, our largest drilling rig, Rig 201, a 4,000 horsepower rig rated to drill to 40,000 feet, is drilling an ultra-deep exploration well for a major oil company in south Louisiana.  As part of these operations, Rig 201 established a world record by setting the deepest string of 16” casing for an onshore well.  It is anticipated that by the time the well is completed, it will be the deepest onshore well in the state of Louisiana.

Rocky Mountains - Our Rocky Mountain division covers several states, including Colorado, Utah, Wyoming, Montana, and North Dakota.  This vast area has produced a number of conventional and unconventional oil and gas fields.  Our drilling rig fleet in this division operated an average of 20.2 drilling rigs during 2012.  We have drilling rigs operating primarily in the Pinedale Anticline of western Wyoming and the Bakken Shale of North Dakota.  One new drilling rig was added to each of these areas during 2012.  We ended 2012 with 13.0 drilling rigs working in the Bakken Shale.

At any given time the number of drilling rigs we can work depends on a number of conditions besides demand, including the availability of qualified labor and the availability of needed drilling supplies and equipment. Not surprisingly, the impact of these conditions tends to fluctuate with the demand for our drilling rigs. For 2010, our average utilization rate was 50%, for 2011 it increased to 61%, and for 2012 it decreased slightly to 58%.

The following table shows the average number of our drilling rigs working by quarter for the years indicated:
 
 
2012
 
2011
 
2010
First quarter
81.5

 
70.0

 
50.9

Second quarter
76.7

 
73.1

 
58.1

Third quarter
73.4

 
78.9

 
65.4

Fourth quarter
64.0

 
82.1

 
70.9


Drilling Rig Fleet.    The following table summarizes the changes made to our drilling rig fleet in 2012. A more complete discussion of the changes follows the table:
 
Drilling rigs owned at December 31, 2011
127

Drilling rigs sold/removed from service (1)
(2
)
Drilling rigs purchased

Drilling rigs constructed
2

Total drilling rigs owned at December 31, 2012
127

_________________________
(1)
During the third-quarter of 2012, we had a fire on one of our drilling rigs.

Dispositions, Acquisitions, and Construction.   During the first half of 2010, our contract drilling segment sold eight of its idle mechanical drilling rigs to an unaffiliated third party. These drilling rigs ranged in horsepower from 800 to 1,000. Proceeds from the sale were $23.9 million with a gain of $5.7 million which was recorded in the first quarter 2010. The proceeds were used to refurbish and upgrade existing drilling rigs in our fleet allowing those drilling rigs to be used in

4


horizontal drilling operations. We also placed into service in our Rocky Mountain division a 1,500 horsepower, diesel-electric drilling rig that previously had been placed on hold during 2009 by our customer.

In September 2010, we entered into a contract with an unaffiliated third-party under which we conveyed three of our idle mechanical drilling rigs and, in exchange, we received a 1,200 horsepower electric drilling rig and $5.3 million. The three drilling rigs sold ranged in horsepower from 650 to 1,000. The transaction closed in October and resulted in a gain of $3.5 million.

At the end of 2010, we began constructing five new 1,500 horsepower, diesel-electric drilling rigs. All of these drilling rigs are now operational and located in the Bakken Shale in North Dakota.

During 2011, we were awarded two additional new build drilling rig contracts for 1,500 horsepower, diesel-electric drilling rigs. One was placed into service during the fourth quarter of 2011 and the other was placed in service during the first quarter of 2012, both in Wyoming.
During the first quarter of 2012, we sold an idle 600 horsepower mechanical drilling rig to an unaffiliated third-party. Additionally, in the second quarter we placed another new 1,500 horsepower, diesel-electric drilling rig to work in North Dakota under a three year contract.
During the third quarter of 2012, we had a fire on one of our drilling rigs located in the mid-continent region. The net book value of the damaged equipment was $3.2 million. We expect that all of the net book value of the damaged equipment will be recoverable from insurance proceeds. As a result of this loss, this segment now has 127 drilling rigs in its fleet. No personnel were injured in this incident.

Historically, our contract drilling segment has experienced a greater demand for natural gas drilling as opposed to drilling for oil and NGLs. However, with the current weakened natural gas market, operators are focusing on drilling for oil and NGLs. Today, approximately 99% of our working drilling rigs are drilling for oil or NGLs. Of those, approximately 97% are drilling horizontal or directional wells.

Drilling Contracts.    Our drilling contracts are generally obtained through competitive bidding on a well by well basis. Contract terms and payment rates vary depending on the type of contract used, the duration of the work, the equipment and services supplied, and other matters. We pay certain operating expenses, including the wages of our drilling personnel, maintenance expenses, and incidental drilling rig supplies and equipment. The contracts are usually subject to early termination by the customer subject to the payment of a fee. Our contracts also contain provisions regarding indemnification against certain types of claims involving injury to persons, property, and for acts of pollution. The specific terms of these indemnifications are subject to negotiation on a contract by contract basis.

The type of contract used determines our compensation. Contracts are generally one of three types: daywork; footage; or turnkey. Additional compensation may be acquired for special risks and unusual conditions. Under a daywork contract, we provide the drilling rig with the required personnel and the operator supervises the drilling of the well. Our compensation is based on a negotiated rate to be paid for each day the drilling rig is used. Footage contracts usually require us to bear some of the drilling costs in addition to providing the drilling rig. We are paid on completion of the well at a negotiated rate for each foot drilled. We did not have any footage contracts in 2012 or 2011 and we drilled four wells under a footage contract in 2010.

Under turnkey contracts we drill the well to a specified depth for a set amount and provide most of the required equipment and services. We bear the risk of drilling the well to the contract depth and are paid when the contract provisions are completed. We may incur losses if we underestimate the costs to drill the well or if unforeseen events occur that increase our costs or result in the loss of the well. We have not worked under a turnkey contract during the last three years. With the exception of the footage contracts noted above, all of our work during the last three years was under daywork contracts. Because market demand for our drilling rigs as well as the desires of our customers determine the types of contracts we use, we cannot predict when and if a part of our drilling will be conducted under footage or turnkey contracts.

The majority of our contracts are on a well-to-well basis, with the rest under term contracts. Term contracts range from six months to three years and, depending on the contract, the rates can either be fixed throughout the term or allow for periodic adjustments.


5


Customers.    During 2012, QEP Resources, Inc. and Kodiak Oil and Gas Corp. were our largest drilling customers accounting for approximately 15% and 10%, respectively, of our total contract drilling revenues. Our work for these customers was under multiple contracts and our business was not substantially dependent on any of these individual contracts. Consequently, none of these contracts on their own were considered to be material. No other third party customer accounted for 10% or more of our contract drilling revenues.

Our contract drilling segment also provides drilling services for our oil and natural gas segment. During 2012, 2011, and 2010, we drilled 78, 81, and 75 wells, respectively, or 10%, 11%, and 13%, respectively, of the total wells drilled by our drilling segment. Depending on the timing of the drilling services performed on our properties those services may be deemed, for financial reporting purposes, to be associated with the acquisition of an ownership interest in the property. Revenues and expenses for these services are eliminated in our income statement, with any profit recognized reducing our investment in our oil and natural gas properties. The contracts for these services are issued under the same conditions and rates as the contracts entered into with unrelated third parties. We eliminated revenue of $49.6 million, $52.2 million, and $40.1 million during 2012, 2011, and 2010, respectively, from our contract drilling segment and eliminated the associated operating expense of $34.1 million, $32.6 million, and $31.0 million during 2012, 2011, and 2010, respectively, yielding $15.5 million, $19.6 million, and $9.1 million during 2012, 2011, and 2010, respectively, as a reduction to the carrying value of our oil and natural gas properties.

OIL AND NATURAL GAS

General.    We began to develop our exploration and production operations in 1979. Today, our wholly owned subsidiary, Unit Petroleum Company conducts our exploration and production activities. Our producing oil and natural gas properties, undeveloped leaseholds, and related assets are located mainly in Oklahoma and Texas, and to a lesser extent, in Arkansas, Colorado, Kansas, Louisiana, Mississippi, Montana, New Mexico, North Dakota, Pennsylvania, Wyoming, and a small portion in Canada.

When we are the operator of a property, we generally attempt to use a drilling rig owned by our contract drilling segment, and we use our mid-stream segment to gather our gas if circumstances warrant it.

The following table presents certain information regarding our oil and natural gas operations as of December 31, 2012:
 
Our Divisions/Area
Number
of
Gross
Wells
 
Number
of Net
Wells
 
Number
of Gross
Wells in
Process
 
Number
of Net
Wells in
Process
 
2012 Average
Net Daily Production
 
 
 
 
Natural
Gas
(Mcf)
 
Oil
(Bbls)
 
NGLs (Bbls)
West division (consists principally of the Rocky Mountain region, New Mexico, Western and Southern Texas, and the Gulf Coast region)
3,239

 
525.39

 
4

 
2.96

 
32,324

 
2,926

 
2,344

East division (consists principally of the Appalachian region, Arkansas, East Texas, Northern Louisiana, and Eastern Oklahoma)
1,693

 
523.79

 
1

 
0.01

 
32,529

 
43

 
62

Central division (consists principally of Kansas, Western Oklahoma, and the Texas Panhandle)
5,130

 
1,774.89

 
9

 
5.16

 
68,835

 
5,990

 
5,234

Total
10,062

 
2,824.07

 
14

 
8.13

 
133,688

 
8,959

 
7,640


As of December 31, 2012, we did not have any significant water floods, pressure maintenance operations, or any other material operations that were in process.

6



Description and Location of Our Core Operations

West division.    In our Wilcox play, located primarily in Polk, Tyler, and Hardin Counties, Texas, we operated and completed 11 gross wells in 2012 with an average working interest of 88% and a success rate of 82%. Three of the 11 wells were completed in our “Gilly” Lower Wilcox field bringing the total number of wells completed in that field to five at year end 2012. Approximately 18% or 30 net Bcfe of the anticipated 168 net Bcfe (242 gross Bcfe) potential reserves are booked as proved producing or proved behind pipe at year end 2012. For 2013, we plan to run one of our drilling rigs which should drill approximately 12 gross wells at an approximate net cost of $60 million. Seven of the 12 wells are planned to be drilled in the “Gilly” Lower Wilcox Field and the remaining five wells will be drilled on other Wilcox prospects.

East division.    Over the last several years, activity in our East Division has been limited due to low gas prices since this area does not generally have oil or NGLs associated with the gas.

Central division.    We recently acquired approximately 105,000 net acres located primarily in south central Kansas in the developing Mississippian play. Unit drilled its first horizontal well in Reno County, Kansas in the second quarter 2012 to a total measured depth of 8,115 feet including 3,850 feet of lateral. First production occurred in May 2012 with an average peak 30 day rate of 352 Boe per day consisting of 315 barrels of oil per day, 12 barrels of NGLs per day, and 150 Mcf of natural gas per day. The production components were approximately 89% oil, 3% NGLs, and 8% natural gas. Based on the production profile of this well, the reserve range estimate for a well in our Kansas Mississippian play would range somewhere between 125 MBoe to 180 MBoe. Using this estimated range and a completed well cost of $3.0 million along with flat pricing of $90 oil, $30 NGLs, and $3.25 natural gas, the typical Mississippian well would have a calculated rate of return (ROR) of approximately 30% to 66%. In addition to the initial well, we drilled three more horizontal Mississippian wells during 2012. Two of the wells had first sales in late December 2012, and the third is waiting on pipeline connection. In the first quarter of 2013, we plan to drill three additional wells before suspending drilling until pipeline infrastructure can be installed, which is scheduled for mid-year 2013. The estimated completion date for the pipeline is June 2013. Current plans are to move one of our drilling rigs back in the Mississippian play starting in July 2013 and possibly adding a second drilling rig in September 2013. For 2013, we anticipate having first sales on approximately 13 gross wells and spending approximately $40 million for drilling and completion in our Mississippian play.

During 2012, we drilled 32 gross wells with an average working interest of 84% in our Marmaton horizontal oil play, located in Beaver County, Oklahoma. Thirty of the wells were short laterals with approximately 4,500 feet of lateral length and two of the wells were extended laterals with approximately 9,700 feet of lateral length. The net production from our Marmaton play for the fourth quarter of 2012 averaged 3,424 barrels of oil per day, 528 barrels of NGLs per day, and 1,775 Mcf of natural gas per day, an increase of 15% over the third quarter 2012 and a 61% year-over-year increase between 2012 and 2011. Included in the year-end reserve calculations are adjustments taken for wellbore communication that some of the wells have experienced. We have adjusted our drilling program to address this issue. For 2013, we anticipate running a two drilling rig program in this play that should result in approximately 40 gross wells at an approximate net cost of $90 million. Due to current well spacing limitations associated with drilling extended lateral wells, the majority of 2013 wells are anticipated to be drilled as short lateral wells. We currently have leases on approximately 112,000 net acres in this play with about 44% of the leasehold held by production.

In our Granite Wash (GW) play located in the Texas Panhandle, we drilled and operated 29 gross horizontal wells during 2012 with an average working interest of 87%. The net production from our GW play for the fourth quarter of 2012 averaged 1,822 barrels of oil per day, 4,988 barrels of NGLs per day, and 46.2 MMcf of natural gas per day, or an equivalent rate of 87.0 MMcfe per day, an increase of 43% over the third quarter 2012 and a 41% year-over-year increase between 2012 and 2011. We expect to work four to six of our drilling rigs drilling horizontal wells in both the newly acquired Noble leasehold and our existing leasehold in 2013, which equates to approximately 37 operated gross GW wells at an approximate net cost of $150 million. We currently own leases on approximately 46,000 net acres with about 80% of the leasehold held by production.

Dispositions and Acquisitions.    There were no material dispositions during 2010 or 2011. In September 2012, we sold our interest in certain Bakken properties (representing approximately 35% of our total acreage in the Bakken play). The proceeds, net of related expenses, were $226.6 million. In addition, we sold certain oil and natural gas assets located in Brazos and Madison Counties,Texas, for approximately $44.1 million. Both dispositions were accounted for as adjustments to the full cost pool with no gain or loss recognized.


7


On June 2, 2010, we completed an acquisition of oil and natural gas properties from certain unaffiliated parties in an effort to explore and develop more oil rich plays. The properties were purchased for approximately $73.7 million in cash, after post-closing adjustments. The purchase price allocation was $48.7 million for proved properties and $25.0 million for undeveloped leasehold not being amortized. The acquisition included approximately 45,000 net leasehold acres and 10 producing oil wells. This acquisition targeted the Marmaton horizontal oil play located mainly in Beaver County, Oklahoma.

On July 20, 2011, we acquired certain producing properties from an unaffiliated seller for approximately $12.3 million in cash, after post-closing adjustments, consisting of 30 operated wells and 59 non-operated well interests located in Beaver, Harper, and Ellis Counties, Oklahoma and Lipscomb County, Texas. The purchase price allocation was $8.4 million for proved properties and $3.9 million for acreage. The acquisition also included in excess of 12,000 net acres held by production available for future development.

On August 31, 2011, we acquired certain producing oil and gas properties for $30.5 million in cash from an unaffiliated seller. Included in the acquisition were more than 500 wells located principally in the Oklahoma Arkoma Woodford and Hartshorne Coal plays along with other properties located throughout Oklahoma and Texas. The acquisition also included approximately 55,000 net acres of which 96% was held by production.

On September 17, 2012, we closed our acquisition of certain oil and natural gas assets from Noble . After final closing adjustments, the acquisition included approximately 83,000 net acres primarily in the Granite Wash, Cleveland, and various other plays in western Oklahoma and the Texas Panhandle. The adjusted amount paid was $592.6 million.
As of April 1, 2012, the effective date of the Noble acquisition, the estimated proved reserves of the acquired properties were 44 MMBoe, The acquisition added approximately 24,000 net leasehold acres to our Granite Wash core area in the Texas Panhandle with significant potential including approximately 600 possible future horizontal drilling locations. The total acreage acquired in other plays in western Oklahoma and the Texas Panhandle was approximately 59,000 net acres and was characterized by high working interest and operatorship, 95% of which was held by production. We also received four gathering systems as part of the transaction and other miscellaneous assets.






8


Well and Leasehold Data.    The following tables identify certain information regarding our oil and natural gas exploratory and development drilling operations:
 
 
Year Ended December 31,
 
2012
 
2011
 
2010
 
Gross
 
Net
 
Gross
 
Net
 
Gross
 
Net
Wells drilled:
 
 
 
 
 
 
 
 
 
 
 
Exploratory:
 
 
 
 
 
 
 
 
 
 
 
Oil:
 
 
 
 
 
 
 
 
 
 
 
West division
1

 
1.00

 

 

 
3

 
1.41

East division

 

 

 

 

 

Central division
1

 
1.00

 

 

 
1

 
1.00

Total oil
2

 
2.00

 

 

 
4

 
2.41

Natural gas:
 
 
 
 
 
 
 
 
 
 
 
West division
3

 
2.49

 
5

 
4.13

 
4

 
4.00

East division

 

 

 

 

 

Central division

 

 

 

 
1

 
0.05

Total natural gas
3

 
2.49

 
5

 
4.13

 
5

 
4.05

Dry:
 
 
 
 
 
 
 
 
 
 
 
West division
1

 
1.00

 
7

 
6.50

 
5

 
4.12

East division

 

 

 

 

 

Central division

 

 

 

 

 

Total dry
1

 
1.00

 
7

 
6.50

 
5

 
4.12

Total exploratory
6

 
5.49

 
12

 
10.63

 
14

 
10.58

Development:
 
 
 
 
 
 
 
 
 
 
 
Oil:
 
 
 
 
 
 
 
 
 
 
 
West division
29

 
4.10

 
21

 
4.57

 
25

 
4.69

East division

 

 

 

 

 

Central division
71

 
34.04

 
56

 
32.81

 
43

 
25.90

Total oil
100

 
38.14

 
77

 
37.38

 
68

 
30.59

Natural gas:
 
 
 
 
 
 
 
 
 
 
 
West division
7

 
4.44

 
9

 
6.26

 
13

 
10.85

East division
2

 
0.76

 
9

 
4.65

 
19

 
11.47

Central division
55

 
30.45

 
44

 
18.32

 
42

 
18.22

Total natural gas
64

 
35.65

 
62

 
29.23

 
74

 
40.54

Dry:
 
 
 
 
 
 
 
 
 
 
 
West division
1

 
0.80

 
3

 
2.03

 
4

 
1.51

East division

 

 
1

 
1.00

 
1

 
0.36

Central division

 

 
5

 
2.15

 
6

 
3.94

Total dry
1

 
0.80

 
9

 
5.18

 
11

 
5.81

Total development
165

 
74.59

 
148

 
71.79

 
153

 
76.94

Total wells drilled
171

 
80.08

 
160

 
82.42

 
167

 
87.52


9


 
Year Ended December 31,
 
2012
 
2011
 
2010
 
Gross
 
Net
 
Gross
 
Net
 
Gross
 
Net
Wells producing or capable of producing:
 
 
 
 
 
 
 
 
 
 
 
Oil:
 
 
 
 
 
 
 
 
 
 
 
West division
2,076

 
178.43

 
2,074

 
183.50

 
2,052

 
178.85

East division
54

 
3.17

 
54

 
3.17

 
52

 
2.58

Central division
807

 
382.34

 
631

 
273.31

 
552

 
234.05

Total oil
2,937

 
563.94

 
2,759

 
459.98

 
2,656

 
415.48

Natural gas:
 
 
 
 
 
 
 
 
 
 
 
West division
1,109

 
330.19

 
1,182

 
335.90

 
1,167

 
324.33

East division
1,632

 
519.62

 
1,636

 
522.15

 
1,086

 
290.04

Central division
4,245

 
1,362.87

 
3,097

 
683.08

 
2,927

 
611.05

Total natural gas
6,986

 
2,212.68

 
5,915

 
1,541.13

 
5,180

 
1,225.42

Total
9,923

 
2,776.62

 
8,674

 
2,001.11

 
7,836

 
1,640.90


As of February 15, 2013, we are currently drilling or participating in 15 gross (8.40 net) wells started during 2013.

Cost incurred for development drilling includes $123.4 million, $111.4 million, and $84.6 million in 2012, 2011, and 2010, respectively, to develop booked proved undeveloped oil and natural gas reserves.

The following table summarizes our leasehold acreage at December 31, 2012:
 
 
Year Ended December 31, 2012
 
Developed
 
Undeveloped
 
Total
 
Gross
 
Net
 
Gross
 
Net (1)
 
Gross
 
Net
West division
300,646

 
99,769

 
184,332

 
98,115

 
484,978

 
197,884

East division
265,514

 
99,034

 
120,374

 
41,935

 
385,888

 
140,969

Central division
739,850

 
269,647

 
403,518

 
268,135

 
1,143,368

 
537,782

Total
1,306,010

 
468,450

 
708,224

 
408,185

 
2,014,234

 
876,635

_________________________ 
(1)
Approximately 72% (West – 79%; East – 46%; and Central – 74%) of the net undeveloped acres are covered by leases that will expire in the years 2013—2015 unless drilling or production extends the terms of those leases.




10


Price and Production Data.    The following tables identify the average sales price, production volumes and average production cost per equivalent barrel for our oil, NGLs, and natural gas production for the years indicated:
 
 
Year Ended December 31,
 
2012
 
2011
 
2010
Average sales price per barrel of oil produced:
 
 
 
 
 
Price before hedging
$
90.19

 
$
93.49

 
$
76.65

Effect of hedging
2.41

 
(6.31
)
 
(7.13
)
Price including hedging
$
92.60

 
$
87.18

 
$
69.52

Average sales price per barrel of NGLs produced:
 
 
 
 
 
Price before hedging
$
30.70

 
$
44.44

 
$
36.96

Effect of hedging
0.88

 
(0.80
)
 
0.08

Price including hedging
$
31.58

 
$
43.64

 
$
37.04

Average sales price per Mcf of natural gas produced:
 
 
 
 
 
Price before hedging
$
2.53

 
$
3.78

 
$
4.05

Effect of hedging
0.84

 
0.48

 
1.57

Price including hedging
$
3.37

 
$
4.26

 
$
5.62


11


 
Year Ended December 31,
 
2012
 
2011
 
2010
Oil production (MBbls):
 
 
 
 
 
West division
1,071

 
893

 
729

East division
16

 
12

 
14

Central division:
 
 
 
 
 
Mendota field
497

 
262

 
149

All other central division fields
1,695

 
1,344

 
629

Total central division
2,192

 
1,606

 
778

Total oil production (MBbls)
3,279

 
2,511

 
1,521

NGLs production (MBbls):
 
 
 
 
 
West division
858

 
798

 
627

East division
23

 
5

 
4

Central division:
 
 
 
 
 
Mendota field
1,128

 
691

 
494

All other central division fields
787

 
745

 
424

Total central division
1,915

 
1,436

 
918

Total NGLs production (MBbls)
2,796

 
2,239

 
1,549

Natural gas production (MMcf):
 
 
 
 
 
West division
11,831

 
11,774

 
10,946

East division
11,906

 
12,768

 
14,029

Central division:
 
 
 
 
 
Mendota field
8,957

 
4,887

 
4,050

All other central division fields
16,236

 
14,675

 
11,731

Total central division
25,193

 
19,562

 
15,781

Total natural gas production (MMcf)
48,930

 
44,104

 
40,756

Total production (MBoe):
 
 
 
 
 
West division
3,901

 
3,653

 
3,180

East division
2,023

 
2,145

 
2,356

Central division:
 
 
 
 
 
Mendota field
3,118

 
1,768

 
1,318

All other central division fields
5,188

 
4,535

 
3,009

Total central division
8,306

 
6,303

 
4,327

Total production (MBoe)
14,230

 
12,101

 
9,863

Average production cost per equivalent Bbl (1)
$
7.00

 
$
6.90

 
$
6.54

_______________________ 
(1)
Excludes ad valorem taxes and gross production taxes.

Our Mendota field, located in the Granite Wash play, includes 19%, 22%, and 20%, respectively of our total proved reserves in 2012, 2011, and 2010, respectively, expressed on an oil equivalent barrels basis, and is the only field that is greater than 15% of our proved reserves.


12


Oil, NGLs, and Natural Gas Reserves.    The following table identifies our estimated proved developed and undeveloped oil, NGLs, and natural gas reserves:
 
 
Year Ended December 31, 2012
 
Natural
Gas
(MMcf)
 
Oil
(MBbls)
 
NGLs (MBbls)
 
Total
Proved
Reserves
(MBoe)
Proved developed:
 
 
 
 
 
 
 
West division
73,177

 
3,837

 
4,536

 
20,569

East division
101,267

 
92

 
169

 
17,139

Central division
278,400

 
12,512

 
20,952

 
79,864

Total proved developed
452,844

 
16,441

 
25,657

 
117,572

Proved undeveloped:
 
 
 
 
 
 
 
West division
12,089

 
1,086

 
398

 
3,499

East division
9,324

 

 

 
1,554

Central division
81,390

 
4,471

 
9,111

 
27,147

Total proved undeveloped
102,803

 
5,557

 
9,509

 
32,200

Total proved
555,647

 
21,998

 
35,166

 
149,772


Oil, NGLs, and natural gas reserves cannot be measured exactly. Estimates of oil, NGLs, and natural gas reserves require extensive judgments of reservoir engineering data and are generally less precise than other estimates made in connection with financial disclosures. We use Ryder Scott Company L.P. (Ryder Scott), independent petroleum consultants, to audit the reserves prepared by our reservoir engineers. Ryder Scott has been providing petroleum consulting services throughout the world for over seventy years. Their summary report is attached as Exhibit 99.1 to this Form 10-K. The wells or locations for which reserve estimates were audited were taken from reserve and income projections prepared by us as of December 31, 2012 and comprised the top 82% of the total proved developed discounted future net income and 87% of the total proved undeveloped discounted future net income (based on the unescalated pricing policy of the SEC).

Our Reservoir Engineering department is responsible for reserve determination for the wells in which we have an interest. Their primary objective is to estimate the wells' future reserves and future net value to us. Data is incorporated from multiple sources including geological, production engineering, marketing, production, land, and accounting departments. The engineers are responsible for reviewing this information for accuracy as it is incorporated into the reservoir engineering database. Our internal audit group then checks to confirm the correctness of the data transfer. New well reserve estimates are provided to management as well as the respective operational divisions for additional scrutiny. Major reserve changes on existing wells are reviewed on a regular basis with the operational divisions to confirm correctness and accuracy. As the external audit is being completed by Ryder Scott, the reservoir department performs a final review of all properties for accuracy of forecasting.

Technical Qualifications

Ryder Scott – Mr. Fred P. Richoux is the primary technical person in charge on behalf of Ryder Scott for their audit of our reserves.

Mr. Richoux, an employee of Ryder Scott since 1978, is the President and member of the Board of Directors at Ryder Scott. He is responsible for coordinating and supervising staff and consulting engineers of the company in ongoing reservoir evaluation studies worldwide as well as other administrative functions at the Company. Before joining Ryder Scott, Mr. Richoux served in a number of engineering positions with Phillips Petroleum Company.

Mr. Richoux earned a Bachelor of Science degree in Electrical Engineering from the University of Louisiana at Lafayette and is a registered Professional Engineer in the State of Texas and the Province of Alberta. He is also a member of the Society of Petroleum Engineers and the Society of Petroleum Evaluation Engineers.


13


In addition to gaining experience and competency through prior work experience, the Texas Board of Professional Engineers requires a minimum of fifteen hours of continuing education annually, including at least one hour in the area of professional ethics, which Mr. Richoux fulfills.

Based on his educational background, professional training and more than 45 years of practical experience in the estimation and evaluation of petroleum reserves, Mr. Richoux has attained the professional qualifications as a Reserves Estimator (requires appropriate degree and/or is registered as Professional Engineer and a has minimum of 3 years experience in the estimation and evaluation of reserves) and Reserves Auditor (requires appropriate degree and/or is registered as Professional Engineer and a has minimum of 10 years experience in the estimation and evaluation of reserves of which at least 5 years of such experience is being in responsible charge of the estimation and evaluation of reserves) set forth in Article III of the “Standards Pertaining to the Estimating and Auditing of Oil and Gas Reserves Information” promulgated by the Society of Petroleum Engineers as of February 19, 2007. For more information regarding Mr. Richoux’s geographic and job specific experience, please refer to the Ryder Scott website at http://www.ryderscott.com/Experience/Employees.

The Company – Responsibility for overseeing the preparation of our reserve report is shared by our reservoir engineers Trenton Mitchell and Robert Lyon.

Mr. Mitchell earned a Bachelor of Science degree in Petroleum Engineering from Texas A&M University in 1994. He has been an employee of Unit since 2002. Initially, he was the Outside Operated Engineer and since 2003 he has served in the capacity of Reservoir Engineer and in 2010 he was promoted to Manager of Reservoir Engineering. Before joining Unit, he served in a number of engineering field and technical support positions with Schlumberger Well Services in their pumping services segment (formerly Dowell Schlumberger). He obtained his Professional Engineer registration from the State of Oklahoma in 2004 and has been a member of Society of Petroleum Engineers (SPE) since 1991.

Mr. Lyon received a Bachelor of Science degree in Petroleum Engineering from the University of Tulsa in 1972 and has spent 33 of his 40 years in the industry directly involved in reserve calculation work. Included in this time were 15 years working for petroleum consulting firms Raymond F. Kravis and Associates and Southmayd and Associates performing independent reserve appraisals and audits for corporations and individuals. He joined Unit in 1996 and has shared responsibility for preparation of the company’s reserve report since that time. Mr. Lyon is a registered professional engineer in the State of Oklahoma and a member of the SPE.

As part of the continuing education requirement for maintaining their professional licenses Mr. Mitchell and Mr. Lyon have attended various seminars and forums to enhance their understanding of current standards & issues for reserves presentation. These forums have included those sponsored by various professional societies and professional service firms including Ryder Scott.

Definitions and Other.    Proved oil, NGLs, and natural gas reserves, as defined in SEC Rule 4-10(a), are those quantities of oil and gas, which, by analysis of geoscience and engineering data, can be estimated with reasonable certainty to be economically producible – from a given date forward, from known reservoirs and under existing economic conditions, operating methods and government regulations – before the time the contracts providing the right to operate expire, unless evidence indicates that renewal is reasonably certain, regardless of whether deterministic or probabilistic methods are used for estimation. The project to extract the hydrocarbons must have commenced or the operator must be reasonably certain that it will commence the project within a reasonable time.

The area of the reservoir considered as proved includes:
The area identified by drilling and limited by fluid contacts, if any, and
Adjacent undrilled portions of the reservoir that can, with reasonable certainty, be judged to be continuous with it and to contain economically producible oil or gas on the basis of available geosciences and engineering data.
In the absence of data on fluid contacts, proved quantities in a reservoir are limited by the lowest known hydrocarbons as seen in a well penetration unless geosciences, engineering or performance data and reliable technology establishes a lower contact with reasonable certainty.

Where direct observation from well penetrations has defined a highest known oil elevation and the potential exists for an associated gas cap, proved oil reserves may be assigned in the structurally higher portions of the reservoir only if geosciences, engineering or performance data and reliable technology establish the higher contact with reasonable certainty.

14



Reserves which can be produced economically through application of improved recovery techniques (including, but not limited to, fluid injection) are included in the proved classification when:
Successful testing by a pilot project in an area of the reservoir with properties no more favorable than in the reservoir as a whole;
The operation of an installed program in the reservoir or other evidence using reliable technology establishes reasonable certainty of the engineering analysis on which the project or program was based; and
The project has been approved for development by all necessary parties and entities, including governmental entities.
Existing economic conditions include prices and costs at which economic producibility from a reservoir is to be determined. The price is the average price during the 12-month period before the ending date of the period covered by the report, determined as an unweighted arithmetic average of the first day of month price for each month within the period, unless prices are defined by contractual arrangements, excluding escalations based on future conditions.

Proved undeveloped oil, NGLs, and natural gas reserves are proved reserves that are expected to be recovered from new wells on undrilled acreage, or from existing wells where a relatively major expenditure is required for completion. Reserves on undrilled acreage are limited to those directly offsetting development spacing areas that are reasonably certain of production when drilled, unless evidence using reliable technology exists that establishes reasonable certainty of economic producibility at greater distances. Undrilled locations can be classified as having undeveloped reserves only if a development plan has been adopted indicating that they are scheduled to be drilled within five years, unless the specific circumstances, justify a longer time. Under no circumstances can estimates for proved undeveloped reserves be attributable to any acreage for which an application of fluid injection or other improved recovery technique is contemplated, unless such techniques have been proved effective by actual projects in the same reservoir or an analogous reservoir, or by other evidence using reliable technology establishing reasonable certainty.

Proved Undeveloped Reserves.    As of December 31, 2012, we had approximately 151 gross proved undeveloped wells all of which we plan to develop within five years of initial disclosure at a net estimated cost of approximately $389.6 million. The future estimated development costs necessary to develop our proved undeveloped oil and natural gas reserves in the United States for the years 2013—2017, as disclosed in our December 31, 2012 oil and natural gas reserve report, are $159.5 million, $178.4 million, $19.9 million, $11.0 million, and $20.8 million, respectively. Our proved undeveloped reserves reported at December 31, 2012 did not include reserves that we did not expect to develop within five years of initial disclosure of such reserves. During 2012, we converted 36 proved undeveloped wells into proved developed wells at a cost of approximately $123.4 million. The proved undeveloped reserves that were converted to proved developed reserves during 2012, represented 1.8 MMBls of oil, 3.0 MMBls of NGLs, and 23.9 Bcf of natural gas.

Our estimated proved reserves and the standardized measure of discounted future net cash flows of the proved reserves at December 31, 2012, 2011, and 2010, the changes in quantities and standardized measure of those reserves for the three years then ended, are shown in the Supplemental Oil and Gas Disclosures included in Item 8 of this report.

Contracts.    Our oil production is sold at or near our wells under purchase contracts at prevailing prices in accordance with arrangements customary in the oil industry. Our natural gas production is sold to intrastate and interstate pipelines as well as to independent marketing firms under contracts with terms generally ranging from one month to a year. Few of these contracts contain provisions for readjustment of price as most of them are market sensitive.

Customers.    During 2012, sales to Valero Energy Corporation accounted for 26% of our oil and natural gas revenues. There was no other company that accounted for more than 10% of our oil and natural gas revenues. During 2012, our mid-stream segment purchased $68.2 million of our natural gas and NGLs production and provided gathering and transportation services of $5.1 million. Intercompany revenue from services and purchases of production between our mid-stream segment and our oil and natural gas segment has been eliminated in our consolidated financial statements. In 2011 and 2010, we eliminated intercompany revenues of $76.1 million and $46.8 million, respectively, attributable to the intercompany purchase of our production of natural gas and NGLs as well as gathering and transportation services.


15


MID-STREAM

General.    Our mid-stream operations are conducted through Superior Pipeline Company L.L.C. Its operations consist of buying, selling, gathering, processing, and treating natural gas. In addition, it operates three natural gas treatment plants, 14 processing plants, 39 active gathering systems, and approximately 1,300 miles of pipeline. Superior and its subsidiaries operate in Oklahoma, Texas, Kansas, Pennsylvania, and West Virginia.

The following table presents certain information regarding our mid-stream segment for the years indicated:
 
 
Year Ended December 31,
 
2012
 
2011
 
2010
Gas gathered—MMBtu/day
288,799

 
215,805

 
183,867

Gas processed—MMBtu/day
165,511

 
116,161

 
82,175

NGLs sold—gallons/day
542,578

 
412,064

 
271,360


Dispositions and Acquisitions.    This segment did not have any significant dispositions or acquisitions during 2011 or 2010.

On September 17, 2012, we closed on the acquisition of certain oil and natural gas assets from Noble. Included were four gathering systems that were transferred into our mid-stream segment. The cost for the systems was $18.7 million.

In December 2012, our mid-stream segment had a $1.2 million write down of our Erick system. There was no volume from the wells connected to this system, the compressor and related surface equipment have been removed from this location and there is no future activity anticipated from this gathering system.

Contracts.    Our mid-stream segment provides its customers with a full range of gathering, processing, and treating services. These services are usually provided to each customer under long-term contracts (more than one year), but we do have some short-term contracts as well. Our customer agreements include the following types of contracts:
Fee-Based Contracts.    These contracts provide for a set fee for gathering and transporting raw natural gas. Our mid-stream’s revenue is a function of the volume of natural gas that is gathered or transported and is not directly dependent on the value of the natural gas. For the year ended December 31, 2012, 39% of our mid-stream segment’s total volumes and 25% of its operating margins (as defined below) were under fee-based contracts.
Percent of Proceeds Contracts (POP).    These contracts provide for our mid-stream segment to retain a negotiated percentage of the sale proceeds from residue natural gas and NGLs it gathers and processes, with the remainder being remitted to the producer. In this arrangement, Superior and the producers are directly dependent on the volume of the commodity and its value; Superior owns a percentage of that commodity and is directly subject to fluctuations in its market value. For the year ended December 31, 2012, 59% of our mid-stream segment’s total volumes and 69% of operating margins (as defined below) were under POP contracts.
Percent of Index Contracts (POI).    Under these contracts our mid-stream’s segment, as the processor, purchases raw well-head natural gas from the producer at a stipulated index price and, after processing the natural gas, sells the processed residual gas and the produced NGLs to third parties. Our mid-stream segment is subject to the economic risk (processing margin risk) that the aggregate proceeds from the sale of the processed natural gas and the NGLs could be less than the amount paid for the unprocessed natural gas. For the year ended December 31, 2012, 2% of our mid-stream segment’s total volumes and 6% of operating margins (as defined below) were under POI contracts.

For each of the above contracts, operating margin is defined as total operating revenues less operating expenses and does not include depreciation and amortization, general and administrative expenses, interest expense, or income taxes.

Customers.    During 2012, ONEOK and Gavilon, LLC accounted for approximately 54% and 10%, respectively, of our mid-stream revenues. We believe that if we lost one or both of these identified customers, there are other customers available to purchase our gas and NGLs.


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VOLATILE NATURE OF OUR BUSINESS

The prevailing prices for oil, NGLs, and natural gas significantly affect our revenues, operating results, cash flow as well as our ability to grow our operations. Historically, oil, NGLs, and natural gas prices have been volatile and we expect them to continue to be so. For each of the periods indicated, the following table shows the highest and lowest average prices our oil and natural gas segment received for its sales of oil, NGLs, and natural gas without taking into account the effect of our hedging activity:
 
 
Oil Price per Bbl
 
NGLs Price per Bbl
 
Natural Gas Price per Mcf
Quarter
High
 
Low
 
High
 
Low
 
High
 
Low
2012:
 
 
 
 
 
 
 
 
 
 
 
Fourth
$
87.01

 
$
84.39

 
$
34.82

 
$
32.42

 
$
3.57

 
$
2.54

Third
$
90.04

 
$
82.69

 
$
24.07

 
$
18.02

 
$
2.78

 
$
2.19

Second
$
100.63

 
$
76.35

 
$
34.65

 
$
24.65

 
$
2.34

 
$
1.65

First
$
104.32

 
$
97.31

 
$
39.77

 
$
36.04

 
$
2.80

 
$
2.17

2011:
 
 
 
 
 
 
 
 
 
 
 
Fourth
$
97.26

 
$
86.63

 
$
46.16

 
$
40.57

 
$
3.46

 
$
3.16

Third
$
96.90

 
$
85.68

 
$
47.08

 
$
45.44

 
$
4.30

 
$
3.68

Second
$
107.87

 
$
95.78

 
$
49.43

 
$
44.60

 
$
4.04

 
$
3.83

First
$
99.77

 
$
86.14

 
$
41.66

 
$
38.35

 
$
4.11

 
$
3.53

2010:
 
 
 
 
 
 
 
 
 
 
 
Fourth
$
85.37

 
$
78.20

 
$
43.34

 
$
38.01

 
$
4.00

 
$
2.87

Third
$
72.69

 
$
72.23

 
$
33.05

 
$
29.15

 
$
4.43

 
$
3.12

Second
$
81.18

 
$
71.19

 
$
36.20

 
$
31.29

 
$
3.99

 
$
3.37

First
$
78.08

 
$
73.83

 
$
43.39

 
$
41.50

 
$
5.57

 
$
4.47


Prices for oil, NGLs, and natural gas are subject to wide fluctuations in response to relatively minor changes in the actual or perceived supply of and demand for oil and natural gas, market uncertainty, and a variety of additional factors that are beyond our control, including:
political conditions in oil producing regions, including the Middle East, Nigeria, and Venezuela;
the ability of the members of the Organization of Petroleum Exporting Countries to agree on prices and their ability to maintain production quotas;
the price of foreign oil imports;
imports of liquefied natural gas;
actions of governmental authorities;
the domestic and foreign supply of oil, NGLs, and natural gas;
the level of consumer demand;
United States storage levels of natural gas;
weather conditions;
domestic and foreign government regulations;
the price, availability, and acceptance of alternative fuels;
volatility in ethane prices causing rejection of ethane as part of the liquids processed stream; and
overall economic conditions.


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These factors and the volatile nature of the energy markets make it impossible to predict with any certainty the future prices of oil, NGLs, and natural gas. You are encouraged to read the Risk Factors discussed in Item 1A of this report for additional risks that can impact our operations.

Our contract drilling operations are dependent on the level of demand in our operating markets. Both short-term and long-term trends in oil, NGLs, and natural gas prices affect demand. Because oil, NGLs, and natural gas prices are volatile, the level of demand for our services can also be volatile.

Our mid-stream operations provide us greater flexibility in delivering our (and other parties) natural gas and NGLs from the wellhead to major natural gas and NGLs pipelines. Margins received for the delivery of these natural gas and NGLs are dependent on the price for oil, natural gas, and NGLs and the demand for natural gas and NGLs in our area of operations. If the price of NGLs falls without a corresponding decrease in the cost of natural gas, it may become uneconomical to us to extract certain NGLs. The volumes of natural gas and NGLs processed are highly dependent on the volume and Btu content of the natural gas and NGLs gathered.

It is possible that the current industry shift in drilling for oil and NGLs may at some point impact future natural gas availability as well as prices for natural gas. In addition, the increasing availability of oil and NGLs may impact the price for these products if supply was to exceed demand.

COMPETITION

All of our businesses are highly competitive and price sensitive. Competition in the contract drilling business traditionally involves factors such as demand, price, efficiency, condition of equipment, availability of labor and equipment, reputation, and customer relations.

Our continued drilling success and the success of other activities integral to our operations will depend, in part, on our ability to attract and retain experienced geologists, engineers, and other professionals. Competition for these professionals can be extremely intense, particularly when the industry is experiencing favorable conditions.

Our oil and natural gas operations likewise encounter strong competition from other oil and natural gas companies. Many of these competitors have greater financial, technical, and other resources than we do and have more experience than we do in the exploration for and production of oil and natural gas.

Our mid-stream segment competes with purchasers and gatherers of all types and sizes, including those affiliated with various producers, other major pipeline companies, as well as independent gatherers for the right to purchase natural gas and NGLs, build gathering and processing systems, and deliver the natural gas and NGLs once the gathering and processing systems are established. The principal elements of competition include the rates, terms and availability of services, reputation, and the flexibility and reliability of service.

OIL AND NATURAL GAS PROGRAMS AND CONFLICTS OF INTEREST

Unit Petroleum Company serves as the general partner of 16 oil and natural gas limited partnerships. Three of these partnerships were formed for investment by third parties and 13 (the employee partnerships) were formed to allow our employees and directors the opportunity to participate with Unit Petroleum Company in its operations. The partnerships formed for use in connection with third party investments were formed in 1984 and 1986. One employee partnership has been formed each year beginning with 1984 and ending with 2011.

The employee partnerships formed in 1984 through 1999 have been combined into a single consolidated partnership. The employee partnerships each have a set annual percentage (ranging from 1% to 15%) of our interest that the partnership acquires in most of the oil and natural gas wells we drill or acquire for our own account during the year in which the partnership was formed. The total interest the participants have in our oil and natural gas wells by participating in these partnerships does not exceed one percent of our interest in the wells.

Under the terms of our partnership agreements, the general partner has broad discretionary authority to manage the business and operations of the partnership, including the authority to make decisions regarding the partnership’s participation in a drilling location or a property acquisition, the partnership’s expenditure of funds, and the distribution of funds to partners. Because the business activities of the limited partners and the general partner are not the same, conflicts of interest will exist

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and it is not possible to entirely eliminate these conflicts. Additionally, conflicts of interest may arise when we are the operator of an oil and natural gas well and also provide contract drilling services. In these cases, the drilling operations are conducted under drilling contracts containing terms and conditions comparable to those contained in our drilling contracts with non-affiliated operators. We believe we fulfill our responsibility to each contracting party and comply fully with the terms of the agreements which regulate these conflicts.

These partnerships are further described in Notes 2 and 10 to the Consolidated Financial Statements in Item 8 of this report.

EMPLOYEES

As of February 15, 2013, we had approximately 1,786 employees in our contract drilling segment, 286 employees in our oil and natural gas segment, 126 employees in our mid-stream segment, and 111 in our general corporate area. None of our employees are members of a union or labor organization nor have our operations ever been interrupted by a strike or work stoppage. We consider relations with our employees to be satisfactory.

GOVERNMENTAL REGULATIONS

Our business depends on the demand for services from the oil and natural gas exploration and development industry, and therefore our business can be affected by political developments and changes in laws and regulations that control or curtail drilling for oil and natural gas for economic, environmental, or other policy reasons.

Various state and federal regulations affect the production and sale of oil and natural gas. All states in which we conduct activities impose varying restrictions on the drilling, production, transportation, and sale of oil and natural gas.

Under the Natural Gas Act of 1938, the Federal Energy Regulatory Commission (the FERC) regulates the interstate transportation and the sale in interstate commerce for resale of natural gas. The FERC’s jurisdiction over interstate natural gas sales has been substantially modified by the Natural Gas Policy Act under which the FERC continued to regulate the maximum selling prices of certain categories of gas sold in “first sales” in interstate and intrastate commerce. Effective January 1, 1993, however, the Natural Gas Wellhead Decontrol Act (the Decontrol Act) deregulated natural gas prices for all “first sales” of natural gas. Because “first sales” include typical wellhead sales by producers, all natural gas produced from our natural gas properties is sold at market prices, subject to the terms of any private contracts which may be in effect. The FERC’s jurisdiction over interstate natural gas transportation is not affected by the Decontrol Act.

Our sales of natural gas will be affected by intrastate and interstate gas transportation regulation. Beginning in 1985, the FERC adopted regulatory changes that have significantly altered the transportation and marketing of natural gas. These changes are intended by the FERC to foster competition by, among other things, transforming the role of interstate pipeline companies from wholesale marketers of natural gas to the primary role of gas transporters. All natural gas marketing by the pipelines is required to divest to a marketing affiliate, which operates separately from the transporter and in direct competition with all other merchants. As a result of the various omnibus rulemaking proceedings in the late 1980s and the subsequent individual pipeline restructuring proceedings of the early to mid-1990s, interstate pipelines must provide open and nondiscriminatory transportation and transportation-related services to all producers, natural gas marketing companies, local distribution companies, industrial end users, and other customers seeking service. Through similar orders affecting intrastate pipelines that provide similar interstate services, the FERC expanded the impact of open access regulations to certain aspects of intrastate commerce.

FERC has pursued other policy initiatives that have affected natural gas marketing. Most notable are (1) the large-scale divestiture of interstate pipeline-owned gas gathering facilities to affiliated or non-affiliated companies; (2) further development of rules governing the relationship of the pipelines with their marketing affiliates; (3) the publication of standards relating to the use of electronic bulletin boards and electronic data exchange by the pipelines to make available transportation information on a timely basis and to enable transactions to occur on a purely electronic basis; (4) further review of the role of the secondary market for released pipeline capacity and its relationship to open access service in the primary market; and (5) development of policy and promulgation of orders pertaining to its authorization of market-based rates (rather than traditional cost-of-service based rates) for transportation or transportation-related services upon the pipeline’s demonstration of lack of market control in the relevant service market.


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As a result of these changes, independent sellers and buyers of natural gas have gained direct access to the particular pipeline services they need and are better able to conduct business with a larger number of counter parties. We believe these changes generally have improved the access to markets for natural gas while, at the same time, substantially increasing competition in the natural gas marketplace. However, we cannot predict what new or different regulations the FERC and other regulatory agencies may adopt or what effect subsequent regulations may have on production and marketing of natural gas from our properties.

Although in the past Congress has been very active in the area of natural gas regulation as discussed above, the more recent trend has been in favor of deregulation and the promotion of competition in the natural gas industry. Thus, in addition to “first sales” deregulation, Congress also repealed incremental pricing requirements and natural gas use restraints previously applicable. There continually are legislative proposals pending in the Federal and state legislatures which, if enacted, would significantly affect the petroleum industry. At the present time, it is impossible to predict what proposals, if any, might actually be enacted by Congress or the various state legislatures and what effect, if any, these proposals might have on the production and marketing of natural gas by us. Similarly, and despite the trend toward federal deregulation of the natural gas industry, whether or to what extent that trend will continue or what the ultimate effect will be on the production and marketing of natural gas by us cannot be predicted.

Our sales of oil and natural gas liquids currently are not regulated and are at market prices. The prices received from the sale of these products are affected by the cost of transporting these products to market. Much of that transportation is through interstate common carrier pipelines. Effective as of January 1, 1995, the FERC implemented regulations generally grandfathering all previously approved interstate transportation rates and establishing an indexing system for those rates by which adjustments are made annually based on the rate of inflation, subject to certain conditions and limitations. These regulations may tend to increase the cost of transporting oil and natural gas liquids by interstate pipeline, although the annual adjustments could result in decreased rates in a given year. These regulations have generally been approved on judicial review. Every five years, the FERC will examine the relationship between the annual change in the applicable index and the actual cost changes experienced by the oil pipeline industry and make any necessary adjustment in the index to be used during the ensuing five years. We are not able to predict with certainty what effect, if any, the periodic review of the index by the FERC will have on us.

Federal, state, and local agencies also have promulgated extensive rules and regulations applicable to our oil and natural gas exploration, production, and related operations. Oklahoma, Texas, and other states require permits for drilling operations, drilling bonds, and the filing of reports concerning operations and impose other requirements relating to the exploration of oil and natural gas. Many states also have statutes or regulations addressing conservation matters including provisions for the unitization or pooling of oil and natural gas properties, the establishment of maximum rates of production from oil and natural gas wells, and the regulation of spacing, plugging and, abandonment of such wells. The statutes and regulations of some states limit the rate at which oil and natural gas is produced from our properties. The federal and state regulatory burden on the oil and natural gas industry increases our cost of doing business and affects our profitability. Because these rules and regulations are amended or reinterpreted frequently, we are unable to predict the future cost or impact of complying with those laws.

Our operations are subject to increasingly stringent federal, state, and local laws and regulations governing protection of the environment. These laws and regulations may require acquisition of permits before certain of our operations may be commenced and may restrict the types, quantities, and concentrations of various substances that can be released into the environment. Planning and implementation of protective measures are required to prevent accidental discharges. Spills of oil, natural gas liquids, drilling fluids, and other substances may subject us to penalties and cleanup requirements. Handling, storage, and disposal of both hazardous and non-hazardous wastes are subject to regulatory requirements.

The federal Clean Water Act, as amended by the Oil Pollution Act, the federal Clean Air Act, the federal Resource Conservation and Recovery Act, and their state counterparts, are the primary vehicles for imposition of
such requirements and for civil, criminal, and administrative penalties and other sanctions for violation of their requirements. In addition, the federal Comprehensive Environmental Response Compensation and Liability Act and similar state statutes impose strict liability, without regard to fault or the legality of the original conduct, on certain classes of persons who are considered responsible for the release of hazardous substances into the environment. Such liability, which may be imposed for the conduct of others and for conditions others have caused, includes the cost of remedial action as well as damages to natural resources.

Climate Regulation.    Recent scientific studies have suggested that emissions of certain gases, commonly referred to as “greenhouse gases,” or GHGs, may be contributing to warming of the Earth’s atmosphere. As a result there have been a variety of regulatory developments, proposals or requirements, and legislative initiatives that have been introduced in the United States

20


(as well as other parts of the World) that are focused on restricting the emission of carbon dioxide, methane, and other greenhouse gases.

In 2007, the United States Supreme Court in Massachusetts, et al. v. EPA, held that carbon dioxide may be regulated as an “air pollutant” under the federal Clean Air Act if it represents a health hazard to the public. On December 7, 2009, the U.S. Environmental Protection Agency (“EPA”) responded to the Massachusetts, et al. v. EPA decision and issued a finding that the current and projected concentrations of GHGs in the atmosphere threaten the public health and welfare of current and future generations, and that certain GHGs from new motor vehicles and motor vehicle engines contribute to the atmospheric concentrations of GHG and hence to the threat of climate change. In addition, the EPA issued a final rule, effective in December 2009, requiring the reporting of GHG emissions from specified large (25,000 metric tons or more) GHG emission sources in the U.S., beginning in 2011 for emissions occurring in 2010. During 2010, the EPA proposed revisions to these reporting requirements to apply to all oil and gas production, transmission, processing, and other facilities exceeding certain emission thresholds. The adoption and implementation of any regulations imposing reporting obligations on, or limiting emissions of GHGs from, our equipment and operations could require us to incur additional costs to reduce emissions of GHGs associated with our operations or could adversely affect demand for the crude oil we gather, transport, store or otherwise handle in connection with our services. In addition, both President Obama and the Administrator of the EPA have repeatedly indicated their preference for comprehensive legislation to address this issue and create the framework for a clean energy economy, with the Obama Administration supporting an emission allowance system. Past proposed legislation in Congress has included an economy wide cap and trade program to reduce U.S. greenhouse gas emissions. Some states are also looking at similar types of laws and regulations.

Our oil and natural gas segment routinely applies hydraulic-fracturing techniques to many of our oil and natural gas properties, including our unconventional resource plays in the Granite Wash of Texas and Oklahoma, the Marmaton of Oklahoma, the Wilcox of Texas, and the Bakken of North Dakota and Montana. The EPA, has commenced a study of the potential environmental impacts of hydraulic fracturing, including the impact on drinking water sources and public health, and a committee of the U.S. House of Representatives is also conducting an investigation of hydraulic fracturing practices. Legislation has been introduced before Congress to provide for federal regulation of hydraulic fracturing and to require disclosure of the chemicals used in the fracturing process. In addition, certain states in which we operate, including Texas and Wyoming have adopted, and other states as well as municipalities and other local governmental entities in some states, have and others are considering adopting regulations and ordinances that could impose more stringent permitting, public disclosure, waste disposal, and well construction requirements on these operations, and possibly even restrict or ban hydraulic fracturing in certain circumstances. Any new laws, regulation, or permitting requirements regarding hydraulic fracturing could lead to operational delay, or increased operating costs or third party or governmental claims, and could result in additional burdens that could serve to delay or limit the drilling services we provide to third parties whose drilling operations could be impacted by these regulations or increase our costs of compliance and doing business as well as delay the development of unconventional gas resources from shale formations which are not commercial without the use of hydraulic fracturing. Restrictions on hydraulic fracturing could also reduce the amount of oil and natural gas that we are ultimately able to produce from our reserves.

Further, after reviewing extensive comments and making a number of changes to its previously July 28, 2011 proposed rules, on April 17, 2012 the EPA issued its final rules that subject a wide range of oil and gas operations (production, processing, transmission, storage, and distribution) to regulation under the New Source Performance Standards (NSPS) and National Emission Standards for Hazardous Air Pollutants (NESHAPS) programs (with the NSPS and NESHAPS published in the Federal Register on August 16, 2012). The EPA revised the NSPS for volatile organic compounds (VOCs) from leaking components at onshore gas processing plants and the NSPS for sulfur dioxide emissions from natural gas processing plants. The EPA also established standards for certain oil and gas operations not covered by existing standards, which will regulate VOC emissions from gas wells, centrifugal and reciprocating compressors, pneumatic controllers, and storage vessels over a certain size. The EPA also made revisions to the existing leak detection and repair requirements for the oil and gas production source category and the natural gas transmission source category and established action limits reflecting most achievable control for certain previously uncontrolled emission sources. There also are additional testing and related notification, record keeping and reporting requirements. These changes were effective October 15, 2012.

The EPA regulations also result in the first federal air standards for natural gas wells that are hydraulically fractured. Refractured gas wells that use the “green completions” will not be considered affected from a federal standpoint. Operators may choose to flare for now from refractured wells and phase in green completions by January 1, 2015, but any such refractured well will be considered an affected facility for permitting purposes.


21


The EPA will be designating nonattainment areas for ozone standards for outdoor quality. These areas will include those areas with significant oil and gas activities. Nonattainment areas will be required to submit state implementation plans in 2015 and to attain the standard by 2015 and 2018 for areas classified as “Marginal” and “Moderate,” respectively. Areas classified as “Serious” must attain by 2021. The federal NSPS constitute a federally required minimum level of control. States have the flexibility to put their own program in place or implement existing programs as long as they are at least as protective as the federal NSPS.

Consequently, while we have been in the process of assessing and implementing the new EPA requirements as required, at this time we do not know and cannot predict with any degree of certainty what areas the EPA will designate nonattainment and what classification will be applied nor what the states may implement for such nonattainment areas which may affect our business segments and use of hydraulic fracturing practices.

We do not know and cannot predict whether there will be any further proposed legislation or regulations It is possible that such future laws, regulations, and/or ordinances could result in increasing our compliance costs or additional operating restrictions as well as those of our customers. It is also possible that such future developments could curtail the demand for fossil fuels which could adversely affect the demand for our services, which in turn could adversely affect our future results of operations. Likewise we cannot predict with any certainty whether any changes to temperature, storm intensity or precipitation patterns as a result of climate change (or otherwise) will have a material impact on our operations.

Compliance with applicable environmental requirements has not, to date, had a material effect on the cost of our operations, earnings, or competitive position. However, as noted above in connection with our discussion of the regulation of GHGs and hydraulic fracturing, compliance with amended, new or more stringent requirements of existing environmental regulations or requirements may cause us to incur additional costs or subject us to liabilities that may have a material adverse effect on our results of operations and financial condition.

FINANCIAL INFORMATION ABOUT GEOGRAPHIC AREAS

Revenues from our Canadian operations during the last three fiscal years, as well as information relating to long-lived assets attributable to those operations are immaterial. We have no other international operations.

Item 1A. Risk Factors

FORWARD-LOOKING STATEMENTS/CAUTIONARY STATEMENT AND RISK FACTORS

This report contains “forward-looking statements” – meaning, statements related to future, not past, events within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended. All statements, other than statements of historical facts, included or incorporated by reference in this document which addresses activities, events or developments which we expect or anticipate will or may occur in the future, are forward-looking statements. The words “believes,” “intends,” “expects,” “anticipates,” “projects,” “estimates,” “predicts,” and similar expressions are used to identify forward-looking statements. This report modifies and supersedes documents filed by us before this report. In addition, certain information that we file with the SEC in the future will automatically update and supersede information contained in this report.

These forward-looking statements include, among others, such things as:
the amount and nature of our future capital expenditures and how we expect to fund our capital expenditures;
the number of wells we plan to drill or rework;
prices for oil, NGLs, and natural gas;
demand for oil, NGLs, and natural gas;
our exploration and drilling prospects;
the estimates of our proved oil, NGLs, and natural gas reserves;
oil, NGLs, and natural gas reserve potential;
development and infill drilling potential;

22


expansion and other development trends of the oil and natural gas industry;
our business strategy;
production of oil, NGLs, and natural gas reserves;
the number of gathering systems and processing plants we plan to construct or acquire;
volumes and prices for natural gas gathered and processed and NGLs sold;
expansion and growth of our business and operations;
demand and drilling rates for our drilling rigs;
our belief that the final outcome of our legal proceedings will not materially affect our financial results;
our ability to timely secure third party services used in completing our wells;
our ability to transport or convey our oil, NGLs, or natural gas production to established pipeline systems; and
federal and state legislative and regulatory initiatives relating to hydrocarbon fracturing which could result in increased costs and additional operating restrictions or delays as well as adversely affecting our business.

These statements are based on certain assumptions and analyses made by us in light of our experience and our perception of historical trends, current conditions, and expected future developments as well as other factors we believe are appropriate in the circumstances. However, whether actual results and developments will conform to our expectations and predictions is subject to a number of risks and uncertainties which could cause actual results to differ materially from our expectations, including:
the risk factors discussed in this report and in the documents we incorporate by reference;
general economic, market, or business conditions;
the availability of and nature or lack of business opportunities that we pursue;
demand for our land drilling services;
changes in laws or regulations;
decreases or increases in commodity prices; and
other factors, most of which are beyond our control.

You should not place undue reliance on any of these forward-looking statements. Except as required by law, we disclaim any current intention to update forward-looking information and to release publicly the results of any future revisions we may make to forward-looking statements to reflect events or circumstances after the date of this report to reflect the occurrence of unanticipated events.

In order to help provide you with a more thorough understanding of the possible effects of some of these influences on any forward-looking statements made by us, the following discussion outlines some (but not all) of the factors that could in the future cause our 2013 and following consolidated results to differ materially from those that may be presented in any forward-looking statement made by us or on our behalf.

Contract Drilling Customer Demand.    With the exception of the drilling we do for our own account, the demand for our contract drilling services depends entirely on the needs of third parties. Based on past history, these parties’ requirements are subject to a number of factors, independent of any subjective factors that directly impact the demand for our drilling rigs, including the availability of funds to carry out their drilling operations. For many of these parties, even if they have available funds, their decision to spend those funds is often based on the then current price for oil, NGLs, and natural gas. Other factors that affect our ability to work our drilling rigs are: the weather which, under certain circumstances, can delay or even cause the abandonment of a project by an operator; the competition we face in securing the award of drilling contracts; our lack of prior history in and recognition in a new market area; and the availability of labor to operate our drilling rigs.

Oil, NGLs, and Natural Gas Prices.    The prices we receive for our oil, NGLs, and natural gas production have a direct impact on our revenues, profitability, and cash flow as well as our ability to meet our projected financial and operational goals.

23


The prices for oil, NGLs, and natural gas are determined on a number of factors beyond our control, including:
the demand for and supply of oil, NGLs, and natural gas;
current weather conditions in the continental United States (which can greatly influence the demand and prices for natural gas at any given time);
the amount and timing of liquid natural gas and liquefied petroleum gas imports and exports; and
the ability of current distribution systems in the United States to effectively meet the demand for oil, NGLs, and natural gas at any given time, particularly in times of peak demand which may result because of adverse weather conditions.
Oil prices are extremely sensitive to foreign influences based on political, social or economic underpinnings, any one of which could have an immediate and significant effect on the price and supply of oil. In addition, prices of oil, NGLs, and natural gas have been at various times influenced by trading on the commodities markets. That trading, at times, has tended to increase the volatility associated with these prices resulting in large differences in prices even on a week-to-week and month-to-month basis. All of these factors, especially when coupled with the fact that much of our product prices are determined on a daily basis, can, and at times do, lead to wide fluctuations in the prices we receive.

Based on our 2012 production, a $0.10 per Mcf change in what we receive for our natural gas production, without the effect of hedging, would result in a corresponding $386,000 per month ($4.6 million annualized) change in our pre-tax operating cash flow. A $1.00 per barrel change in our oil price, without the effect of hedging, would have a $259,000 per month ($3.1 million annualized) change in our pre-tax operating cash flow and a $1.00 per barrel change in our NGLs price, without the effect of hedging, would have a $220,000 per month ($2.6 million annualized) change in our pre-tax operating cash flow.

In order to reduce our exposure to short-term fluctuations in the price of oil, NGLs, and natural gas, we sometimes enter into hedging arrangements such as swaps and collars. To date, we have hedged part, but not all of our production which only provides price protection against declines in oil, NGLs, and natural gas prices on the production subject to our hedges, but not otherwise. Should market prices for the production we have hedged exceed the prices due under our hedges, our hedging arrangements then expose us to risk of financial loss and limit the benefit to us of those increases in market prices. During 2012, substantially all of our oil, NGLs, and natural gas volumes were sold at market responsive prices. To help manage our cash flow and capital expenditure requirements, we hedged approximately 68% and 37% of our 2012 average daily production for oil and natural gas, respectively. A more thorough discussion of our hedging arrangements is contained in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section of this report contained in Item 7.

Uncertainty of Oil, NGLs, and Natural Gas Reserves; Ceiling Test.    There are many uncertainties inherent in estimating quantities of oil, NGLs, and natural gas reserves and their values, including many factors beyond our control. The oil, NGLs, and natural gas reserve information included in this report represents only an estimate of these reserves. Oil, NGLs, and natural gas reservoir engineering is a subjective and an inexact process of estimating underground accumulations of oil, NGLs, and natural gas that cannot be measured in an exact manner. Estimates of economically recoverable oil, NGLs, and natural gas reserves depend on a number of variable factors, including historical production from the area compared with production from other producing areas, and assumptions concerning:
reservoir size;
the effects of regulations by governmental agencies;
future oil, NGLs, and natural gas prices;
future operating costs;
severance and excise taxes;
development costs; and
workover and remedial costs.

Some or all of these assumptions may vary considerably from actual results. For these reasons, estimates of the economically recoverable quantities of oil, NGLs, and natural gas attributable to any particular group of properties, classifications of those oil, NGLs, and natural gas reserves based on risk of recovery, and estimates of the future net cash flows

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from oil, NGLs, and natural gas reserves prepared by different engineers or by the same engineers but at different times may vary substantially. Accordingly, oil, NGLs, and natural gas reserve estimates may be subject to periodic downward or upward adjustments. Actual production, revenues, and expenditures with respect to our oil, NGLs, and natural gas reserves will likely vary from estimates and those variances may be material.
The information regarding discounted future net cash flows included in this report is not necessarily the current market value of the estimated oil, NGLs, and natural gas reserves attributable to our properties. The use of full cost accounting requires us to use the unweighted arithmetic average of the commodity prices existing on the first day of each of the 12 months before the end of the reporting period to calculate discounted future revenues, unless prices were otherwise determined under contractual arrangements. Actual future prices and costs may be materially higher or lower. Actual future net cash flows are also affected, in part, by the following factors:
the amount and timing of oil, NGLs, and natural gas production;
supply and demand for oil, NGLs, and natural gas;
increases or decreases in consumption; and
changes in governmental regulations or taxation.

In addition, the 10% discount factor, required by the SEC for use in calculating discounted future net cash flows for reporting purposes, is not necessarily the most appropriate discount factor based on interest rates in effect from time to time and the risks associated with our operations or the oil and natural gas industry in general.

We review quarterly the carrying value of our oil and natural gas properties under the full cost accounting rules of the SEC. Under these rules, capitalized costs of proved oil and natural gas properties may not exceed the present value of estimated future net revenues from those proved reserves, discounted at 10%. Application of this “ceiling test” generally requires pricing future revenue at the unescalated 12-month average price and requires a write-down for accounting purposes if we exceed the ceiling. We may be required to write down the carrying value of our oil and natural gas properties when oil, NGLs, and natural gas prices are depressed. If a write-down is required, it would result in a charge to earnings but would not impact our cash flow from operating activities. Once incurred, a write-down of oil and natural gas properties is not reversible.

As a result of these ceiling test rules, during the quarters ending June 30, 2012 and December 31, 2012, we recorded a non-cash ceiling test write down of $115.9 million pre-tax ($72.1 million, net of tax) and $167.7 million pre-tax ($104.4 million, net of tax), respectively. No ceiling test write down was necessary during 2011 or 2010.
If there are further declines in the 12-month average prices, including the discounted value of our commodity hedges, we may be required to record a write-down in future periods.

We are continually identifying and evaluating opportunities to acquire oil and natural gas properties, including acquisitions that would be significantly larger than those we have consummated to date. We cannot assure you that we will successfully consummate any acquisition, that we will be able to acquire producing oil and natural gas properties that contain economically recoverable reserves or that any acquisition will be profitably integrated into our operations.

Debt and Bank Borrowing.    We have incurred and currently expect to continue to incur substantial capital expenditures because of the growth in our operations. Historically, we have funded our capital needs through a combination of internally generated cash flow and borrowings under our bank credit agreement. In 2011 and 2012, we issued $250.0 million (the 2011 Notes) and $400.0 million (the 2012 Notes), respectively, of senior subordinated notes (collectively, the Notes). We have also, from time to time, obtained funds through equity financing. We currently have, and will continue to have, a certain amount of indebtedness. At December 31, 2012, our outstanding long-term debt under our credit agreement was $71.1 million and the amount of the Notes, net of unamortized discount, was $645.3 million.

Depending on the amount of our debt, the cash flow needed to satisfy that debt and the covenants contained in our bank credit agreement and those applicable to the Notes could:
limit funds otherwise available for financing our capital expenditures, our drilling program or other activities or cause us to curtail these activities;
limit our flexibility in planning for or reacting to changes in our business;
place us at a competitive disadvantage to those of our competitors that are less indebted than we are;

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make us more vulnerable during periods of low oil, NGLs, and natural gas prices or in the event of a downturn in our business; and
prevent us from obtaining additional financing on acceptable terms or limit amounts available under our existing or any future credit facilities.

Our ability to meet our debt obligations depends on our future performance. If the requirements of our indebtedness are not satisfied, a default could be deemed to occur and our lenders or the holders of the Notes would be entitled to accelerate the payment of the outstanding indebtedness. If that were to occur, we would not have sufficient funds available and probably would not be able to obtain the financing required to meet our obligations.

The amount of our existing debt, as well as our future debt, if any, is, to a large extent, based on the costs associated with the projects we undertake at any given time and of our cash flow. Generally, our normal operating costs are those resulting from the drilling of oil and natural gas wells, the acquisition of producing properties, the costs associated with the maintenance, upgrade or expansion of our drilling rig fleet, and the operations of our natural gas buying, selling, gathering, processing, and treating systems. To some extent, these costs, particularly the first two are discretionary and we maintain a degree of control regarding the timing or the need to incur them. But, in some cases, unforeseen circumstances may arise, such as in the case of an unanticipated opportunity to make a large acquisition or the need to replace a costly drilling rig component due to an unexpected loss, which could force us to incur additional debt above that which we had expected or forecasted. Likewise, if our cash flow should prove to be insufficient to cover our current cash requirements we would need to increase our debt either through bank borrowings or otherwise.

RISK FACTORS

There are many other factors that could adversely affect our business. The following discussion describes the material risks currently known to us. However, additional risks that we do not know about or that we currently view as immaterial may also impair our business or adversely affect the value of our securities. You should carefully consider the risks described below together with the other information contained in, or incorporated by reference into, this report.

If demand for oil, NGLs, and natural gas is reduced, our ability to market as well as produce our oil, NGLs, and natural gas may be negatively affected.

Historically, oil, NGLs, and gas prices have been extremely volatile, with significant increases and significant price drops being experienced from time to time. In the future, various factors beyond our control will have a significant effect on oil, NGLs, and gas prices. Such factors include, among other things, the domestic and foreign supply of oil, NGLs, and gas, the price of foreign imports, the levels of consumer demand, the price and availability of alternative fuels, the availability of pipeline capacity, and changes in existing and proposed federal regulation and price controls.

The oil, NGLs, and natural gas markets are also unsettled due to a number of factors. Production from oil and natural gas wells in some geographic areas of the United States has been curtailed for considerable periods of time due to a lack of market demand and/or transportation and storage capacity. It is possible, however, that some of our wells may in the future be shut-in or that oil, NGLs, and natural gas will be sold on terms less favorable than might otherwise be obtained should demand for oil, NGLs, and natural gas decrease. Competition for available markets has been vigorous and there remains great uncertainty about prices that purchasers will pay. Oil, NGLs, and natural gas surpluses could result in our inability to market oil, NGLs, and natural gas profitably, causing us to curtail production and/or receive lower prices for our oil, NGls, and natural gas, situations which would adversely affect us.

Disruptions in the financial markets could affect our ability to obtain financing or refinance existing indebtedness on reasonable terms and may have other adverse effects.

Commercial-credit market disruptions may result in tight credit markets in the United States. Liquidity in the global-credit markets can be severely contracted by market disruptions making terms for certain financings less attractive, and in certain cases, result in the unavailability of certain types of financing. As a result of credit-market turmoil, we may not be able to obtain debt financing, or refinance existing indebtedness on favorable terms, which could affect operations and financial performance.



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Oil, NGLs, and natural gas prices are volatile, and low prices have negatively affected our financial results and could do so in the future.

Our revenues, operating results, cash flow, and future rate of growth depend substantially on prevailing prices for oil, NGLs, and natural gas. Historically, oil, NGLs, and natural gas prices and markets have been volatile, and they are likely to continue to be volatile in the future. Any decline in prices in the future would have a negative impact on our future financial results.

Prices for oil, NGLs, and natural gas are subject to wide fluctuations in response to relatively minor changes in the supply of and demand for oil, NGLs, and natural gas, market uncertainty, and a variety of additional factors that are beyond our control. These factors include:
political conditions in oil producing regions, including the Middle East, Nigeria, and Venezuela;
the ability of the members of the Organization of Petroleum Exporting Countries to agree on prices and their ability to maintain production quotas;
the price of foreign oil imports;
imports of liquefied natural gas;
actions of governmental authorities;
the domestic and foreign supply of oil, NGLs, and natural gas;
the level of consumer demand;
U.S. storage levels of oil, NGLs, and natural gas;
weather conditions;
domestic and foreign government regulations;
the price, availability, and acceptance of alternative fuels; and
overall economic conditions.

These factors and the volatile nature of the energy markets make it impossible to predict with any certainty the future prices of oil, NGLs, and natural gas.

Our contract drilling operations depend on levels of activity in the oil, NGLs, and natural gas exploration and production industry.

Our contract drilling operations depend on the level of activity in oil, NGLs, and natural gas exploration and production in our operating markets. Both short-term and long-term trends in oil, NGLs, and natural gas prices affect the level of that activity. Because oil, NGLs, and natural gas prices are volatile, the level of exploration and production activity can also be volatile. Any decrease from current oil, NGLs, and natural gas prices would depress the level of exploration and production activity. This, in turn, would likely result in a decline in the demand for our drilling services and would have an adverse effect on our contract drilling revenues, cash flows, and profitability. As a result, the future demand for our drilling services is uncertain.

The industries in which we operate are highly competitive, and many of our competitors have greater resources than we do.

The drilling industry in which we operate is generally very competitive. Most drilling contracts are awarded on the basis of competitive bids, which may result in intense price competition. Some of our competitors in the contract drilling industry have greater financial and human resources than we do. These resources may enable them to better withstand periods of low drilling rig utilization, to compete more effectively on the basis of price and technology, to build new drilling rigs or acquire existing drilling rigs, and to provide drilling rigs more quickly than we do in periods of high drilling rig utilization.

The oil and natural gas industry is also highly competitive. We compete in the areas of property acquisitions and oil and natural gas exploration, development, production, and marketing with major oil companies, other independent oil and natural gas concerns, and individual producers and operators. In addition, we must compete with major and independent oil and natural

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gas concerns in recruiting and retaining qualified employees. Many of our competitors in the oil and natural gas industry have substantially greater resources than we do.

Continued growth through acquisitions is not assured.

In the past, we have experienced growth in each of our segments, in part, through mergers and acquisitions. The contract land drilling industry, the exploration and development industry, as well as the gas gathering and processing industry, have experienced significant consolidation over the past several years, and there can be no assurance that acquisition opportunities will continue to be available. Additionally, we are likely to continue to face intense competition from other companies for available acquisition opportunities.

There can be no assurance that we will:
be able to identify suitable acquisition opportunities;
have sufficient capital resources to complete additional acquisitions;
successfully integrate acquired operations and assets;
effectively manage the growth and increased size;
maintain the crews and market share to operate any future drilling rigs we may acquire; or
successfully improve our financial condition, results of operations, business or prospects in any material manner as a result of any completed acquisition.

We may incur substantial indebtedness to finance future acquisitions and also may issue debt instruments, equity securities, or convertible securities in connection with any acquisitions. Debt service requirements could represent a significant burden on our results of operations and financial condition and the issuance of additional equity would be dilutive to existing shareholders. Also, continued growth could strain our management, operations, employees, and other resources.

Successful acquisitions, particularly those of oil and natural gas companies or of oil and natural gas properties require an assessment of a number of factors, many of which are beyond our control. These factors include recoverable reserves, exploration potential, future oil, NGLs, and natural gas prices, operating costs, and potential environmental and other liabilities. Such assessments are inexact and their accuracy is inherently uncertain.

Our operations have significant capital requirements, and our indebtedness could have important consequences.

We have experienced and may continue to experience substantial capital needs in the growth of our operations. We have $645.3 million of indebtedness outstanding (net of unamortized discount) under the senior subordinated notes we have issued to date and in addition, have the right to borrow up to $500.0 million under our credit agreement. As of February 15, 2013, we have outstanding borrowings of $67.5 million under our credit agreement. Our level of indebtedness, the cash flow needed to satisfy our indebtedness, and the covenants governing our indebtedness could:
limit funds available for financing capital expenditures, our drilling program or other activities or cause us to curtail these activities;
limit our flexibility in planning for, or reacting to changes in, our business;
place us at a competitive disadvantage to some of our competitors that are less leveraged than we are;
make us more vulnerable during periods of low oil, NGLs, and natural gas prices or in the event of a downturn in our business; and
prevent us from obtaining additional financing on acceptable terms or limit amounts available under our existing or any future credit facilities.

Our ability to meet our debt service and other contractual and contingent obligations will depend on our future performance. In addition, lower oil, NGLs, and natural gas prices could result in future reductions in the amount available for borrowing under our credit agreement, reducing our liquidity, and even triggering mandatory loan repayments.


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The instruments governing our indebtedness contain various covenants limiting the conduct of our business.

The indentures governing our notes and our credit agreement contain various restrictive covenants that limit the conduct of our business. In particular, these agreements will place certain limits on our ability to, among other things:
incur additional indebtedness, guarantee obligations or issue disqualified capital stock;
pay dividends or distributions on our capital stock or redeem, repurchase or retire our capital stock;
make investments or other restricted payments;
grant liens on assets;
enter into transactions with stockholders or affiliates;
sell assets;
issue or sell capital stock of certain subsidiaries; and
merge or consolidate.
In addition, our credit agreement also requires us to maintain a minimum current ratio and a maximum leverage ratio.
If we fail to comply with the restrictions in the indentures governing our notes, our credit agreement or any other subsequent financing agreements, a default may allow the creditors, if the agreements so provide, to accelerate the related indebtedness as well as any other indebtedness to which a cross-acceleration or cross-default provision applies. If that occurs, we may not be able to make all of the required payments or borrow sufficient funds to refinance that debt. Even if new financing were available at that time, it may not be on terms acceptable to us. In addition, lenders may be able to terminate any commitments they had made to make available further funds.

Our future performance depends on our ability to find or acquire additional oil, NGLs, and natural gas reserves that are economically recoverable.

In general, production from oil and natural gas properties declines as reserves are depleted, with the rate of decline depending on reservoir characteristics. Unless we successfully replace the reserves that we produce, our reserves will decline, resulting eventually in a decrease in oil, NGLs, and natural gas production and lower revenues and cash flow from operations. Historically, we have succeeded in increasing reserves after taking production into account through exploration and development. We have conducted these activities on our existing oil and natural gas properties as well as on newly acquired properties. We may not be able to continue to replace reserves from these activities at acceptable costs. Lower prices of oil, NGLs, and natural gas may further limit the kinds of reserves that can economically be developed. Lower prices also decrease our cash flow and may cause us to decrease capital expenditures.

We are continually identifying and evaluating opportunities to acquire oil and natural gas properties, including acquisitions that would be significantly larger than those consummated to date by us. We cannot assure you that we will successfully consummate any acquisition, that we will be able to acquire producing oil and natural gas properties that contain economically recoverable reserves or that any acquisition will be profitably integrated into our operations.

The competition for producing oil and natural gas properties is intense. This competition could mean that to acquire properties we will have to pay higher prices and accept greater ownership risks than we have in the past.


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Our exploration and production and mid-stream operations involve a high degree of business and financial risk which could adversely affect us.

Exploration and development involve numerous risks that may result in dry holes, the failure to produce oil, NGLs, and natural gas in commercial quantities and the inability to fully produce discovered reserves. The cost of drilling, completing, and operating wells is substantial and uncertain. Numerous factors beyond our control may cause the curtailment, delay, or cancellation of drilling operations, including:
unexpected drilling conditions;
pressure or irregularities in formations;
capacity of pipeline systems;
equipment failures or accidents;
adverse weather conditions;
compliance with governmental requirements; and
shortages or delays in the availability of drilling rigs or delivery crews and the delivery of equipment.

Exploratory drilling is a speculative activity. Although we may disclose our overall drilling success rate, those rates may decline. Although we may discuss drilling prospects that we have identified or budgeted for, we may ultimately not lease or drill these prospects within the expected time frame, or at all. Lack of drilling success will have an adverse effect on our future results of operations and financial condition.

Our mid-stream operations involve numerous risks, both financial and operational. The cost of developing gathering systems and processing plants is substantial and our ability to recoup these costs is uncertain. Our operations may be curtailed, delayed, or canceled as a result of many things beyond our control, including:
unexpected changes in the deliverability of natural gas reserves from the wells connected to the gathering systems;
availability of competing pipelines in the area;
capacity of pipeline systems;
equipment failures or accidents;
adverse weather conditions;
compliance with governmental requirements;
delays in the development of other producing properties within the gathering system’s area of operation; and
demand for natural gas and its constituents.

Many of the wells from which we gather and process natural gas are operated by other parties. As a result, we have little control over the operations of those wells which can act to increase our risk. Operators of those wells may act in ways that are not in our best interests.

Competition for experienced technical personnel may negatively impact our operations or financial results.

Our continued oil and natural gas segment and mid-stream segment success and the success of other activities integral to our operations will depend, in part, on our ability to attract and retain experienced geologists, engineers, and other professionals. Competition for these professionals can be extremely intense, particularly when the industry is experiencing favorable conditions.

Our hedging arrangements might limit the benefit of increases in oil, NGLs, and natural gas prices.

In order to reduce our exposure to short-term fluctuations in the price of oil, NGLs, and natural gas, we sometimes enter into hedging arrangements. Our hedging arrangements apply to only a portion of our production and provide only partial price protection against declines in oil, NGLs, and natural gas prices. These hedging arrangements may expose us to risk of financial

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loss and limit the benefit to us of increases in prices.

Estimates of our reserves are uncertain and may prove to be inaccurate.

There are numerous uncertainties inherent in estimating quantities of proved reserves and their values, including many factors beyond our control. The reserve data represents only estimates. Reservoir engineering is a subjective and inexact process of estimating underground accumulations of oil and natural gas that cannot be measured in an exact manner. Estimates of economically recoverable oil, NGLs, and natural gas reserves depend on a number of variable factors, including historical production from the area compared with production from other producing areas, and assumptions concerning:
the effects of regulations by governmental agencies;
future oil, NGLs, and natural gas prices;
future operating costs;
severance and excise taxes;
development costs; and
workover and remedial costs.

Some or all of these assumptions may vary considerably from actual results. For these reasons, estimates of the economically recoverable quantities of oil, NGLs, and natural gas attributable to any particular group of properties, classifications of those reserves based on risk of recovery, and estimates of the future net cash flows from reserves prepared by different engineers or by the same engineers but at different times may vary substantially. Accordingly, reserve estimates may be subject to downward or upward adjustment. Actual production, revenues and expenditures with respect to our reserves will likely vary from estimates, and those variances may be material.

The information regarding discounted future net cash flows should not be considered as the current market value of the estimated oil, NGLs, and natural gas reserves attributable to our properties. As required by the SEC, the estimated discounted future net cash flows from proved reserves are based on prices on the first day of the month for each month within the 12-month period before the end of the reporting period and costs as of the date of the estimate, while actual future prices and costs may be materially higher or lower. Actual future net cash flows also will be affected by the following factors:
the amount and timing of actual production;
supply and demand for oil, NGLs, and natural gas;
increases or decreases in consumption; and
changes in governmental regulations or taxation.

In addition, the 10% per year discount factor, which is required by the SEC to be used in calculating discounted future net cash flows for reporting purposes, is not necessarily the most appropriate discount factor based on interest rates in effect from time to time and risks associated with our operations or the oil and natural gas industry in general.

If oil, NGLs, and natural gas prices decrease or are unusually volatile, we may be required to take write-downs of our oil and natural gas properties, the carrying value of our drilling rigs or our natural gas gathering and processing systems.

We review quarterly the carrying value of our oil and natural gas properties under the full cost accounting rules of the SEC. Under these rules, capitalized costs of proved oil and natural gas properties may not exceed the present value of estimated future net revenues from proved reserves, discounted at 10% per year. Application of the ceiling test generally requires pricing future revenue at the unweighted arithmetic average of the price on the first day of month for each month within the 12-month period prior to the end of the reporting period, unless prices were defined by contractual arrangements, and requires a write-down for accounting purposes if the ceiling is exceeded. We may be required to write down the carrying value of our oil and natural gas properties when oil, NGLs, and natural gas prices are depressed. If a write-down is required, it would result in a charge to earnings, but would not impact cash flow from operating activities. Once incurred, a write-down of oil and natural gas properties is not reversible at a later date.


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Our drilling equipment, transportation equipment, gas gathering and processing systems, and other property and equipment are carried at cost. We are required to periodically test to see if these values, including associated goodwill and other intangible assets, have been impaired whenever events or changes in circumstances suggest the carrying amount may not be recoverable. If any of these assets are determined to be impaired, the loss is measured as the amount by which the carrying amount of the asset exceeds its fair value. An estimate of fair value is based on the best information available, including prices for similar assets. Changes in these estimates could cause us to reduce the carrying value of property, equipment, and related intangible assets. Once these values have been reduced, they are not reversible.


Our operations present inherent risks of loss that, if not insured or indemnified against, could adversely affect our results of operations.

Our contract drilling operations are subject to many hazards inherent in the drilling industry, including blowouts, cratering, explosions, fires, loss of well control, loss of hole, damaged or lost drilling equipment, and damage or loss from inclement weather. Our exploration and production and mid-stream operations are subject to these and similar risks. Any of these events could result in personal injury or death, damage to or destruction of equipment and facilities, suspension of operations, environmental damage, and damage to the property of others. Generally, drilling contracts provide for the division of responsibilities between a drilling company and its customer, and we seek to obtain indemnification from our drilling customers by contract for some of these risks. To the extent that we are unable to transfer these risks to drilling customers by contract or indemnification agreements (or to the extent we assume obligations of indemnity or assume liability for certain risks under our drilling contracts), we seek protection from some of these risks through insurance. However, some risks are not covered by insurance and we cannot assure you that the insurance we do have or the indemnification agreements we have entered into will adequately protect us against liability from all of the consequences of the hazards described above. The occurrence of an event not fully insured or indemnified against, or the failure of a customer to meet its indemnification obligations, could result in substantial losses. In addition, we cannot assure you that insurance will be available to cover any or all of these risks. Even if available, the insurance might not be adequate to cover all of our losses, or we might decide against obtaining that insurance because of high premiums or other costs.

In addition, we are not the operator of many of our wells. As a result, our operating risks for those wells and our ability to influence the operations for those wells are less subject to our control. Operators of those wells may act in ways that are not in our best interests.

Governmental and environmental regulations could adversely affect our business.

Our business is subject to federal, state, and local laws and regulations on taxation, the exploration for and development, production, and marketing of oil and natural gas, and safety matters. Many laws and regulations require drilling permits and govern the spacing of wells, rates of production, prevention of waste, unitization and pooling of properties, and other matters. These laws and regulations have increased the costs of planning, designing, drilling, installing, operating, and abandoning our oil and natural gas wells and other facilities. In addition, these laws and regulations, and any others that are passed by the jurisdictions where we have production, could limit the total number of wells drilled or the allowable production from successful wells, which could limit our revenues.

We are (or could become) subject to complex environmental laws and regulations adopted by the various jurisdictions where we own or operate. We could incur liability to governments or third parties for discharges of oil, natural gas or other pollutants into the air, soil or water, including responsibility for remedial costs. We could potentially discharge these materials into the environment in any number of ways including the following:
from a well or drilling equipment at a drill site;
from gathering systems, pipelines, transportation facilities, and storage tanks;
damage to oil and natural gas wells resulting from accidents during normal operations; and
blowouts, cratering, and explosions.

Because the requirements imposed by laws and regulations are frequently changed, we cannot assure you that laws and regulations enacted in the future, including changes to existing laws and regulations, will not adversely affect our business. The current Congress and White House administration may impose or change laws and regulations that will adversely affect our

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business. With the trend toward stricter standards, greater regulation, and more extensive permit requirements, our risks related to environmental matters and our environmental expenditures could increase in the future. In addition, because we acquire interests in properties that have been operated in the past by others, we may be liable for environmental damage caused by the former operators, which liability could be material.

Any future implementation of price controls on oil, NGLs, and natural gas would affect our operations.

Certain groups have asserted efforts to have the United States Congress impose some form of price controls on either oil, natural gas or both. There is no way at this time to know what result these efforts will have nor, if implemented, their effect on our operations. However, it is possible that these efforts, if successful, would serve to limit the amount that we might be able to get for our future oil, NGLs, and natural gas production. Any future limits on the price of oil, NGLs, and natural gas could also result in adversely affecting the demand for our drilling services.

Our shareholders’ rights plan and provisions of Delaware law and our by-laws and charter could discourage change in control transactions and prevent shareholders from receiving a premium on their investment.

Our by-laws and charter provide for a classified board of directors with staggered terms and authorizes the board of directors to set the terms of preferred stock. In addition, our charter and Delaware law contain provisions that impose restrictions on business combinations with interested parties. We have also adopted a shareholders’ rights plan. Because of our shareholders’ rights plan and these provisions of our by-laws, charter, and Delaware law, persons considering unsolicited tender offers or other unilateral takeover proposals may be more likely to negotiate with our board of directors rather than pursue non-negotiated takeover attempts. As a result, these provisions may make it more difficult for our shareholders to benefit from transactions that are opposed by an incumbent board of directors.

New technologies may cause our current exploration and drilling methods to become obsolete, resulting in an adverse effect on our production.

Our industry is subject to rapid and significant advancements in technology, including the introduction of new products and services using new technologies. As competitors use or develop new technologies, we may be placed at a competitive disadvantage, and competitive pressures may force us to implement new technologies at a substantial cost. In addition, competitors may have greater financial, technical, and personnel resources that allow them to enjoy technological advantages and may in the future allow them to implement new technologies before we can. We cannot be certain that we will be able to implement technologies on a timely basis or at a cost that is acceptable to us. One or more of the technologies that we currently use or that we may implement in the future may become obsolete, and we may be adversely affected.

We may be affected by climate change and market or regulatory responses to climate change.

Climate change, including the impact of potential global warming regulations, could have a material adverse effect on our results of operations, financial condition, and liquidity. Restrictions, caps, taxes, or other controls on emissions of greenhouse gasses, including diesel exhaust, could significantly increase our operating costs. Restrictions on emissions could also affect our customers that (a) use commodities that we carry to produce energy, (b) use significant amounts of energy in producing or delivering the commodities we carry, or (c) manufacture or produce goods that consume significant amounts of energy or burn fossil fuels, including chemical producers, farmers and food producers, and automakers and other manufacturers. Significant cost increases, government regulation, or changes of consumer preferences for goods or services relating to alternative sources of energy or emissions reductions could materially affect the markets for the commodities associated with our business, which in turn could have a material adverse effect on our results of operations, financial condition, and liquidity. Government incentives encouraging the use of alternative sources of energy could also affect certain of our customers and the markets for certain of the commodities associated with our business in an unpredictable manner that could alter our business activities. Finally, we could face increased costs related to defending and resolving legal claims and other litigation related to climate change and the alleged impact of our operations on climate change. Any of these factors, individually or in operation with one or more of the other factors, or other unforeseen impacts of climate change could reduce the amount of business activity we conduct and have a material adverse effect on our results of operations, financial condition, and liquidity.

The results of our operations depend on our ability to transport oil, NGLs, and gas production to key markets.

The marketability of our oil, NGLs, and natural gas production depends in part on the availability, proximity, and capacity of pipeline systems, refineries, and other transportation sources. The unavailability of or lack of available capacity on these

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systems and facilities could result in the shut-in of producing wells or the delay or discontinuance of development plans for properties. Federal and state regulation of oil, NGLs, and natural gas production and transportation, tax and energy policies, changes in supply and demand, pipeline pressures, damage to or destruction of pipelines, and general economic conditions could adversely affect our ability to produce, gather and, transport oil, NGLs, and natural gas.

The loss of one or a number of our larger customers could have a material adverse effect on our financial condition and results of operations.

During 2012 , QEP Resources, Inc. and Kodiak Oil and Gas Corp. were our largest drilling customers accounting for approximately 15% and 10%, respectively, of our total contract drilling revenues. No other third party customer accounted for 10% or more of our contract drilling revenues. Any of our customers may choose not to use our services and the loss of one or a number of our larger customers could have a material adverse effect on our financial condition and results of operations.

Shortages of completion equipment and services could delay or otherwise adversely affect our oil and natural gas segment’s operations.

In the past year or so, the increase in horizontal drilling activity in certain areas has resulted in shortages in the availability of third party equipment and services required for the completion of wells drilled by our oil and natural gas segment. As a result, we have experienced delays in completing some of our wells. Although we have taken steps to try to reduce the delays associated with these services, we anticipate that these services will remain in high demand for the immediate future and could delay, restrict, or curtail part of our exploration and development operations, which could in turn harm our results.

Our mid-stream segment depends on certain natural gas producers and pipeline operators for a significant portion of its supply of natural gas and NGLs. The loss of any of these producers could result in a decline in our volumes and revenues.

We rely on certain natural gas producers for a significant portion of our natural gas and NGLs supply. While some of these producers are subject to long-term contracts, we may be unable to negotiate extensions or replacements of these contracts on favorable terms, if at all. The loss of all or even a portion of the natural gas volumes supplied by these producers, as a result of competition or otherwise, could have a material adverse effect on our mid-stream segment unless we were able to acquire comparable volumes from other sources.

The counterparties to our commodity derivative contracts may not be able to perform their obligations to us, which could materially affect our cash flows and results of operations.

To reduce our exposure to adverse fluctuations in the prices of oil and natural gas, we currently, and may in the future, enter into commodity derivative contracts for a significant portion of our forecasted oil, NGLs, and natural gas production. The extent of our commodity price exposure is related largely to the effectiveness and scope of our derivative activities, as well as to the ability of counterparties under our commodity derivative contracts to satisfy their obligations to us. The worldwide financial and credit crisis may have adversely affected the ability of these counterparties to fulfill their obligations to us. If one or more of our counterparties is unable or unwilling to make required payments to us under our commodity derivative contracts, it could have a material adverse effect on our financial condition and results of operations.

Reliance on management.

We depend greatly on the efforts of our executive officers and other key employees to manage our operations. The loss or unavailability of any of our executive officers or other key employees could have a material adverse effect on our business.

We are subject to various claims and litigation that could ultimately be resolved against us requiring material future cash payments and/or future material charges against our operating income and materially impairing our financial position.

The nature of our business makes us highly susceptible to claims and litigation. We are subject to various existing legal claims and lawsuits, which could have a material adverse effect on our consolidated financial position, results of operations, or cash flows. Any claims or litigation, even if fully indemnified or insured, could negatively affect our reputation among our customers and the public, and make it more difficult for us to compete effectively or obtain adequate insurance in the future.


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Derivatives regulation included in current financial reform legislation could impede our ability to manage business and financial risks by restricting our use of derivative instruments as hedges against fluctuating commodity prices and interest rates.

In July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Act) was passed by Congress and signed into law. The Act contains significant derivatives regulation, including a requirement that certain transactions be cleared on exchanges and a requirement to post cash collateral (commonly referred to as “margin”) for such transactions. The Act provides for a potential exception from these clearing and cash collateral requirements for commercial end-users and it includes a number of defined terms that will be used in determining how this exception applies to particular derivative transactions and the parties to those transactions. 

We use crude oil, NGLs, and natural gas derivative instruments with respect to a portion of our expected production in order to reduce commodity price uncertainty and enhance the predictability of cash flows relating to the marketing of our crude oil and natural gas. As commodity prices increase, our derivative liability positions increase; however, none of our current derivative contracts require the posting of margin or similar cash collateral when there are changes in the underlying commodity prices that are referred to in these contracts.

Depending on the rules and definitions adopted by the CFTC, we could be required to post collateral with our dealer counterparties for our commodities derivative transactions. Such a requirement could have a significant impact on our business by reducing our ability to execute derivative transactions to reduce commodity price uncertainty and to protect cash flows. Requirements to post collateral would cause significant liquidity issues by reducing our ability to use cash for investment or other corporate purposes, or would require us to increase our level of debt. In addition, a requirement for our counterparties to post collateral would likely result in additional costs being passed on to us, thereby decreasing the effectiveness of our hedges and our profitability.

Proposed federal and state legislative and regulatory initiatives relating to hydraulic fracturing could result in increased costs and additional operating restrictions or delays.

Hydraulic-fracturing is an essential and common practice in the oil and gas industry used to stimulate production of oil, natural gas, and associated liquids from dense subsurface rock formations. Our oil and natural gas segment routinely apply hydraulic-fracturing techniques to many of our oil and natural gas properties, including our unconventional resource plays in the Granite Wash of Texas and Oklahoma, the Marmaton of Oklahoma, the Wilcox of Texas, and the Mississippian of Kansas. Hydraulic-fracturing involves using water, sand, and certain chemicals to fracture the hydrocarbon-bearing rock formation to allow the flow of hydrocarbons into the wellbore. The process is typically regulated by state oil and natural gas commissions; however, the EPA has asserted federal regulatory authority over certain hydraulic-fracturing activities involving diesel under the Safe Drinking Water Act and has begun the process of drafting guidance documents related to this newly asserted regulatory authority. In addition, legislation has been introduced before Congress, called the Fracturing Responsibility and Awareness of Chemicals Act, to provide for federal regulation of hydraulic-fracturing and to require disclosure of the chemicals used in the hydraulic-fracturing process.

Certain states in which we operate, including Texas and Wyoming, have adopted, and other states are considering adopting, regulations that could impose more stringent permitting, public disclosure, waste disposal, and well construction requirements on hydraulic-fracturing operations or otherwise seek to ban fracturing activities altogether. For example, Texas adopted a law in June 2011 requiring disclosure to the Railroad Commission of Texas (RCT) and the public of certain information regarding the components used in the hydraulic-fracturing process. In addition to state laws, local land use restrictions, such as city ordinances, may restrict or prohibit the performance of well drilling in general and/or hydraulic fracturing in particular. In the event state, local, or municipal legal restrictions are adopted in areas where we are currently conducting, or in the future plan to conduct operations, we may incur additional costs to comply with such requirements that may be significant in nature, experience delays or curtailment in the pursuit of exploration, development, or production activities, and perhaps even be precluded from the drilling and/or completion of wells.

There are certain governmental reviews either underway or being proposed that focus on environmental aspects of hydraulic-fracturing practices. The White House Council on Environmental Quality is coordinating a review of hydraulic-fracturing practices, and a committee of the United States House of Representatives has conducted an investigation of hydraulic-fracturing practices. Furthermore, a number of federal agencies are analyzing, or have been requested to review, a variety of environmental issues associated with hydraulic fracturing. The EPA has commenced a study of the potential environmental effects of hydraulic fracturing on drinking water and groundwater. In addition, the U.S. Department of Energy is

35


conducting an investigation into practices the agency could recommend to better protect the environment from drilling using hydraulic-fracturing completion methods.

Additionally, certain members of the Congress have called upon the U.S. Government Accountability Office to investigate how hydraulic fracturing might adversely affect water resources, the U.S. Securities and Exchange Commission to investigate the natural gas industry and any possible misleading of investors or the public regarding the economic feasibility of pursuing natural gas deposits in shales by means of hydraulic fracturing, and the U.S. Energy Information Administration to provide a better understanding of that agency’s estimates regarding natural gas reserves, including reserves from shale formations, as well as uncertainties associated with those estimates. These ongoing or proposed studies, depending on their course and results obtained, could spur initiatives to further regulate hydraulic fracturing under the Safe Drinking Water Act or other regulatory processes.

Further, after reviewing extensive comments and making a number of changes to its previously July 28, 2011 proposed rules, on April 17, 2012 the EPA issued its final rules that subject a wide range of oil and gas operations (production, processing, transmission, storage, and distribution) to regulation under the New Source Performance Standards (NSPS) and National Emission Standards for Hazardous Air Pollutants (NESHAPS) programs (with the NSPS and NESHAPS published in the Federal Register on August 16, 2012). The EPA revised the NSPS for volatile organic compounds (VOCs) from leaking components at onshore gas processing plants and the NSPS for sulfur dioxide emissions from natural gas processing plants. The EPA also established standards for certain oil and gas operations not covered by existing standards, which will regulate VOC emissions from gas wells, centrifugal and reciprocating compressors, pneumatic controllers, and storage vessels over a certain size. The EPA also made revisions to the existing leak detection and repair requirements for the oil and gas production source category and the natural gas transmission source category and established action limits reflecting most achievable control for certain previously uncontrolled emission sources. There also are additional testing and related notification, record keeping and reporting requirements. These changes were effective October 15, 2012.

Increased regulation and attention given to the hydraulic fracturing process could lead to greater opposition, including litigation, to oil and gas production activities using hydraulic fracturing techniques. Additional legislation or regulation could also lead to operational delays or increased operating costs in the production of oil, natural gas, and associated liquids including from the development of shale plays, or could make it more difficult to perform hydraulic fracturing. The adoption of additional federal, state or local laws or the implementation of regulations regarding hydraulic fracturing could potentially cause a decrease in the completion of new oil and gas wells, increased compliance costs and time, which could adversely affect our financial position, results of operations, and cash flows.

On October 20, 2011, EPA announced a schedule for development of standards for disposal of wastewater produced from shale gas operations to publicly owned treatment works (POTWs). The regulations will be developed under EPA’s Effluent Guidelines Program under the authority of the Clean Water Act. EPA anticipates issuing the proposed rules in 2014.

Our ability to produce crude oil, natural gas, and associated liquids economically and in commercial quantities could be impaired if we are unable to acquire adequate supplies of water for our drilling operations and/or completions or are unable to dispose of or recycle the water we use at a reasonable cost and in accordance with applicable environmental rules.

To our knowledge, there have been no citations, suits, or contamination of potable drinking water arising from our fracturing operations. We do not have insurance policies in effect that are intended to provide coverage for losses solely related to hydraulic fracturing operations; however, it is possible that our general liability and excess liability insurance policies might cover third-party claims related to hydraulic fracturing operations and associated legal expenses depending on the specific nature of the claims, the timing of the claims, as well as the specific terms of such policies.

The hydraulic fracturing process on which we depend to produce commercial quantities of crude oil, natural gas, and associated liquids from many reservoirs requires the use and disposal of significant quantities of water.

Our inability to secure sufficient amounts of water, or to dispose of or recycle the water used in our oil and natural gas segment operations, could adversely impact our operations. Moreover, the imposition of new environmental initiatives and regulations could include restrictions on our ability to conduct certain operations such as hydraulic fracturing or disposal of wastes, including, but not limited to, produced water, drilling fluids, and other wastes associated with the exploration, development or production of oil and natural gas.

Compliance with environmental regulations and permit requirements governing the withdrawal, storage and, use of

36


surface water or groundwater necessary for hydraulic fracturing of wells may increase our operating costs and cause delays, interruptions, or termination of our operations, the extent of which cannot be predicted, all of which could have an adverse effect on our operations and financial condition.

Events in the financial markets and the economy could adversely affect our operations and financial condition.
As a result of volatility in oil, NGLs, and natural gas prices and substantial uncertainty in the capital markets due to the uncertain global economic environment, a number of our drilling customers have reduced spending on exploration and development drilling. In addition, it is uncertain whether customers, vendors, and/or suppliers will be able to access financing necessary to sustain their operations, fulfill their commitments, or fund future operations and obligations. The uncertainty in the global economic environment may result in a decrease in demand for drilling rigs. These conditions could have a material adverse effect on our business, financial condition, and results of operations.
We may decide not to drill some of the prospects we have identified, and locations that we do drill may not yield oil, natural gas, and NGLs in commercially viable quantities.
Our oil and natural gas segment's prospective drilling locations are in various stages of evaluation, ranging from a prospect that is ready to drill to a prospect that will require additional geological and engineering analysis. Based on a variety of factors, including future oil, natural gas, and NGLs prices, the generation of additional seismic or geological information, and other factors, we may decide not to drill one or more of these prospects. As a result, we may not be able to increase or maintain our reserves or production, which in turn could have an adverse effect on our business, financial position, and results of operations. In addition, the SEC's reserve reporting rules include a general requirement that, subject to limited exceptions, proved undeveloped reserves may only be booked if they relate to wells scheduled to be drilled within five years of the date of booking. At December 31, 2012, we had 151 proved undeveloped drilling locations. To the extent that we do not drill these locations within five years of initial booking, they may not continue to qualify for classification as proved reserves, and we may be required to reclassify such reserves as unproved reserves. The reclassification of those reserves could also have a negative effect on the borrowing base under our credit facility.

The cost of drilling, completing, and operating a well is often uncertain, and cost factors can adversely affect the economics of a well. Our efforts will be uneconomic if we drill dry holes or wells that are productive but do not produce enough oil, NGLs, and natural gas to be commercially viable after drilling, operating, and other costs.
The borrowing base under our credit agreement is determined semi-annually at the discretion of the lenders and is based in a large part on the prices for oil, NGLs, and natural gas.

Significant declines in oil, NGLs, and natural gas prices may result in a decrease in our borrowing base. The lenders can unilaterally adjust the borrowing base and therefore the borrowings permitted to be outstanding under our credit agreement. If outstanding borrowings are in excess of the borrowing base, we must (a) repay the loan in excess of the borrowing base, (b) dedicate additional properties to the borrowing base, or (c) begin monthly principal payments in accordance with our credit agreement.

Item 1B. Unresolved Staff Comments
None.

Item 2.     Properties
The information called for by this item was consolidated with and disclosed in connection with Item 1 above.

Item 3.     Legal Proceedings
Panola Independent School District No. 4, et al. v. Unit Petroleum Company, No. CJ-07-215, District Court of Latimer County, Oklahoma.

Panola Independent School District No. 4, Michael Kilpatrick, Gwen Grego, Carla Lessel, Thelma Christine Pate, Juanita Golightly, Melody Culberson and Charlotte Abernathy are the Plaintiffs in this case and are royalty owners in oil and gas drilling and spacing units for which the our exploration segment distributes royalty. The Plaintiffs' central allegation is that our exploration segment has underpaid royalty obligations by deducting post-production costs or marketing related fees. Plaintiffs sought to pursue the case as a class action on behalf of persons who receive royalty from us for our Oklahoma production. We

37


have asserted several defenses including that the deductions are permitted under Oklahoma law. We also asserted that the case should not be tried as a class action due to the materially different circumstances that determine what, if any, deductions are taken for each lease. On December 16, 2009, the trial court entered its order certifying the class. On May 11, 2012, the Court of Civil Appeals reversed the trial court's order certifying the class. The Plaintiffs petitioned the Oklahoma Supreme Court for certiorari and on October 8, 2012, the Plaintiff's petition was denied. The Plaintiffs recently filed a second request to certify a class of royalty owners that is slightly smaller than their first attempt. We will continue to resist certification using the defenses described above, as well as new defenses based on the Court of Civil Appeals' decertification of the Plaintiffs' original class action. The merits of Plaintiffs' claims will remain stayed while class certification issues are pending.


Item 4.     Mine Safety Disclosures
Not applicable.

PART II

Item 5.     Market for the Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities

Our common stock trades on the New York Stock Exchange under the symbol “UNT.” The following table identifies the high and low sales prices per share of our common stock for the periods indicated:

  
2012
 
2011
Quarter
High
 
Low
 
High
 
Low
First
$
50.82

 
$
41.53

 
$
62.47

 
$
44.84

Second
$
43.83

 
$
32.14

 
$
63.76

 
$
51.58

Third
$
46.27

 
$
34.59

 
$
62.66

 
$
36.50

Fourth
$
46.97

 
$
39.73

 
$
53.35

 
$
33.58


On February 15, 2013, the closing sale price of our common stock, as reported by the NYSE, was $48.24 per share. On that date, there were approximately 1,064 holders of record of our common stock.

We have never declared any cash dividends on our common stock and currently have no plans to do so. Any future determination by our board of directors to pay dividends on our common stock will be made only after considering our financial condition, results of operations, capital requirements and other relevant factors. Additionally, our bank credit agreement and the Notes prohibit the payment of cash dividends on our common stock under certain circumstances. For further information regarding our bank credit agreement and the Notes agreement’s impact on our ability to pay dividends see “Our Credit Agreement and Senior Subordinated Notes” under Item 7 of this report.

Performance Graph.    The following graph and related information shall not be deemed “soliciting material” or be deemed to be “filed” with the SEC, nor shall such information be incorporated by reference into any future filing, except to the extent that we specifically incorporate it by reference into such filing.













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Set forth below is a line graph comparing our cumulative total shareholder return on our common stock with the cumulative total return of the S&P 500 Stock Index, S&P 600 Oil and Gas Exploration & Production and our peer group which includes Helmerich & Payne, Patterson – UTI Energy Inc. and Pioneer Drilling Co. The graph below assumes an investment of $100 at the beginning of the period. The shareholder return set forth below is not necessarily indicative of future performance.



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Item 6.     Selected Financial Data

The following table shows selected consolidated financial data. The data should be read in conjunction with Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” for a review of 2012, 2011, and 2010 activity.
 
 
As of and for the Year Ended December 31,
 
 
2012
 
2011
 
2010
 
2009
 
2008
 
 
(In thousands except per share amounts)
 
Revenues(1)
$
1,315,123

 
$
1,207,503

 
$
870,671

  
$
707,188

  
$
1,357,153

 
Net income (loss)
$
23,176

(2) 
$
195,867

 
$
146,484

 
$
(55,500
)
(3) 
$
143,625

(4) 
Net income (loss) per common share:
 
 
 
 
 
 
 
 
 
 
Basic
$
0.48

 
$
4.11

 
$
3.10

 
$
(1.18
)
  
$
3.08

 
Diluted
$
0.48

 
$
4.08

 
$
3.09

 
$
(1.18
)
  
$
3.06

 
Total assets
$
3,761,120

 
$
3,256,720

 
$
2,669,240

  
$
2,228,399

  
$
2,581,866

 
Long-term debt
$
716,359

 
$
300,000

 
$
163,000

  
$
30,000

  
$
199,500

 
Other long-term liabilities
$
167,545

 
$
113,830

 
$
92,389

  
$
81,126

  
$
75,807

 
Cash dividends per common share
$

 
$

 
$

  
$

  
$

 
_________________________ 
(1)
During the third quarter of 2012, we made the decision to prospectively use mark-to-market accounting for our economic hedges. Previously, we reported all realized and unrealized hedging gains (losses) in oil and natural gas revenues and now we reflect gains (losses) on non-designated hedges and the ineffectiveness from cash flow hedges along with other revenue items in other income (expense) below income from operations. Prior year amounts have been reclassified to conform to current year presentation.
(2)
In June 2012 and December 2012, due to low 12-month average commodity prices, we incurred non-cash ceiling test write downs of our oil and natural gas properties of $115.9 million pre-tax ($72.1 million net of tax) and $167.7 million pre-tax ($104.4 million net of tax), respectively.
(3)
In March 2009, we incurred a non-cash ceiling test write down of our oil and natural gas properties of $281.2 million pre-tax ($175.1 million net of tax) due to low commodity prices at quarter-end.
(4)
In December 2008, we incurred a non-cash ceiling test write down of our oil and natural gas properties of $282.0 million pre-tax ($175.5 million net of tax) due to low commodity prices at year-end.

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Item 7.     Management’s Discussion and Analysis of Financial Condition and Results of Operations

Please read the following discussion of our financial condition and results of operations in conjunction with the consolidated financial statements and related notes included in Item 8 of this report.

General

We operate, manage, and analyze our results of operations through our three principal business segments:
Contract Drilling – carried out by our subsidiary Unit Drilling Company and its subsidiaries. This segment contracts to drill onshore oil and natural gas wells for others and for our own account.
Oil and Natural Gas – carried out by our subsidiary Unit Petroleum Company. This segment explores, develops, acquires, and produces oil and natural gas properties for our own account.
Mid-Stream – carried out by our subsidiary Superior Pipeline Company, L.L.C. and its subsidiaries. This segment buys, sells, gathers, processes, and treats natural gas for third parties and for our own account.

Business Outlook

As discussed in other parts of this report, the success of our consolidated business, as well as that of each of our three operating segments depends, to a large extent, on: the prices we receive for our oil, NGLs, and natural gas production; the demand for oil, NGLs, and natural gas; and the demand for our drilling rigs which, in turn, influences the amounts we can charge for the use of those drilling rigs. Although all of our current operations (with the exception of a minor amount of production in Canada) are located within the United States, events outside the United States can and do have an impact on us and our industry.

In addition to their direct impact on us, low commodity prices–if sustained for a long period of time–could impact the liquidity of some of our industry partners and customers which, in turn, could limit their ability to meet their financial obligations to us.

Our 2013 current capital budget for all of our business segments forecasts a 6% increase over our 2012 capital expenditures, excluding acquisitions. Our oil and natural gas segment’s capital budget is $586.0 million, a 16% increase over 2012, excluding acquisitions and ARO liability. We plan to continue our aggressive drilling program into 2013 with a significant portion of the wells being horizontal. Our drilling segment’s capital budget is $98.0 million, a 26% increase over 2012. Our plans for 2013 include continuing to refurbish and upgrade several of our existing drilling rigs in order that those drilling rigs can be used in horizontal drilling operations. Our mid-stream segment’s capital budget is $105.0 million, a 36% decrease from 2012, excluding acquisitions. New and continued projects are discussed further in the Executive Summary.

Our 2013 current capital expenditures budget is based on realized prices for the year of $93.05 per barrel of oil, $32.05 per barrel of NGLs, and $3.56 per Mcf. This budget is subject to possible periodic adjustments for various reasons including changes in commodity prices and industry conditions. Funding for the budget will come primarily from internally generated cash flow and, if necessary, borrowings under our credit agreement.

Executive Summary

Contract Drilling

The rate at which our drilling rigs were used (“our utilization rate”) for the fourth quarter 2012 was 50%, compared to 58% and 65% for the third quarter of 2012 and the fourth quarter of 2011, respectively.

Dayrates for the fourth quarter of 2012 averaged $19,828, a 1% decrease from the third quarter of 2012 and an increase of 3% over the fourth quarter of 2011. The decrease from the third quarter of 2012 is due primarily to the terminated contracts having higher rates (drilling rigs that were under long-term contracts, but were terminated early by the operator). The increase over the fourth quarter of 2011 was due primarily to new drilling rigs going into service for which we received a higher rate, increased demand for drilling rigs in the 1,000 horsepower range which increased their rates somewhat offset by the decrease in higher dayrates associated with the terminated contracts.


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Direct profit (contract drilling revenue less contract drilling operating expense) for the fourth quarter of 2012 decreased 29% from the third quarter of 2012 and 32% from the fourth quarter of 2011. For both comparative periods utilization decreased. Additionally, during the fourth quarter of 2012, we received $0.1 million in termination fees compared to $6.7 million received in the third quarter of 2012 for three drilling rigs that were under long-term contracts but were terminated early by the operator.

Operating cost per day for the fourth quarter of 2012 increased 3% over the third quarter of 2012 and 6% over the fourth quarter of 2011. The increases over the third quarter were primarily due to increases in drilling rig servicing and workers' compensation costs while the increases over the fourth quarter of 2011 are primarily due to increases in direct expenses due to wage increases for rig personnel and to a lesser extent from higher worker's compensation and indirect costs.

Historically, our contract drilling segment has experienced a greater demand for natural gas drilling as opposed to drilling for oil and NGLs. However, with the current weakened natural gas market, operators are now focusing on drilling for oil and NGLs. Today, approximately 99% of our working drilling rigs are drilling for oil or NGLs. Of those, approximately 97% are drilling horizontal or directional wells.

During 2011, we were awarded two additional new build rig contracts for 1,500 horsepower, diesel-electric drilling rigs. One was placed into service during the fourth quarter of 2011 and the other was placed in service during the first quarter of 2012, both in Wyoming.
During the first quarter of 2012, we sold an idle 600 horsepower mechanical drilling rig to an unaffiliated third-party. Additionally, during the second quarter of 2012, we placed another new 1,500 horsepower, diesel-electric drilling rig in North Dakota (under a three year contract).
During the third quarter of 2012, we had a fire on one of our drilling rigs in the mid-continent region. The net book value of the damaged equipment on the rig was $3.2 million. We expect that all of the net book value of the damaged equipment will be recoverable from insurance proceeds. As a result of this loss, this segment now has 127 drilling rigs in its fleet. No personnel were injured in this incident.

Our anticipated 2013 capital expenditures for this segment are $98.0 million, a 26% increase over 2012.

As of December 31, 2012, we had 27 term drilling contracts with original terms ranging from six months to three years. Twenty-one of these contracts are up for renewal in 2013, six in the first quarter, five in the second quarter, eight in the third quarter and two in the fourth quarter and six are up for renewal in 2014 and later. Term contracts may contain a fixed rate for the duration of the contract or provide for rate adjustments within a specific range from the existing rate.

Oil and Natural Gas

Fourth quarter 2012 production from our oil and natural gas segment was 4,115,000 barrels of oil equivalent (Boe), an 18% increase over the third quarter of 2012 and a 26% increase over the fourth quarter of 2011. These increases came primarily from production associated with the Noble acquisition and, to a lesser extent, from new wells completed in oil and NGLs rich prospects. Oil and NGLs production during 2012 was 43% of our total production compared to 39% of our total production during 2011.

Fourth quarter 2012 oil and natural gas revenues increased 22% over the third quarter of 2012 and increased 17% over the fourth quarter of 2011. These increases were primarily due to increases in production and commodity prices.

Our NGLs, natural gas, and oil prices for the fourth quarter of 2012 increased 59%, 7%, and 1%, respectively, over the third quarter of 2012. Our oil prices increased 4% over the fourth quarter of 2011 while natural gas and NGLs prices decreased 11% and 22%, respectively.

Direct profit (oil and natural gas revenues less oil and natural gas operating expense) increased 21% over the third quarter of 2012 and 16% over the fourth quarter of 2011. The increases were primarily attributable to increased production from developmental drilling and acquisitions, as well as increases in commodity prices over the third quarter of 2012.


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Operating cost per Boe produced for the fourth quarter of 2012 increased 6% over the third quarter of 2012 and decreased 5% from the fourth quarter of 2011. The costs increased over the third quarter of 2012 due to increased gross production taxes and increases in lease operating expenses (LOE) due to increased workover expense and higher saltwater disposal fees. The decrease from the fourth quarter 2011 was primarily due to a decrease in well servicing and transportation charges and a decrease in production taxes due to tax credits applied to the 2012 rate.

For the quarter ended June 30, 2012, the 12-month average commodity prices, including the discounted value of our cash flow hedges, decreased significantly resulting in a non-cash ceiling test write down of $115.9 million pre-tax ($72.1 million, net of tax). Our qualifying cash flow hedges used in the ceiling test determination at June 30, 2012, consisted of swaps and collars, covering production of 0.0 MMBoe in 2012 and 0.0 MMBoe in 2013. The effect of those hedges on the June 30, 2012 ceiling test was a $32.5 million pre-tax increase in the discounted net cash flows of our oil and natural gas properties.

For the quarter ended December 31, 2012, the 12-month average commodity prices, including the discounted value of our cash flow hedges, decreased significantly resulting in a non-cash ceiling test write down of $167.7 million pre-tax ($104.4 million, net of tax). Our qualifying cash flow hedges used in the ceiling test determination at December 31, 2012, consisted of swaps and collars covering 0.0 MMBoe in 2013. The effect of those hedges on the December 31, 2012 ceiling test was a $29.8 million pre-tax increase in the discounted net cash flows of our oil and natural gas properties. Our oil and natural gas hedging is discussed in Note 13 of the Notes to our Consolidated Financial Statements.

If there are further declines in the 12-month average prices, including the discounted value of our commodity hedges, we may be required to record a write-down in future periods.

For 2012 we hedged approximately 68% of our average daily oil production and approximately 37% of our average natural gas production to help manage our cash flow and capital expenditure requirements.

Currently for 2013 we have hedged approximately 8,330 Bbls per day of oil production and 100,000 Mmbtu per day of natural gas production. The oil production is hedged under swap contracts at an average price of $97.94 per barrel. The natural gas production is hedged by swaps for 80,000 Mmbtu per day and a collar for 20,000 Mmbtu per day. The swap transactions were done at a comparable average NYMEX price of $3.65. The collar transaction was done at a comparable average NYMEX floor price of $3.25 and ceiling price of $3.72.

Currently for 2014 we have hedged 4,000 Bbls per day of oil production. The oil production is hedged by swaps for 2,000 Bbls per day and collars for 2,000 Bbls per day. The swap transactions were done at an average price of $91.40 per barrel. The collar transactions were done at an average floor price of $90.00 per barrel and ceiling price of $95.00 per barrel.

On September 17, 2012, we closed on the acquisition of certain oil and natural gas assets from Noble. After final closing adjustments, the acquisition included approximately 83,000 net acres primarily in the Granite Wash, Cleveland, and various other plays in western Oklahoma and the Texas Panhandle. The adjusted amount paid was $592.6 million.

As of April 1, 2012, the effective date of the Noble acquisition, the estimated proved reserves of the acquired properties were 44 MMBoe, The acquisition added approximately 24,000 net leasehold acres to our Granite Wash core area in the Texas Panhandle with significant potential including approximately 600 possible future horizontal drilling locations. The total acreage acquired in other plays in western Oklahoma and the Texas Panhandle was approximately 59,000 net acres and was characterized by high working interest and operatorship, 95% of which was held by production. We also received four gathering systems as part of the transaction and other miscellaneous assets.

Also in September 2012, we sold our interest in certain Bakken properties (representing approximately 35% of our total acreage in the Bakken play). The proceeds, net of related expenses were $226.6 million. In addition, we sold certain oil and natural gas assets located in Brazos and Madison Counties, Texas for approximately $44.1 million. Both dispositions were accounted for as adjustments to the full cost pool with no gain or loss recognized.

During 2012, we drilled 171 wells (80.08 net wells). Our 2013 production guidance is approximately 16.0 to 16.5 MMBoe, an increase of 13% to 16% over 2012, although actual results will continue to be subject to many factors. For 2013, we plan to participate in the drilling of 180 wells. Our oil and natural gas segment’s capital budget is $586.0 million, a 16% increase over 2012, excluding acquisitions and ARO liability.


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Mid-Stream

Fourth quarter 2012 liquids sold per day decreased 23% from the third quarter of 2012 and decreased 14% from the fourth quarter of 2011. During the third quarter 2012, one of our customers completed construction of their own processing plant and moved their volumes off our system resulting in decreases in liquids sold, gas gathered, and gas processed. In addition, during the fourth quarter of 2012, certain processing plants were rejecting ethane due to weak ethane prices. For the fourth quarter of 2012, gas processed per day decreased 2% from the third quarter of 2012 and increased 4% over the fourth quarter of 2011. In 2011 and 2012, we upgraded several of our existing processing facilities and added processing plants which was the primary reason for increased volumes. In 2012, these increases were offset by the decrease of one of our customers discussed above. For the fourth quarter of 2012, gas gathered per day increased 17% over the third quarter of 2012 and increased 26% over the fourth quarter of 2011 primarily from well connects throughout 2012.

NGLs prices in the fourth quarter of 2012 increased 31% over the prices received in the third quarter of 2012 and decreased 11% from the prices received in the fourth quarter of 2011. Because certain of the contracts used by our mid-stream segment for NGLs transactions are percent of proceeds (POP) contracts -- under which we receive a share of the proceeds from the sale of the NGLs--our revenues from those POP contracts fluctuate based on the prices of NGLs.

Direct profit (mid-stream revenues less mid-stream operating expense) for the fourth quarter of 2012 decreased 4% from the third quarter of 2012 and decreased 16% from the fourth quarter of 2011. The decreases were primarily due to decreases in NGLs volumes from the comparative periods. This was slightly offset by an increase in NGLs prices from the third quarter of 2012. Total operating cost for our mid-stream segment for the fourth quarter of 2012 increased 10% over the third quarter of 2012 and decreased 8% from the fourth quarter of 2011 due primarily to the increase and decrease in gas purchased in the respective period.

During the second quarter of 2012, we completed the installation of our fifth processing plant at our Hemphill County, Texas facility.  We now have the capacity at that facility to process 160 MMcf per day of our own and third-party Granite Wash natural gas production.

At our Cashion facility, we have extended our gathering system to the north to connect wells that are being drilled in that area. Due to this increased activity, we installed a new 25 MMcf per day high efficiency turbo-expander processing plant at this facility that became operational in March 2012.  With the installation of this additional plant, our total processing capacity increased to approximately 45 MMcf per day at our Cashion facility.

In the Mississippian play in north central Oklahoma, a new gas gathering system and processing plant in Noble and Kay Counties, Oklahoma, known as the Bellmon system, was completed and began operating late in the second quarter.  This system currently consists of approximately 83 miles of pipelines with a 20 MMcf per day gas processing plant. An additional 30 MMcf per day gas processing plant is scheduled to be installed in the first quarter of 2013.  We also connected our existing Remington system to the new Bellmon system which required laying approximately 26 miles of pipeline and installing related compression services.  In addition to these projects, we completed the installation of a NGLs line from our Bellmon plant to Medford, Oklahoma.  This project consists of approximately 20 miles of 6” pipeline and was completed in the 4th quarter of 2012.

We are continuing to expand operations in the Appalachian region.  In the fourth quarter of 2012, construction was completed on the first phase of our Pittsburgh Mills gathering facility in Allegheny and Butler Counties, Pennsylvania.  The first phase of this project consists of approximately seven miles of gathering pipeline.  In the first quarter of 2013, the related compressor station will be completed. We currently have 10 wells connected to this gathering system. The current gathered volumes from these wells is approximately 28 MMcf per day.  Construction activity for expansion of this pipeline continues as the producer is maintaining its drilling activity.

In December 2012, we had a $1.2 million write-down of our Erick system. There was no volume from the wells connected to this system, the compressor and related surface equipment have been removed from this location and there is no future activity anticipated from this gathering system.

Our anticipated 2013 capital expenditures for this segment are $105.0 million, a 36% decrease from 2012, excluding acquisitions.


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Critical Accounting Policies and Estimates

Summary

In this section, we identify those critical accounting policies we follow in preparing our financial statements and related disclosures. Many of these policies require us to make difficult, subjective, and complex judgments in the course of making estimates of matters that are inherently imprecise. Some accounting policies involve judgments and uncertainties to such an extent that there is reasonable likelihood that materially different amounts could have been reported under different conditions, or if different assumptions had been used. We evaluate our estimates and assumptions on a regular basis. We base our estimates on historical experience and various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates and assumptions used in preparation of our financial statements. In the following discussion we will attempt to explain the nature of these estimates, assumptions and judgments, as well as the likelihood that materially different amounts would be reported in our financial statements under different conditions or using different assumptions.











































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The following table lists the critical accounting policies, estimates and assumptions that can have a significant impact on the application of these accounting policies, and the financial statement accounts affected by these estimates and assumptions.

Accounting Policies
 
Estimates or Assumptions